-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QytT32gsYcBL+0794UqCAoCgBLCMGnwTn5nxu1gabxwGjI3jj+lj9tq+HCM6+mpw TelNZCKnfpgksZaRKIcBhA== 0000929624-99-000576.txt : 19990331 0000929624-99-000576.hdr.sgml : 19990331 ACCESSION NUMBER: 0000929624-99-000576 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PMI GROUP INC CENTRAL INDEX KEY: 0000935724 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 943199675 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13664 FILM NUMBER: 99579065 BUSINESS ADDRESS: STREET 1: 601 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94111 BUSINESS PHONE: 4157887878 MAIL ADDRESS: STREET 1: 601 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94111 10-K 1 FORM 10-K UNITED STATES ------------- SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-13664 THE PMI GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 601 Montgomery Street 94-3199675 (State of Incorporation) San Francisco, California 94111 (I.R.S. Employer (Address of principal Identification No.) executive offices) (415) 788-7878 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - ------------------------------- ---------------------------------------------- Common Stock, $.01 par value New York Stock Exchange Pacific Exchange Preferred Stock Purchase Rights New York Stock Exchange Pacific Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock (common stock) held by non- affiliates of the registrant as of the close of business on February 26, 1999 was $1,297,762,997 based on the closing sale price of the common stock on the New York Stock Exchange consolidated tape on that date. Number of shares outstanding of the Registrant's common stock, as of the close of business on February 26, 1999: 30,093,055. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Stockholders for the fiscal year ended December 31, 1998 are incorporated by reference into Items 6 through 8 of Part II. Portions of the Proxy Statement for registrant's 1999 Annual Meeting of Stockholders to be held on May 20, 1999 are incorporated by reference into Items 10 through 13 of Part III. The Exhibit Index is located on page 54. TABLE OF CONTENTS PART I.......................................................................................... 3 Cautionary Statement Item 1. Business............................................................................... 3 A. General.................................................................................... 3 B. Products................................................................................... 4 C. Industry Overview.......................................................................... 6 D. Competition and Market Share............................................................... 7 E. Customers.................................................................................. 10 F. Business Composition....................................................................... 10 G. Sales, Product Development and Underwriting Personnel...................................... 12 H. Underwriting Practices..................................................................... 13 I. Affordable Housing......................................................................... 16 J. Defaults and Claims....................................................................... 16 K. Reinsurance................................................................................ 24 L. Claims-Paying Ability Ratings.............................................................. 25 M. Investment Portfolio....................................................................... 26 N. Other Businesses........................................................................... 26 O. Regulation................................................................................. 28 P. Employees.................................................................................. 32 Q. Statements and Risk Factors Concerning the Company's Operations and Future Results......... 32 Item 2. Properties............................................................................. 39 Item 3. Legal Proceedings...................................................................... 39 Item 4. Submission of Matters to a Vote of Security Holders.................................... 39 PART II......................................................................................... 41 Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.............. 41 Common Stock.................................................................................. 41 Preferred Stock............................................................................... 41 Payment of Dividends and Policy............................................................... 41 Item 6. Selected Financial Data................................................................ 42 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 42 Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 42 Item 8. Financial Statements and Supplementary Data............................................ 42 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 42 PART III........................................................................................ 42 Item 10. Directors and Executive Officers of the Registrant.................................... 42 Item 11. Executive Compensation................................................................ 42 Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 43 Item 13. Certain Relationships and Related Transactions........................................ 43 PART IV......................................................................................... 43
1 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 43 INDEX TO EXHIBITS............................................................................... 54
2 CAUTIONARY STATEMENT Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this document, other documents filed with the Securities and Exchange Commission, press releases, conferences, or otherwise that are not historical facts, or are preceded by, followed by or that include the words "believes", "expects", "anticipates", "estimates", or similar expressions, and that relate to future plans, events or performance are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include the following: (i) the statement that management believes any increase in the GSEs loan limit eligible for their purchase may positively affect the number of loans eligible for mortgage insurance and may have the effect of increasing the size of the insurance mortgage market; (ii) the statement that management anticipates that contract underwriting will continue to generate a significant percentage of PMI's NIW and that customer demand for contract underwriting services will increase; (iii) the statement that management also believes the number of contract underwriters deployed by the Company will decrease as mortgage origination volumes decline; and (iv) the statement that although management expects that California should continue to account for the majority of total claims paid, management anticipates that with continued improvement in the California economy, increased benefits of loss mitigation and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline for the foreseeable future. When a forward-looking statement includes a statement of the assumptions or bases underlying the forward-looking statement, the Company cautions that, while it believes such assumptions or bases to be reasonable and makes them in good faith, assumed facts or bases almost always vary from actual results, and the difference between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, the Company or its management expresses an expectation or belief as to future results, such expectations or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. The Company's actual results may differ materially from those expressed in any forward-looking statements made by the Company. These forward-looking statements involve a number of risks or uncertainties including, but not limited to, the items addressed in section Q. "Statements and Risk Factors Concerning the Company's Operations and Future Results" (Risk Factors "RF# 1-14") set forth below and other risks detailed from time to time in the Company's periodic filings with the Securities and Exchange Commission. All forward-looking statements of the Company are qualified by and should be read in conjunction with such risk disclosure. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. PART I Item 1. Business A. General The PMI Group, Inc. ("TPG"), a Delaware corporation, is a holding company which conducts its residential mortgage insurance business through its direct wholly-owned subsidiaries PMI Mortgage Insurance Co. ("PMI"), an Arizona corporation, Residential Guaranty Co. ("RGC"), an Arizona corporation, Residential Insurance Co. ("RIC"), an Arizona corporation, TPG Insurance Co. ("TIC"), a Vermont corporation, and PMI Mortgage Guaranty Co. ("PMG"), an Arizona corporation. TPG also conducts non-residential mortgage insurance business through its wholly-owned subsidiaries American Pioneer Title Insurance Company ("APTIC"), a Florida corporation, TPG Segregated Portfolio Company ("TSPC"), a Cayman Islands corporation, and PMI Capital I, a Delaware trust. In addition, PMI owns all of the outstanding common stock of PMI Mortgage Services Co. ("MSC"), a California corporation which is engaged in the business of contract underwriting, and PMI Securities Co. ("SEC"), a Delaware 3 corporation, which is an inactive broker-dealer. PMI is licensed in all 50 states of the United States and the District of Columbia. TPG and its subsidiaries are collectively referred to as the "Company". PMI also owns 50% of the outstanding shares of common stock of CMG Mortgage Insurance Company ("CMG"), a Wisconsin corporation, which also conducts a residential mortgage insurance business. CMG is accounted for on the equity method in the Company's consolidated financial statements. TPG is also a principal investor in RAM Reinsurance Company Ltd. ("RAM Re"), a financial guaranty reinsurance company based in Bermuda. TPG, through PMI and CMG, is one of the leading residential mortgage insurers in the United States. In addition to primary mortgage insurance, TPG subsidiaries provide title insurance, contract underwriting and various services and products for the home mortgage finance industry. PMI was founded in 1972 and was acquired by Allstate Insurance Company ("Allstate") in 1973. In April 1995, Allstate sold approximately seventy percent of the common stock of TPG in an initial public offering (the "IPO"). In April 1998, Allstate exchanged most of its holdings of TPG common stock to redeem its Exchangeable Notes due on April 15, 1998. The Notes were sold to the public concurrently with the IPO. Currently, Allstate has no significant holdings of TPG common stock. At December 31, 1998, the Company's total assets were $1.8 billion and its shareholders' equity was $1.1 billion. B. Products There are two principal types of private residential mortgage insurance, both of which insure a mortgage lender or investor in mortgage loans against borrower default: "primary" and "pool." Primary insurance provides mortgage insurance coverage to lenders who receive a down payment of 20% or less from a borrower. This includes mortgage insurance coverage for lenders for mortgages with: (i) loan-to-value ratios ("LTVs") of 85% and below, (ii) LTVs in excess of 85% and less than or equal to 90% ("90s"); (iii) LTVs in excess of 90% and less than or equal to 95% ("95s"); and (iv) LTVs in excess of 95% and less than or equal to 97% ("97s"). At December 31, 1998, the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), generally the primary investors in mortgage loans, required that 90s have 25% coverage, and 95s and 97s have 30% coverage. Fannie Mae and Freddie Mac are collectively referred to as government-sponsored enterprises ("GSEs"). The GSEs recently announced programs which provide for reduced mortgage insurance coverage requirements. (See "D. Competition and Market Share", below and RF3). The coverage percentage insured by PMI is determined by the lender, usually to comply with Fannie Mae and Freddie Mac requirements to reduce the loss exposure on loans purchased by them. Pool insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions. Pool insurance generally covers the loss on a defaulted mortgage loan which exceeds the claim payment under the primary coverage, if primary insurance is required on that mortgage loan, as well as the total loss on a defaulted mortgage loan which did not require primary insurance, in each case up to a stated aggregate loss limit. Primary Insurance PMI provides primary insurance coverage, insuring lenders and mortgage loan investors against borrower default on individual first lien mortgage loans on one-to-four unit residential properties, including condominiums. PMI and other private mortgage insurers have no limit as to the maximum principal balance of loans for which they may issue mortgage insurance. Primary coverage can be used on any type of residential mortgage loan instrument approved by PMI and is generally underwritten on a loan-by-loan basis. (See "H. Underwriting Practices", below.) Primary mortgage insurance provides mortgage default protection to lenders or investors on individual loans. PMI's obligation to an insured with respect to a claim is determined by applying the appropriate coverage percentage to the claim amount. In lieu of paying the coverage percentage of the claim amount, PMI has the option of: (i) paying the entire claim amount and taking title to the mortgaged property, or (ii) in the case of certain sales, paying the difference between the sales proceeds received by the insured and the claim amount up to a maximum of the coverage percentage. See "J. Defaults and Claims--Claims", below. PMI offers coverage ranging from 4% to 42% of the total of the outstanding loan principal, delinquent interest and certain expenses associated with a default and the subsequent foreclosure of a mortgage loan ("claim amount"). The percentage of the total claim amount subject to payment by PMI in the event of a claim on a mortgage loan that is 4 the subject of primary insurance ("coverage percentage") was predominantly in the 25% to 30% range for primary new insurance written ("NIW") for the year ended December 31, 1998. The average coverage percentage for PMI was 24.9% of NIW for the year ended December 31, 1998. Certain states limit the amount of risk a mortgage insurer may retain with respect to coverage of an insured loan to 25% of the indebtedness to the insured. Coverage in excess of 25% of the indebtedness to the insured ("deep coverage") must be reinsured. To minimize reliance on third party reinsurers on deep coverage business, TPG formed RGC, RIC, TIC and PMG to provide reinsurance of such deep coverage to PMI and CMG. (See "K. Reinsurance", below.). At December 31, 1998, PMI's average coverage percentage on insurance in force was 23.9%. See "C. Industry Overview--Fannie Mae and Freddie Mac", below. Mortgage insurance coverage cannot be canceled by PMI, except for nonpayment of premiums or certain material violations of PMI's Master Policy. Mortgage insurance coverage can be canceled by the insured at any time. Generally, mortgage insurance remains renewable at the option of the insured at a rate fixed when the insurance on the loan was initially issued. As a result, the impact of increased claims and incurred losses from policies originated in a particular year cannot be offset by renewal premium increases on policies in force or mitigated by nonrenewal of insurance coverage. (See RF4). Mortgage insurance premiums are usually charged to the borrower by the mortgage lender or loan servicer, which in turn remits the premiums to the mortgage insurer. PMI has the following basic types of premium payment plans. Monthly Premium. A premium payment plan in which premiums are paid monthly over the term of the coverage ("Monthly Premium Plan"). Under PMI's Monthly Premium Plan only one or two months' of premium is paid at the mortgage loan closing, and thereafter monthly premiums are collected by the loan servicer for monthly remittance to PMI. PMI also offers a plan under which the first monthly premium is payable at the time the first monthly mortgage payment is due ("pmiNU MONTHLY/SM/"). The pmiNU MONTHLY/SM/ plan helps reduce the amount a borrower would typically have to pay at closing, thereby increasing mortgage loan affordability. Monthly Premium and pmiNU MONTHLY/SM/ Plans represented 97.5% of NIW in 1998. Beginning in April 1999, PMI will offer two new monthly premium products, pmiNU MONTHLY Premier/SM/, and pmiMonthly Premier/SM/, which offer the option to finance a portion of the premium, or to pay a larger portion of the premium up-front to receive a lower monthly premium. These new products are designed to compete with the GSEs' programs which require the payment of an additional fee for a further reduction in mortgage insurance coverage. See "D. Competition and Market Share", below and RF3. Single Premium. A premium payment plan that requires an initial premium payment that extends coverage for more than one year and involves a lump-sum payment at the loan closing ("Single Premium Plan"), which may be refundable if the coverage is canceled by the insured lender (which generally occurs when the loan is repaid or the value of the property has increased significantly). The single premium can be financed by the borrower by adding it to the principal amount of the mortgage and generally covers the greater of 10 years or amortization of the underlying loan to an 80% LTV. Single Premium Plans represented 1.7% of NIW in 1998. Annual Premium. A premium payment plan that requires the payment of the first-year premium at the time of mortgage loan closing and annual renewal premium payments in advance each year thereafter ("Annual Premium Plan"). Renewal payments generally are collected in monthly installments from the borrower along with the mortgage payment and held in escrow by the loan servicer for annual remittance to PMI in advance of each renewal year. Annual Premium Plans represented 0.8% of NIW in 1998. Pool Insurance During the fourth quarter of 1997, PMI began offering a pool insurance product to state housing finance authorities GSEs as part of PMI's value added strategy. New risk written for this product was $450.3 million for the year ended December 31, 1998 and was not significant for 1997. This product is similar in structure to the pool insurance product previously offered by PMI during 1990 - 1993, but has better risk management characteristics, including lower stop loss limits, improved nationwide geographic diversification and lower LTVs risk in force under pool 5 insurance programs with PMI's customers represented approximately two percent of the $19.3 billion total primary risk in force at December 31, 1998. See RF10. Risk-Sharing Products In addition to standard primary and pool insurance, PMI offers: (i) layered co- insurance, a primary mortgage insurance program for a covered loan for which a mortgage originator or a state housing authority retains liability for losses above a certain level of aggregate losses and below a second specified level of aggregate losses, above which the mortgage insurer retains liability; (ii) pmiADVANTAGE/SM/, a lender-paid primary mortgage insurance program that provides reductions from standard rates based on the quality of the business generated; (iii) pmiCAPTIVE/SM/, a captive reinsurance program that allows a reinsurance company, generally an affiliate of the lender, to assume primary mortgage insurance default losses at a specified entry point up to a maximum aggregate exposure, up to an agreed upon amount of total coverage; (iv) performance assurance agreements, for which PMI compensates lenders to cover a layer of losses in excess of a specified level of losses associated with business generated by the lender; and (v) pmiEXTRA/SM/ coverage, a product which provides an additional layer of primary mortgage insurance coverage (up to 15%) on all insured loans in a portfolio sold to GSEs. TPG also offers performance notes, a program whereby TPG issues an unsecured, private placement note that pays a base rate of interest plus, if appropriate, a performance addition. The interest rate on the note varies based on the performance of the lender's book of business written during the origination period. To date the risk-sharing products have not represented a significant portion of PMI's or TPG's revenues. Several of the above risk-sharing products, as well as pool insurance, are the subject of pending regulatory reviews. Management is unable to predict the impact of these regulatory issues on these products. See "D. Competition and Market Share" and "RF2 and RF8". C. Industry Overview Fannie Mae and Freddie Mac The GSEs are the predominant purchasers and sellers of conventional mortgage loans in the United States, providing a direct link between the primary mortgage origination markets and the capital markets. The GSEs are permitted to purchase conventional high- LTV mortgages only if the lender (i) secures private mortgage insurance from an eligible insurer on those loans; (ii) retains a participation of not less than 10% in the mortgage; or (iii) agrees to repurchase or replace the mortgage in the event of a default under specified conditions. If the lender retains a participation in the mortgage or agrees to repurchase or replace the mortgage, applicable federal bank and savings institution regulations may increase the level of capital required by the loan originations. Because loan originators prefer to make loans that may be marketed in the secondary market to Fannie Mae and/or Freddie Mac without having to hold such capital, they are motivated to purchase mortgage insurance from insurers deemed eligible by the GSEs. PMI is an authorized mortgage insurer for the GSEs. See "O. Regulation", below. Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for such insurers to be eligible to insure loans sold to such agencies. One of the GSEs eligibility requirements is that private mortgage insurers, including PMI, must at least maintain an AA- rating with any public national rating agency. Any change in PMI's existing eligibility status, primarily its claims-paying ability rating from the various rating agencies, could have a material and adverse effect on the Company's financial condition and results of operations. See RF5 Effective January 1, 1999 Fannie Mae and Freddie Mac announced increases in the maximum principal balance of loans eligible for purchase by Fannie Mae and Freddie Mac to $240,000. Since the GSEs are the primary investors in mortgage loans, they have the ability to implement new eligibility requirements for mortgage insurers, change the pricing arrangements for purchasing retained participation mortgages as compared to insured mortgages or alter or liberalize underwriting standards on low down payment mortgages they purchase. Private mortgage insurers, including PMI, are affected by such changes implemented by Fannie Mae or Freddie Mac. See "D. Competition and Market Share", "O. Regulation", and RF2 and RF3. 6 Since 1992, Fannie Mae and Freddie Mac have been subject to oversight legislation for GSEs which simultaneously tightened their capital requirements and set goals for affordable housing. Their goals are based on the percentage of loans purchased by the GSEs, determined by the number of dwelling units securing such loans. Fannie Mae also expanded its Community Home Buyers Program to include a commitment to purchase a certain volume of 97s. TPG believes that the GSEs' announced goals for 1998 were that at least 42% of the units financed by each GSE be low- and moderate-income housing, and that approximately 25% of such units be in underserved areas (which are defined as census tracts with either a median income no greater than 90% of area median, or with a median income no greater than 120% of area median income and a minority population of at least 30%). TPG believes that the GSEs' goals to expand purchases of affordable housing loans have increased the overall size of the total mortgage insurance market because such loans are traditionally in excess of 80% LTV, with a majority being in excess of 90% LTV. Freddie Mac's and Fannie Mae's automated underwriting services, Loan Prospector/SM/ and Desktop Underwriter/TM/, respectively, can be used by mortgage originators to determine whether Freddie Mac or Fannie Mae will purchase a loan prior to closing. Through these systems, lenders are able to obtain approval for mortgage guaranty insurance with any participating mortgage insurer. PMI works with both agencies in offering insurance services through their systems, while utilizing its proprietary risk management systems to monitor the risk quality of loans insured through such systems. See "H. Underwriting Practices--Role of Technology, and Delegated Underwriting", below. Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of mortgage insurance generally provide that a borrower's written request to cancel mortgage insurance should be honored if: (a) the borrower has a satisfactory payment record with no payment more than 30 days delinquent in the 12 month period preceding the request for cancellation; and (b) the unpaid principal balance of the mortgage is not greater than 80% of the original value of the property. The Home Owners Protection Act of 1998 (the "Act"), which is effective on July 29, 1999, provides for the automatic termination, or cancellation upon a borrower's request, of private mortgage insurance upon satisfaction of certain conditions. The Act applies to owner-occupied residential mortgage loans regardless of lien priority, with borrower-paid mortgage insurance, and which closed after the effective date of the Act. FHA loans are not covered by the Act. Under the Act, automatic termination of mortgage insurance would generally occur once the loan-to-value ratio ("LTV") reaches 78%. A borrower may generally request cancellation of mortgage insurance once the LTV reaches 80% of the home's original value, or when actual payments reduce the loan balance to 80% of the home's original value, whichever occurs earlier. For borrower initiated cancellation of mortgage insurance, the borrower must have a good payment history. Good payment history generally requires that there have been no payments during the 12-month period preceding the loan's cancellation date 30 days or more past due, or 60 days or more past due during the 12-month period beginning 24 months before the loan's cancellation date. Loans which are deemed "high risk" by the GSEs, require automatic termination of mortgage insurance coverage once the LTV is first scheduled to reach 77% of the original value of the property without regard to the actual outstanding balance. The Act preempts all but more protective, preexisting state laws. See "O. Regulation", and RF4, below. D. Competition and Market Share The U.S. private mortgage insurance industry consists of nine active mortgage insurers, including Mortgage Guaranty Insurance Corporation ("MGIC"), GE Capital Mortgage Insurance Corporation ("GEMICO"), an affiliate of GE Capital Corporation, and United Guaranty Residential Insurance Company ("UGC"), an affiliate of American International Group, Inc. PMI, including CMG, is the third largest private mortgage insurer in the United States based on new primary insurance written in 1998 and direct primary insurance in force at December 31, 1998. (Source: Inside Mortgage Finance.) In 1998, MGIC possessed the largest share of the private mortgage insurance market, with approximately 23.1% of NIW, and GEMICO, PMI and UGC had market shares of approximately 16.4%, 16.2% and 12.7%, respectively. (Source: Inside Mortgage Finance.) PMI's 1998 market share percentage includes 1.3% of the market held by CMG. See Part II, Item 7-- "Management's Discussion And Analysis Of Financial Condition And Results of Operations", and RF2. 7 The following table indicates the market share by private mortgage insurer based on NIW over the past five years:
Private Mortgage Insurance Industry Market Share Year Ended December 31, ------------------------------------------------------------ 1998 1997 1996 1995 1994 --------- ---------- ---------- ---------- ---------- Mortgage Guaranty Insurance Corp. 23.1 % 26.4 % 25.5 % 27.4 % 25.7 % GE Capital Mortgage Insurance Corp. 16.4 16.5 18.5 20.1 27.6 PMI Mortgage Insurance Co. (1) 16.2 13.8 14.7 13.5 13.8 United Guaranty Corp. 12.7 12.8 12.7 12.9 13.3 Commonwealth Mortgage Assurance Co. 11.3 11.3 9.7 9.6 7.8 Republic Mortgage Insurance Co. 9.7 10.3 11.2 9.7 8.7 Amerin Guaranty Corp. 8.1 6.5 6.0 5.3 1.9 Triad Guaranty Insurance Corp. 2.5 2.4 1.7 1.5 1.2 --------- ---------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========== ========== ========== ==========
Source: Inside Mortgage Finance (1) Includes CMG. The following table indicates the market share by private mortgage insurer for each quarter in 1998:
Private Mortgage Insurance Industry Market Share 1998 by Quarter ----------------------------------------------------------- 4Q 1998 3Q 1998 2Q 1998 1Q 1998 ------------- ------------- ------------- ----------- Mortgage Guaranty Insurance Corp. 22.2 % 23.2 % 23.1 % 24.1 % PMI Mortgage Insurance Co. (1) 16.4 16.6 16.3 15.0 GE Capital Mortgage Insurance Corp. 15.4 17.1 17.1 16.2 United Guaranty Corp. 13.3 12.3 12.4 12.4 Commonwealth Mortgage Assurance Co. 11.5 11.3 10.7 11.7 Republic Mortgage Insurance Co. 9.7 9.8 9.8 9.7 Amerin Guaranty Corp. 8.7 7.3 8.2 8.3 Triad Guaranty Insurance Corp. 2.8 2.4 2.4 2.6 ------------- ------------- ------------- ----------- Total 100.0 % 100.0 % 100.0 % 100.0 % ============= ============= ============= ===========
Source: Inside Mortgage Finance (1) Includes CMG. PMI and other private mortgage insurers also compete directly with federal and state governmental and quasi-governmental agencies, principally the FHA and, to a lesser degree, the VA. These agencies sponsor government-backed mortgage insurance programs which accounted for 43.7%, 45.6%, and 44.8% for 1998, 1997 and 1996, respectively, of all loans insured or guaranteed(2). Effective January 1, 1999, the Department of Housing and Urban Development announced an increase in the maximum individual loan amount that FHA can insure to $208,800 from 8 $197,620. The maximum individual loan amount that the VA can insure is $203,150. (See RF2). Private mortgage insurers have no limit as to maximum individual loan amounts that they can insure. (2) According to data from the Department of Housing and Urban Development ("HUD"), VA and Inside Mortgage Finance. The Omnibus Spending Bill of 1999, signed into law on October 21, 1998 streamlined the FHA down payment formula by eliminating tiered minimum cash investment requirements and establishing maximum loan-to-value ratios based on loan size and closing costs, making FHA insurance more competitive with private mortgage insurance in areas with higher home prices. See RF2. The following table indicates the relative share of the mortgage insurance market based on NIW by FHA/VA and private mortgage insurers over the past five years. Federal Government and Private Mortgage Insurance Market Share
Year Ended December 31, ------------------------------------------------------------ 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- FHA/VA 43.7 % 45.6 % 44.8 % 38.5 % 51.8 % Private Mortgage Insurance 56.3 54.4 55.2 61.5 48.2 ---------- ---------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========== ========== ========== ========== ==========
Fannie Mae and Freddie Mac announced an increase in the maximum single-family principal balance loan limit eligible for their purchase from $227,150 to $240,000 effective in 1999. Since the GSEs are the predominant purchasers and sellers of conventional mortgage loans in the United States, loan originators prefer to make loans that may be marketed in the secondary market to Fannie Mae and/or Freddie Mac. Loan originators are motivated to purchase mortgage insurance from insurers deemed eligible by the GSEs. Because PMI is an authorized mortgage insurer for the GSEs, management believes any increase in the GSEs loan limit eligible for their purchase may positively affect the number of loans eligible for mortgage insurance and may have the effect of increasing the size of the mortgage insurance market. See "C. Industry Overview", above, and RF3. Freddie Mac and Fannie Mae both recently announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSE's automated underwriting services, Loan Prospector/SM/ and Desktop Underwriter/TM/, respectively. Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage options provide for: (i) across-the-board reductions in required MI coverage on 30-year fixed- rate loans recommended for approval by GSE's automated underwriting services to the levels in effect in 1994; (ii) reduction in required MI coverage, for loans with only a 5% down payment (a 95% LTV), from 30% to 25% of the mortgage loan covered by MI; (iii) reduction in required MI coverage, for loans with a 10% down payment (a 90% LTV loan), from 25% to 17% of the mortgage loan covered by MI. In addition, the GSE's announced programs to further reduce MI coverage upon the payment of an additional fee by the lender. Under this option, a 95% LTV loan will require 18% of the mortgage loan to have mortgage insurance coverage. Similarly, a 90% LTV loan will require 12% of the mortgage loan have mortgage insurance. In order for the home buyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. See RF3. The Office of the Comptroller of the Currency has granted permission to certain national banks to form a reinsurance company as a wholly-owned operating subsidiary for the purpose of reinsuring mortgage insurance written on loans originated or purchased by such bank. The Federal Reserve Board is in the process of considering whether similar activities are permitted for bank holding companies. The Office of Thrift Supervision has also recently granted permission for subsidiaries of thrift institutions to reinsure private mortgage insurance coverage on loans originated or purchased by affiliates of such thrift's parent organization. The reinsurance subsidiaries of 9 national banks, savings institutions, or bank holding companies could become significant competitors of the Company in the future. See "O. Regulation", and RF2. PMI and other private mortgage insurers also compete indirectly with mortgage lenders that elect to retain the risk of loss from defaults on all or a portion of their high-LTV mortgage loans rather than obtain insurance for such risk. Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10% second mortgage lien, and 10% of the purchase price from borrower's funds ("80/10/10"). This 80/10/10 product competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. The Federal Deposit Insurance Corporation and other banking regulators recently approved rules to be effective April 1, 1999 that would require national banks to hold almost twice as much risk-based capital to cover possible defaults on the 80/10/10 products when the lender holds the first and second mortgage. State-chartered banks already are subject to the higher capital requirement. (See RF2). Any change in legislation which affects the risk-based capital rules imposed on banks and savings institutions, or which change the GSEs' insurance requirements may affect the desirability of foregoing insurance for lending institutions or the GSEs and, therefore, affect the size of the insurance mortgage market. See "O. Regulation", below. In addition to captive reinsurance arrangements with subsidiaries of banks, mortgage insurers like PMI reinsure some portion of coverage issued to certain lenders with affiliates of those lenders and/or through uncaptive structures. TPG also issues performance notes to certain lenders or their affiliates, which notes pay a base rate of interest plus, if appropriate, a performance addition. PMI is pursuing various risk-sharing arrangements for certain of its customers, including offering various premium rates based on the risk characteristics, loss performance or class of business of the loans to be insured, or the costs associated with doing such business. While many factors are considered in determining rates, there can be no assurance that the premiums charged will be adequate to compensate PMI or TPG for the risks associated with the coverage provided to its customers. Management is unable to predict the impact of these arrangements with non-bank captive reinsurers and uncaptive reinsurers, or the performance notes or their long-term competitive effect. See "K. Reinsurance" and RF4. In addition to competition from federal agencies, PMI and other private mortgage insurers face limited competition from state-supported mortgage insurance funds. As of December 31, 1998, several states (among them California, Connecticut, Maryland, Massachusetts, New York, and Vermont) have state housing insurance funds which are either independent agencies or affiliated with state housing agencies. For the year ended December 31, 1998, total mortgage originations according to Inside Mortgage Finance were estimated to be $1.5 trillion compared to $849.7 billion for the year ended December 31, 1997. E. Customers PMI insures mortgage loans funded by mortgage originators. Mortgage originators include mortgage bankers, savings institutions, commercial banks and other mortgage lenders. See RF1. For the year ended December 31, 1998, PMI's primary customers were mortgage bankers, with the balance of its customers being savings institutions, commercial banks and other mortgage lenders. Mortgage brokers originate loans on behalf of mortgage lenders and are not master policyholders. As a result, mortgage brokers are not the beneficiaries of policies issued by PMI. The beneficiary under the master policy is the owner of the insured loan and, accordingly, when a loan is sold, the purchaser of the loan is entitled to the policy benefits. F. Business Composition A significant percentage of PMI's premiums earned is generated from its existing insurance in force and not from new insurance written. PMI's policies for insurance coverage typically have a policy duration averaging five to seven years. Insurance coverage may be canceled by the policy owner or servicer of the loan at any time. PMI has no control over the owner's or servicer's decision to cancel insurance coverage and self-insure or place coverage 10 with another mortgage insurance company. However, the GSE's have restrictions on changing mortgage insurance provider. There can be no assurance that policies for insurance coverage originated in a particular year or for a particular customer will not be canceled at a later time or that the Company will be able to regain such insurance coverage at a later time. The composition of PMI's direct primary risk in force, as summarized on the following table, reflects several changes over the five-year period from 1994 to 1998. The relatively low interest rates during this period resulted in an increasing percentage of mortgages insured by PMI at a fixed rate of interest, representing 89.7% of direct primary risk in force at December 31, 1998, up from 74.4% at year-end 1994. Based on PMI's experience, fixed rate loans represent less risk than adjustable rate mortgages ("ARMs") because claim frequency on ARMs is generally higher than on fixed rate loans. PMI charges higher premium rates for ARMs, 95s and 97s to compensate for the higher risk associated with such loans, although there can be no certainty that the differential in the higher premium rate will be adequate to compensate for the higher risk. In 1995, the GSEs increased their coverage requirements to 30% and 25%, on 95s and 90s, respectively. PMI's percentage of risk in force with the higher coverage requirements has steadily increased since 1995, and the percentage of risk in force comprised of 95s with 30% coverage has increased from 28.8% for the year ended December 31, 1997 to 34.4%, for the year ended December 31, 1998. During the period between 1997 and 1998, PMI's amount of direct primary risk in force increased by 6.6% from $18.1 billion at December 31, 1997 to $19.3 billion at December 31, 1998. The direct primary risk in force increased by 4.4% for period between 1996 and 1997 from $17.3 billion, to $18.1 billion, at December 31, 1996 and 1997, respectively. Recently Fannie Mae and Freddie Mac reduced the mortgage insurance coverage requirements for borrowers recommended for approval by their automated loan underwriting systems, Desktop Underwriter/SM/ and Loan Prospector/SM/, respectively. Management believes it is too early to assess impact of the Fannie Mae and Freddie Mac reduction of required levels of mortgage insurance on the Company's financial condition and results of operations. If the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, however, such reduction could have a materially adverse impact on the Company's financial condition and results of operations. See "D. Competition and Market Share", above and RF3. The composition of PMI's NIW has included an increasing percentage of mortgages with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December 31, 1998, 46.3% of PMI's risk in force consisted of 95s, which, in PMI's experience, have had a claims frequency approximately twice that of mortgages with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At December 31, 1998, 3.3% of PMI's risk in force consisted of 97s which have even higher risk characteristics than 95s and greater uncertainty as to pricing adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which, although priced higher, have risk characteristics that exceed the risk characteristics associated with PMI's book of business as a whole. Since the fourth quarter of 1997, PMI has offered a pool insurance product. Pool insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions and generally covers the loss on a defaulted mortgage loan that exceeds the claim payment under the primary coverage, if primary insurance is required on that mortgage loan. Pool insurance also generally covers the total loss on a defaulted mortgage loan that did not require primary insurance, in each case up to a stated aggregate loss limit. New pool risk written was $450.3 million for the year ended December 31, 1998. Management is uncertain about the amount of new pool risk that will be written in 1999, but believes total new pool risk written in 1999 will be less than the amount of pool risk written in 1998. Although PMI charges higher premium rates for loans that have higher risk characteristics, including ARMs, 95s, 97s and pool insurance products, the premiums earned on such products, and the associated investment income, may ultimately prove to be inadequate to compensate for future losses from such products. See RF10. The following table reflects the percentage of PMI's direct primary risk in force (as determined on the basis of information available on the date of mortgage origination) by categories and as of the dates indicated: 11 Direct Risk in Force
As of December 31, ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ----------- ----------- ----------- ------------ Direct Risk in Force (In millions) $ 19,324 $ 18,092 $ 17,336 $ 15,130 $ 13,243 ============ =========== =========== =========== ============ Lender Concentration: Top 10 Lenders (by original applicant) 30.0 % 27.8 % 26.0 % 22.5 % 20.4 % ============ =========== =========== =========== ============ LTV: 97s 3.3 % 1.8 % 1.1 % 0.4 % 0.0 % 95s 46.3 46.2 43.6 40.2 35.7 90s and below 50.4 52.0 55.3 59.4 64.3 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============ Average Coverage Percentage 23.9 % 24.3 % 22.4 % 21.2 % 20.1 % ============ =========== =========== =========== ============ Loan Type: Fixed 89.7 % 83.3 % 80.6 % 76.8 % 74.4 % ARM 9.2 15.2 17.7 21.3 23.9 ARM (scheduled/potential negative amortization) 1.1 1.5 1.7 1.9 1.7 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============ Mortgage Term: 15 years and under 5.3 % 6.3 % 9.4 % 8.6 % 10.3 % Over 15 years 94.7 93.7 90.6 91.4 89.7 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============ Property Type: Single-family detached 87.1 % 86.3 % 86.7 % 86.7 % 86.3 % Condominium 6.4 6.8 6.9 7.1 7.5 Other (1) 6.5 6.9 6.4 6.2 6.2 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============ Occupancy Status: Primary residence 98.6 % 99.0 % 99.2 % 99.3 % 99.4 % Second home 1.0 0.8 0.6 0.5 0.3 Non-owner occupied 0.4 0.2 0.2 0.2 0.3 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============ Loan Amount: $100,000 or less 26.4 % 27.3 % 28.3 % 28.8 % 29.9 % Over $100,000 and up to $250,000 66.1 65.6 64.8 64.3 63.5 Over $250,000 7.5 7.1 6.9 6.9 6.6 ------------ ----------- ----------- ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============ =========== =========== =========== ============
(1) Includes two-to-four unit dwellings, townhouses, row houses and cooperatives. G. Sales, Product Development and Underwriting Personnel PMI employs a sales force and underwriting staff located throughout the country to sell its products, underwrite loans and provide services to lenders located throughout the United States. At December 31, 1998, PMI had 34 sales and underwriting service field and satellite offices located in 22 states. PMI's sales force receives compensation 12 comprised of a base salary with incentive compensation tied to performance objectives. PMI's Product Development and Pricing Department has primary responsibility for advertising, sales materials, and the creation of new products and services. PMI's product development and underwriting management personnel are eligible to participate in a bonus plan; all other personnel are compensated solely by salary. PMI's underwriting force have access to electronic data interchange and automated mortgage scoring systems which give them the ability to more efficiently process and underwrite both conforming and non-conforming loans to investors standards. See "H. Underwriting Practices - Role of Technology" below. PMI's Certificate Priority Center ("CPC"), in Dallas Texas is the central processing facility for underwriting data input and the issuance of PMI's insurance certificates. New policies processed at the CPC represented 38.3% of PMI's NIW in 1998 compared with 0.4% in 1997. During 1998, applications processed at the CPC represented 47.0% of all applications compared with 1.2% in 1997. The Company, through MSC, provides contract underwriting services that enable customers to improve the efficiency and quality of their operations by outsourcing all or part of their mortgage loan underwriting. Such contract underwriting services are provided for mortgage loans for which PMI provides mortgage insurance and for loans on which PMI does not. MSC also performs all of the contract underwriting activities of CMG. As a part of its contract underwriting services, PMI provides remedies which may include the assumption of some of the costs of repurchasing insured and uninsured loans from the GSEs and other investors. Generally, the scope of these remedies are in addition to those contained in PMI's master primary insurance policies. Contract underwriting services have become increasingly important to mortgage lenders as they seek to reduce costs. New policies processed by contract underwriters represented 35.0% of PMI's NIW in 1998 compared with 21.6% in 1997. Management anticipates that contract underwriting will continue to generate a significant percentage of PMI's NIW and that customer demand for contract underwriting services will increase. Management also believes the number of contract underwriters deployed by the Company will decrease as mortgage origination volumes decline. See RF7. H. Underwriting Practices Risk Management Approach PMI underwrites its primary business based upon the historical performance of risk factors of individual loan profiles, and utilizes automated underwriting systems in the risk selection process to assist the underwriter with decision making. PMI's underwriting process evaluates five categories of risk: . Borrower. An evaluation of the borrower's credit history is an integral part of PMI's risk selection process. In addition to the borrower's credit history, PMI analyzes several factors, including the borrower's employment history, income, funds needed for closing, and the details of the home purchase. . Loan Characteristics. PMI analyzes four general characteristics of the loan product to quantify risk: (i) LTV; (ii) type of loan instrument; (iii) type of property; and (iv) purpose of the loan. Certain categories of loans are generally not insured by PMI because such loans are deemed to have an unacceptable level of risk, such as loans with scheduled negative amortization, and loans originated using limited documentation. . Property Profile. PMI reviews appraisals regarding methodology used to determine the property price. . Housing Market Profile. PMI places significant emphasis on the condition of regional housing markets in determining its underwriting guidelines. PMI analyzes the factors that impact housing values in each of its major markets and closely monitors regional market activity on a quarterly basis. . Mortgage Lender. PMI tracks the historical risk performance of all customers that hold a master policy. This information is factored into the determination of the loan programs that PMI will approve for various lenders. 13 PMI uses national and territorial underwriting guidelines to evaluate the potential risk of default on mortgage loans submitted for insurance coverage. The national guidelines have developed over time and take into account PMI's loss experience and the underwriting guidelines of Fannie Mae and Freddie Mac. PMI expects its internal and contract underwriters to utilize their knowledge of local markets, risk management principles and business judgment in evaluating loans on their own merits in conjunction with PMI's underwriting guidelines. Accordingly, PMI's underwriting staff is trained to consider combined risk characteristics and their impact in different real estate markets and have discretionary authority to insure loans which are substantially in conformance with PMI's published underwriting guidelines. Significant deviations from such guidelines require higher level underwriting approval. PMI also offers pre- and post-loan credit counseling to borrowers using the 97% product as an aid in managing the greater risks associated with 97s compared to 95s. See RF12 Underwriting Process To obtain mortgage insurance on a specific mortgage loan, a master policyholder typically submits an application to one of PMI's regional underwriting offices, supported by various documents. Besides the standard full documentation submission program, PMI also accepts applications for insurance under a reduced documentation submission program (the "Quick Application Program"), which is limited to those lenders with a track record of high quality business. PMI's Quick Application Program allows selected lenders to submit insurance applications that do not include all standard documents. The lender is required to maintain written verification of employment and source of funds needed for closing and other supporting documentation in its origination file. PMI may schedule on-site audits of lenders' files on loans submitted under this program. The amount of business written under the Quick Application Program was 4.4% of PMI's NIW in 1998. PMI's Certificate Priority Center ("CPC"), in Dallas Texas, was designed to centralize the processing of data input for PMI's insurance certificates and to enhance operational productivity and efficiency, customer service and expense management. See "H. Sales, Product Development and Underwriting Personnel", above. The documents submitted to PMI by the mortgage lender generally include a copy of the borrower's loan application, an appraisal report or other statistical evaluation on the property by either the lender's staff appraiser or an independent appraiser, a written credit report on the borrower and, under the standard full documentation submission program, a verification of the borrower's employment, income and funds needed for the loan closing (principally, down payment) and the home purchase contract. Once the loan package is received by PMI's home or field underwriting offices, key borrower, property and loan product information is extracted from the file by an underwriting staff member and analyzed by automated underwriting systems -- pmiAURA/SM/ and pmiTERRA/SM/. During 1998, 62.2% of applications received were approved by the automated underwriting systems. In 1997, 70.6% of applications received were approved by the automated underwriting systems. Such applications generally have favorable risk characteristics, such as strong borrower credit ratings, low borrower debt- to-income ratios and stable borrower income histories. Any loans not automatically approved are referred to an underwriter for review of the entire insurance application package. The underwriter reviews the detailed systems analysis and borrower, loan and property profiles to determine if the risk is acceptable. The underwriter either approves, delays the final decision pending receipt of more information or declines the application for insurance. PMI generally responds within one business day after an application and supporting documentation is received. PMI's rejection rate remained consistent with 1997 at approximately 8.0% for the year ended December 31, 1998. PMI shares its knowledge of risk management principles and real estate economic conditions with customers to improve the quality of submitted business and reduce the rejection rate. Delegated Underwriting PMI's Partner Delivered Quality Program (the "PDQ Program"), introduced in 1991, is a delegated underwriting program whereby approved lenders are allowed to determine whether loans meet program guidelines and requirements approved by PMI and are thus eligible for mortgage insurance. At present, over 1,000 lenders actively approve applications under the PDQ Program. PMI's delegated business accounted for 52.7% and 50.3% of PMI's 14 NIW in 1998 and 1997, respectively, and represented 37.3% of PMI's total risk in force at December 31, 1998. PMI believes the percentage of risk in force written under the PDQ Program will increase further in the future as the program is expanded to include additional qualified lenders. Delegated underwriting enables PMI to meet mortgage lenders' demands for immediate insurance coverage of certain loans. Such types of programs have now become standard industry practice. Under the PDQ Program, customers utilize their own PMI-approved underwriting guidelines and eligibility requirements in determining whether PMI is committed to insuring a loan. Once the lender notifies PMI of an insured loan, key loan risk characteristics are evaluated by the pmiAURA/SM/ model to monitor the quality of delegated business on an ongoing basis. Additionally, PMI audits a representative sample of loans insured by each lender participating in the PDQ Program on a regular basis to determine compliance with program requirements. If a lender participating in the program tentatively commits PMI to insure a loan which fails to meet all of the applicable underwriting guidelines, PMI is obligated to insure such a loan except under certain narrowly-drawn exceptions to coverage (for example, maximum loan-to-value criteria). Loans that are not eligible for the PDQ Program may be submitted to PMI for insurance coverage through the normal process. PMI's PDQ Program is also accessed through a customer interface with Freddie Mac's Loan Prospector/SM/ system. PMI has currently limited its interface participation with Loan Prospector/SM/ customers and/or lenders who are approved to use the PDQ program. PMI believes that the performance of its delegated insured loans will not vary materially over the long-term from the performance of all other insured loans because: (i) only qualified lenders who demonstrate underwriting proficiency are eligible for the program; (ii) only loans meeting average-to-above average underwriting eligibility criteria are eligible for the program; and (iii) PMI has the ability to monitor the quality of loans submitted under the PDQ Program with proprietary risk management tools and an on-site audit of each PDQ lender. Role of Technology PMI accepts applications for insurance electronically through an electronic data interchange ("EDI") link with a lender. EDI links, through pmiPAPERLESS/SM/, serve to reduce paperwork for both PMI and its customers, streamline the process by which mortgage insurance is applied for, reduce the number of errors associated with re-entering information, and increase the speed with which PMI is able to respond to applications, all of which can enhance PMI's relationship with lenders. In 1987, PMI completed development of pmiAURA/SM/ in conjunction with Allstate. The system was initially developed utilizing five years of performance information from approximately 300,000 borrower profiles. The system employs claim and risk statistical models to predict the relative likelihood of default by a mortgage borrower. pmiAURA/SM/ assigns all applications received by PMI a risk score predicting the likelihood of default, and automatically refers certain applications to underwriters based on higher risk characteristics, territorial underwriting guidelines or other administrative requirements. PMI has updated the pmiAURA/SM/ database with performance data of over 2 million loans, and has added economic and demographic information to the database in order to enhance pmiAURA/SM/ predictive power. During 1997, the 4th generation of pmiAURA/SM/ was released which enabled the pmiAURA/SM/ system to generate three types of scores: a loan risk score that assesses the risk solely due to the borrower, loan and property characteristics independent of market risk; a market score which is a measure of the default risk due solely to the metropolitan area economic conditions; and the pmiAURA/SM/ Score, which combines the information in the loan risk and market scores. Also, the newest generation includes a revised credit score indicator. PMI intends to further update the model from time to time. In 1991, the pmiTERRA/SM/ system was installed to complement pmiAURA/SM/ by providing a fully automated appraisal analysis, and currently contains over 900,000 residential property profiles. This analysis determines if the appraiser adequately supported the final estimate of value. A key ingredient in the pmiTERRA/SM/ appraisal model is a consideration of the health of the real estate market in which the property is located. 15 The automated underwriting systems free underwriters from having to review the highest quality applications, and enable the underwriters to focus on more complex credit packages and market and lender analyses. In addition to their use in underwriting almost all of PMI's mortgage insurance applications from lenders, the automated underwriting systems provide daily reports that assist underwriting management in monitoring the credit and property risk being committed for mortgage insurance. On the basis of its experience with the automated underwriting systems, PMI believes that, in addition to improving underwriting results, these automated underwriting systems have improved PMI's underwriting efficiency and have brought consistency to the underwriting judgment process. PMI's contract underwriters and its field underwriting force have access to PMI's automated underwriting systems. PMI, through its internal underwriting systems, provides its customers access to Freddie Mac's and Fannie Mae's automated underwriting services, Loan Prospector/SM/ and Desktop Underwriter/SM/, respectively, which are used as tools by mortgage originators to determine whether Freddie Mac or Fannie Mae will purchase a loan prior to closing. PMI works with both agencies in offering insurance services through their systems, while utilizing its proprietary risk management systems to monitor the risk quality of loans insured through such systems. As an added benefit, pmiAURA's/SM/ extensive database provides detailed performance reports of underwriting quality trends by geographic region, product type, customer characteristics and other key factors. These reports allow PMI's underwriting management to monitor risk quality on a daily basis and to formulate long-term responses to developing risk quality trends. Ultimately, such responses can lead to regional variations from, or permanent changes to, PMI's underwriting guidelines. PMI currently licenses pmiAURA/SM/ to approximately 25 customers or lenders, including 6 of the top 10 mortgage lenders, who use pmiAURA/SM/ as a tool to help understand more completely the risk profiles of the loans they originate and the applications PMI is most likely to approve. PMI, through The Customer Technology Division of MSC, makes available to all pmiAURA/SM/ licensees customer service, technical support and software upgrades. During 1998, pmiAURA/SM/, was approved by all four Wall Street rating agencies as an effective tool for establishing levels of credit support needed on securities backed by non-conforming, conventional loans. I. Affordable Housing PMI insures residential mortgages identified by its customers as loans secured by properties owned and occupied by low- and moderate-income borrowers, or by borrowers who reside in areas targeted for community reinvestment or redevelopment ("affordable housing" loans). The percentage of affordable housing loans designated as such by lenders was 6.5% of new risk written in 1998, as compared to 9.10% in 1997. Management believes that affordable housing loans have higher risks than its other insured business. As a result, PMI has instituted various programs seeking to mitigate the higher risk characteristics of such loans. J. Defaults and Claims Defaults PMI's default rate has decreased to 2.31% at December 31, 1998 from the December 31, 1997 rate of 2.38%. This decrease was primarily due to an improvement in the national economy, and particularly California, and to an increase in policies in force. See RF12 and Part II Item 7 "Management's Discussion and Analysis of Financial Condition And Results of Operations". PMI's claim process begins with the receipt of notification of a default from the insured on an insured loan. Default is defined in the master policy as the failure by the borrower to pay when due an amount equal to the scheduled monthly mortgage payment under the terms of the mortgage. The master policy requires insureds to notify PMI of defaults no later than 130 days after the initial default. Generally, defaults are reported sooner, and the average time for default reporting in 1998 by PMI insureds was approximately within 60 days of the initial default. PMI has historically included all defaults reported by the lenders in its default inventory, regardless of the time period since 16 the initial default. The incidence of default is affected by a variety of factors, including the reduction of the borrower's income, unemployment, divorce, illness, the inability to manage credit and the level of interest rates. Defaults that are not cured result in a claim to PMI. See "Claims and Policy Servicing" below. Borrowers may cure defaults by making all delinquent loan payments or by selling the property in full satisfaction of all amounts due under the mortgage. The following table shows the number of loans insured by PMI, the number of loans in default and the default rate. Historical Default Rates Total Insured Loans in Force
Year Ended December 31, ------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ----------- ---------- ----------- ---------- ----------- Number of Insured Loans in Force 714,210 698,831 700,084 657,800 612,806 Number of Loans in Default 16,528 16,638 15,326 13,022 11,550 Default Rate 2.31 % 2.38 % 2.19 % 1.98 % 1.88 %
Default rates differ from region to region in the United States depending upon economic conditions and cyclical growth patterns. The two tables below illustrate the impact of economic cycles on the various regions of the United States and the ten largest states by PMI's risk in force as of December 31, 1998.
Default Rates by Region(1) As of Period End, ------------------------------------------------------------------------------------------------ 1998 1997 --------------------------------- --------------------------------- Region 4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1st Q 1996 1995 1994 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Pacific(2) 2.69 % 2.67 % 2.72 % 3.03 % 3.14 % 3.17 % 3.12 % 3.28 % 3.22 % 3.34 % 2.99 % New England(3) 1.79 1.68 1.64 1.81 1.81 1.79 1.82 1.87 1.80 1.93 1.98 Northeast(4) 2.91 2.77 2.68 2.88 2.79 2.67 2.57 2.56 2.52 2.22 2.11 South Central(5) 1.92 1.78 1.73 1.87 1.98 1.87 1.71 1.68 1.67 1.51 1.76 Mid-Atlantic(6) 2.37 2.23 2.22 2.40 2.35 2.29 2.17 2.15 2.03 1.65 1.60 Great Lakes(7) 1.98 1.94 1.88 1.88 1.86 1.75 1.56 1.63 1.82 1.21 1.28 Southeast(8) 2.39 2.16 2.10 2.35 2.31 2.13 2.05 1.99 1.93 1.53 1.41 North Central(9) 1.96 1.91 1.78 1.95 1.95 1.75 1.67 1.65 1.61 1.31 1.03 Plains(10) 1.73 1.63 1.45 1.53 1.56 1.56 1.40 1.25 1.21 0.89 0.68 Total Portfolio 2.31 2.20 2.16 2.36 2.38 2.29 2.20 2.22 2.19 1.98 1.88
(1) Default rates are shown by region on location of the underlying property. (2) Includes California, Hawaii, Nevada, Oregon and Washington. (3) Includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont. (4) Includes New Jersey, New York and Pennsylvania. (5) Includes Alaska, Arizona, Colorado, Louisiana, New Mexico, Oklahoma, Texas and Utah. (6) Includes Delaware, Maryland, Virginia, Washington, D.C. and West Virginia. (7) Includes Indiana, Kentucky, Michigan and Ohio. (8) Includes Alabama, Arkansas, Florida, Georgia, Mississippi, North Carolina, South Carolina and Tennessee. (9) Includes Illinois, Minnesota, Missouri and Wisconsin. (10) Includes Idaho, Iowa, Kansas, Montana, Nebraska, North Dakota, South Dakota and Wyoming. 17 PMI's Default Rates for Top 10 States by Total Risk in Force(1)
Percent of PMI's Primary Risk in Force as of Default Rate December 31, as of December 31, -------------------- ------------------------------------------------------------- 1998 1998 1997 1996 1995 1994 ---------------- -------- -------- -------- -------- -------- California 17.6 % 3.15 % 3.73 % 3.81 % 4.08 % 3.72 % Florida 7.3 3.08 2.93 2.40 1.92 1.86 Texas 7.2 2.18 2.25 2.04 1.85 2.29 New York 4.9 2.98 2.94 2.59 2.30 2.00 Washington 4.8 1.58 1.66 1.58 1.21 0.96 Illinois 4.2 2.35 2.56 2.14 1.84 0.60 Virginia 4.1 1.55 1.67 1.54 1.18 1.20 Pennsylvania 4.1 2.64 2.38 2.13 1.91 1.72 Georgia 4.0 2.01 1.87 2.59 2.26 2.14 Massachusetts 3.9 1.67 1.67 1.73 1.91 2.04 Total Portfolio 100.0 % 2.31 % 2.38 % 2.19 % 1.98 % 1.88 %
(1) Top ten states as determined by total risk in force as of December 31, 1998. Default rates are shown by states based on location of the underlying property. Default rates on PMI's California policies decreased to 3.15% (representing 3,067 loans in default) at December 31, 1998, from 3.73% (representing 3,991 loans in default) at December 31, 1997. Claim sizes on California policies tend to be larger than the national average claim size due to higher loan balances relative to other states. (See "Claims and Servicing", below). Policies written in California accounted for approximately 48% and 64% of the total dollar amount of claims paid for the year ended December 31, 1998 and 1997, respectively. Although management expects that California should continue to account for the majority of total claims paid, management anticipates that with continued improvement in the California economy, increased benefits of loss mitigation and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline for the foreseeable future. See RF11 The following table sets forth the dispersion of PMI's primary insurance in force and risk in force as of December 31, 1998, by year of policy origination since PMI began operations in 1972. 18 Insurance and Risk in Force by Policy Year
Primary Percent Primary Percent Policy Year Insurance in Force of Total Risk in Force of Total --------------------- ----------- ------------------- ----------- ($ in thousands) ($ in thousands) 1972 - 1991 $ 4,226,669 5% $ 879,684 5% 1992 5,066,645 6% 989,627 5% 1993 10,485,549 13% 2,100,152 11% 1994 6,831,009 8% 1,459,165 8% 1995 6,872,617 9% 1,802,821 9% 1996 9,940,144 12% 2,632,644 14% 1997 11,485,537 14% 3,020,328 16% 1998 25,773,912 33% 6,439,414 32% --------------------- ----------- ------------------- ----------- Total Portfolio $ 80,682,082 100% $ 19,323,835 100% ===================== =========== =================== ===========
Claims and Servicing The majority of claims under PMI policies have historically occurred during the third through the sixth years after issuance of the policies. Insurance written by PMI from the period January 1, 1993 through December 31, 1996 represents 42.3% of PMI's insurance in force at December 31, 1998. This substantial volume of PMI's business is in its expected peak claim period. Despite increasing coverage percentages and increasing mortgage principal amounts, direct primary claims paid by PMI in 1998 decreased to approximately $118.4 million compared with $147.1 million in 1997. The frequency of claims does not directly correlate to the frequency of defaults because the rate at which defaults cure is influenced by (i) the individual borrower's financial resources and circumstances, and (ii) regional economic differences. Whether an uncured default leads to a claim principally depends on the borrower's equity at the time of default and the borrower's (or the insured's) ability to sell the home for an amount sufficient to satisfy all amounts due under the mortgage loan. During the default period, PMI works with the insured for possible early disposal of the underlying property when the chance of the loan reinstating is minimal. Such dispositions typically result in a savings to PMI over the percentage coverage amount payable under the master policy. The following table sets forth the dispersion of PMI's primary insurance in force as of December 31, 1998, by year of policy origination and average coupon rate. 19
Insurance in Force by Policy Year and Average Coupon Rate As of December 31, 1998 ----------------------------------------------------- Policy Average Percent Year Rate (1) IIF of Total ------- ---------- --------------- ---------- 1998 7.16 % $ 25,773,912 32.0 % 1997 7.80 11,485,537 14.2 1996 7.86 9,940,144 12.3 1995 8.03 6,872,617 8.5 1994 7.82 6,831,009 8.5 1993 7.50 10,485,549 13.0 1992 8.16 5,066,645 6.3 1972 - 1991 9.10 4,226,669 5.2 --------------- ---------- Total $ 80,682,082 100.0 % =============== ==========
(1) Average coupon rate on 30 year fixed rate mortgages Under the terms of PMI's master policy, the lender is required to file a claim with PMI no later than 60 days after it has acquired title to the underlying property, usually through foreclosure. An insurance claim amount includes (i) the amount of unpaid principal due under the loan; (ii) the amount of accumulated delinquent interest due on the loan (excluding late charges) to the date of claim filing; (iii) expenses advanced by the insured under the terms of the master policy, such as hazard insurance premiums, property maintenance expenses and property taxes to the date of claim filing; and (iv) certain foreclosure and other expenses, including attorneys' fees. Such claim amount is subject to review and possible adjustment by PMI. Depending on the applicable state foreclosure law, an average of about 12 months elapses from the date of default to payment of a claim on an uncured default. PMI's master policy excludes coverage on loans secured by property with physical damage, whether caused by fire, earthquake or other hazard where the borrower's default was caused by an uninsured casualty. PMI has the right to rescind coverage (and not pay a claim) if the lender, its agents or the borrower misrepresent material information in the insurance application. According to industry practice, a misrepresentation is generally considered material if the insurer would not have agreed to insure the loan had the true facts been known at the time of certificate issuance. Within 60 days after a claim has been filed, PMI has the option of: (i) paying the coverage percentage specified in the certificate of insurance (usually 17% to 30% multiplied by the claim amount); (ii) in the event the property is sold pursuant to an arrangement made prior to or during the 60-day period after the claim is filed (a "prearranged sale"), paying the lesser of (A) 100% of the claim amount less the proceeds of sale of the property or (B) the coverage percentage multiplied by the claim amount, or (iii) paying 100% of the claim amount in exchange for the insured's conveyance to PMI of good and marketable title to the property, with PMI then selling the property for its own account. Properties acquired through the last option are included on PMI's balance sheet in other assets as residential properties from claim settlements (also known as "REO"). PMI attempts to choose the claim settlement option which best mitigates the amount of its claim payment. Generally, however, PMI settles by paying the coverage percentage multiplied by the claim amount. In 1998 and 1997, PMI settled 22.1% and 12.3%, respectively, of the primary claims processed for payment on the basis of a prearranged sale. In each of 1998 and 1997, PMI 20 exercised the option to acquire the property on less than 4% of the primary claims processed for payment. At December 31, 1998, PMI owned $8.6 million of REO valued at the lower of cost or estimated realizable value. The ratio of the claim paid to the original risk in force relating to such loan is referred to as claim severity and is a factor that influences PMI's losses. The main determinants of claim severity are the accrued interest on the mortgage loan and the foreclosure expenses. These amounts depend in part on the time required to complete foreclosure, which varies depending on state laws. Pre- foreclosure sales and other early workout efforts help to reduce overall severity. The average claim severity level has decreased from 99.9% in 1994 to 95.8% in the period from 1994 to 1998. Technology for Claims and Policy Servicing Technology is an integral part of the claims and policy servicing process and PMI believes that technology will continue to take on a greater role in increasing internal efficiencies and improving customer service. PMI uses a personal computer-based automated claim-for-loss worksheet program, developed in 1987, which compiles pertinent data while automatically calculating the claim amount and predicting the best settlement alternative. To enhance efficiencies and ease of use for its customers, PMI developed Document Free ClaimEase/SM/, which is designed to require only an addendum to the uniform claim-for-loss worksheet, reducing paperwork and resulting in more rapid claims settlements. In addition, several technology tools have also been developed by PMI: pmiPHONE- CONNECT/SM/, which is a voice response application, enabling the insured to access PMI's database by using their telephones to inquire on the status of their coverage and get information on billings, refunds, coverage and renewals; pmiPC-CONNECT/SM/, which gives the insured the ability to dial into PMI's database using a modem-equipped personal computer to inquire about and update certain loan information, including the filing of claims; in 1998 PMI introduced an enhanced version of pmiPC-CONNECT/SM/ named pmiWEB-CONNECT/SM/ which provides access by the Insured to PMI's database via the Internet; PMI is also capable of receiving claims, handling premium billing, and loan sale transfers via EDI. To contain costs and expand internal efficiencies, PMI uses optical imaging in its claims functions, allowing PMI to eliminate the transfer and storage of documents relating to claims. PMI, through its automatic default reporting process ("ADR"), allows paperless reporting of default information by the insured. In 1985, the Company adopted substantially more conservative underwriting standards that, along with increased prices and generally improving economic conditions in various regions, are believed by the Company to have contributed to the substantially lower cumulative loss payment ratios in 1985 and subsequent years. While the cumulative loss payment ratios of policy years 1985 through 1998 will increase over time, the cumulative loss payment ratios for each such year at December 31, 1994 is lower than the cumulative loss payment ratios for each of the years 1980 through 1984 at the same number of years after original policy issuance. The following table sets forth cumulative losses paid by PMI at the end of each successive year after the year of original policy issuance ("policy year"), expressed as a percentage of the cumulative premiums written on such policies. This table further shows that, measured by cumulative losses paid relative to cumulative premiums written ("cumulative loss payment ratios"), the performance of policies originally issued in the years 1980 through 1984 was adverse, with cumulative loss payment ratios for those years ranging from 115.5% to 260.3% at the end of 1994. Such adverse experience was significantly impacted by deteriorating economic and real estate market conditions in the "Oil Patch" states. 21
Years Percentage of Cumulative Since Losses Paid to Cumulative Premiums Written Policy Issue Policy Issue Year --------------------------------------------------------------------------- 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 --------------------------------------------------------------------------- (in percents) 1 0.4 0.3 0.8 0.3 0.2 - 0.1 - - - 2 9.2 18.7 30.3 11.8 8.0 4.4 1.5 0.4 0.1 0.3 3 27.0 68.5 86.5 37.0 41.2 18.8 5.2 2.0 2.0 3.6 4 48.6 106.0 132.9 80.3 82.2 35.4 8.8 5.1 6.1 10.9 5 64.8 134.1 177.6 128.5 113.4 47.7 12.2 9.7 11.7 22.0 6 74.5 160.0 230.0 165.0 126.2 56.7 15.7 13.1 18.6 32.4 7 85.6 184.0 251.1 176.7 133.5 60.9 18.6 17.6 23.1 40.3 8 98.3 196.9 265.4 183.8 138.5 63.1 21.4 20.7 26.2 45.6 9 107.7 203.3 265.7 187.0 141.2 65.1 24.1 23.0 29.1 49.9 10 111.3 205.3 264.3 189.0 141.9 65.3 25.8 25.1 31.9 51.6 11 112.9 207.0 263.7 190.7 142.9 65.9 27.4 26.7 33.6 12 114.2 208.8 264.5 191.3 142.5 65.8 28.5 27.8 13 114.7 209.0 263.2 191.1 142.1 65.8 28.9 14 115.1 209.8 262.1 190.6 141.8 65.9 15 115.2 209.6 261.5 190.2 141.5 16 115.4 209.3 260.8 189.8 17 115.5 208.9 260.3 18 115.6 208.6 19 115.5
-------------------------------------------------------------------- 1990 1991 1992 1993 1994 1995 1996 1997 1998 -------------------------------------------------------------------- (in percents) 1 - - - - - 0.1 - 0.1 - 2 0.7 0.8 1.2 1.0 1.0 2.8 3.5 2.3 3 7.2 6.7 6.9 5.5 6.5 11.4 8.5 4 17.9 16.8 16.3 13.4 14.6 15.5 5 31.7 28.8 28.3 19.2 18.1 6 41.7 39.8 37.1 21.2 7 50.4 48.3 40.3 8 56.6 51.4
The table also demonstrates the general improvement in PMI's cumulative loss payment ratios since policy year 1982. This reflects both improved claims experience for the more recent years and the higher premium rates charged by PMI beginning in 1984. Policy years 1986 through 1988 generally have had the best cumulative loss payment ratios of any years since 1980. Policy years 1989 through 1992 display somewhat higher loss payment ratios than 1986 through 1988 at the same age of development. This is due primarily to the increased refinancings of mortgages originated in policy years 1989 to 1992, resulting in reduced aggregate premiums, and to higher default rates on California loans, which have demonstrated relatively higher persistency. Claim activity is not spread evenly throughout the coverage period of a primary book of business. Based on the Company's experience, the majority of claims occur in the third through sixth years after loan origination, and relatively few claims are paid during the first two years after loan origination. 22 Loss Reserves A significant period of time may elapse between the occurrence of the borrower's default on mortgage payments (the event triggering a potential future claims payment), the reporting of such default to PMI and the eventual payment of the claim related to such uncured default. To recognize the liability for unpaid losses related to the default inventory, PMI (similar to other mortgage insurers) establishes loss reserves in respect of defaults included in such inventory, based upon the estimated claim rate and estimated average claim amount. Included in loss reserves are loss adjustment expense ("LAE") reserves and incurred, but not reported, reserves. These reserves are estimates and there can be no assurance that PMI's reserves will prove to be adequate to cover ultimate loss developments on reported defaults. (See RF12). Consistent with industry accounting practices, PMI does not establish loss reserves in respect of estimated potential defaults that may occur in the future. PMI's reserving process for primary insurance segments default notifications by year of receipt of the notice by PMI (the "report year method"). In the report year method, ultimate claim rates and average claim amounts selected for the current and each of the four prior report years are estimated based on past experience and management judgment. Claim rates and amounts are also estimated by region for the most recent report years to validate nationwide report year estimates, which are then used in the normal reserving methodology. For each report year, the claim rate, estimated average claim amount and the number of reported defaults are multiplied together to determine the amount of direct incurred losses for that report year. Losses paid to date for that report year are subtracted from the estimated report year incurred losses to obtain the loss reserve for that report year. The sum of the reserves for those five years, together with a reserve for expected losses on the few defaults still pending from prior years, yields the total loss reserve on reported defaults. PMI reviews its claim rate and claim amount assumptions on at least a quarterly basis and adjusts its loss reserves accordingly. The impact of inflation is not explicitly isolated from other factors influencing the reserve estimates, although inflation is implicitly included in the estimates. PMI does not discount its loss reserves for financial reporting purposes. PMI's reserving process is based upon the assumption that past experience, adjusted for the anticipated effect of current economic conditions and projected future economic trends, provides a reasonable basis for estimating future events. However, estimation of loss reserves is a difficult process, especially in light of the rapidly changing economic conditions over the past few years in certain regions of the United States. In addition, economic conditions that have affected the development of the loss reserves in the past may not necessarily affect development patterns in the future. Pool business loss reserving, is subject to the same assumptions and economic uncertainties as primary insurance, and generally involves the following process. PMI divides all currently pending Pool insurance delinquencies into six categories of delinquency, which connote progressively more serious stages of default (e.g., delinquent less than four months, delinquent more than four months, in foreclosure but no sale date set, etc.). A claim rate is selected for each category based on past experience and management judgement. Expected claim sizes, stated as a percentage of the outstanding loan balance on the delinquent loan, are similarly selected. The loss reserve is then generally calculated as the sum over all delinquent loans of the product of the outstanding loan balance, the claim rate and the expected claim size percentage. PMI's Actuarial Services department performs the loss reserve analysis. On the basis of such loss reserve analysis, management believes that the loss reserves are, in the aggregate, computed in accordance with commonly accepted loss reserving standards and principles and meet the requirements of the insurance laws and regulations to which it is subject. Management believes that the loss reserves are a reasonable provision for all unpaid loss and LAE obligations under the terms of its policies and agreements. See RF12. Such reserves are necessarily based on estimates and the ultimate net cost may vary from such estimates. These estimates are regularly reviewed and updated using the most current information available. Any resulting adjustments are reflected in current financial statements. The following table is a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses for each of the last three years: 23
1998 1997 1996 -------------- -------------- -------------- ($ in thousands) Balance, January 1 $ 202,387 $ 199,774 $ 192,087 Less reinsurance recoverable 6,067 5,287 17,899 -------------- -------------- -------------- Net balance, January 1 196,320 194,487 174,188 -------------- -------------- -------------- Losses and loss adjustment expenses (principally in respect of defaults occurring in) Current year 146,884 158,147 161,740 Prior years (11,168) (5,890) (9,331) -------------- -------------- -------------- Total losses and loss adjustment expenses 135,716 152,257 152,409 -------------- -------------- -------------- Losses and loss adjustment expense payments (principally in respect of defaults occurring in) Current year 12,503 27,700 23,353 Prior years 111,056 122,724 108,757 -------------- -------------- -------------- Total payments 123,559 150,424 132,110 -------------- -------------- -------------- Net balance, December 31 208,477 196,320 194,487 Plus reinsurance recoverable 6,782 6,067 5,287 -------------- -------------- -------------- Balance, December 31 $ 215,259 $ 202,387 $ 199,774 ============== ============== ==============
As a result of changes in estimates of ultimate losses resulting from insured events in prior years, the provision for losses and loss adjustment expenses (net of reinsurance recoverables) decreased by $11.2 million, $5.9 million, and $9.3 million in 1998, 1997 and 1996, respectively, due primarily to lower-than- anticipated losses in California. Such estimates were based on management's analysis of various economic trends (including the real estate market and unemployment rates) and their effect on recent claim rate and claim severity experience. K. Reinsurance The use of reinsurance as a source of capital and as a risk management tool is well established within the mortgage insurance industry. In addition, certain mortgage insurers, including PMI, have agreed to reinsure portions of the risk written on loans originated by certain lenders with captive reinsurance companies affiliated with such lenders. Reinsurance does not discharge PMI, as the primary insurer, from liability to a policyholder. The reinsurer simply agrees to indemnify PMI for the reinsurer's share of losses incurred under a reinsurance agreement, unlike an assumption arrangement, where the assuming reinsurer's liability to the policyholder is substituted for that of PMI's. Forestview In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage Insurance Company ("Forestview") whereby Forestview agreed to reinsure all liabilities (net of amounts collected from third party reinsurers and indemnitors) in connection with PMI's mortgage pool insurance business in exchange for premiums received. In 1994, Forestview also agreed that as soon as practicable after November 1, 1994, Forestview and PMI would seek regulatory approval for the Reinsurance Treaty to be deemed to be an assumption agreement and that, upon receipt of the requisite approvals, Forestview would assume such liabilities. Forestview's claims-paying ability is currently rated "AA" by Fitch IBCA. Forestview's previous claims-paying ability rating of "AA" (Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in 1997. These ratings are subject to revisions or withdrawal at any time by the assigning rating organization. Management is uncertain at this time what impact the withdrawal of the claims-paying ability rating will have on the parties' ability to timely consummate the assumption transaction. Pursuant to this agreement, PMI ceded $9.0 million of pool premiums to 24 Forestview and Forestview reimbursed PMI for pool claims on the covered policies in the amount of $26.8 million in 1998. The failure of Forestview to meet its contractual commitments would materially and adversely affect the Company's financial condition and results of operations. See RF14. Capital Mortgage In March 1994, PMI entered into a quota share reinsurance agreement with Capital Mortgage Reinsurance Company ("Capital Mortgage") (claims-paying ability rating of "AA+" at December 31, 1998 from S&P) whereby PMI ceded to Capital Mortgage 5% of PMI's liability under its primary insurance policies written in 1993 through 1997 (and 5% of the related premiums). This agreement, which was canceled effective December 31, 1997, provides for a ceding commission to be paid by Capital Mortgage to PMI relating to premiums ceded. Capital Mortgage remains liable on a runoff basis for nine years (subject to either party's right to commute the agreement at six years) and receives renewal premiums on the ceded portion of the primary insurance in force at the time of cancellation of the agreement. See Part II, Item 8, Financial Statements Note 6--"Reinsurance." Reinsurance Subsidiaries; RGC, RIC, PMG and TIC Certain states limit the amount of risk a mortgage insurer may retain to 25% of the indebtedness to the insured and, as a result, the deep coverage portion of such insurance over 25% must be reinsured. To minimize reliance on third party reinsurers and to permit PMI and CMG to retain the premiums (and related risk) on deep coverage business, TPG formed several wholly-owned subsidiaries RGC, RIC, PMG and TIC to provide reinsurance of such deep coverage to PMI and CMG. PMI and CMG use reinsurance provided by its reinsurance subsidiaries solely for purposes of compliance with statutory coverage limits. While TPG's reinsurance subsidiaries generally have the ability to write direct mortgage insurance and to provide reinsurance to unaffiliated mortgage insurers, TPG currently intends to have its reinsurance subsidiaries write reinsurance solely for PMI and CMG. See RF2 and RF8 During 1997 PMI began issuing pool insurance to select companies. In connection with the pool policies issued, PMI may only retain 25% of the risk covered by such policies. PMI intends to reinsure the remaining risk though its affiliates, including RGC, PMG and other subsidiaries being formed. See "B. Products", above; "O. Regulation" and RF2, RF7, and RF8 L. Claims-Paying Ability Ratings PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard & Poor's Rating Services ("S&P"), "AA+" (Very Strong) by Fitch Investors Service, Inc. ("Fitch"), "AA+" (Very High) by Duff & Phelps Credit Rating Co. ("Duff & Phelps") and "Aa2" (Excellent) by Moody's Investors Service, Inc. ("Moody's"). PMI's claims-paying ability ratings from certain national rating agencies have been based in significant part on various capital support commitments from Allstate ("Allstate Support Agreements"). On October 28, 1994, TPG entered into a runoff support agreement with Allstate (the "Runoff Support Agreement") to replace various capital support commitments that Allstate had previously provided to PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI prior to October 28, 1994 if PMI's financial condition deteriorates below specified levels, or if a third party brings a claim thereunder or, in the alternative, Allstate may make contributions directly to PMI or TPG. In the event that Allstate makes payments or contributions under the Runoff Support Agreement, (which possibility management believes is remote), Allstate would receive subordinated debt or preferred stock of PMI or TPG in return. Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for such insurers to be eligible to insure loans sold to such agencies. In order to be Fannie Mae and Freddie Mac eligible, PMI must maintain an AA rating with any public national rating agency. See RF3 and RF5 25 M. Investment Portfolio Cash flow from the Company's investment portfolio represented approximately 48.0% of its total cash flow from operations during 1998. PMI's investment policy is to attain consistent, competitive after tax total returns. A strong emphasis is placed on providing a predictable, high level of income, while maintaining adequate levels of liquidity, safety and preservation of capital; growth is a secondary consideration. Fixed income investment duration is restricted to the estimated range of liability and surplus duration plus or minus 25%. In addition to satisfying state regulatory limits, minimum average fixed income credit quality of "A" rating must be maintained and no single credit risk may exceed 5% of total investments. At December 31, 1998, based on market value, approximately 96.6% of the Company's total investment portfolio was invested in securities rated "A" or better, with 61.1% rated "AAA" and 25.3% rated "AA," in each case by at least one nationally recognized securities rating organization. The Company's investment policies and strategies are subject to change depending upon regulatory, economic and market conditions and the existing or anticipated financial condition and operating requirements, including the tax position of the Company. During 1998, approximately 96% of the Company's investment portfolio was managed internally. At December 31, 1998, the consolidated market value of the Company's investment portfolio was approximately $1.5 billion. At December 31, 1998, municipal securities represented 77.9% of the market value of the total investment portfolio. Securities due in less than one year, within one to five years, after ten years, and other represented 0.5%, 4.8%, 11.6%, 78.8% and 4.3%, respectively, of such total market value. The Company's net pre-tax investment income (excluding capital gains) was $84.7 million for the year ended December 31, 1998, which represented a pre-tax yield of 6.06% for the year, a decline from 6.14% for 1997. This decrease was the result of a decline in the average interest rate on investments in 1998 as compared to 1997. Net realized capital gains on the investment portfolio were $24.6 million and $19.6 million for 1998 and 1997, respectively. See Part II, Item 8, Financial Statements Note 3-- "Investments." N. Other Businesses TPG seeks to supplement its core mortgage insurance business and enhance its customer relationships through ancillary businesses and may, from time to time, invest in joint ventures or acquire related businesses in whole or in part or diversify into other lines of business utilizing the Company's credit enhancement and/or mortgage default analysis skills. TPG, through certain subsidiaries, provides title insurance and various services and products for the home mortgage finance industry, such as contract underwriting and the licensing of its proprietary underwriting and real estate valuation systems. Total revenues recognized for the year ended December 31, 1998 from TPG's businesses other than PMI constituted approximately 17.4% of the Company's consolidated revenues, compared with approximately 13.8% and 12.7%, respectively, in 1997 and 1996. Ram Re During the first quarter of 1998, TPG became a principal investor in RAM Reinsurance Company Ltd. ("RAM Re), the first AAA rated financial guaranty reinsurance company based in Bermuda. This strategic investment was consummated, in part, because of the perceived industry need for additional sources of highly rated financial guaranty capacity and because of the desire to diversify into similar business industries. Ram Re commenced business in 1998. Three executives of the Company serve as directors of Ram Re. American Pioneer Title Insurance Co. 26 The Company acquired APTIC, a Florida-based title insurance company, in 1992 as part of its strategy to provide additional mortgage-related services to its customers. APTIC is licensed in 39 states and the District of Columbia. Although APTIC is currently writing business in 30 states, it primarily provides real estate title insurance on residential property in Florida. A title insurance policy protects the insured party against losses resulting from title defects, liens and encumbrances existing as of the effective date of the policy and not specifically excepted from the policy's coverage. Based on direct premiums written during 1998, APTIC is ranked fifth among the 28 active title insurers conducting business in the State of Florida. For the year ended December 31, 1998, 77.3% of APTIC's premiums earned came from its Florida operations. APTIC generates title insurance business through both direct and indirect marketing to realtors, attorneys and lenders. As a direct marketer, APTIC operates, under the name Chelsea Title Company, a branch network of title production facilities and real estate closing offices. As an indirect marketer, APTIC recruits and works with corporate title agencies, attorney agencies and approved attorneys. Its agency business accounted for 93.8% and 94.1% of APTIC's premiums earned for the years ended December 31, 1998 and 1997, respectively. CMG Mortgage Insurance Company CMG offers mortgage guaranty insurance for loans originated by credit unions. CMG is operated as a joint venture between PMI and CUNA Mutual Investment Corporation ("CMIC"), with PMI having a 45% ownership interest from September 1994 to September 1998. Beginning October 1998 PMI's ownership increased to 50%. PMI and CMIC provide services to the venture, with CMIC providing primarily sales and marketing services and PMI providing primarily insurance operation services. CMIC is a part of the CUNA Mutual Group, which provides insurance and selected financial services to credit unions and their members in the United States and over 50 other countries. As of December 31, 1998, CMG was licensed and operational in 49 states and the District of Columbia. CMG is approved as a mortgage insurer by both Fannie Mae and Freddie Mac, as well as by other purchasers of credit union originated mortgage loans. Since inception, CMG has issued approximately 1,300 master policies to credit union and credit union affiliated organizations nationwide. At December 31, 1998 CMG had $4.2 billion of primary insurance in force. Under the terms of the joint venture arrangement, at the end of fifteen years or earlier under certain limited conditions, CMIC has the right to require PMI to sell, and PMI has the right to require CMIC to purchase, PMI's interest in CMG for an amount equal to the then current fair market value. For this purpose, fair market value will be determined by agreement between PMI and CMIC, or failing such agreement, through appraisal by nationally recognized investment banking firms. PMI Mortgage Services Co. MSC, established in 1993, provides a variety of technical products and mortgage underwriting services through a staff of underwriters in 34 field offices. The Customer Technology Division of MSC provides technical products and services to PMI's customers. This department licenses use of pmiAURA/SM/ and pmiTERRA/SM/ to customers for a fee, assists PMI's customers in establishing EDI links with PMI, and provides other value added services. The Risk Management Division of MSC provides contract underwriting services that enable customers to improve the efficiency and quality of their operations by outsourcing all or part of their mortgage loan underwriting to MSC. Such contract underwriting services are provided for mortgage loans for which PMI provides mortgage insurance and for loans on which PMI does not. MSC also performs all of the mortgage insurance underwriting activities of CMG. Contract underwriting services have become increasingly important to mortgage lenders as they seek to reduce costs. Competition increased in 1998 among mortgage insurance companies for contract underwriting 27 customers. Contract underwriting on-site is generally more expensive for the Company than underwriting a loan in-house and is becoming an increasingly popular method among mortgage lenders for processing loan applications. Contract underwriting processed loans represented 35.0% of PMI's NIW for the year ended December 31, 1998 compared to 21.6% for the year ended December 31, 1997. Management anticipates that contract underwriting will continue to generate a significant percentage of PMI's NIW and that customer demand for contract underwriting services will increase. Management also believes the number of contract underwriters deployed by the Company will decrease as mortgage origination volumes decline. See RF7. O. Regulation State Regulation, Federal Legislation, and Fannie Mae and Freddie Mac State Regulation. General. The Company's insurance subsidiaries are subject to comprehensive, detailed regulation for the protection of policyholders, rather than for the benefit of investors, by the insurance departments of the various states in which they are licensed to transact business. Although their scope varies, state insurance laws in general grant broad powers to supervisory agencies or officials to examine companies and to enforce rules or exercise discretion touching almost every significant aspect of the insurance business. These include the licensing of companies to transact business and varying degrees of control over claims handling practices, reinsurance arrangements, premium rates, the forms and policies offered to customers, financial statements, periodic financial reporting, permissible investments (see "Investment Portfolio" above) and adherence to financial standards relating to statutory surplus, dividends and other criteria of solvency intended to assure the satisfaction of obligations to policyholders. Mortgage insurers are generally restricted by state insurance laws and regulations to writing residential mortgage insurance business only. This restriction prohibits PMI, RGC, PMG, RIC and CMG from directly writing other types of insurance. However, the noninsurance subsidiaries of TPG are not generally subject to regulation under state insurance laws except with respect to transactions with their insurance affiliates. The Company's title insurance subsidiary, APTIC, is subject to comprehensive regulation in the states in which it is licensed to transact business. Among other things, such regulation requires APTIC to adhere to certain financial standards relating to statutory reserves and other criteria of solvency. Generally, title insurers are restricted to writing only title insurance, and may not transact any other kind of insurance. This restriction prohibits APTIC from using its capital and resources in support of other types of insurance businesses. Insurance Holding Company Regulation. All states have enacted legislation that requires each insurance company in a holding company system to register with the insurance regulatory authority of its state of domicile and to furnish to such regulator financial and other information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Most states also regulate transactions between insurance companies and their parents and affiliates. Generally, such regulations require that all transactions within a holding company system between an insurer and its affiliates be fair and reasonable and that the insurer's statutory policyholders' surplus following any transaction with an affiliate be both reasonable in relation to its outstanding liabilities and adequate for its needs. In addition, Arizona law requires that the Arizona Director of Insurance be given 30-days prior notice of certain types of agreements between an insurance company and an affiliate. Because TPG is an insurance holding company and PMI, PMG, RGC and RIC are Arizona insurance companies, the Arizona insurance laws regulate, among other things, certain transactions in the Company's Common Stock and certain transactions between PMI and PMG, RGC and RIC and their parent or affiliates. Specifically, no person may, directly or indirectly, offer to acquire or acquire beneficial ownership of more than 10% of any class of outstanding securities of TPG, PMI or PMG, RGC and RIC unless such person files a statement and other documents with the Arizona Director of Insurance and obtains the Director's prior approval after a public hearing is 28 held on the matter. In addition, material transactions between PMI and PMG, RGC and RIC and their parent or affiliates are subject to certain conditions, including that they be "fair and reasonable." These restrictions generally apply to all persons controlling or under common control with PMI or PMG, RGC and RIC. "Control" is presumed to exist if 10% or more of PMI's or PMG's, RGC's and RIC s voting securities is owned or controlled, directly or indirectly, by a person, although the Arizona Director of Insurance may find that "control" in fact does or does not exist where a person owns or controls either a lesser or greater amount of securities. In addition, since APTIC is domiciled in the State of Florida, TPG is also regulated as an insurance holding company under Florida law. The applicable requirements of Florida law are similar to the provisions of the Arizona insurance laws regulating insurance holding companies, with the exception that in Florida, regulatory approval must be obtained prior to the acquisition, directly or indirectly, of 5% or more of the voting securities of APTIC or TPG. Because CMG is domiciled in Wisconsin, TPG is also regulated as an insurance holding company under Wisconsin law. The applicable requirements of Wisconsin law are similar to those of Arizona law regulating insurance holding companies, except that the hearing to approve a change in control is optional in Wisconsin. For purposes of Arizona, Florida and Wisconsin law, "control" means the power to direct or cause the direction of the management of an insurer, whether through the ownership of voting securities, by contract other than a commercial contract for goods or nonmanagement services, or otherwise, unless the power is the result of an official position with or corporate office held by the person. Reserves. PMI is required under the insurance laws of Arizona and certain other states to establish a special contingency reserve with annual additions of amounts equal to 50% of premiums earned. The insurance laws of the various states, including Florida, impose additional reserve requirements applicable to title insurers such as APTIC. For instance, title insurers must maintain, in addition to reserves for outstanding losses, an unearned premium reserve computed according to statute and are subject to limitations with respect to the level of risk they can assume on any one contract. At December 31, 1998, PMI had statutory policyholders' surplus of $165.4 million and statutory contingency reserve of $1,028.4 million. See Part II, Item 8, Financial Statements Note 14-- "Statutory Accounting." Dividends. PMI's ability to pay dividends is limited under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay dividends out of available surplus and (ii) without prior approval of the Arizona Insurance Directory, such dividends during any 12-month period may not exceed the lesser of 10% of policyholders' surplus as of the preceding year end, or the last calendar year's investment income. In accordance with Arizona law, PMI is permitted to pay ordinary dividends to TPG of $16.5 million in 1999 without prior approval of the Arizona Insurance Director. See Part II, Item 8, Financial Statements Note 13-- "Dividends and Shareholders Equity." The laws of Florida limit the payment of dividends by APTIC to PMI in any one year to 10% of available and accumulated surplus derived from realized net operating profits and net realized capital gains. As a result, APTIC may be limited in its ability to pay dividends to PMI. CMG's ability to pay dividends to PMI is subject to the laws of Wisconsin. In addition to the dividend restrictions described above, insurance regulatory authorities have broad discretion to limit the payment of dividends by insurance companies. For example, if insurance regulators determine that payment of a dividend or any other payments to an affiliate (such as payments under a tax sharing agreement, payments for employee or other services, or payments pursuant to a surplus note) would, because of the financial condition of the paying insurance company or otherwise, be hazardous to such insurance company's policyholders or creditors, the regulators may block payments that would otherwise be permitted without prior approval. Premium Rates and Policy Forms. PMI's premium rates and policy forms are subject to regulation in every state in which it is licensed to transact business in order to protect policyholders against the adverse effects of excessive, inadequate or unfairly discriminatory rates and to encourage competition in the insurance marketplace. In all states, premium rates and, in most states, policy forms must be filed prior to their use. In some states, such rates and forms must also be approved prior to use. Changes in premium rates are subject to being justified, generally on the basis of the insurer's loss experience, expenses and future trend analysis. The general default experience in the mortgage insurance industry may also be considered. 29 Reinsurance. Regulation of reinsurance varies by state. Except for Arizona, Illinois, Wisconsin, New York and California, most states have no special restrictions on mortgage guaranty reinsurance other than standard reinsurance requirements applicable to property and casualty insurance companies. Certain restrictions apply under Arizona law to domestic companies and under the laws of several other states to any licensed company ceding business to unlicensed reinsurers. Under such laws, if a reinsurer is not admitted or approved in such states, the company ceding business to the reinsurer cannot take credit in its statutory financial statements for the risk ceded to such reinsurer absent compliance with certain reinsurance security requirements. Arizona prohibits reinsurance unless the reinsurance arrangements meets certain requirements, even if no statutory financial statement credit is to be taken. In addition, Arizona, Wisconsin and several other states limit the amount of risk a mortgage insurer may retain with respect to coverage of an insured loan to 25% of the insured's claim amount. Coverage in excess of 25% (i.e., deep coverage) must be reinsured. See "K. Reinsurance" above. Examination. PMI, APTIC, PMG, RGC and RIC and CMG are subject to examination of their affairs by the insurance departments of each of the states in which they are licensed to transact business. The Arizona Director of Insurance periodically conducts a financial examination of insurance companies domiciled in Arizona. In lieu of examining a foreign insurer, the Commissioner may accept an examination report by a state that has been accredited by the NAIC. Federal Regulation. Private mortgage insurers are indirectly, but significantly, impacted by regulations affecting purchasers of mortgage loans, such as Freddie Mac and Fannie Mae, and regulations affecting governmental insurers, such as the FHA and VA, and mortgage lenders. As a result, changes in federal housing legislation and other laws and regulations that affect the demand for private mortgage insurance may have a material effect on private mortgage insurers, including PMI. Legislation that increases the number of persons eligible for FHA or VA mortgages could have an adverse affect on the Company's ability to compete with the FHA or VA. The Home Owners Protection Act of 1998 (the "Act"), which is effective on July 29, 1999, provides for the automatic termination, or cancellation upon a borrower's request, of private mortgage insurance upon satisfaction of certain conditions. The Act applies to owner-occupied residential mortgage loans regardless of lien priority, with borrower-paid mortgage insurance, closed after the effective date of the Act. FHA loans are not covered by the Act. Under the Act, automatic termination of mortgage insurance would generally occur once the loan-to-value ratio ("LTV") reaches 78%. A borrower may generally request cancellation of mortgage insurance once the LTV reaches 80% of the home's original value, or when actual payments reduce the loan balance to 80% of the home's original value, whichever occurs earlier. For borrower initiated cancellation of mortgage insurance, the borrower must have a good payment history. Good payment history generally requires that there have been no payments during the 12-month period preceding the loan's cancellation date 30 days or more past due, or 60 days or more past due during the 12-month period beginning 24 months before the loan's cancellation date. Loans which are deemed "high risk" by the GSEs, require automatic termination of mortgage insurance coverage once the LTV is first scheduled to reach 77% of the original value of the property without regard to the actual outstanding balance. The Act preempts all but more protective, preexisting state laws. Protected state laws are preempted if inconsistent with the Act. Protected state laws are consistent with the Act if they require: (i) termination of mortgage insurance at an earlier date or higher mortgage principal balance than required by the Act, or (ii) disclosure of more, earlier, or more frequent information. States which enacted mortgage insurance cancellation laws on or before January 2, 1998, have until July 29, 2000 to make their statutes consistent with the Act. States that currently have mortgage insurance cancellation or notification laws include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New York, Texas and Washington. (See RF10) RESPA. The Real Estate Settlement and Procedures Act of 1974 ("RESPA") applies to most residential mortgages insured by PMI, and related regulations provide that mortgage insurance is a "settlement service" for purposes of loans subject to RESPA. Subject to limited exceptions, RESPA prohibits persons from accepting anything of value for referring real estate settlement services to any provider of such services. Although many states, including 30 Arizona, prohibit mortgage insurers from giving rebates, RESPA has been interpreted to cover many non-fee services as well. The recently renewed interest of HUD in pursuing violations of RESPA has increased awareness of both mortgage insurers and their customers of the possible sanctions of this law. HMDA. Most originators of mortgage loans are required to collect and report data relating to a mortgage loan applicant's race, nationality, gender, marital status and census tract to HUD or the Federal Reserve under the Home Mortgage Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect possible discrimination in home lending and, through disclosure, to discourage such discrimination. Mortgage insurers are not required pursuant to any law or regulation to report HMDA data, although under the laws of several states, mortgage insurers are currently prohibited from discriminating on the basis of certain classifications. The active mortgage insurers, through their trade association, MICA, have entered into an agreement with the Federal Financial Institutions Examinations Council ("MFIEC") to report the same data on loans submitted for insurance as is required for most mortgage lenders under HMDA. Mortgage lenders are subject to various laws, including HMDA, the Community Reinvestment Act and the Fair Housing Act. And Fannie Mae and Freddie Mac are subject to various laws, including laws relating to government sponsored enterprises, which may impose obligations or create incentives for increased lending to low and moderate income persons or in targeted areas. Fannie Mae and Freddie Mac. TPG and PMI are also significantly, impacted by laws and regulations affecting originators and purchasers of mortgage loans, particularly Fannie Mae and Freddie Mac, eligibility requirements imposed by the GSEs on private mortgage insurers for such insurers to be eligible to insure loans sold to such agencies and regulations affecting governmental insurers such as the FHA. Private mortgage insurers, including PMI, are highly dependent upon federal housing legislation and other laws and regulations which affect the demand for private mortgage insurance and the housing market generally. See "C industry Overview - Fannie Mae and Freddie Mac", above and RF3 Fannie Mae and Freddie Mac announced an increase in the maximum single-family principal balance loan limit eligible for their purchase from $227,150 to $240,000 effective in 1999. Fannie Mae and Freddie Mac both recently announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSEs' automated underwriting services, Desktop Underwriter/TM/ and Loan Prospector/SM/, respectively. Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage options provide for: (i) across-the-board reductions in required MI coverage on 30-year fixed-rate loans recommended for approval by GSE's automated underwriting services to the levels in effect in 1994; (ii) reduction in required MI coverage, for loans with only a 5 percent down payment (a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down payment (a 90 percent LTV loan), from 25 percent to 17 percent of the mortgage loan covered by MI.. In addition, the GSE's announced programs to further reduce MI coverage upon the payment of an additional fee by the lender. Under this option, a 95 percent LTV loan will require 18 percent of the mortgage loan have mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12 percent of the mortgage loan have mortgage insurance. In order for the home buyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. (See RF3). During October 1998, Freddie Mac sought to amend its charter to allow it to use any method of default loss protection that is financially equal or superior, on an individual or pooled basis, to the protection provided by private mortgage insurance companies. The legislation containing the proposed charter amendment was subsequently rescinded. Subsequent to the withdrawal of the legislation, Freddie Mac announced that it would pursue a permanent charter amendment that would allow Freddie Mac to utilize alternative forms of default loss protection, such as spread accounts, or otherwise forego the use of private mortgage insurance on higher loan-to-value mortgages. In addition, Fannie Mae announced it is interested in pursuing new risk management options and is working with mortgage insurers and lenders on appropriate risk management and dispersion of risk, which may include a reduction in the use of mortgage insurance. Fannie Mae and Freddie Mac also have the discretion to reduce the amount of private mortgage insurance they require on loans. (See RF3) 31 National Association of Insurance Commissioners. The NAIC has developed a rating system, the Insurance Regulatory Information System ("IRIS"), primarily intended to assist state insurance departments in overseeing the statutory financial condition of all insurance companies operating within their respective states. IRIS consists of 11 key financial ratios, which are intended to indicate unusual fluctuations in an insurer's statutory financial position and/or operating results. P. Employees At December 31, 1998, TPG, including its subsidiaries had 1,016 full and part- time employees; 733 persons perform services primarily for PMI not including contract underwriter's, 13 perform services primarily for MSC, 14 perform services primarily for CMG and an additional 256 persons are employed by APTIC. TPG's employees are not unionized and TPG considers its employee relations to be good. In addition, MSC had 627 contract workers at December 31, 1998. Q. STATEMENTS AND RISK FACTORS CONCERNING THE COMPANY'S OPERATIONS AND FUTURE RESULTS General Conditions (RF1) Several factors such as economic recessions, declining housing values, higher unemployment rates, deteriorating borrower credit, rising interest rates, increases in refinance activity caused by declining interest rates, changes in legislation affecting the mortgage insurance industry, or combinations of such factors might affect the mortgage insurance industry and demand for housing in general and could materially and adversely affect the Company's financial condition and results of operations. Such economic events could materially and adversely impact the demand for mortgage insurance, cause claims on policies issued by PMI to increase, and/or cause a similar adverse increase in PMI's loss experience. Other factors that may influence the amount of NIW by PMI include: mortgage insurance industry volumes of new business; the impact of competitive underwriting criteria and product offerings and services, including mortgage pool insurance and contract underwriting services; the ability to recruit and maintain a sufficient number of qualified underwriters; the effect of risk- sharing structured transactions; changes in the performance of the financial markets; PMI's claims-paying ability rating; general economic conditions that affect the demand for or acceptance of the Company's products; changes in government housing policy; changes in government regulations or interpretations regarding the Real Estate Settlement Procedures Act and customer consolidation. PMI's financial condition and results of operations may materially and adversely be impacted by changes in legislation which affects the ability of Fannie Mae or Freddie Mac to offer a substitute for mortgage insurance, including self- insurance and alternative forms of credit support, or for the FHA or the VA to increase statutory lending limits or other expansion of eligibility for the FHA and VA. (See RF2). PMI's financial condition and results of operations may materially and adversely be impacted by changes in legislation, statutory charters and regulations governing banks and savings institutions to form reinsurance subsidiaries or permit the offering of other products which do not require mortgage insurance. In addition, PMI's financial condition and results of operations may materially and adversely be impacted by a reduction in the amount of mortgage insurance coverage required by Fannie Mae and Freddie Mac. (See RF3) The costs of Year 2000 remediation, the dates on which the Company estimates that it will complete such remediation and possible risks associated with the Year 2000 issue are based upon the Company's current estimates and are subject to various uncertainties that could cause the actual results to differ materially from the Company's expectations. Such uncertainties include, among others, the success of the Company in identifying systems that are not Year 2000 compliant, the nature and amount of programming required to remediate each affected system, the 32 nature and adequacy of testing performed by the Company, the availability of qualified personnel, consultants and other resources, and the success of the Year 2000 remediation efforts of others. If the Company's recently completed remediation of its mission critical mortgage insurance origination and application processing process is faulty or fails for any reason to be Year 2000 compliant, this circumstance could adversely impact its business operations and could have a material adverse affect on the Company's financial condition, liquidity and results of operations. See Management Discussion and Analysis - Year 2000 Issues. Market Share and Competition (RF2) The Company's financial condition and results of operations could be materially and adversely affected by a decline in its market share, or a decline in market share of the private mortgage insurance industry as a whole. Numerous factors bear on the relative position of the private mortgage insurance industry versus government and quasi-governmental competition as well as the competition of lending institutions that choose to remain uninsured, self-insure through affiliates, or offer residential mortgage products that do not require mortgage insurance. The impact of competitive underwriting criteria and product offerings, including mortgage pool insurance and contract underwriting, has a direct impact on the Company's market share. Further, several of the Company's competitors have greater direct or indirect capital reserves that provide them with potentially greater flexibility than the Company in addressing competitive issues. PMI competes directly with federal and state governmental and quasi-governmental agencies, principally the FHA and, to a lesser degree, the VA. The Office of the Comptroller of the Currency has granted permission to certain national banks to form a reinsurance company as a wholly-owned operating subsidiary for the purpose of reinsuring mortgage insurance written on loans originated or purchased by such bank. The Federal Reserve Board is in the process of considering whether similar activities are permitted for bank holding companies. The Office of Thrift Supervision has also recently granted permission for subsidiaries of thrift institutions to reinsure private mortgage insurance coverage on loans originated or purchased by affiliates of such thrift's parent organization.. The reinsurance subsidiaries of national banks, savings institutions, or bank holding companies could become significant competitors of the Company in the future. Mortgage lenders, other than banks, thrifts or their affiliates, are forming reinsurance affiliates that are typically regulated solely by the insurance authority of their state of domicile. Management believes that such reinsurance affiliates will increase competition in the mortgage insurance industry and may materially and adversely impact PMI's market share. PMI offers various risk-sharing structured transactions, including a captive reinsurance program as part of its strategic relationships with its customers. PMI's customers have indicated an increasing demand for such products. PMI's captive reinsurance program allows a reinsurance company, generally an affiliate of the lender, to assume mortgage insurance default losses either on a quota share basis, or at a specified entry point up to a maximum aggregate exposure, up to an agreed upon amount of total coverage. An increasing percentage of PMI's NIW is being generated by customers which have captive reinsurance programs, and it is expected that this will continue and increase. Based on the current structure, such products have the potential of reducing the Company's business revenue as more premiums are ceded to customer captives. There can be no assurance that PMI's risk-sharing structured transactions will continue to be accepted by its customers. The inability of the Company to provide acceptable risk-sharing structured transactions to its customers would likely have an adverse effect on the competitive position of PMI and consequently could materially and adversely affect the Company's financial condition, liquidity and results of operations. Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10% second mortgage lien, and 10% of the purchase price from borrower's funds ("80/10/10"). This 80/10/10 product competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. The Federal Deposit Insurance Corporation and other banking regulators recently approved rules to be effective April 1, 1999 that would require national banks to hold almost twice as much risk-based capital to cover possible defaults on the 80/10/10 products when the lender holds the first and second mortgage. State-chartered banks already are subject to the higher capital requirement. If the 80/10/10 product becomes a widely accepted alternative to mortgage insurance, it could have a material and adverse impact on the Company's financial condition and results of operations. 33 Legislation and regulatory changes affecting the FHA have affected demand for private mortgage insurance. Effective January 1, 1999, the Department of Housing and Urban Development announced an increase in the maximum individual loan amount that FHA can insure to $208,800 from $197,620. The maximum individual loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of 1999, signed into law on October 21, 1998, among other items, streamlined the FHA downpayment formula by eliminating tiered minimum cash investment requirements and establishing maximum loan-to-value ratios based on loan size and closing costs, making FHA insurance more competitive with private mortgage insurance in areas with higher home prices. Although management believes that it is too early to ascertain the impact of the increase in the maximum individual loan amount the FHA can insure, any increase in the maximum loan amount would likely have an adverse effect on the competitive position of PMI and, consequently, could materially and adversely affect the Company's financial condition and results of operations. Fannie Mae and Freddie Mac (RF3) The GSEs are permitted by statute to purchase conventional high-LTV mortgages from lenders who obtain mortgage insurance on those loans. Fannie Mae and Freddie Mac have some discretion to increase or decrease the amount of private mortgage insurance coverage they require on loans. Fannie Mae and Freddie Mac both recently announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSEs' automated underwriting services, Desktop Underwriter/TM/ and Loan Prospector/SM/, respectively. Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage options provide for: (i) across-the-board reductions in required MI coverage on 30-year fixed-rate loans recommended for approval by GSE's automated underwriting services to the levels in effect in 1994; (ii) reduction in required MI coverage, for loans with only a 5 percent down payment (a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down payment (a 90 percent LTV loan), from 25 percent to 17 percent of the mortgage loan covered by MI.. In addition, the GSE's announced programs to further reduce MI coverage upon the payment of an additional fee by the lender. Under this option, a 95 percent LTV loan will require 18 percent of the mortgage loan have mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12 percent of the mortgage loan have mortgage insurance. In order for the home buyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. Management believes it is too early to assess impact of the Fannie Mae and Freddie Mac reduction of required levels of mortgage insurance on the Company's financial condition and results of operation. If the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, however, such reduction could have a materially adverse impact on the Company's financial condition and results of operation. During October 1998, Freddie Mac sought to amend its charter to allow it to use any method of default loss protection that is financially equal or superior, on an individual or pooled basis, to the protection provided by private mortgage insurance companies. The legislation containing the proposed charter amendment was subsequently rescinded. Currently, Freddie Mac can purchase loans with downpayments of less than 20%, only if the loans are insured or use other limited methods to protect against default. Subsequent to the withdrawal of the legislation, Freddie Mac announced that it would pursue a permanent charter amendment that would allow Freddie Mac to utilize alternative forms of default loss protection, such as spread accounts, or otherwise forego the use of private mortgage insurance on higher loan-to- value mortgages. In addition, Fannie Mae announced it is interested in pursuing new risk management options and is working with mortgage insurers and lenders on appropriate risk management and dispersion of risk, which may include a reduction in the use of mortgage insurance. Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of mortgage insurance generally provide that a borrower's written request to cancel mortgage insurance should be honored if: (a) the borrower has a 34 satisfactory payment record, no payment more than 30 days delinquent in the 12- month period preceding the request for cancellation; and (b) the unpaid principal balance of the mortgage is not greater than 80% of the original value of the property. (See RF4 for a discussion of recent Federal legislation providing for guidelines for automatic mortgage insurance cancellation) The GSEs are the predominant purchasers and sellers of conventional mortgage loans in the United States, providing a direct link between the primary mortgage origination markets and the capital markets. Because loan originators prefer to make loans that may be marketed in the secondary market to Fannie Mae and/or Freddie Mac they are motivated to purchase mortgage insurance from insurers deemed eligible by the GSEs. Although management believes that it is too early to ascertain the impact of the increase in the maximum individual loan amount the GSEs can insure, management believes any increase in the maximum loan amount would likely increase the number of loans eligible for mortgage insurance and may have the effect of increasing the size of the mortgage insurance market, and have a positive effect on the competitive position of PMI and consequently could materially affect the Company's financial condition and results of operations. Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for such insurers to be eligible to insure loans sold to such agencies. Under Fannie Mae and Freddie Mac regulations, PMI needs to maintain at least an "AA-" or equivalent claims-paying ability rating in order to provide mortgage insurance on loans purchased by the GSEs. Failure to maintain such a rating would effectively cause PMI to be ineligible to provide mortgage insurance. A loss of PMI's existing eligibility status, either due to a failure to maintain a minimum claims-paying ability rating from the various rating agencies or non-compliance with other eligibility requirements, would have a material, adverse effect on the Company's financial condition and results of operations. (See RF2) Insurance in Force (RF4) A significant percentage of PMI's premiums earned is generated from its existing insurance in force and not from new insurance written. PMI's policies for insurance coverage typically have a policy duration of six to eight years. Insurance coverage may be canceled by the policy owner or servicer of the loan at any time. PMI has no control over the owner's or servicer's decision to cancel insurance coverage and self-insure or place coverage with another mortgage insurance company. There can be no assurance that policies for insurance coverage originated in a particular year or for a particular customer will not be canceled at a later time or that the Company will be able to regain such insurance coverage at a later time. As a result, the Company's financial condition and results of operation could be materially and adversely affected by greater than anticipated policy cancellations or lower than projected persistency resulting in declines in insurance in force. Upon request by an insured, PMI must cancel the mortgage insurance for a mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"), which is effective on July 29, 1999, provides for the automatic termination, or cancellation upon a borrower's request, of private mortgage insurance upon satisfaction of certain conditions. The Act applies to owner- occupied residential mortgage loans regardless of lien priority, with borrower-paid mortgage insurance, closed after the effective date of the Act. FHA loans are not covered by the Act. Under the Act, automatic termination of mortgage insurance would generally occur once the loan-to-value ratio ("LTV") reaches 78%. A borrower may generally request cancellation of mortgage insurance once the LTV reaches 80% of the home's original value, or when actual payments reduce the loan balance to 80% of the home's original value, whichever occurs earlier. For borrower initiated cancellation of mortgage insurance, the borrower must have a good payment history. Good payment history generally requires that there have been no payments during the 12-month period preceding the loan's cancellation date 30 days or more past due, or 60 days or more past due during the 12-month period beginning 24 months before the loan's cancellation date. Loans which are deemed "high risk" by the GSEs, require automatic termination of mortgage insurance coverage once the LTV is first scheduled to reach 77% of the original value of the property without regard to the actual outstanding balance. The Act preempts all but more protective, preexisting state laws. Protected state laws are preempted if inconsistent with the Act. Protected state laws are consistent with the Act if they require: (i) termination of mortgage insurance at an earlier date or higher mortgage principal balance than required by the Act, or (ii) disclosure of more, earlier, or more frequent information. States which enacted mortgage insurance cancellation laws on or before January 2, 1998, have until July 29, 2000 to make their statutes consistent with the Act. States that currently have mortgage insurance cancellation or notification laws include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New York, Texas and Washington. Management is uncertain about the impact of the Act on PMI's insurance in force, but believes any reduction in premiums attributed to the Act's required cancellation of mortgage insurance, will not have a significant impact on the Company's financial condition and results of operation for the foreseeable future. (See RF10) During an environment of falling interest rates, an increasing number of borrowers refinance their mortgage loans. PMI and other mortgage insurance companies generally experience an increase in the prepayment rate of insurance in force, resulting from policy cancellations of older books of business with higher rates of interest. Although PMI 35 has a history of expanding business during low interest rate environments, the resulting increase of NIW may ultimately prove to be inadequate to compensate for the loss of insurance in force arising from policy cancellations. A decrease in persistency, resulting from policy cancellations of older books of business affected by refinancings (which are affected, among other things, by decreases in interest rates) may materially and adversely impact the level or rate of growth of insurance in force or risk in force and consequently have similar impacts on the Company's financial condition and results of operations. Rating Agencies (RF5) PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc., "AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit Rating Co. These ratings are subject to revisions or withdrawal at any time by the assigning rating organization. The ratings by the organizations are based upon factors relevant to PMI's policyholders, principally PMI's capital resources as computed by the rating agencies, and are not applicable to the Company's common stock or outstanding debt. Rating agencies generally assess capital charges on pool insurance policies based on price and structure. One published methodology for assessing the capital requirement for pool insurance is based on the real estate depression which occurred in oil producing states during the mid-1980's. Management believes the current capital charge that could be levied on pool insurance risk by one rating agency is approximately $1.00 of capital for each $1.40 of pool insurance risk. In comparison, primary mortgage insurance regulators specifically limit the amount of insurance risk that may be written by PMI according to a number of financial tests, including limiting risk, to a multiple of 25 times PMI's statutory capital (which includes the contingency reserve). The rating agencies could change their view as to the capital charges that are assessed on pool insurance products at any time. (See RF10) Management believes that a significant reduction in PMI's claims-paying ratings could have a material, adverse effect on the Company's financial condition and results of operations. (See RF6) Liquidity (RF6) In the mortgage guaranty insurance industry, liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations, including premiums received and investment income, in order to meet its financial commitments, which are principally obligations under the insurance policies it has written. Liquidity requirements are significantly influenced by the level and severity of claims. TPG's principal sources of funds are dividends from PMI and APTIC, investment income and funds that may be raised from time to time in the capital markets. Numerous factors bear on the Company's ability to maintain and meet its capital and liquidity needs, including the performance of the financial markets, standards and factors used by various credit rating agencies, financial covenants in credit agreements, and standards imposed by state insurance regulators relating to the payment of dividends by insurance companies. Any significant change in the performance of the financial markets negatively affecting the Company's ability to secure sources of capital, or changes in the standards used by credit rating agencies which adversely impact PMI's claims- paying ability rating, or changes in the insurance laws of Arizona, Florida or Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at currently permissible levels, could adversely affect the Company's ability to maintain capital resources to meet its business needs, and thereby have a material, adverse affect on the Company's financial condition, liquidity and results of operations. Contract Underwriting Services; New Products (RF7) The Company provides contract underwriting services for a fee that enable customers to improve the efficiency and quality of their operations by outsourcing all or part of their mortgage loan underwriting. As a part of its contract underwriting services, PMI provides remedies which may include the assumption of some of the costs of repurchasing insured and uninsured loans from the GSEs and other investors. Generally, the scope of these remedies 36 are in addition to those contained in PMI's master primary insurance policies. Due to the increasing demand of contract underwriting services, the limited number of underwriting personnel available, and heavy price competition among mortgage insurance companies, PMI's inability to recruit and maintain a sufficient number of qualified underwriters, or any significant increase in the cost PMI incurs to satisfy remedy obligations for underwriting services, could materially and adversely affect its market share and materially and adversely affect the Company's financial condition and results of operations. TPG and PMI, from time to time, introduce new mortgage insurance products or programs. The Company's financial condition and results of operations could be materially and adversely affected if PMI or the Company experiences delays in introducing competitive new products and programs. In addition, for any introduced product, there can be no assurance that such products, including any mortgage pool type products, or programs will be as profitable as the Company's existing products and programs. New York Department of Insurance (RF8) In February 1999, the New York Department of Insurance stated in Circular Letter No. 2, addressed to all private mortgage insurers licensed in New York that certain pool risk-share and structured products and programs would be considered to be illegal under New York law. PMI believes that it complies with the requirements of Circular Letter No. 2 with respect to transactions that are governed by it. In the event the New York Department of Insurance determined PMI was not in compliance with Circular Letter No. 2, it could materially and adversely affect the Company's financial condition and results of operations. Risk-to-Capital Ratio (RF9) The State of Arizona, and other regulators specifically limit the amount of insurance risk that may be written by PMI, by a variety of financial factors. Other factors affecting PMI's risk-to-capital ratio include: (i) regulatory review and oversight by the State of Arizona, PMI's state of domicile for insurance regulatory purposes; (ii) limitations under the Runoff Support Agreement with Allstate, which prohibit PMI from paying any dividends if, after the payment of any such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; (iii) TPG's credit agreements; and (iv) TPG's and PMI's credit or claims-paying ability ratings which generally require that the rating agencies' risk-to-capital ratio not exceed 20 to 1. Significant losses could cause a material reduction in statutory capital, causing an increase in the risk-to-capital ratio and thereby limit PMI's ability to write new business. The inability to write new business could materially and adversely affect the Company's financial condition and results of operations. Changes in Composition of Insurance Risk Written; Pool Insurance (RF10) The composition of PMI's NIW has included an increasing percentage of mortgages with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December 31, 1998, 46.3% of PMI's risk in force consisted of 95s, which, in PMI's experience, have had a claims frequency approximately twice that of mortgages with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At December 31, 1998, 3.3% of PMI's risk in force consisted of 97s which have even higher risk characteristics than 95s and greater uncertainty as to pricing adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which, although priced higher, have risk characteristics that exceed the risk characteristics associated with PMI's book of business as a whole. Since the fourth quarter of 1997, PMI has offered a new pool insurance product. Pool insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions and generally covers the loss on a defaulted mortgage loan that exceeds the claim payment under the primary coverage, if primary insurance is required on that mortgage loan. Pool insurance also generally covers the total loss on a defaulted mortgage loan which did not require primary insurance, in each case up to a stated aggregate loss limit. New pool risk written was $450 million for the year ended December 31, 1998. Management is uncertain about the amount of new pool risk which will be written in 1999, but believes total new 1999 pool risk will be less than in 1998. Although PMI charges higher premium rates for loans that have higher 37 risk characteristics, including ARMs, 95s, 97s and pool insurance products, the premiums earned on such products, and the associated investment income, may ultimately prove to be inadequate to compensate for future losses from such products. Such losses could materially and adversely affect the Company's financial condition and results of operations. (See RF5) Potential Increase in Claims (RF11) Mortgage insurance coverage generally cannot be canceled by PMI and remains renewable at the option of the insured until required to be canceled under applicable Federal or state laws for the life of the loan. As a result, the impact of increased claims from policies originated in a particular year generally cannot be offset by premium increases on policies in force or mitigated by nonrenewal of insurance coverage. There can be no assurance, however, that the premiums charged will be adequate to compensate PMI for the risks and costs associated with the coverage provided to its customers. (See RF5) Loss Reserves (RF12) PMI establishes loss reserves based upon estimates of the claim rate and average claim amounts, as well as the estimated costs, including legal and other fees, of settling claims. Such reserves are based on estimates, which are regularly reviewed and updated. There can be no assurance that PMI's reserves will prove to be adequate to cover ultimate loss development on incurred defaults. The Company's financial condition and results of operations could be materially and adversely affected if PMI's reserve estimates are insufficient to cover the actual related claims paid and expenses incurred. Regional Concentration (RF13) In addition to nationwide economic conditions, PMI could be particularly affected by economic downturns in specific regions where a large portion of its business is concentrated, particularly California, Florida, and Texas, where PMI has 17.6%, 7.3% and 7.2% of its risk in force concentrated and where the default rate on all PMI policies in force is 3.15%, 3.08% and 2.18% compared with 2.31% nationwide as of December 31, 1998. Continuing Relationships with Allstate and Affiliate (RF14) In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage Insurance Company ("Forestview") whereby Forestview agreed to reinsure all liabilities (net of amounts collected from third party reinsurers and indemnitors) in connection with PMI's mortgage pool insurance business in exchange for premiums received. In 1994, Forestview also agreed that as soon as practicable after November 1, 1994, Forestview and PMI would seek regulatory approval for the Reinsurance Treaty to be deemed to be an assumption agreement and that, upon receipt of the requisite approvals, Forestview would assume such liabilities. Forestview's claims-paying ability is currently rated "AA" by Fitch IBCA. Forestview's previous claims-paying ability rating of "AA" (Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in 1997. These ratings are subject to revisions or withdrawal at any time by the assigning rating organization. Management is uncertain at this time what impact the withdrawal of the claims-paying ability rating will have on the parties' ability to timely consummate the assumption transaction. Pursuant to this agreement, PMI ceded $9.0 million of pool premiums to Forestview and Forestview reimbursed PMI for pool claims on the covered policies in the amount of $26.8 million in 1998. The failure of Forestview to meet its contractual commitments would materially and adversely affect the Company's financial condition and results of operations. On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff Support Agreement") with Allstate Insurance Company ("Allstate") to replace various capital support commitments that Allstate had previously provided to PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI prior to October 28, 1994, if PMI's financial condition deteriorates below specified levels, or if a third party brings a claim thereunder. Alternatively, Allstate may make contributions directly to PMI or TPG. In the event that Allstate makes payments or contributions under the Runoff Support Agreement (which possibility management believes is remote), 38 Allstate would receive subordinated debt or preferred stock of PMI or TPG in return. No payment obligation arose under the Runoff Support Agreement. Item 2. Properties TPG leases its home office in San Francisco, California, which consists of approximately 99,928 square feet of office space. The San Francisco lease expires on December 31, 2004. In addition, TPG leases space for 34 PMI field offices. Such field office leases cover an average of approximately 4,300 square feet and have terms of not more than five years. During 1997, PMI established its Certificate Priority Center, which is located in Dallas, Texas. The CPC consists of approximately 17,563 square feet of office space. TPG believes its existing properties are well utilized and are suitable and adequate for its present circumstances. Item 3. Legal Proceedings Various legal actions and regulatory reviews are currently pending that involve the Company and specific aspects of its conduct of business. In the opinion of management, the ultimate liability or resolution in one or more of the foregoing actions is not expected to have a material adverse effect on the financial condition or results of operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted during the fourth quarter of 1998 to a vote of stockholders through the solicitation of proxies or otherwise. EXECUTIVE OFFICERS OF REGISTRANT Set forth below is certain information regarding TPG's executive officers as of December 31, 1998, including age as of March 31, 1999, and business experience for at least the past five years. W. ROGER HAUGHTON, 51, has been Chairman of the Board of TPG since May 1998 and has been Chief Executive Officer since January 1995. Mr. Haughton was President of TPG from January 1995 until September 1998. Mr. Haughton has been Chairman, Chief Executive Officer and President of PMI Mortgage Insurance Co. ("PMI") since January 1993. Mr. Haughton joined PMI in 1985 as Vice President of Underwriting, after 16 years with Allstate Insurance Company ("Allstate"). In 1987, he was promoted to Vice President/General Manager for PMI's Central Zone, responsible for all sales and field office operations in that region. In 1989, he became Group Vice President of Insurance Operations, Claims and Actuarial Services departments. In March 1999, Mr. Haughton concluded his two-year term as President of the Mortgage Insurance Companies of America ("MICA"), the industry trade association, a position he has held since March 1997. He also has a long history of active volunteerism with various affordable housing organizations, including Habitat for Humanity, and serves on the board of Social Compact. Mr. Haughton has been a Director since January 1995. He is an Ex Officio member of the Governance and Nominating Committee L. STEPHEN SMITH, 49, President and Chief Operating Officer of TPG and PMI since September 1998. Prior thereto he was Executive Vice President of Marketing and Field Operations of PMI since May 1994 and was elected to the same positions with TPG in January 1995. Prior thereto, he was PMI's Senior Vice President of Field Operations from September 1993 to May 1994, Senior Vice President of Marketing and Customer Technology from December 1991 to September 1993 and Vice President/General Manager of PMI's Eastern Zone from September 1985 to December 1991. 39 CLAUDE J. SEAMAN, 52, has been Group Executive Vice President Strategic Investments of TPG and PMI since February 1999. Prior thereto, he was Executive Vice President of Insurance Operations of PMI since May 1994, and was elected to the same positions with TPG in January 1995. Prior thereto, he was PMI's Senior Vice President of Insurance Operations from March 1993 to May 1994, Vice President of Claims from December 1991 to March 1993 and Vice President of Underwriting from January 1987 to December 1991. JOHN M. LORENZEN, Jr., 54, has been Executive Vice President of PMI since May 1994 and Chief Financial Officer of PMI since April 1989, and was elected to the same positions with TPG in January 1995. Prior thereto, he was PMI's Senior Vice President from April 1989 to May 1994 and Vice President of Finance from April 1985 to April 1989. BRADLEY M. SHUSTER, 44, has been Executive Vice President Corporate Development of TPG and PMI since February 1999. Prior thereto, he was Senior Vice President, Treasurer and Chief Investment Officer of PMI since August 1995, and was elected to the same position with TPG, in September 1995. Prior thereto, he was an audit partner with the accounting firm of Deloitte & Touche LLP from May 1988 to July 1995. THOMAS C. BROWN, 50, has been Executive Vice President, Field Operations of TPG and PMI since September 1998. Prior thereto he was Senior Vice President of National Accounts of TPG and PMI since joining TPG in June 1997. Prior to joining TPG, he was president and chief executive officer of Centerbank Mortgage Company, positions he held since 1989. VICTOR J. BACIGALUPI, 55, has been Senior Vice President, General Counsel and Secretary of TPG and PMI since November 1996. Prior to joining TPG, he was a partner in the law firm of Bronson, Bronson & McKinnon LLP, San Francisco, California since February 1992. DANIEL L. ROBERTS, 49, has been Senior Vice President, Chief Information Officer of TPG and PMI since December 1997. Prior to joining TPG, he was vice president and chief information officer of St. Joseph Health System, a position he held since he joined the company in October 1994. Prior thereto, he was vice president, information services and chief information officer for a division of Catholic Healthcare West, positions he held since joining the company in December 1990. Mr. Roberts was a consulting partner with the accounting firm of Deloitte & Touche from July 1985 to December 1990. 40 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Common Stock TPG is listed on the New York Stock Exchange and the Pacific Exchange under the trading symbol PMA. As of December 31, 1998 there were 30,278,601 shares issued and outstanding. As of February 26, 1999 there were 30,093,055 shares issued and outstanding held by approximately 38 stockholders of record and approximately 8,000 beneficial owners of shares held by brokers and fiduciaries. The following table shows the high, low and closing common stock prices by quarter from the New York Stock Exchange Composite Listing for the two years ended December 31, 1998 and 1997:
1998 1997 ---------------------------------- ------------------------------ High Low Close High Low Close ---------- ----------- ----------- -------- ----------- --------- First quarter 83 7/8 63 3/4 80 3/4 56 7/8 50 50 1/8 Second quarter 85 1/2 68 7/16 73 15/32 63 47 3/4 62 3/8 Third quarter 75 1/4 41 1/2 45 3/4 63 13/16 56 1/2 57 5/16 Fourth quarter 59 7/8 33 49 3/8 74 56 1/2 72 5/16
Preferred Stock TPG's Board of Directors is authorized to issue up to 5,000,000 shares of preferred stock of TPG in classes or series and to fix the designations, preferences, qualifications, limitations or restrictions of any class or series with respect to the rate and nature of dividends, the price and terms and conditions on which shares may be redeemed, the amount payable in the event of voluntary or involuntary liquidation, the terms and conditions for conversion or exchange into any other class or series of the stock, voting rights and other terms. The Company may issue, without the approval of the holders of common stock, preferred stock which has voting, dividend or liquidation rights superior to the common stock and which may adversely affect the rights of the holders of common stock. The Company has reserved for issuance under the Shareholder Rights Plan described below up to 400,000 shares of preferred stock. Shareholder Rights Plan On January 13, 1998, the Company adopted a Preferred Share Purchase Rights Plan ("Rights Plan"). Under the Rights Plan, all shareholders of record as of January 26, 1998 received rights to purchase shares of a new series of preferred stock on the basis of one right for each common stock held on that date. However, rights issued under the Rights Plan will not be exercisable initially. The rights will trade with the Company's common stock and no certificates will be issued until certain triggering events occur. The Rights Plan has a 10-year term from the record date, but the Company's Board of Director's will review the merits of redeeming or continuing the Rights Plan not less than once every three years. Rights issued under the plan will be exercisable only if a person or group acquires 10% or more of the Company's common stock or announces a tender offer for 10% or more of the common stock. If a person or group acquires 10% or more of the Company's common stock, all rightholders except the buyer will be entitled to acquire the Company's common stock at a discount and/or under certain circumstances to purchase shares of the acquiring company at a discount. The Rights Plan contains an exception that would allow passive institution investors to acquire up to a 15% ownership interest before the rights would become exercisable. Payment of Dividends and Policy Payment of future dividends is subject to a declaration by TPG's Board of Directors. The dividend policy is also dependent on the ability of PMI to pay dividends to TPG, which is subject to, among other factors, regulatory restrictions by the Arizona Department of Insurance and TPG's credit agreements and the Runoff Support 41 Agreement. (See Part I. "O. Regulation" and Part II, Item 8, Financial Statement Note 13--"Dividends and Stockholders' Equity".) During the second quarter of 1995, TPG's Board of Directors declared its first dividend on common stock of $0.05 per share, and has declared and paid a quarterly dividend of $0.05 per share through the fourth quarter of 1998. Item 6. Selected Financial Data The information required by this Item is incorporated by reference from portions of The PMI Group, Inc. 1998 Annual Report to Stockholders under the heading "Five year Summary of Financial Data" filed as part of Exhibit 13.1. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by this Item is incorporated by reference from portions of The PMI Group, Inc. 1998 Annual Report to Stockholders under the heading "Management Discussion and Analysis" as part of Exhibit 13.1. Item 7A. Quantitative and Qualitative Disclosures About Market Risk At December 31, 1998, the average duration of the Company's fixed income investment portfolio was 5.3 years, and the Company had no derivative financial instruments in its investment portfolio. The result of a 1% increase in interest rates would be a 5.3% decrease in the value of the Company's investment portfolio, while the result of a 1% decrease in interest rates would be a 4.8% increase in the value of the Company's investment portfolio. Item 8. Financial Statements and Supplementary Data The information required by this Item is incorporated by reference from portions of The PMI Group, Inc. 1998 Annual Report to Stockholders as part of Exhibit 13.1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The information concerning TPG's Directors as required by this Item is incorporated by reference from TPG's 1999 Proxy Statement under the captions "Nominees For Director of TPG" and "Section 16(a) Beneficial Ownership Reporting Compliance". Information regarding Executive Officers of TPG is included in a separate item captioned "Executive Officers of Registrant" in Part I of this report. Item 11. Executive Compensation The information required by this Item is incorporated by reference from TPG's 1999 Proxy Statement under the captions "Directors-Compensation and Benefits," "Executive Compensation" and "Compensation Committee Interlocks and Insider Participants". Item 12. Security Ownership of Certain Beneficial Owners and Management 42 The information required by this Item is incorporated by reference from TPG's 1999 Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management". Item 13. Certain Relationships and Related Transactions Not Applicable. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Financial Statements: The financial statements listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules are filed as part of this Form 10-K. 2. Financial Statement Schedules: The financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules are filed as part of the Form 10-K. All other schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or notes thereto. 3. Exhibits: The exhibits listed in the accompanying Index to Exhibits are filed as part of this Form 10-K. (b) Reports on Form 8-K: (i) On January 19, 1999, TPG filed a report on Form 8-K to announce that Fannie Mae issued a press release announcing the expansion of available mortgage insurance options reducing the amount of mortgage insurance required on loans purchased by Fannie Mae; and (ii) On January 22, 1999, TPG filed a report on Form 8-K to announce its fourth quarter earnings and financial results for the period ended December 31, 1998, and to announce additional statements made on January 20, 1999 during the fourth quarter earnings conference call with analysts. 43 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES [Item 14(a) 1 and 2]
Page ----------------------------------------- Annual Report Consolidated Financial Statements Form 10-K To Shareholders --------------------------------- -------------------- ------------------ Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 N/A 26 Consolidated Balance Sheets as of December 31, 1998 and 1997 N/A 27 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 N/A 28 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 N/A 29 Notes to Consolidated Financial Statements N/A 30-47 Report of Independent Auditors N/A 48 Financial Statement Schedules ----------------------------- Report of Independent Auditors on Financial Statement Schedules as of and 36 N/A for the specified years in the three-year period ended December 31, 1998: Schedule I-Summary of investments other than in related parties 37 N/A Schedule II-Condensed financial information of Registrant 38-41 N/A Schedule III-Supplementary insurance information 42 N/A Schedule IV-reinsurance 43 N/A
44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Francisco, State of California, on the 30th day of March, 1999. The PMI Group, Inc. BY: /s/ W. Roger Haughton ------------------------------------------------- W. Roger Haughton Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 30, 1999 by the following persons on behalf of the registrant and in the capacities indicated. /s/ W. Roger Haughton Chairman of the Board and March 30, 1999 - ---------------------------- Chief Executive Officer W. Roger Haughton /s/ John M. Lorenzen, Jr. Executive Vice President, March 30, 1999 - ---------------------------- Chief Financial Officer, John M. Lorenzen, Jr. and Assistant Secretary (Principal Financial Officer) /s/ William A. Seymore Vice President, Controller March 30, 1999 - ---------------------------- (Controller and Principal William A. Seymore Accounting Officer) /s/ James C. Castle Director March 30, 1999 - ---------------------------- James C. Castle /s/ Donald C. Clark Director March 30, 1999 - ---------------------------- Donald C. Clark /s/ Wayne E. Hedien Director March 30, 1999 - ---------------------------- Wayne E. Hedien /s/ John D. Roach Director March 30, 1999 - ---------------------------- John D. Roach /s/ Kenneth T. Rosen Director March 30, 1999 - ---------------------------- Kenneth T. Rosen /s/ Richard L. Thomas Director March 30, 1999 - ---------------------------- Richard L. Thomas /s/ Mary Lee Widener Director March 30, 1999 - ---------------------------- Mary Lee Widener /s/ Ronald H. Zech Director March 30, 1999 - ---------------------------- Ronald H. Zech 45 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of The PMI Group, Inc.: We have audited the consolidated financial statements of The PMI Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated January 20, 1999; such consolidated financial statements and report are included in your 1998 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of The PMI Group, Inc. and subsidiaries, listed in item 14(a) 2. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, represent fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP San Francisco, California January 20, 1999 46 THE PMI GROUP, INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998
Amount at which Amortized Market Shown in the Type of Investment Cost Value Balance Sheet ---------------- --------------- --------------- (In thousands) Fixed maturities: Bonds: United States government and government agencies and authorities $ 53,918 $ 55,978 $ 55,978 States, municipalities and political subdivisions 1,110,665 1,193,738 1,193,738 All other corporate 104,042 107,153 107,153 ---------------- --------------- --------------- Total fixed maturities 1,268,625 $ 1,356,869 1,356,869 ---------------- =============== --------------- Equity securities: Common stocks: Banks, trust and insurance companies 158 $ 156 156 Industrial, miscellaneous and all other 33,971 58,629 58,629 Non-redeemable preferred stocks 17,240 17,706 17,706 ---------------- --------------- --------------- Total equity securities 51,369 $ 76,491 76,491 ---------------- =============== --------------- Short-term investments 38,414 38,414 ---------------- --------------- Total investments, other than related party $ 1,358,408 $ 1,471,774 ================ ===============
47 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS PARENT COMPANY ONLY December 31, 1998 and 1997
1998 1997 ---------------- ----------------- ASSETS (Dollars in thousands) Investment portfolio, available for sale, at market value: Fixed income securities (cost - $50,578 and $96,316) $ 51,904 $ 97,605 Short-term investments 3,722 36,177 ---------------- ----------------- Total investment portfolio 55,626 133,782 ---------------- ----------------- Cash 473 437 Investment in subsidiaries, at equity in net assets 1,238,209 1,120,809 Other assets 12,491 12,317 ---------------- ----------------- Total assets $ 1,306,799 $ 1,267,345 ================ ================= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Long-term debt $ 99,476 $ 99,409 Accounts payable - affiliates 1,678 1,113 Other liabilities 5,997 3,544 ---------------- ----------------- Total liabilities 107,151 104,066 ---------------- ----------------- Commitments and contingent liabilities (Note A) - - Junior subordinated deferrable interest debenture held solely by subsidiary trust 102,133 102,099 Shareholders' equity: Preferred stock-$.01 par value; 5,000,000 shares authorized - - Common stock -- $.01 par value; 125,000,000 shares authorized, 35,196,002 and 35,147,247 shares issued 352 351 Additional paid-in capital 265,040 262,448 Accumulated other comprehensive income 74,462 71,936 Retained earnings 1,060,724 876,588 ---------------- ----------------- 1,400,578 1,211,323 Less treasury stock (4,917,401 and 2,684,000 shares at cost) 303,063 150,143 ---------------- ----------------- Total shareholders' equity 1,097,515 1,061,180 ---------------- ----------------- Total liabilities and shareholders' equity $ 1,306,799 $ 1,267,345 ================ =================
See accompanying supplementary notes to Parent company condensed financial statements. 48 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS PARENT COMPANY ONLY Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 -------------- -------------- -------------- (In thousands) Revenue: Equity in undistributed net income of subsidiaries $ 90,696 $ 101,488 $ 110,758 Subsidiary dividends 103,200 78,863 47,660 Investment income, net 9,600 8,990 2,532 Capital gains (losses), net 1,045 (2,405) 113 -------------- -------------- -------------- Total revenue 204,541 186,936 161,063 -------------- -------------- -------------- Expenses: Operating expenses 722 642 437 Interest expense 15,592 14,618 907 -------------- -------------- -------------- Total expenses 16,314 15,260 1,344 -------------- -------------- -------------- Income before tax 188,227 171,676 159,719 Income tax expense (benefit) (2,133) (3,633) 1,801 -------------- -------------- -------------- Net income $ 190,360 $ 175,309 $ 157,918 ============== ============== ==============
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME PARENT COMPANY ONLY Years Ended December 31, 1998, 1997 and 1996 (in thousands)
1998 1997 1996 -------------- -------------- -------------- Net income $ 190,360 $ 175,309 $ 157,918 ------------ ------------ ----------- Other comprehensive income net of tax: Unrealized gain on investments: Unrealized holding gains (losses) arising during period 3,205 19,664 (5,979) Less: reclassification adjustment for (gains) losses included in net income (679) 1,563 (73) ------------ ------------ ----------- Other comprehensive income (loss), net of tax 2,526 21,227 (6,052) ------------ ------------ ----------- Comprehensive income $ 192,886 $ 196,536 $ 151,866 ============ ============ ===========
See accompanying supplementary notes to Parent company condensed financial statements. 49 SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS PARENT COMPANY ONLY Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 --------------- ---------------- --------------- (In thousands) Cash flows from operating activities: Net income $ 190,360 $ 175,309 $ 157,918 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization 1,063 848 185 Equity in net income of subsidiaries (193,896) (180,351) (158,418) Capital (gains) losses, net (1,045) 2,405 (113) Increase (decrease) in payable to affiliates 565 (4,246) 1,127 Other 2,282 (10,437) (551) --------------- ---------------- --------------- Net cash provided by (used in) operating activities (671) (16,472) 148 --------------- ---------------- --------------- Cash flows from investing activities: Dividends from subsidiaries 103,200 78,863 26,300 Investment in affiliates (4,000) (13,093) (14,683) Purchases of fixed income securities (1,000) (92,350) (77,037) Purchases of equity securities (20,173) - - Investment collections of fixed income securities 6,271 5,000 20,848 Proceeds from sales of fixed income securities 40,522 46,667 - Proceeds from sales of equity securities 93 - - Net (increase) decrease in short-term investments 32,455 13,200 (19,147) --------------- ---------------- --------------- Net cash provided by (used in) investing activities 157,368 38,287 (63,719) --------------- ---------------- --------------- Cash flows from financing activities: Issuance of junior subordinated debentures - 102,093 - Issuance of long-term debt - - 99,337 Dividends paid to shareholders (6,333) (6,733) (7,002) Proceeds from exercise of stock options 2,592 3,181 1,135 Purchase of The PMI Group, Inc. common stock (152,920) (120,002) (30,057) --------------- ---------------- --------------- Net cash provided by (used in) financing activities (156,661) (21,461) 63,413 --------------- ---------------- --------------- Net increase (decrease) in cash 36 354 (158) Cash at beginning of year 437 83 241 --------------- ---------------- --------------- Cash at end of year $ 473 $ 437 $ 83 =============== ================ ===============
See accompanying supplementary notes to Parent company condensed financial statements. 50 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT COMPANY ONLY SUPPLEMENTARY NOTES Note A The accompanying Parent Company ("TPG") financial statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements (including Notes 10, 11 and 12 related to long-term obligations, commitments and contingent liabilities and the junior subordinated debenture) appearing on pages 30-47 of The PMI Group, Inc. 1998 Annual Report to Shareholders. Note B During 1998, 1997 and 1996, TPG received $103.2 million, $78.9 million, and $26.3 million , respectively, of ordinary and extraordinary cash dividends from subsidiaries. In addition, during 1996 TPG received $21.4 million of non-cash dividends from a subsidiary. 51 THE PMI GROUP, INC AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION As of and for the Years Ended December 31, 1998, 1997 and 1996
Reserve for Losses and Losses and Amortization Deferred Loss Net Loss of Deferred Other Acquisition Adjustment Unearned Premiums Investment Adjustment Acquisition Operating Premiums Segment Costs Expenses Premiums Earned Income Expenses Costs Expenses Written ------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ ------------- (In thousands) 1998: MI (1) $ 61,605 $ 206,132 $ 94,886 $ 411,922 $ 77,257 $ 135,097 $ 60,280 $ 44,293 $ 409,796 Title - 9,127 - 79,304 1,401 619 - 69,109 79,304 Other (2) - - - - 6,023 - - 29,223 - ------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ ------------- Total $ 61,605 $ 215,259 $ 94,886 $ 491,226 $ 84,681 $ 135,716 $ 60,280 $ 142,625 $ 489,100 ============ ============ ============= ============= =========== ============= ============ ============ ============= 1997: MI (1) $ 37,864 $ 192,211 $ 94,150 $ 394,010 $ 73,007 $ 150,367 $ 43,395 $ 40,952 $ 372,114 Title - 10,176 - 59,938 1,257 1,890 - 53,085 59,938 Other (2) - - - - 8,872 - - 17,708 - ------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ ------------- Total $ 37,864 $ 202,387 $ 94,150 $ 453,948 $ 83,136 $ 152,257 $ 43,395 $ 111,745 $ 432,052 ============ ============ ============= ============= =========== ============= ============ ============ ============= 1996: MI (1) $ 31,633 $ 190,425 $ 116,951 $ 359,527 $ 63,689 $ 150,642 $ 46,192 $ 18,183 $ 349,809 Title - 9,349 - 53,211 1,162 1,767 - 48,012 53,211 Other (2) - - - - 2,591 - - 13,615 - ------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ ------------- Total $ 31,633 $ 199,774 $ 116,951 $ 412,738 $ 67,442 $ 152,409 $ 46,192 $ 79,810 $ 403,020 ============ ============ ============= ============= =========== ============= ============ ============ =============
(1) Represents Mortgage Insurance Operations (2) Represents ancillary services and parent company investment income. The 1997 and 1996 amounts have been restated to conform to the SFAS 131 presentation of segments. 52 THE PMI GROUP, INC. AND SUBSIDIARIES SCHEDULE IV - REINSURANCE Years Ended December 31, 1998, 1997 and 1996
Percentage Ceded Assumed of Amount Premiums earned for the Gross to Other from Other Net Assumed year ended December 31, Amount Companies Companies Amount to Net --------------- --------------- --------------- --------------- ------------ (In thousands, except percentages) 1998: Mortgage Guaranty $ 426,613 $ 17,783 $ 3,092 $ 411,922 0.8% Title 79,483 188 9 79,304 0.0% --------------- --------------- --------------- --------------- ------------ Total $ 506,096 $ 17,971 $ 3,101 $ 491,226 0.6% =============== =============== =============== =============== ============ 1997: Mortgage Guaranty $ 398,904 $ 6,068 $ 1,174 $ 394,010 0.3% Title 60,068 138 8 59,938 0.0% --------------- --------------- --------------- --------------- ------------ Total $ 458,972 $ 6,206 $ 1,182 $ 453,948 0.3% =============== =============== =============== =============== ============ 1996: Mortgage Guaranty $ 372,439 $ 13,546 $ 634 $ 359,527 0.2% Title 53,392 181 - 53,211 0.0% --------------- --------------- --------------- --------------- ------------ Total $ 425,831 $ 13,727 $ 634 $ 412,738 0.2% =============== =============== =============== =============== ============
53 INDEX TO EXHIBITS [Item 14(a) 3]
Exhibit Number Description of Exhibits - ------------ ------------------------------------------------------------------------------------------------------ 3.1(b) Restated Certificate of Incorporation of the Registrant. 3.2(g) By-laws of the Registrant as amended and restated September 15, 1998. 4.1(b) Specimen common stock Certificate. 4.2(d) Indenture dated as of November 19, 1996 between The PMI Group, Inc. and the Bank of New York Trustee in connection with sale of $100,000,000 aggregate principal amount of 6 3/4% Notes due November 15, 2006. 4.3(e) The Junior Subordinated Indenture dated February 4, 1997 between The PMI Group, Inc. and The Bank of New York, Inc. 4.4(e) Form of Right Certificate, relating to Rights Agreement dated as of January 26, 1998. 10.1* PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of February 18, 1999 10.2* The PMI Group, Inc. Equity Incentive Plan. (amended & restated as of February 18, 1999 10.3(f)* The PMI Group, Inc. Stock Plan for Non-Employee Directors. (amended & restated as of July 23, 1998). 10.4(f) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended & restated as of July 23, 1998). 10.5(a) Form of 1984 Master Policy of PMI Mortgage Insurance Co. 10.6(a) Form of 1994 Master Policy of PMI Mortgage Insurance Co. 10.7(a) CMG Shareholders Agreement dated September 8, 1994 between CUNA Mutual Investment Corporation and PMI Mortgage Insurance Co. 10.8(b) Runoff Support Agreement dated October 28, 1994 between Allstate Insurance Company, the Registrant and PMI Mortgage Insurance Co. 10.9(a) Mortgage Pool Guaranty Insurance Reinsurance Treaty effective February 14, 1994 ceded by PMI Mortgage Insurance Co. to Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.). 10.10(a) First Amendment Agreement made as of October 27, 1994 between PMI Mortgage Insurance Co. and Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.). 10.11(a) Mortgage Guaranty Insurance Reinsurance Treaty effective December 31, 1991 ceded by PMI Mortgage Insurance Co. to Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.). 10.12(a) Termination Agreement made as of October 27, 1994 between PMI Mortgage Insurance Co. and Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.).
54
Exhibit Number Description of Exhibits - ------------ ------------------------------------------------------------------------------------------------------ 10.13(b) Form of Services Agreement between the Registrant, PMI Mortgage Insurance Co., and Forestview Mortgage Insurance Co. 10.14(b) Form of Tax Sharing Agreement among the Registrant, the Registrant's subsidiaries, The Allstate Corporation, Allstate Insurance Company and Sears, Roebuck and Co. 10.15(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty effective January 1, 1991 issued to PMI Mortgage Insurance Co. by Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover"). 10.16(a) First Amendment to Mortgage Insurance Variable Quota Share Reinsurance Treaty made as of January 1, 1992 between Hannover and PMI Mortgage Insurance Co. 10.17(f) Supplemental Employee Retirement Plan (amended and restated as of February 12, 1998). 10.18(a) First Amendment to the Quota Share Primary Mortgage Reinsurance Agreement (No. 15031-940) made as of October 1, 1994 between PMI Mortgage Insurance Co. and Capital Mortgage Reinsurance Company 10.19(a) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.20(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January 1, 1994 issued to PMI Mortgage Insurance Co. by Hannover. 10.21(c) The PMI Group, Inc. Retirement Plan. 10.22(e) The Guarantee Agreement, dated February 4, 1997 between The PMI Group, Inc. (As Guarantor) and The Bank of New York (As Trustee). 10.23(e) Amended and Restated Trust Agreement dated as of February 4, 1997 among The PMI Group, Inc., as Depositor, The Bank of New York, as Property Trustee, and The Bank of New York (Delaware), as Delaware Trustee. 10.24(h)* The PMI Group, Inc., Employee Stock Purchase Plan 10.25(e) Form of Change of Control Employment Agreement. 10.26 The PMI Group, Inc., Officer Deferred Compensation Plan. 11.1 Statement re: computation of per share earnings. 12.1 Statement re: computation of earnings to fixed charges. 13.1 Selected Financial Data, Management's Discussion and Analysis of Financial Condition and Results of Operations and Financial Statements and Supplementary Data portions of The PMI Group, Inc.'s 1998 Annual Report to Shareholders. 21.1 Subsidiaries of the Registrant. 23.1 Independent Auditors' Consent. 27.1 Financial Data Schedule.
- -------------- (a) Previously filed with the Company's Form S-1 Registration Statement (No. 33- 88542), which became effective in April 1995 ("Form S-1"). 55 (b) Previously filed with Amendment No. 1 to Form S-1, filed with the SEC on March 2, 1995. (c) Previously filed with Amendment No. 2 to Form S-1, filed with the SEC on March 13, 1995. (d) Previously filed with Form 8-K, filed with the SEC on November 25, 1996 (e) Previously filed with Form 10-K, filed with the SEC on March 27, 1998. (f) Previously filed with Form 10-Q, filed with the SEC on August 13, 1998. (g) Previously filed with Form 8-K, filed with the Sec on September 29, 1998. (h) Previously filed with the Company's Form S-3 Registration Statement (No. 33-66829) which became effective in November 1998. * Compensatory or benefit plan in which certain executive officers or Directors of The PMI Group, Inc., or its subsidiaries are eligible to participate. 56 EX-10.1 2 BONUS INCENTIVE PLAN EXHIBIT 10.1 THE PMI GROUP, INC. BONUS INCENTIVE PLAN TABLE OF CONTENTS
PAGE SECTION 1 BACKGROUND, PURPOSE AND DURATION....................... 1 1.1 Effective Date......................................... 1 1.2 Purpose of the Plan.................................... 1 SECTION 2 DEFINITIONS............................................ 1 2.1 "1934 Act"............................................. 1 2.2 "Actual Award"......................................... 1 2.3 "Affiliate"............................................ 1 2.4 "Base Salary".......................................... 1 2.5 "Board"................................................ 1 2.6 "Change of Control".................................... 1 2.7 "Code"................................................. 3 2.8 "Committee"............................................ 4 2.9 "Company".............................................. 4 2.10 "Determination Date"................................... 4 2.11 "Disability"........................................... 4 2.12 "Employee"............................................. 4 2.13 "Fair Market Value".................................... 4 2.14 "Fiscal Year".......................................... 4 2.15 "Maximum Award"........................................ 4 2.16 "Participant".......................................... 4 2.17 "Payout Formula"....................................... 4 2.18 "Performance Goals".................................... 4 2.19 "Performance Period"................................... 5 2.20 "Plan"................................................. 5 2.21 "Retirement"........................................... 5 2.22 "Shares"............................................... 5 2.23 "Target Award"......................................... 5 2.24 "Termination of Service"............................... 5 SECTION 3 SELECTION OF PARTICIPANTS AND DETERMINATION OF AWARDS.. 5 3.1 Selection of Participants.............................. 5 3.2 Determination of Performance Goals..................... 5 3.3 Determination of Target Awards......................... 5 3.4 Determination of Payout Formula or Formulae............ 5 3.5 Determination of Actual Awards......................... 6 3.6 Special Rule for Change of Control..................... 6 SECTION 4 PAYMENT OF AWARDS...................................... 6 4.1 Right to Receive Payment............................... 6 4.2 Timing of Payment...................................... 6 4.3 Form of Payment........................................ 6
-i- TABLE OF CONTENTS (CONTINUED)
PAGE 4.4 Payment in the Event of Death or Disability............ 7 SECTION 5 ADMINISTRATION......................................... 7 5.1 Committee is the Administrator......................... 7 5.2 Committee Authority.................................... 7 5.3 Decisions Binding...................................... 7 5.4 Delegation by the Committee............................ 7 SECTION 6 GENERAL PROVISIONS..................................... 7 6.1 Tax Withholding........................................ 7 6.2 No Effect on Employment or Service..................... 8 6.3 Participation.......................................... 8 6.4 Indemnification........................................ 8 6.5 Successors............................................. 8 6.6 Beneficiary Designations............................... 8 6.7 Nontransferability of Awards........................... 8 SECTION 7 AMENDMENT, TERMINATION AND DURATION.................... 9 7.1 Amendment, Suspension or Termination................... 9 7.2 Duration of the Plan................................... 9 SECTION 8 LEGAL CONSTRUCTION..................................... 9 8.1 Gender and Number...................................... 9 8.2 Severability........................................... 9 8.3 Requirements of Law.................................... 9 8.4 Governing Law.......................................... 9 8.5 Captions............................................... 9
-ii- THE PMI GROUP, INC. BONUS INCENTIVE PLAN SECTION 1 BACKGROUND, PURPOSE AND DURATION 1.1 Effective Date. The Plan is effective as of February 18, 1999, -------------- subject to ratification by an affirmative vote of the holders of a majority of the Shares which are present in person or by proxy and entitled to vote at the 1999 Annual Meeting of Stockholders of the Company. 1.2 Purpose of the Plan. The Plan is intended to increase ------------------- shareholder value and the success of the Company by motivating key executives (1) to perform to the best of their abilities, and (2) to achieve the Company's objectives. The Plan's goals are to be achieved by providing such executives with incentive awards based on the achievement of goals relating to the performance of the Company and its individual business units. The Plan is intended to permit the grant of awards that qualify as performance-based compensation under section 162(m) of the Code. SECTION 2 DEFINITIONS The following words and phrases shall have the following meanings unless a different meaning is plainly required by the context: 2.1 "1934 Act" means the Securities Exchange Act of 1934, as amended. -------- Reference to a specific section of the 1934 Act or regulation thereunder shall include such section or regulation, any valid regulation promulgated under such section, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such section or regulation. 2.2 "Actual Award" means as to any Performance Period, the actual ------------ award (if any) payable to a Participant for the Performance Period. Each Actual Award is determined by the Payout Formula for the Performance Period, subject to the Committee's authority under Section 3.5 to reduce the award otherwise determined by the Payout Formula. 2.3 "Affiliate" means any corporation or other entity (including, but --------- not limited to, partnerships and joint ventures) controlled by the Company. 2.4 "Base Salary" means as to any Performance Period, the ----------- Participant's annualized salary rate on the last day of the Performance Period. Such Base Salary shall be before both (a) deductions for taxes or benefits, and (b) deferrals of compensation pursuant to Company-sponsored plans. 2.5 "Board" means the Board of Directors of the Company. ----- 2.6 "Change of Control" means: ----------------- (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, (iv) any beneficial ownership maintained by (but not additional acquisitions by), The Allstate Corporation and its subsidiaries, and their respective successors ("Allstate"), pending such time that Allstate distributes or transfers its current ownership interest in the Outstanding Company Common Stock and Outstanding Company Voting Securities as contemplated by the Prospectus dated April 10, 1995, relating to the initial public offering of the common stock of the Company, or (v) any acquisition pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2.6. Notwithstanding the foregoing, in its sole discretion, the Board may increase the 20% threshold set forth above in this subsection (a) prior to any acquisition of 20% or more beneficial ownership of the Outstanding Company Common Stock or the Outstanding Company Voting Securities; provided, that (i) such increased threshold shall apply only to the acquisition and maintenance of beneficial ownership by any Person eligible to report such beneficial ownership at the time of such acquisition on Schedule 13G under the Exchange Act, and (ii) in the event that any Person initially eligible to so report on Schedule 13G thereafter ceases to be eligible to so report on Schedule 13G, the occurrence of the event causing such Person no longer to be eligible to so report shall be deemed an acquisition by such Person of all of the Outstanding Company Common Stock and Outstanding Company Voting Securities beneficially owned by such Person immediately prior to such occurrence; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation by the Company of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets of another entity (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the 2 individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. Notwithstanding the foregoing, a Change of Control shall not be deemed to occur solely because any Person acquires beneficial ownership of 20% or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock as a result of the acquisition of such securities or stock by the Company, which acquisition reduces the number of the Outstanding Company Voting Securities or Outstanding Company Common Stock; provided, that if after such acquisition by the Company such Person (while such Person remains the beneficial owner of 20% or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock) becomes the beneficial owner of additional shares of such Outstanding Company Voting Securities or Outstanding Company Common Stock (as the case may be), a Change of Control shall then occur. Capitalized terms used in this Section 2.6, not otherwise defined, shall have the meaning set forth in the form of change of control employment agreement approved at the February 12, 1998 meeting of the Board. 2.7 "Code" means the Internal Revenue Code of 1986, as amended. ---- Reference to a specific section of the Code or regulation thereunder shall include such section or regulation, any valid regulation promulgated thereunder, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such section or regulation. 3 2.8 "Committee" means the committee appointed by the Board (pursuant --------- to Section 5.1) to administer the Plan. Until otherwise determined by the Board, the Company's Nominating and Compensation Committee shall constitute the Committee. 2.9 "Company" means The PMI Group, Inc., a Delaware corporation, or ------- any successor thereto. 2.10 "Determination Date" means the latest possible date that will ------------------ not jeopardize a Target Award's qualification as performance-based compensation under section 162(m) of the Code. 2.11 "Disability" means a permanent and total disability determined ---------- in accordance with uniform and nondiscriminatory standards adopted by the Committee from time to time. 2.12 "Employee" means any employee of the Company or of an Affiliate, -------- whether such employee is so employed at the time the Plan is adopted or becomes so employed subsequent to the adoption of the Plan. 2.13 "Fair Market Value" means the arithmetic mean of the highest and ----------------- lowest per share selling prices of the Shares, as quoted in the New York Stock Exchange Composite Transactions Index for the date in question. 2.14 "Fiscal Year" means any fiscal year of the Company. ----------- 2.15 "Maximum Award" means as to any aggregate Actual Awards to any ------------- Participant for any Performance Period, $2,000,000. 2.16 "Participant" means as to any Performance Period, an Employee ----------- who has been selected by the Committee for participation in the Plan for that Performance Period. 2.17 "Payout Formula" means as to any Performance Period, the formula -------------- or payout matrix established by the Committee pursuant to Section 3.4 in order to determine the Actual Awards (if any) to be paid to Participants. The formula or matrix may differ from Participant to Participant. 2.18 "Performance Goals" means the goal(s) (or combined goal(s)) ----------------- determined by the Committee (in its discretion) to be applicable to a Participant for a Target Award for a Performance Period. As determined by the Committee, the Performance Goals for any Target Award applicable to a Participant may provide for a targeted level or levels of achievement using one or more of the following measures: (a) Cash Operating Earnings Per Share, (b) Earnings Per Share, (c) Expense Ratio, (d) Loss Ratio, (e) Market Share, (f) Net Income, (g) Net Operating Income Earnings Per Share, (h) Net Operating Income Per Share, (i) New Insurance Written, (j) Price to Earnings Ratio, (k) Return on Average Equity, (l) Risk in Force, and (m) Total Shareholder Return. The Performance Goals may differ from Participant to Participant and from award to award. Any criteria used may be measured in absolute terms or as compared to another 4 company or companies. Any criteria used may be measured against the performance of the Company as a whole or a segment of the Company. 2.19 "Performance Period" means any period of not less than twelve ------------------ consecutive calendar months, as determined by the Committee in its sole discretion. 2.20 "Plan" means The PMI Group, Inc. Bonus Incentive Plan, as set ---- forth in this instrument and as hereafter amended from time to time. 2.21 "Retirement" means (a) a Termination of Service occurring on or ---------- after age sixty five (65), (b) a Termination of Service at or after age 55 with at least ten years of Benefit Accrual Service (as defined under The PMI Group, Inc. Retirement Plan, as amended), or (c) a Termination of Service approved by the Company as an early retirement; provided that in the case of a Section 16 Person, such early retirement must be approved by the Committee. 2.22 "Shares" means shares of the Company's common stock, $0.01 par ------ value. 2.23 "Target Award" means the target award payable under the Plan to ------------ a Participant for the Performance Period, expressed as a percentage of his or her Base Salary, as determined by the Committee in accordance with Section 3.3. 2.24 "Termination of Service" means a cessation of the employee- ---------------------- employer relationship between an Employee and the Company or an Affiliate for any reason, including, but not by way of limitation, a termination by resignation, discharge, death, Disability, Retirement, or the disaffiliation of an Affiliate, but excluding any such termination where there is a simultaneous reemployment by the Company or an Affiliate. SECTION 3 SELECTION OF PARTICIPANTS AND DETERMINATION OF AWARDS 3.1 Selection of Participants. The Committee, in its sole ------------------------- discretion, shall select the Employees of the Company who shall be Participants for any Performance Period. Participation in the Plan is in the sole discretion of the Committee, and on a Performance Period by Performance Period basis. Accordingly, an Employee who is a Participant for a given Performance Period in no way is guaranteed or assured of being selected for participation in any subsequent Performance Period or Periods. 3.2 Determination of Performance Goals. The Committee, in its sole ---------------------------------- discretion, shall establish the Performance Goals for each Participant for the Performance Period. Such Performance Goals shall be set forth in writing. 3.3 Determination of Target Awards. The Committee, in its sole ------------------------------ discretion, shall establish a Target Award for each Participant. Each Participant's Target Award shall be determined by the Committee in its sole discretion, and each Target Award shall be set forth in writing. 5 3.4 Determination of Payout Formula or Formulae. On or prior to the ------------------------------------------- Determination Date, the Committee, in its sole discretion, shall establish a Payout Formula or Formulae for purposes of determining the Actual Award (if any) payable to each Participant. Each Payout Formula shall (a) be in writing, (b) be based on a comparison of actual performance to the Performance Goals, (c) provide for the payment of a Participant's Target Award if the Performance Goals for the Performance Period are achieved, and (d) provide for an Actual Award greater than or less than the Participant's Target Award, depending upon the extent to which actual performance exceeds or falls below the Performance Goals. Notwithstanding the preceding, no Participant's Actual Award under the Plan may exceed his or her Maximum Award. 3.5 Determination of Actual Awards. After the end of each ------------------------------ Performance Period, the Committee shall certify in writing the extent to which the Performance Goals applicable to each Participant for the Performance Period were achieved or exceeded. The Actual Award for each Participant shall be determined by applying the Payout Formula to the level of actual performance which has been certified by the Committee. Notwithstanding any contrary provision of the Plan, the Committee, in its sole discretion, may (a) eliminate or reduce the Actual Award payable to any Participant below that which otherwise would be payable under the Payout Formula, and (b) determine what Actual Award, if any, will be paid in the event of a Termination of Service prior to the end of the Performance Period. 3.6 Special Rule for Change of Control. Notwithstanding any contrary ---------------------------------- provision of the Plan, immediately upon the occurrence of a Change of Control that occurs prior to a Participant's Termination of Service, 100% of any Target Award shall be deemed to be earned and shall be immediately payable to the Participant. Notwithstanding the preceding provisions of this Section 3.6, if the Committee determines that automatic payment of Target Awards following a Change of Control would cause a Change of Control transaction to be ineligible for pooling of interests accounting under APB No. 16, which transaction (but for such automatic payment) otherwise would have been eligible for such accounting treatment, the Committee, in its sole discretion, may determine that no such automatic payment shall occur. SECTION 4 PAYMENT OF AWARDS 4.1 Right to Receive Payment. Each Actual Award that may become ------------------------ payable under the Plan shall be paid solely from the general assets of the Company. Nothing in this Plan shall be construed to create a trust or to establish or evidence any Participant's claim of any right other than as an unsecured general creditor with respect to any payment to which he or she may be entitled. 4.2 Timing of Payment. Payment of each Actual Award shall be made as ----------------- soon as practicable, but no later than 90 days after the end of the Performance Period during which the Award was earned. 4.3 Form of Payment. Each Actual Award normally shall be paid in --------------- cash (or its equivalent) in a single lump sum. However, the Committee, in its sole discretion, may declare any Actual Award, in whole or in part, payable in restricted stock granted under the Company's 6 Equity Incentive Plan. The number of Shares of restricted stock granted shall be determined by dividing the cash amount foregone by the Fair Market Value of a Share on the date that the cash payment otherwise would have been made. Any such restricted stock shall be subject to the vesting schedule (not to exceed two calendar years) as may be determined by the Committee, provided that accelerated vesting automatically shall occur upon death, Retirement or involuntary Termination of Service without cause. 4.4 Payment in the Event of Death or Disability. If a Participant ------------------------------------------- dies or becomes Disabled prior to the payment of an Actual Award earned by him or her prior to death or Disability for a prior Performance Period, the Award shall be paid to his or her estate or to the Participant, as the case may be, subject to the Committee's discretion to reduce or eliminate any Actual Award otherwise payable. SECTION 5 ADMINISTRATION 5.1 Committee is the Administrator. The Plan shall be administered ------------------------------ by the Committee. The Committee shall consist of not less than two (2) members of the Board. The members of the Committee shall be appointed from time to time by, and serve at the pleasure of, the Board. Each member of the Committee shall qualify as an "outside director" under section 162(m) of the Code. If it is later determined that one or more members of the Committee do not so qualify, actions taken by the Committee prior to such determination shall be valid despite such failure to qualify. 5.2 Committee Authority. It shall be the duty of the Committee to ------------------- administer the Plan in accordance with the Plan's provisions. The Committee shall have all powers and discretion necessary or appropriate to administer the Plan and to control its operation, including, but not limited to, the power to (a) determine which Employees shall be granted awards, (b) prescribe the terms and conditions of awards, (c) interpret the Plan and the awards, (d) adopt such procedures and subplans as are necessary or appropriate to permit participation in the Plan by Employees who are foreign nationals or employed outside of the United States, (e) adopt rules for the administration, interpretation and application of the Plan as are consistent therewith, and (f) interpret, amend or revoke any such rules. 5.3 Decisions Binding. All determinations and decisions made by the ----------------- Committee, the Board, and any delegate of the Committee pursuant to the provisions of the Plan shall be final, conclusive, and binding on all persons, and shall be given the maximum deference permitted by law. 5.4 Delegation by the Committee. The Committee, in its sole --------------------------- discretion and on such terms and conditions as it may provide, may delegate all or part of its authority and powers under the Plan to one or more directors and/or officers of the Company; provided, however, that the Committee may delegate its authority and powers only with respect to awards that are not intended to qualify as performance-based compensation under section 162(m) of the Code. 7 SECTION 6 GENERAL PROVISIONS 6.1 Tax Withholding. The Company shall withhold all applicable taxes --------------- from any Actual Award, including any federal, state and local taxes (including, but not limited to, the Participant's FICA and SDI obligations). 6.2 No Effect on Employment or Service. Nothing in the Plan shall ---------------------------------- interfere with or limit in any way the right of the Company to terminate any Participant's employment or service at any time, with or without cause. For purposes of the Plan, transfer of employment of a Participant between the Company and any one of its Affiliates (or between Affiliates) shall not be deemed a Termination of Service. Employment with the Company and its Affiliates is on an at-will basis only. The Company expressly reserves the right, which may be exercised at any time and without regard to when during a Performance Period such exercise occurs, to terminate any individual's employment with or without cause, and to treat him or her without regard to the effect which such treatment might have upon him or her as a Participant. 6.3 Participation. No Employee shall have the right to be selected ------------- to receive an award under this Plan, or, having been so selected, to be selected to receive a future award. 6.4 Indemnification. Each person who is or shall have been a member --------------- of the Committee, or of the Board, shall be indemnified and held harmless by the Company against and from (a) any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit, or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan or any award, and (b) from any and all amounts paid by him or her in settlement thereof, with the Company's approval, or paid by him or her in satisfaction of any judgment in any such claim, action, suit, or proceeding against him or her, provided he or she shall give the Company an opportunity, at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such persons may be entitled under the Company's Certificate of Incorporation or Bylaws, by contract, as a matter of law, or otherwise, or under any power that the Company may have to indemnify them or hold them harmless. 6.5 Successors. All obligations of the Company under the Plan, with ---------- respect to awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business or assets of the Company. 6.6 Beneficiary Designations. If permitted by the Committee, a ------------------------ Participant under the Plan may name a beneficiary or beneficiaries to whom any vested but unpaid award shall be paid in the event of the Participant's death. Each such designation shall revoke all prior designations by the Participant and shall be effective only if given in a form and manner acceptable to the Committee. In the absence of any such designation, any vested benefits remaining unpaid at the Participant's death shall be paid to the Participant's estate. 8 6.7 Nontransferability of Awards. No award granted under the Plan ---------------------------- may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will, by the laws of descent and distribution, or to the limited extent provided in Section 6.6. All rights with respect to an award granted to a Participant shall be available during his or her lifetime only to the Participant. SECTION 7 AMENDMENT, TERMINATION AND DURATION 7.1 Amendment, Suspension or Termination. The Board, in its sole ------------------------------------ discretion, may amend or terminate the Plan, or any part thereof, at any time and for any reason. The amendment, suspension or termination of the Plan shall not, without the consent of the Participant, alter or impair any rights or obligations under any Target Award theretofore granted to such Participant. No award may be granted during any period of suspension or after termination of the Plan. 7.2 Duration of the Plan. The Plan shall commence on the date -------------------- specified herein, and subject to Section 7.1 (regarding the Board's right to amend or terminate the Plan), shall remain in effect thereafter. SECTION 8 LEGAL CONSTRUCTION 8.1 Gender and Number. Except where otherwise indicated by the ----------------- context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural. 8.2 Severability. In the event any provision of the Plan shall be ------------ held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. 8.3 Requirements of Law. The granting of awards under the Plan shall ------------------- be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required. 8.4 Governing Law. The Plan and all awards shall be construed in ------------- accordance with and governed by the laws of the State of California, but without regard to its conflict of law provisions. 8.5 Captions. Captions are provided herein for convenience only, and -------- shall not serve as a basis for interpretation or construction of the Plan. 9 EXECUTION IN WITNESS WHEREOF, The PMI Group, Inc., by its duly authorized officer, has executed the Plan on the date indicated below. THE PMI GROUP, INC. Dated: _____________, 1999 By: /s/ Charles Broom ------------------------------- Name: Charles Broom Title: V.P. Human Resources 10 EX-10.2 3 EQUITY INCENTIVE PLAN EXHIBIT 10.2 THE PMI GROUP, INC. EQUITY INCENTIVE PLAN (FEBRUARY 18, 1999 RESTATEMENT) TABLE OF CONTENTS
Page SECTION 1 BACKGROUND, PURPOSE AND DURATION.............................. 1 1.1 Effective Date................................................ 1 1.2 Purpose of the Plan........................................... 1 SECTION 2 DEFINITIONS................................................... 1 2.1 "1934 Act".................................................... 1 2.2 "Affiliate"................................................... 1 2.3 "Award"....................................................... 1 2.4 "Award Agreement"............................................. 1 2.5 "Board"....................................................... 1 2.6 "Change of Control"........................................... 2 2.7 "Code"........................................................ 3 2.8 "Committee"................................................... 3 2.9 "Company"..................................................... 4 2.10 "Consultant".................................................. 4 2.11 "Deferred Compensation Account"............................... 4 2.12 "Determination Date".......................................... 4 2.13 "Director".................................................... 4 2.14 "Disability".................................................. 4 2.15 "Employee".................................................... 4 2.16 "Exercise Price".............................................. 4 2.17 "Fair Market Value"........................................... 4 2.18 "Fiscal Year"................................................. 4 2.19 "Grant Date".................................................. 4 2.20 "Incentive Stock Option"...................................... 4 2.21 "Nonqualified Stock Option"................................... 4 2.22 "Option"...................................................... 5 2.23 "Participant"................................................. 5 2.24 "Performance Goals"........................................... 5 2.25 "Performance Period".......................................... 5 2.26 "Performance Share"........................................... 5 2.27 "Performance Unit"............................................ 5 2.28 "Period of Restriction"....................................... 5 2.29 "Plan"........................................................ 5 2.30 "Restricted Stock"............................................ 5 2.31 "Retirement".................................................. 5 2.32 "Rule 16b-3".................................................. 5 2.33 "Section 16 Person"........................................... 6 2.34 "Share"....................................................... 6 2.35 "Stock Unit".................................................. 6 2.36 "Subsidiary".................................................. 6 2.37 "Termination of Service"...................................... 6
-i- TABLE OF CONTENTS (CONTINUED)
PAGE SECTION 3 ADMINISTRATION................................................ 6 3.1 The Committee................................................. 6 3.2 Authority of the Committee.................................... 6 3.3 Delegation by the Committee................................... 7 3.4 Decisions Binding............................................. 7 SECTION 4 SHARES SUBJECT TO THE PLAN.................................... 7 4.1 Number of Shares.............................................. 7 4.2 Lapsed Awards................................................. 7 4.3 Adjustments in Awards and Authorized Shares................... 7 SECTION 5 STOCK OPTIONS................................................. 7 5.1 Grant of Options.............................................. 7 5.2 Award Agreement............................................... 8 5.3 Exercise Price................................................ 8 5.3.1 Nonqualified Stock Options............................. 8 5.3.2 Incentive Stock Options................................ 8 5.3.3 Substitute Options..................................... 8 5.4 Expiration of Options......................................... 8 5.4.1 Expiration Dates....................................... 8 5.4.2 Death of Participant................................... 9 5.4.3 Committee Discretion................................... 9 5.5 Exercisability of Options..................................... 9 5.5.1 Special Rule for Retirement, Death and Disability...... 9 5.5.2 Special Rule for Change of Control..................... 9 5.6 Payment....................................................... 9 5.7 Restrictions on Share Transferability......................... 10 5.8 Deferral...................................................... 10 5.8.1 Election to Defer Option Proceeds...................... 10 5.8.2 Form and Timing of Payment............................. 10 5.8.3 Participants Remain Unsecured Creditors................ 11 5.8.4 Nontransferability of Deferred Option Compensation Accounts............................................... 11 5.8.5 Provisions of the Officer Deferred Compensation Plan May Govern............................................. 11 5.9 Certain Additional Provisions for Incentive Stock Options..... 11 5.9.1 Exercisability......................................... 11 5.9.2 Termination of Service................................. 11 5.9.3 Company and Subsidiaries Only.......................... 11 5.9.4 Expiration............................................. 11 5.10 Grant of Reload Options....................................... 11 SECTION 6 RESTRICTED STOCK.............................................. 12 6.1 Grant of Restricted Stock..................................... 12 6.2 Restricted Stock Agreement.................................... 12
-ii- TABLE OF CONTENTS (CONTINUED)
PAGE 6.3 Transferability............................................... 12 6.4 Other Restrictions............................................ 12 6.4.1 General Restrictions................................... 12 6.4.2 Section 162(m) Performance Restrictions................ 12 6.4.3 Legend on Certificates................................. 13 6.5 Removal of Restrictions....................................... 13 6.5.1 Special Rule for Retirement, Death and Disability...... 13 6.5.2 Special Rule for Change of Control..................... 13 6.6 Voting Rights................................................. 13 6.7 Dividends and Other Distributions............................. 13 6.8 Return of Restricted Stock to Company......................... 14 SECTION 7 PERFORMANCE UNITS AND PERFORMANCE SHARES...................... 14 7.1 Grant of Performance Units and Shares......................... 14 7.2 Initial Value................................................. 14 7.3 Performance Objectives and Other Terms........................ 14 7.3.1 General Performance Objectives......................... 14 7.3.2 Section 162(m) Performance Objectives.................. 14 7.4 Earning of Performance Units and Performance Shares........... 14 7.4.1 Special Rule for Retirement, Death and Disability...... 15 7.4.2 Special Rule for Change of Control..................... 15 7.5 Form and Timing of Payment.................................... 15 7.5.1 Deferrals.............................................. 15 7.6 Cancellation.................................................. 15 SECTION 8 MISCELLANEOUS................................................. 15 8.1 No Effect on Employment or Service............................ 15 8.2 Participation................................................. 16 8.3 Indemnification............................................... 16 8.4 Successors.................................................... 16 8.5 Beneficiary Designations...................................... 16 8.6 Nontransferability of Awards.................................. 16 8.7 No Rights as Stockholder...................................... 17 8.8 Withholding Requirements...................................... 17 8.9 Withholding Arrangements...................................... 17 SECTION 9 AMENDMENT, TERMINATION AND DURATION........................... 17 9.1 Amendment, Suspension or Termination.......................... 17 9.2 Duration of the Plan.......................................... 17 SECTION 10 LEGAL CONSTRUCTION............................................ 18 10.1 Gender and Number............................................. 18 10.2 Severability.................................................. 18 10.3 Requirements of Law........................................... 18
-iii- TABLE OF CONTENTS (CONTINUED)
PAGE 10.4 Governing Law................................................. 18 10.5 Captions...................................................... 18
-iv- THE PMI GROUP, INC. EQUITY INCENTIVE PLAN (February 18, 1999 Restatement) SECTION 1 BACKGROUND, PURPOSE AND DURATION 1.1 Effective Date. The PMI Group, Inc. having established Plan, -------------- hereby amends and restates the Plan, effective as of February 18, 1999, subject to the approval of the Plan by a majority of the shares of the common stock of the Company which are present in person or by proxy and entitled to vote at the 1999 Annual Meeting of the Stockholders of the Company. The terms of the Plan, as in effect prior to February 18, 1999, shall govern any outstanding Awards granted prior to February 18, 1999. 1.2 Purpose of the Plan. The Plan is intended to increase incentives ------------------- and to encourage Share ownership on the part of (1) employees of the Company and its Affiliates, and (2) consultants who provide significant services to the Company and its Affiliates. The Plan also is intended to further the growth and profitability of the Company. The Plan is intended to permit the grant of Awards that qualify as performance-based compensation under section 162(m) of the Code. SECTION 2 DEFINITIONS The following words and phrases shall have the following meanings unless a different meaning is plainly required by the context: 2.1 "1934 Act" means the Securities Exchange Act of 1934, as amended. -------- Reference to a specific section of the 1934 Act or regulation thereunder shall include such section or regulation, any valid regulation promulgated under such section, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such section or regulation. 2.2 "Affiliate" means any corporation or any other entity (including, --------- but not limited to, partnerships and joint ventures) controlling, controlled by, or under common control with the Company. 2.3 "Award" means, individually or collectively, a grant under the ----- Plan of Nonqualified Stock Options, Incentive Stock Options, Restricted Stock, Performance Units or Performance Shares. 2.4 "Award Agreement" means the written agreement setting forth the --------------- terms and provisions applicable to each Award granted under the Plan. 2.5 "Board" means the Board of Directors of the Company. ----- 2.6 "Change of Control" means: ----------------- (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of twenty percent (20%) or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, (iv) any beneficial ownership maintained by (but not additional acquisitions by), The Allstate Corporation and its subsidiaries, and their respective successors ("Allstate"), pending such time that Allstate distributes or transfers its current ownership interest in the Outstanding Company Common Stock and Outstanding Company Voting Securities as contemplated by the Prospectus dated April 10, 1995, relating to the initial public offering of the common stock of the Company, or (v) any acquisition pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 2.6. Notwithstanding the foregoing, in its sole discretion, the Board may increase the twenty percent (20%) threshold set forth above in this subsection (a) prior to any acquisition of twenty percent (20%) or more beneficial ownership of the Outstanding Company Common Stock or the Outstanding Company Voting Securities; provided, that (i) such increased threshold shall apply only to the acquisition and maintenance of beneficial ownership by any Person eligible to report such beneficial ownership at the time of such acquisition on Schedule 13G under the Exchange Act, and (ii) in the event that any Person initially eligible to so report on Schedule 13G thereafter ceases to be eligible to so report on Schedule 13G, the occurrence of the event causing such Person no longer to be eligible to so report shall be deemed an acquisition by such Person of all of the Outstanding Company Common Stock and Outstanding Company Voting Securities beneficially owned by such Person immediately prior to such occurrence; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation by the Company of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets of another entity (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities 2 who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than sixty percent (60%) of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, twenty percent (20%) or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. Notwithstanding the foregoing, a Change of Control shall not be deemed to occur solely because any Person acquires beneficial ownership of twenty percent (20%) or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock as a result of the acquisition of such securities or stock by the Company, which acquisition reduces the number of the Outstanding Company Voting Securities or Outstanding Company Common Stock; provided, that if after such acquisition by the Company such Person (while such Person remains the beneficial owner of twenty percent (20%) or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock) becomes the beneficial owner of additional shares of such Outstanding Company Voting Securities or Outstanding Company Common Stock (as the case may be), a Change of Control shall then occur. Capitalized terms used in this Section 2.6, not otherwise defined, shall have the meaning set forth in the form of change of control employment agreement approved at the February 12, 1998 meeting of the Board. 2.7 "Code" means the Internal Revenue Code of 1986, as amended. ---- Reference to a specific section of the Code or regulation thereunder shall include such section or regulation, any valid regulation promulgated thereunder, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such section or regulation. 2.8 "Committee" means the committee appointed by the Board (pursuant --------- to Section 3.1) to administer the Plan. Unless otherwise determined by the Board, the Company's Compensation Committee shall constitute the Committee. 3 2.9 "Company" means The PMI Group, Inc., a Delaware corporation, or ------- any successor thereto. 2.10 "Consultant" means any consultant, independent contractor, or ---------- other person who provides significant services to the Company or its Affiliates, but who is neither an Employee nor a Director. 2.11 "Deferred Compensation Account" means an account established in ----------------------------- the name of the Participant on the books and records of the Company pursuant to Section 5.8. 2.12 "Determination Date" means the latest possible date that will ------------------ not jeopardize an Award's qualification as performance-based compensation under section 162(m) of the Code. Notwithstanding the previous sentence, for Awards not intended to qualify as performance-based compensation, "Determination Date" shall mean such date as the Committee may determine in its discretion. 2.13 "Director" means any individual who is a member of the Board. -------- 2.14 "Disability" means a permanent and total disability within the ---------- meaning of section 22(e)(3) of the Code, provided that in the case of Awards other than Incentive Stock Options, the Committee in its discretion may determine whether a permanent and total disability exists in accordance with uniform and non-discriminatory standards adopted by the Committee from time to time. 2.15 "Employee" means any employee of the Company or of an Affiliate, -------- whether such employee is so employed at the time the Plan is adopted or becomes so employed subsequent to the adoption of the Plan. 2.16 "Exercise Price" means the price at which a Share may be -------------- purchased by a Participant pursuant to the exercise of an Option. 2.17 "Fair Market Value" means the mean between the high and low ----------------- prices for Shares on the relevant date, or if there were no sales on such date, the arithmetic mean of the highest and lowest quoted selling prices on the nearest day before and the nearest day after the relevant date, as determined by the Committee. 2.18 "Fiscal Year" means the fiscal year of the Company. ----------- 2.19 "Grant Date" means, with respect to an Award, the date that the ---------- Award was granted. The Grant Date shall be the date on which the Committee approves the material terms of the Award or such later date as the Committee, in its discretion, may determine. 2.20 "Incentive Stock Option" means an Option to purchase Shares ---------------------- which is designated as an Incentive Stock Option and is intended to meet the requirements of section 422 of the Code. 4 2.21 "Nonqualified Stock Option" means an option to purchase Shares ------------------------- which is not intended to be an Incentive Stock Option. 2.22 "Option" means an Incentive Stock Option or a Nonqualified Stock ------ Option. 2.23 "Participant" means an Employee or Consultant who has an ----------- outstanding Award. 2.24 "Performance Goals" means the goal(s) (or combined goal(s)) ----------------- determined by the Committee (in its discretion) to be applicable to a Participant with respect to an Award. As determined by the Committee, the Performance Goals applicable to an Award may provide for a targeted level or levels of achievement using one or more of the following measures: (a) Cash Operating Earnings Per Share, (b) Earnings Per Share, (c) Expense Ratio, (d) Loss Ratio, (e) Market Share, (f) Net Income, (g) Net Operating Income Earnings Per Share, (h) Net Operating Income Per Share, (i) New Insurance Written, (j) Price to Earnings Ratio, (k) Return on Average Equity, (l) Risk in Force, and (m) Total Shareholder Return. The Performance Goals may differ from Participant to Participant and from Award to Award. Any criteria used may be measured in absolute terms or as compared to another company or companies. Any criteria used may be measured against the performance of the Company as a whole or a segment of the Company. 2.25 "Performance Period" means any period of not less than twelve ------------------ consecutive calendar months, as determined by the Committee, in its sole discretion. 2.26 "Performance Share" means a Performance Share granted to a ----------------- Participant pursuant to Section 7. 2.27 "Performance Unit" means a Performance Unit granted to a ---------------- Participant pursuant to Section 7. 2.28 "Period of Restriction" means the period during which shares of --------------------- Restricted Stock are subject to forfeiture and/or restrictions on transferability. 2.29 "Plan" means The PMI Group, Inc. Equity Incentive Plan, as set ---- forth in this instrument and as hereafter amended from time to time. 2.30 "Restricted Stock" means an Award granted to a Participant ---------------- pursuant to Section 6. 2.31 "Retirement" means, in the case of an Employee, (a) a ---------- Termination of Service occurring on or after age sixty five (65), (b) a Termination of Service at or after age 55 with at least ten years of Benefit Accrual Service (as defined under The PMI Group, Inc. Retirement Plan, as amended), or (c) a Termination of Service approved by the Company as an early retirement; provided that in the case of a Section 16 Person, such early retirement must be approved by the Committee. With respect to a Consultant, no Termination of Service shall be deemed to be on account of "Retirement." 5 2.32 "Rule 16b-3" means Rule 16b-3 promulgated under the 1934 Act, as ---------- amended, and any future regulation amending, supplementing or superseding such regulation. 2.33 "Section 16 Person" means a person who, with respect to the ----------------- Shares, is subject to section 16 of the 1934 Act. 2.34 "Share" means one share of the Company's common stock, $.01 par ----- value. 2.35 "Stock Unit" means a bookkeeping entry initially representing an ---------- amount equivalent to the Fair Market Value of one Share covered by the exercise of an Option in respect of which the Participant has made a deferral election pursuant to Section 5.8. Stock Units represent an unfunded and unsecured obligation of the Company. 2.36 "Subsidiary" means any corporation in an unbroken chain of ---------- corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. 2.37 "Termination of Service" means (a) in the case of an Employee, a ---------------------- cessation of the employee-employer relationship between an Employee and the Company or an Affiliate for any reason, including, but not by way of limitation, a termination by resignation, discharge, death, Disability, Retirement, or the disaffiliation of an Affiliate, but excluding any such termination where there is a simultaneous reemployment by the Company or an Affiliate; and (b) in the case of a Consultant, a cessation of the service relationship between a Consultant and the Company or an Affiliate for any reason, including, but not by way of limitation, a termination by resignation, discharge, death, Disability, or the disaffiliation of an Affiliate, but excluding any such termination where there is a simultaneous re-engagement of the consultant by the Company or an Affiliate. SECTION 3 ADMINISTRATION 3.1 The Committee. The Plan shall be administered by the Committee. ------------- The Committee shall consist of not less than two (2) Directors. The members of the Committee shall be appointed from time to time by, and serve at the pleasure of, the Board. Each member of the Committee shall qualify as (a) a "non-employee director" under Rule 16b-3, and (b) an "outside director" under section 162(m) of the Code. If it is later determined that one or more members of the Committee do not so qualify, actions taken by the Committee prior to such determination shall be valid despite such failure to qualify. 3.2 Authority of the Committee. It shall be the duty of the -------------------------- Committee to administer the Plan in accordance with the Plan's provisions. The Committee shall have all powers and discretion necessary or appropriate to administer the Plan and to control its operation, including, but not limited to, the power to (a) determine which Employees and Consultants shall be granted Awards, (b) prescribe the terms and conditions of the Awards, (c) interpret the Plan and the Awards, (d) adopt such procedures and subplans as are necessary or appropriate to permit participation in the Plan by Employees and Consultants who are foreign 6 nationals or employed outside of the United States, (e) adopt rules for the administration, interpretation and application of the Plan as are consistent therewith, and (f) interpret, amend or revoke any such rules. 3.3 Delegation by the Committee. The Committee, in its sole --------------------------- discretion and on such terms and conditions as it may provide, may delegate all or any part of its authority and powers under the Plan to one or more Directors and/or officers of the Company; provided, however, that the Committee may not delegate its authority and powers (a) with respect to Section 16 Persons, (b) in any way which would jeopardize the Plan's qualification under Rule 16b-3, or (c) with respect to Awards which are intended to qualify as performance-based compensation under section 162(m) of the Code. 3.4 Decisions Binding. All determinations and decisions made by the ----------------- Committee, the Board, and any delegate of the Committee pursuant to the provisions of the Plan shall be final, conclusive, and binding on all persons, and shall be given the maximum deference permitted by law. SECTION 4 SHARES SUBJECT TO THE PLAN 4.1 Number of Shares. Subject to adjustment as provided in Section ---------------- 4.3, the total number of Shares available for grant under the Plan shall not exceed 2,900,000. Notwithstanding the preceding, the aggregate number of Shares subject to Awards of Restricted Stock granted under the Plan shall not exceed 90,000 and the aggregate number of Shares subject to Awards of Performance Units and Performance Shares granted under the Plan shall not exceed 90,000. Shares granted under the Plan may be either authorized but unissued Shares or treasury Shares. 4.2 Lapsed Awards. If an Award terminates, expires, or lapses for ------------- any reason, any Shares subject to such Award again shall be available to be the subject of an Award. In addition, if any Shares are tendered to the Company (whether by physical delivery or attestation) as full or partial payment for the exercise of an Option or in satisfaction of a tax withholding obligation pursuant to an Award, only the net Shares issued shall be deemed delivered for purposes of determining the maximum number of Shares that may be delivered under Section 4.1. 4.3 Adjustments in Awards and Authorized Shares. In the event of any ------------------------------------------- merger, reorganization, consolidation, recapitalization, separation, liquidation, stock dividend, split-up, Share combination, or other change in the corporate structure of the Company affecting the Shares, the Committee shall adjust the number, class, and price of Shares which may be delivered under the Plan, the number, and class of Shares subject to outstanding Awards, and the numerical limit of Section 5.1, 6.1 and 7.1 in such manner as the Committee (in its sole discretion) shall determine to be appropriate to prevent the dilution or diminution of such Awards. 7 SECTION 5 STOCK OPTIONS 5.1 Grant of Options. Subject to the terms and provisions of the ---------------- Plan, Options may be granted to Employees and Consultants at any time and from time to time as determined by the Committee in its sole discretion. The Committee, in its sole discretion, shall determine the number of Shares subject to each Option, provided that during any Fiscal Year, no Participant shall be granted Options covering more than 200,000 Shares. The Committee may grant Incentive Stock Options, Nonqualified Stock Options, or a combination thereof. 5.2 Award Agreement. Each Option shall be evidenced by an Award --------------- Agreement that shall specify the Exercise Price, the expiration date of the Option, the number of Shares to which the Option pertains, any conditions to exercise of the Option, and such other terms and conditions as the Committee, in its discretion, shall determine. The Award Agreement shall specify whether the Option is intended to be an Incentive Stock Option or a Nonqualified Stock Option. 5.3 Exercise Price. Subject to the provisions of this Section 5.3, -------------- the Exercise Price for each Option shall be determined by the Committee in its sole discretion. 5.3.1 Nonqualified Stock Options. In the case of a -------------------------- Nonqualified Stock Option, the Exercise Price shall be not less than one hundred percent (100%) of the Fair Market Value of a Share on the Grant Date. 5.3.2 Incentive Stock Options. In the case of an Incentive ----------------------- Stock Option, the Exercise Price shall be not less than one hundred percent (100%) of the Fair Market Value of a Share on the Grant Date; provided, however, that if on the Grant Date, the Employee (together with persons whose stock ownership is attributed to the Employee pursuant to section 424(d) of the Code) owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any of its Subsidiaries, the Exercise Price shall be not less than one hundred and ten percent (110%) of the Fair Market Value of a Share on the Grant Date. 5.3.3 Substitute Options. Notwithstanding the provisions of ------------------ Sections 5.3.1 and 5.3.2, in the event that the Company or an Affiliate consummates a transaction described in section 424(a) of the Code (e.g., the acquisition of property or stock from an unrelated corporation), persons who become Employees or Consultants on account of such transaction may be granted Options in substitution for options granted by their former employer. If such substitute Options are granted, the Committee, in its sole discretion and consistent with section 424(a) of the Code, shall determine the exercise price of such substitute Options. 5.4 Expiration of Options. --------------------- 5.4.1 Expiration Dates. Each Option shall terminate no later ---------------- than the first to occur of the following events: (a) The expiration of ten (10) years from the Grant Date; or 8 (b) The expiration of one (1) year from the date of the Participant's Termination of Service for a reason other than the Participant's death, Disability or Retirement; or (c) The expiration of three (3) years from the date of the Participant's Termination of Service by reason of Disability; or (d) The expiration of three (3) years from the date of the Participant's Retirement (subject to Section 5.9.2 regarding Incentive Stock Options); or (e) The date for termination of the Option determined by the Committee in its sole discretion and set forth in the written Award Agreement. 5.4.2 Death of Participant. Notwithstanding Section 5.4.1, if a -------------------- Participant who is an Employee dies prior to the expiration of his or her Options, the Committee, in its discretion, may provide that his or her Options shall be exercisable for up to three (3) years after the date of death. If a Participant who is a Consultant dies prior to the expiration of his or her Options, the Committee, in its discretion, may provide that his or her Options shall be exercisable for up to three (3) years after the date of death. 5.4.3 Committee Discretion. Subject to the limits of Sections 5.4.1 -------------------- and 5.4.2, the Committee, in its sole discretion, (a) shall provide in each Award Agreement when each Option expires and becomes unexercisable, and (b) may, after an Option is granted and before such Option expires, extend the maximum term of the Option (subject to Section 5.9.4 regarding Incentive Stock Options). 5.5 Exercisability of Options. Options granted under the Plan shall ------------------------- be exercisable at such times and be subject to such restrictions and conditions as the Committee shall determine in its sole discretion. After an Option is granted, the Committee, in its sole discretion, may accelerate the exercisability of the Option. 5.5.1 Special Rule for Retirement, Death and Disability. ------------------------------------------------- Notwithstanding any contrary provision of the Plan, the right to exercise each Option shall accrue as to one hundred percent (100%) of the Shares subject to such Option upon the Participant's Termination of Service due to Retirement, death or Disability. 5.5.2 Special Rule for Change of Control. Notwithstanding any ---------------------------------- contrary provision of the Plan, immediately upon the occurrence of a Change of Control that occurs prior to a Participant's Termination of Service, the right to exercise each Option then outstanding shall accrue as to one hundred percent (100%) of the Shares subject to such Option. Notwithstanding the preceding provisions of this Section 5.5.2, if the Committee determines that the acceleration of vesting of Options following a Change of Control would cause a Change of Control transaction to be ineligible for pooling of interests accounting under APB No. 16, which transaction (but for such accelerated vesting) otherwise would have been eligible for such accounting treatment, the Committee, in its sole discretion, may determine that no such accelerated vesting shall occur. 9 5.6 Payment. Options shall be exercised by the Participant's ------- delivery of a written notice of exercise to the Secretary of the Company (or its designee), setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares. Upon the exercise of any Option, the Exercise Price shall be payable to the Company in full in cash or its equivalent. The Committee, in its sole discretion, also may permit exercise (a) by tendering previously acquired Shares having an aggregate Fair Market Value at the time of exercise equal to the total Exercise Price, or (b) by any other means which the Committee, in its sole discretion, determines to both provide legal consideration for the Shares, and to be consistent with the purposes of the Plan. Subject to Section 5.8, as soon as practicable after receipt of a written notification of exercise and full payment for the Shares purchased, the Company shall deliver to the Participant (or the Participant's designated broker), Share certificates (which may be in book entry form) representing such Shares. 5.7 Restrictions on Share Transferability. The Committee may impose ------------------------------------- such restrictions on any Shares acquired pursuant to the exercise of an Option as it may deem advisable, including, but not limited to, restrictions related to applicable Federal securities laws, the requirements of any national securities exchange or system upon which Shares are then listed or traded, or any blue sky or state securities laws. 5.8 Deferral. -------- 5.8.1 Election to Defer Option Proceeds. Notwithstanding any --------------------------------- contrary provision of the Plan, a Participant who is eligible to defer income under the Company's Officer Deferred Compensation Plan may elect, at the discretion of, and in accordance with rules which may be established by, the Committee, to defer delivery of the proceeds of exercise of an Option which is exercised by means of an exchange of Shares as described in Section 5.6(a), provided that Shares tendered or applied in exercise of such Option shall have been held by the Participant for at least six (6) months prior to such exercise. A Participant's election as provided in the preceding sentence shall be irrevocable. Notwithstanding any other provision of this Section 5.8, a deferral election made by a Participant pursuant to this Section 5.8.1 shall be void and shall not be given effect unless (i) the Participant's deferral election is made at least six (6) full calendar months prior to the calendar month in which the Option otherwise would expire, (ii) the Participant's deferral election is made at least six (6) full calendar months prior to the calendar month in which the Option is exercised, and (iii) the Participant is employed by or is rendering services to the Company or any of its Subsidiaries on the date of exercise of the Option. For purposes of either or both of clauses (i) or (ii) of the preceding sentence, rules established by the Committee may require an election earlier than the six (6) calendar month period described therein. Upon exercise of an Option to which a deferral election applies, the Shares covered by such exercise shall not be issued or transferred to the Participant, and instead, a number of Stock Units equal to the number of Shares covered by such exercise and in respect of which the Participant has made a deferral election, shall be credited to a Deferred Option Compensation 10 Account at the date of exercise. A separate Deferred Option Compensation Account shall be maintained with respect to each Participant and to each effective deferral election. 5.8.2 Form and Timing of Payment. Payment of Stock Units shall -------------------------- be made by issuance of Shares on such date or dates or upon the occurrence of such event or events as the Committee may authorize the Participant to designate at the time a deferral election under Section 5.8.1 is made, provided, however, that in no event shall payment occur more than sixty (60) days after a Participant's Termination of Service for any reason. The number of Shares to be so distributed may be increased by dividend equivalents, which may be valued as if reinvested in Shares. Until payment of a Stock Unit is made, the number of Shares represented by a Stock Unit shall be subject to adjustment pursuant to Section 4.3. 5.8.3 Participants Remain Unsecured Creditors. Participants --------------------------------------- have the status of general unsecured creditors of the Company with respect to their Deferred Option Compensation Accounts, and such accounts constitute a mere promise by the Company to make payments with respect thereto. 5.8.4 Nontransferability of Deferred Option Compensation -------------------------------------------------- Accounts. A Participant's right to benefit payments with respect to the Deferred Option Compensation Accounts may not be anticipated, alienated, sold, transferred, assigned, pledged, encumbered, attached or garnished by creditors of the Participant or the Participant's beneficiary and any attempt to do so shall be void and shall not be given effect. 5.8.5 Provisions of the Officer Deferred Compensation Plan May -------------------------------------------------------- Govern. To the extent determined by the Committee, any amount deferred under this Section 5.8, and any Deferred Option Compensation Account, may be treated and held as a portion of the Company's Officer Deferred Compensation Plan, in which event the provisions of such plan shall govern the operation and administration of amounts deferred under this Section 5.8 and credited to Deferred Option Compensation Accounts. 5.9 Certain Additional Provisions for Incentive Stock Options. --------------------------------------------------------- 5.9.1 Exercisability. The aggregate Fair Market Value -------------- (determined on the Grant Date(s)) of the Shares with respect to which Incentive Stock Options are exercisable for the first time by any Employee during any calendar year (under all plans of the Company and its Subsidiaries) shall not exceed $100,000. 5.9.2 Termination of Service. If any portion of an Incentive ---------------------- Stock Option is exercised more than three (3) months after the Participant's Termination of Service for any reason other than Disability or death (unless (a) the Participant dies during such three-month period, and (b) the Award Agreement or the Committee permits later exercise), the portion so exercised shall be deemed a Nonqualified Stock Option. 5.9.3 Company and Subsidiaries Only. Incentive Stock Options ----------------------------- may be granted only to persons who are employees of the Company or a Subsidiary on the Grant Date. 11 5.9.4 Expiration. No Incentive Stock Option may be exercised ---------- after the expiration of ten (10) years from the Grant Date; provided, however, that if the Option is granted to an Employee who, together with persons whose stock ownership is attributed to the Employee pursuant to section 424(d) of the Code, owns stock possessing more than ten percent (10%) of the total combined voting power of all classes of the stock of the Company or any of its Subsidiaries, the Option may not be exercised after the expiration of five (5) years from the Grant Date. 5.10 Grant of Reload Options. The Committee may provide in an Award ----------------------- Agreement that a Participant who exercises all or part of an Option by payment of the Exercise Price with already-owned Shares, shall be granted an additional option (a "Reload Option") for a number of shares of stock equal to the number of Shares tendered to exercise the previously granted Option plus, if the Committee so determines, any Shares withheld or delivered in satisfaction of any tax withholding requirements. As determined by the Committee, each Reload Option shall (a) have a Grant Date which is the date as of which the previously granted Option is exercised, and (b) be exercisable on the same terms and conditions as the previously granted Option, except that the Exercise Price shall be determined as of the Grant Date. SECTION 6 RESTRICTED STOCK 6.1 Grant of Restricted Stock. Subject to the terms and provisions ------------------------- of the Plan, the Committee, at any time and from time to time, may grant Shares of Restricted Stock to Employees and Consultants in such amounts as the Committee, in its sole discretion, shall determine. The Committee, in its sole discretion, shall determine the number of Shares to be granted to each Participant, provided that during any Fiscal Year, no Participant shall be granted more than 10,000 Shares of Restricted Stock. 6.2 Restricted Stock Agreement. Each Award of Restricted Stock shall -------------------------- be evidenced by an Award Agreement that shall specify the Period of Restriction, the number of Shares granted, any price to be paid for the Shares, and such other terms and conditions as the Committee, in its sole discretion, shall determine. Unless the Committee determines otherwise, Shares of Restricted Stock shall be held by the Company as escrow agent until the restrictions on such Shares have lapsed. 6.3 Transferability. Shares of Restricted Stock may not be sold, --------------- transferred, pledged, assigned, or otherwise alienated or hypothecated until the end of the applicable Period of Restriction. 6.4 Other Restrictions. The Committee, in its sole discretion, may ------------------ impose such other restrictions on Shares of Restricted Stock as it may deem advisable or appropriate, in accordance with this Section 6.4. 6.4.1 General Restrictions. The Committee may set restrictions -------------------- based upon the achievement of specific performance objectives (Company-wide, business unit or individual), applicable federal or state securities laws, or any other basis determined by the Committee in its discretion. 12 6.4.2 Section 162(m) Performance Restrictions. For purposes of --------------------------------------- qualifying grants of Restricted Stock as "performance-based compensation" under section 162(m) of the Code, the Committee, in its discretion, may set restrictions based upon the achievement of Performance Goals. The Performance Goals shall be set by the Committee on or before the latest date permissible to enable the Restricted Stock to qualify as "performance-based compensation" under section 162(m) of the Code. In granting Restricted Stock which is intended to qualify under section 162(m) of the Code, the Committee shall follow any procedures determined by it from time to time to be necessary or appropriate to ensure qualification of the Restricted Stock under section 162(m) of the Code (e.g., in determining the Performance Goals). 6.4.3 Legend on Certificates. The Committee, in its ---------------------- discretion, maylegend the certificates representing Restricted Stock to give appropriate notice of such restrictions. For example, the Committee may determine that some or all certificates representing Shares of Restricted Stock shall bear the following legend: "The sale or other transfer of the shares of stock represented by this certificate, whether voluntary, involuntary, or by operation of law, is subject to certain restrictions on transfer as set forth in The PMI Group, Inc. Equity Incentive Plan, and in a Restricted Stock Agreement. A copy of the Plan and such Restricted Stock Agreement may be obtained from the Secretary of The PMI Group, Inc." 6.5 Removal of Restrictions. Shares of Restricted Stock covered by ----------------------- each Restricted Stock grant made under the Plan shall be released from escrow as soon as practicable after the last day of the Period of Restriction. The Committee, in its discretion, may accelerate the time at which any restrictions shall lapse, and remove any restrictions. After the restrictions have lapsed, the Participant shall be entitled to have any legend or legends under Section 6.4 removed from his or her Share certificate, and the Shares shall be freely transferable by the Participant. 6.5.1 Special Rule for Retirement, Death and Disability. ------------------------------------------------- Notwithstanding any contrary provision of the Plan, one hundred percent (100%) of any outstanding Shares of Restricted Stock shall be one hundred percent (100%) vested in the Participant upon the Participant's Termination of Service due to Retirement, death or Disability. 6.5.2 Special Rule for Change of Control. Notwithstanding any ---------------------------------- contrary provision of the Plan, immediately upon the occurrence of a Change of Control that occurs prior to a Participant's Termination of Service, one hundred percent (100%) of any outstanding Shares of Restricted Stock shall be one hundred percent (100%) vested in the Participant. Notwithstanding the preceding provisions of this Section 6.5.2, if the Committee determines that the acceleration of vesting of Restricted Stock following a Change of Control would cause a Change of Control transaction to be ineligible for pooling of interests accounting under APB No. 16, which transaction (but for such accelerated vesting) otherwise would have been eligible for such accounting treatment, the Committee, in its sole discretion, may determine that no such accelerated vesting shall occur. 13 6.6 Voting Rights. During the Period of Restriction, Participants ------------- holding Shares of Restricted Stock granted hereunder may exercise full voting rights with respect to those Shares, unless otherwise provided in the Award Agreement. 6.7 Dividends and Other Distributions. During the Period of --------------------------------- Restriction, Participants holding Shares of Restricted Stock shall be entitled to receive all dividends and other distributions paid with respect to such Shares unless otherwise provided in the Award Agreement. If any such dividends or distributions are paid in Shares, the Shares shall be subject to the same restrictions on transferability and forfeitability as the Shares of Restricted Stock with respect to which they were paid. 6.8 Return of Restricted Stock to Company. On the date set forth in ------------------------------------- the Award Agreement, the Restricted Stock for which restrictions have not lapsed shall revert to the Company and again shall become available for grant under the Plan. SECTION 7 PERFORMANCE UNITS AND PERFORMANCE SHARES 7.1 Grant of Performance Units and Shares. Performance Units and ------------------------------------- Performance Shares may be granted to Employees and Consultants at any time and from time to time, as shall be determined by the Committee, in its sole discretion. The Committee shall have complete discretion in determining the number of Performance Units and Performance Shares granted to any Participant, provided that during any Fiscal Year no more than 10,000 Performance Units or Performance Shares may be granted to any Participant. 7.2 Initial Value. Each Performance Unit shall have an initial value ------------- that is established by the Committee on or before the Grant Date, provided that such value shall not exceed the Fair Market Value of a Share on the Grant Date. Each Performance Share shall have an initial value equal to the Fair Market Value of a Share on the Grant Date. 7.3 Performance Objectives and Other Terms. The Committee shall set -------------------------------------- performance objectives in its discretion which, depending on the extent to which they are met, will determine the number or value of Performance Units or Shares that will be paid out to the Participants. The Committee may set performance objectives based upon the achievement of Company-wide, business unit, or individual goals, or any other basis determined by the Committee in its discretion. The time period during which the performance objectives must be met shall be called the "Performance Period." Each Award of Performance Units or Shares shall be evidenced by an Award Agreement that shall specify the Performance Period, and such other terms and conditions as the Committee, in its sole discretion, shall determine. 7.3.1 General Performance Objectives. The Committee may set ------------------------------ performance objectives based upon the achievement of Company-wide, business unit or individual goals, or any other basis determined by the Committee in its discretion. 7.3.2 Section 162(m) Performance Objectives. For purposes of ------------------------------------- qualifying grants of Performance Units or Shares as "performance-based compensation" under section 162(m) of the Code, the Committee, in its discretion, may determine that the performance 14 objectives applicable to Performance Units or Shares shall be based on the achievement of Performance Goals. The Performance Goals shall be set by the Committee on or before the latest date permissible to enable the Performance Units or Shares to qualify as "performance-based compensation" under section 162(m) of the Code. In granting Performance Units or Shares which are intended to qualify under section 162(m) of the Code, the Committee shall follow any procedures determined by it from time to time to be necessary or appropriate to ensure qualification of the Performance Units or Shares under section 162(m) of the Code (e.g., in determining the Performance Goals). 7.4 Earning of Performance Units and Performance Shares. After the --------------------------------------------------- applicable Performance Period has ended, the Participant shall be entitled to receive a payout of the number of Performance Units or Shares earned during the Performance Period, depending upon the extent to which the applicable performance objectives have been achieved. After the grant of a Performance Unit or Share, the Committee, in its sole discretion, may reduce or waive any performance objectives for Award, except with respect to Awards which are intended to qualify as performance-based compensation under Section 162(m) of the Code. 7.4.1 Special Rule for Retirement, Death and Disability. ------------------------------------------------- Notwithstanding any contrary provision of the Plan, upon the Participant's Termination of Service due to Retirement, death or Disability, one hundred percent (100%) of any outstanding Performance Units or Shares shall be deemed to be earned and shall be immediately payable to the Participant, or, in cases where a Participant has received a target award of Performance Units or Shares, one hundred percent (100%) of the target amount shall vest. 7.4.2 Special Rule for Change of Control. Notwithstanding any ---------------------------------- contrary provision of the Plan, immediately upon the occurrence of a Change of Control that occurs prior to a Participant's Termination of Service, one hundred percent (100%) of any outstanding Performance Units or Shares shall be deemed to be earned and shall be immediately payable to the Participant, or, in cases where a Participant has received a target award of Performance Units or Shares, one hundred percent (100%) of the target amount shall vest. Notwithstanding the preceding provisions of this Section 7.4.2, if the Committee determines that the acceleration of vesting of Performance Units or Shares following a Change of Control would cause a Change of Control transaction to be ineligible for pooling of interests accounting under APB No. 16, which transaction (but for such accelerated vesting) otherwise would have been eligible for such accounting treatment, the Committee, in its sole discretion, may determine that no such accelerated vesting shall occur. 7.5 Form and Timing of Payment. Subject to Section 7.5.1, payment of -------------------------- earned Performance Units or Performance Shares shall be made as soon as practicable after the expiration of the applicable Performance Period. The Committee, in its sole discretion, may pay such earned Awards in cash, Shares or a combination thereof. 7.5.1 Deferrals. The Committee, in its sole discretion, may --------- permit a Participant to defer receipt of the payment of cash or the delivery of Shares that would otherwise be delivered to a Participant under this Section 7.5. Any such deferral elections shall be subject to such rules and procedures as shall be determined by the Committee in its sole discretion. 15 7.6 Cancellation. On the date set forth in the Award Agreement, all ------------ unearned or unvested Performance Units or Performance Shares shall be forfeited to the Company, and again shall be available for grant under the Plan. SECTION 8 MISCELLANEOUS 8.1 No Effect on Employment or Service. Nothing in the Plan shall ---------------------------------- interfere with or limit in any way the right of the Company to terminate any Participant's employment or service at any time, with or without cause. For purposes of the Plan, transfer of employment of a Participant between the Company and any one of its Affiliates (or between Affiliates) shall not be deemed a Termination of Service. Employment with the Company and its Affiliates is on an at-will basis only. 8.2 Participation. No Employee or Consultant shall have the right to ------------- be selected to receive an Award under this Plan, or, having been so selected, to be selected to receive a future Award. 8.3 Indemnification. Each person who is or shall have been a member --------------- of the Committee, or of the Board, shall be indemnified and held harmless by the Company against and from (a) any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit, or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan or any Award Agreement, and (b) from any and all amounts paid by him or her in settlement thereof, with the Company's approval, or paid by him or her in satisfaction of any judgment in any such claim, action, suit, or proceeding against him or her, provided he or she shall give the Company an opportunity, at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such persons may be entitled under the Company's Certificate of Incorporation or Bylaws, by contract, as a matter of law, or otherwise, or under any power that the Company may have to indemnify them or hold them harmless. 8.4 Successors. All obligations of the Company under the Plan, with ---------- respect to Awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation or otherwise, of all or substantially all of the business or assets of the Company. 8.5 Beneficiary Designations. If permitted by the Committee, a ------------------------ Participant under the Plan may name a beneficiary or beneficiaries to whom any vested but unpaid Award shall be paid in the event of the Participant's death. Each such designation shall revoke all prior designations by the Participant and shall be effective only if given in a form and manner acceptable to the Committee. In the absence of any such designation, any vested benefits remaining unpaid at the Participant's death shall be paid to the Participant's estate and, subject to the terms of the Plan and of the applicable Award Agreement, any unexercised vested Award may be exercised by the administrator or executor of the Participant's estate. 16 8.6 Nontransferability of Awards. No Award granted under the Plan ---------------------------- may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will, by the laws of descent and distribution, or to the limited extent provided in Section 8.5. All rights with respect to an Award granted to a Participant shall be available during his or her lifetime only to the Participant. Notwithstanding the foregoing, the Participant may, in a manner specified by the Committee, transfer a Nonqualified Stock Option by bona fide gift and not for any consideration, to (a) a member of the Participant's immediate family, (b) a trust or other entity for the exclusive benefit of the Participant and/or a member or members of the Participant's immediate family, (c) a partnership, limited liability company or other entity whose only partners or members are the Participant and/or a member or members of the Participant's immediate family, or (d) a tax-qualified, not for profit organization. 8.7 No Rights as Stockholder. Except to the limited extent provided ------------------------ in Sections 6.6 and 6.7, no Participant (nor any beneficiary) shall have any of the rights or privileges of a stockholder of the Company with respect to any Shares issuable pursuant to an Award (or exercise thereof), unless and until certificates representing such Shares shall have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Participant (or beneficiary). 8.8 Withholding Requirements. Prior to the delivery of any Shares or ------------------------ cash pursuant to an Award (or exercise thereof), the Company shall have the power and the right to deduct or withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy federal, state, local and foreign taxes (including the Participant's FICA obligation) required to be withheld with respect to such Award (or exercise thereof). Notwithstanding any contrary provision of the Plan, if a Participant fails to remit to the Company such withholding amount within the time period specified by the Committee (in its discretion), the Participant's Award may, in the Committee's discretion, be forfeited and in such case the Participant shall not receive any of the Shares subject to such Award. 8.9 Withholding Arrangements. The Committee, in its sole discretion ------------------------ and pursuant to such procedures as it may specify from time to time, may permit or require a Participant to satisfy all or part of the tax withholding obligations in connection with an Award by (a) having the Company withhold otherwise deliverable Shares, or (b) delivering to the Company already-owned Shares having a Fair Market Value equal to the amount required to be withheld. The amount of the withholding requirement shall be deemed to include any amount which the Committee determines, not to exceed the amount determined by using the maximum federal, state, local or foreign jurisdiction marginal income tax rates applicable to the Participant with respect to the Award on the date that the amount of tax to be withheld is to be determined. The Fair Market Value of the Shares to be withheld or delivered shall be determined as of the date that the taxes are required to be withheld. SECTION 9 AMENDMENT, TERMINATION AND DURATION 9.1 Amendment, Suspension or Termination. The Board, in its sole ------------------------------------ discretion, may amend or terminate the Plan, or any part thereof, at any time and for any reason. 17 The amendment, suspension or termination of the Plan shall not, without the consent of the Participant, alter or impair any rights or obligations under any Award theretofore granted to such Participant. No Award may be granted during any period of suspension or after termination of the Plan. 9.2 Duration of the Plan. The Plan shall commence on the date -------------------- specified herein, and subject to Section 9.1 (regarding the Board's right to amend or terminate the Plan), shall remain in effect thereafter. However, without further stockholder approval, no Incentive Stock Option may be granted under the Plan after ten (10) years from the Effective Date. SECTION 10 LEGAL CONSTRUCTION 10.1 Gender and Number. Except where otherwise indicated by the ----------------- context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural. 10.2 Severability. In the event any provision of the Plan shall be ------------ held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. 10.3 Requirements of Law. The granting of Awards and the issuance of ------------------- Shares under the Plan shall be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required. 10.4 Governing Law. The Plan and all Award Agreements shall be ------------- construed in accordance with and governed by the laws of the State of California, but without regard to its conflict of law provisions. 10.5 Captions. Captions are provided herein for convenience only, -------- and shall not serve as a basis for interpretation or construction of the Plan. 18 EXECUTION IN WITNESS WHEREOF, The PMI Group, Inc., by its duly authorized officer, has executed the Plan on the date indicated below. THE PMI GROUP, INC. Dated: 3/17, 1999 By /s/ Charles Broom --------------------------- Name: Charles Broom Title: V.P Human Resources 19 EX-10.26 4 OFFICER DEFERRED COMPENSATION PLAN EXHIBIT 10.26 THE PMI GROUP, INC. OFFICER DEFERRED COMPENSATION PLAN (Effective July 1, 1997) (Amended and Restated as of July 23, 1998) TABLE OF CONTENTS
SECTION 1 DEFINITIONS................................... 1 1.1 "Affiliate...................................... 1 1.2 "Beneficiary.................................... 1 1.3 "Board of Directors............................. 1 1.4 "Change of Control.............................. 1 1.5 "Code........................................... 3 1.6 "Committee...................................... 3 1.7 "Company........................................ 3 1.8 "Compensation................................... 3 1.9 "Compensation Deferrals......................... 3 1.10 "Disability.................................... 4 1.11 "Eligible Employee............................. 4 1.12 "Employers..................................... 4 1.13 "ERISA......................................... 4 1.14 "Financial Hardship............................ 4 1.15 "Insurance Company............................. 4 1.16 "Participant................................... 4 1.17 "Participant's Account......................... 4 1.18 "Plan.......................................... 4 1.19 "Plan Year..................................... 5 1.20 "Qualified Institutional Investor.............. 5 1.21 "1934 Act...................................... 5 SECTION 2................................................ 5 PARTICIPATION............................................ 5 2.1 Participation................................... 5 2.1.1. Initial Elections by Current Employees.. 5 2.1.2. Initial Elections by Other Employees.... 5 2.1.3. Elections for Subsequent Plan Years..... 5 2.1.4. Separate Election to Defer Bonuses...... 5 2.1.5. No Election Changes During Plan Year.... 6 2.1.6. Specific Timing and Method of Election.. 6 2.2 Suspension of Compensation Deferrals............ 6 2.2.1. Automatic Suspension.................... 6 2.2.2. Permissible Suspension.................. 6 2.3 Termination of Participation.................... 6
-i- TABLE OF CONTENTS (continued)
SECTION 3...................................................... 6 COMPENSATION DEFERRAL ELECTIONS................................ 6 3.1 Compensation Deferrals................................ 6 3.2 Crediting of Compensation Deferrals................... 7 3.3 Deemed Investment Return on Accounts.................. 7 3.4 Form of Payment....................................... 7 3.5 Term of Deferral...................................... 7 3.6 Changes in Elections as to Term and Form for Payment.. 8 SECTION 4...................................................... 8 ACCOUNTING..................................................... 8 4.1 Participants' Accounts................................ 8 4.2 Participants Remain Unsecured Creditors............... 8 4.3 Accounting Methods.................................... 8 4.4 Reports............................................... 8 SECTION 5...................................................... 9 DISTRIBUTIONS.................................................. 9 5.1 Normal Time for Distribution.......................... 9 5.2 Change of Control..................................... 9 5.3 Special Rule for Death or Disability.................. 9 5.4 Special Rule re Deductibility......................... 9 5.5 Latest Permissible Distribution Date.................. 10 5.6 Beneficiary Designations.............................. 10 5.6.1. Spousal Consent............................... 10 5.6.2. Changes and Failed Designations............... 10 5.7 Financial Hardship.................................... 11 5.8 Payments to Incompetents.............................. 11 5.9 Undistributable Accounts.............................. 11 5.10 Committee Discretion................................. 11 SECTION 6...................................................... 11 PARTICIPANT'S INTEREST IN ACCOUNT.............................. 11 6.1 Compensation Deferral Contributions................... 11 SECTION 7...................................................... 12 ADMINISTRATION OF THE PLAN..................................... 12 7.1 Plan Administrator.................................... 12 7.2 Committee............................................. 12 7.3 Actions by Committee.................................. 12
-ii- TABLE OF CONTENTS (continued)
7.4 Powers of Committee....................................... 12 7.5 Decisions of Committee.................................... 13 7.6 Administrative Expenses................................... 13 7.7 Eligibility to Participate................................ 13 7.8 Indemnification........................................... 13 SECTION 8.......................................................... 14 FUNDING............................................................ 14 8.1 Unfunded Plan............................................. 14 SECTION 9.......................................................... 14 MODIFICATION OR TERMINATION OF PLAN................................ 14 9.1 Employers' Obligations Limited............................ 14 9.2 Right to Amend or Terminate............................... 14 9.3 Effect of Termination..................................... 14 SECTION 10......................................................... 15 GENERAL PROVISIONS................................................. 15 10.1 Participation by Affiliates.............................. 15 10.2 Inalienability........................................... 15 10.3 Rights and Duties........................................ 15 10.4 No Enlargement of Employment Rights...................... 15 10.5 Apportionment of Costs and Duties........................ 15 10.6 Compensation Deferrals Not Counted Under Other Employee Benefit Plans............................................ 15 10.7 Applicable Law........................................... 15 10.8 Severability............................................. 16 10.9 Captions................................................. 16 APPENDIX A......................................................... 17
-iii- THE PMI GROUP, INC. OFFICER DEFERRED COMPENSATION PLAN (Effective July 1, 1997) THE PMI GROUP, INC., a Delaware corporation, hereby establishes The PMI Group, Inc. Officer Deferred Compensation Plan, effective July 1, 1997, for the benefit of a select group of management and highly compensated employees of the Company and its participating Affiliates, in order to provide such employees with certain deferred compensation benefits. The Plan is an unfunded deferred compensation plan that is intended to qualify for the exemptions provided in sections 201, 301, and 401 of ERISA. SECTION 1 DEFINITIONS The following words and phrases shall have the following meanings unless a different meaning is plainly required by the context: 1.1 "Affiliate" shall mean (a) the Company, and (b) each corporation, trade or business which is, together with any Employer, a member of a controlled group of corporations or an affiliated service group or under common control (within the meaning of section 414(b), (c) or (m) of the Code), but only for the period during which such other entity is so affiliated with any Employer. 1.2 "Beneficiary" shall mean the person or persons entitled to receive the balance credited to a Participant's Account under the Plan upon the death of a Participant, as provided in Section 5.4. 1.3 "Board of Directors" shall mean the Board of Directors of the Company, as constituted from time to time. 1.4 "Change of Control" "Change of Control" shall mean: (a) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, (iv) any beneficial ownership maintained by (but not additional acquisitions by), The Allstate Corporation and its subsidiaries, and their respective successors ("Allstate"), pending such time that Allstate distributes or transfers its current ownership interest in the Outstanding Company Common Stock and Outstanding Company Voting Securities as contemplated by the Prospectus dated April 10, 1995, relating to the initial public offering of the common stock of the Company, or (v) any acquisition pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Section 1.4. Notwithstanding the foregoing, in its sole discretion, the Board may increase the 20% threshold set forth above in this subsection (a) prior to any acquisition of 20% or more beneficial ownership of the Outstanding Company Common Stock or the Outstanding Company Voting Securities; provided, that (i) such increased threshold shall apply only to the acquisition and maintenance of beneficial ownership by any Person eligible to report such beneficial ownership at the time of such acquisition on Schedule 13G under the Exchange Act, and (ii) in the event that any Person initially eligible to so report on Schedule 13G thereafter ceases to be eligible to so report on Schedule 13G, the occurrence of the event causing such Person no longer to be eligible to so report shall be deemed an acquisition by such Person of all of the Outstanding Company Common Stock and Outstanding Company Voting Securities beneficially owned by such Person immediately prior to such occurrence; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation by the Company of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets of another entity (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock 2 and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. Notwithstanding the foregoing, a Change of Control shall not be deemed to occur solely because any Person acquires beneficial ownership of 20% or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock as a result of the acquisition of such securities or stock by the Company, which acquisition reduces the number of the Outstanding Company Voting Securities or Outstanding Company Common Stock; provided, that if after such acquisition by the Company such Person (while such Person remains the beneficial owner of 20% or more of the Outstanding Company Voting Securities or Outstanding Company Common Stock) becomes the beneficial owner of additional shares of such Outstanding Company Voting Securities or Outstanding Company Common Stock (as the case may be), a Change of Control shall then occur. Capitalized terms used in this Section 1.4, not otherwise defined, shall have the meaning set forth in the form of change of control employment agreement approved at the February 12, 1998 meeting of the Board of Directors. 1.5 "Code" shall mean the Internal Revenue Code of 1986, as amended. Reference to a specific section of the Code shall include such section, any valid regulation promulgated thereunder, and any comparable provision of any future legislation amending, supplementing or superseding such section. 1.6 "Committee" shall mean the committee appointed by (and serving at the pleasure of) the Chief Executive Officer of the Company (the "CEO") to administer the Plan. As of the effective date of the Plan, the members of the Committee shall be the CEO and the Company's senior human resources officer. 1.7 "Company" shall mean The PMI Group, Inc., a Delaware corporation. 1.8 "Compensation" shall mean the base salary and bonuses (if any) of a Participant. The Committee, in its discretion, shall from time to time designate the types of bonuses which shall be eligible for deferral under the Plan. A Participant's Compensation shall not include any other type of remuneration. 1.9 "Compensation Deferrals" shall mean the amounts credited to Participants' Accounts under the Plan pursuant to their deferral elections made in accordance with Section 2.1. 3 1.10 "Disability" or "Disabled" shall mean the mental or physical inability of a Participant to perform the regularly assigned duties of his or her employment, provided that such inability (a) has continued or is expected to continue for a period of at least 6 months and (b) is evidenced by the certificate of a physician satisfactory to the Committee stating that such inability exists and is likely to be permanent. 1.11 "Eligible Employee" shall mean an employee of an Employer who holds office at the level of Vice President or above, including any Assistant Vice President or Field Vice President. Notwithstanding the preceding, the Board of Directors, in its sole discretion, may (a) change the required title for purposes of determining eligibility for the Plan, and (b) determine that one or more otherwise eligible employees of an Employer shall not be Eligible Employees. 1.12 "Employers" shall mean the Company and each of its Affiliates that adopts the Plan with the approval of the Board of Directors. With respect to an individual Participant, "Employer" shall mean the Company or its Affiliate that (a) directly employs such Participant, and (b) has adopted the Plan (with the approval of the Board of Directors). 1.13 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. Reference to a specific section of ERISA shall include such section, any valid regulation promulgated thereunder, and any comparable provision of any future legislation amending, supplementing or superseding such section. 1.14 "Financial Hardship" shall mean a severe financial emergency which is caused by a sudden and unexpected accident, illness or other event beyond the control of the Participant which, absent a suspension of deferrals under Section 2.2 or accelerated distribution under Section 5.5, would result in severe financial burden to the Participant or a member of his or her immediate family. A Financial Hardship does not exist to the extent that the hardship may be relieved by (a) reimbursement or compensation by insurance, (b) by liquidation of the Participant's other assets (to the extent such liquidation would not itself cause severe financial hardship), or (c) any loan available to the Participant (to the extent the payments on such loan would not themselves cause severe financial hardship. 1.15 "Insurance Company" shall mean PMI Mortgage Insurance Co., an Arizona corporation. The Insurance Company is a wholly-owned subsidiary of the Company. 1.16 "Participant" shall mean an Eligible Employee who (a) has become a Participant in the Plan pursuant to Section 2.1 and (b) has not ceased to be a Participant pursuant to Section 2.3. 1.17 "Participant's Account" or "Account" shall mean, as to any Participant, the separate account maintained on the books of the Insurance Company in order to reflect his or her interest under the Plan. 1.18 "Plan" shall mean The PMI Group, Inc. Officer Deferred Compensation Plan, as set forth in this instrument and as hereafter amended from time to time. 4 1.19 "Plan Year" shall mean the calendar year. Notwithstanding the preceding, the 1997 Plan Year shall be the period July 1, 1997 (the effective date of the Plan), through December 31, 1997. 1.20 "Qualified Institutional Investor" shall mean as of any time of determination any Person (as defined in Section 1.4): (a) that is eligible to file a Schedule 13G with respect to all securities of the Company beneficially owned by such Person pursuant to Rule 13d-1(b)(1) promulgated under the 1934 Act (as such Rule is in effect on the date hereof), (b) that is not required to file a Schedule 13D under the 1934 Act (or any successor or comparable report) with respect to any securities of the Company, and (c) that beneficially owns less than 15% of the common stock of the Company, par value $.01 per share, outstanding at the time of determination. 1.21 "1934 Act" means the Securities and Exchange Act of 1934, as amended. SECTION 2 PARTICIPATION 2.1 Participation. Each Eligible Employee's decision to become a Participant shall be entirely voluntary. 2.1.1. Initial Elections by Current Employees. An Eligible Employee may elect to become a Participant in the Plan by electing, no later than July 30, 1997, to make Compensation Deferrals under the Plan. An election under this Section 2.1.1 to make Compensation Deferrals shall be effective only for the remainder of the 1997 Plan Year. 2.1.2. Initial Elections by Other Employees. Each individual who becomes an Eligible Employee after July 1, 1997 (whether by hire or promotion) may elect to become a Participant in the Plan by electing, within thirty days of the date of his or her hire or promotion (as the case may be), to make Compensation Deferrals under the Plan. An election under this Section 2.1.2 to make Compensation Deferrals shall be effective only for the remainder of the Plan Year with respect to which the election is made. 2.1.3. Elections for Subsequent Plan Years. An Eligible Employee may elect to become a Participant (or to continue or reinstate his or her active participation) in the Plan for any subsequent Plan Year by electing, no later than December 31 of the preceding Plan Year, to make Compensation Deferrals under the Plan. An election under this Section 2.1.3 to make Compensation Deferrals shall be effective only for the Plan Year with respect to which the election is made. 2.1.4. Separate Election to Defer Bonuses. Each Eligible Employee shall make a separate Compensation Deferral election with respect to the bonus portion(s) (if any) of his or her Compensation. An Eligible Employee's Compensation Deferral election with respect to his or her bonus(es) shall be made no later than the deadline specified by the Committee for the 5 particular Plan Year during which the Eligible Employee will perform the services for which a bonus may be paid, except to the limited extent provided in Section 2.1.2. 2.1.5. No Election Changes During Plan Year. After the beginning of a Plan Year, a Participant shall not be permitted to change or revoke his or her deferral election for such Plan Year, except to the limited extent provided in Section 2.2. 2.1.6. Specific Timing and Method of Election. Notwithstanding any contrary provision of this Section 2.1, the Committee, in its sole discretion, shall determine the manner and deadlines for Participants to make Compensation Deferral elections. The deadlines prescribed by the Committee may be earlier than the deadlines specified in this Section 2.1, but shall not be later than such specified deadlines. 2.2 Suspension of Compensation Deferrals. 2.2.1. Automatic Suspension. In the event that a Participant receives a financial hardship withdrawal from The PMI Group, Inc. Savings and Profit-Sharing Plan or any other plan (maintained by an Employer) which contains a qualified cash or deferred arrangement under section 401(k) of the Code (collectively, the "401(k) Plans"), the Participant's Compensation Deferrals under the Plan (if any) shall be suspended for a period of twelve (12) months from the date that the Participant received such hardship withdrawal. Notwithstanding the preceding, the Participant's Compensation Deferrals shall be not be so suspended if the Committee determines that such suspension is not required in order to preserve the tax-qualification of the 401(k) Plans. 2.2.2. Permissible Suspension. In the event that a Participant incurs a Financial Hardship, the Committee, in its sole discretion, may suspend the Participant's Compensation Deferrals for the remainder of the Plan Year. However, an election to make Compensation Deferrals under Section 2.1 shall be irrevocable as to amounts deferred as of the effective date of any suspension in accordance with this Section 2.2.2. 2.3 Termination of Participation. An Eligible Employee who has become a Participant shall remain a Participant until his or her entire vested Account balance is distributed. However, an Eligible Employee who has become a Participant may or may not be an active Participant making Compensation Deferrals for a particular Plan Year, depending upon whether he or she has elected to make Compensation Deferrals for such Plan Year. SECTION 3 COMPENSATION DEFERRAL ELECTIONS 3.1 Compensation Deferrals. At the times and in the manner prescribed in Section 2.1, each Eligible Employee may elect to defer portions of his or her Compensation and to have the amounts of such deferrals credited to his or her Account. For each Plan Year, an Eligible Employee may elect to defer an amount equal to any percentage or any specific dollar amount of his or her Compensation, provided that the percentage or dollar amount elected by the Participant shall result in an expected deferral at least the lesser of (a) $5,000, or (b) 5% of his or her 6 Compensation. Notwithstanding any contrary provision of the Plan, the Committee may reduce a Participant's Compensation Deferrals to the extent necessary to satisfy any required deductions for welfare plans or any deductions required by law. 3.2 Crediting of Compensation Deferrals. The amounts deferred pursuant to Section 3.1 shall reduce the Participant's Compensation for the Plan Year and shall be credited to the Participant's Account as of the last day of the month in which the amounts (but for the deferral) would have been paid to the Participant. For each Plan Year, the exact dollar amount to be deferred from each Compensation payment shall be determined by the Committee under such formulae as it shall adopt from time to time. 3.3 Deemed Investment Return on Accounts. Although no assets will be segregated or otherwise set aside with respect to a Participant's Account, the amount that is ultimately payable to the Participant with respect to his or her Account shall be determined as if such Account had been invested in such manner as the Committee, in its discretion, may specify from time to time (including, but not limited to, the equity return method. The Committee, in its sole discretion, shall adopt (and may modify from time to time) such rules and procedures as it deems necessary or appropriate to implement the deemed investment of the Participants' Accounts. Such procedures shall (a) provide that a Participant shall be entitled to make deemed investment elections as to the deemed investment of his or her Account, and (b) permit a Participant to elect (not less than once per calendar quarter) to have part or all of his or her Account deemed to be invested in common stock of the Company (including reinvestment of any deemed dividends). However, such procedures may differ among Participants or classes of Participants, as determined by the Committee in its discretion. 3.4 Form of Payment. Each Participant shall indicate on his or her deferral election (made pursuant to Section 3.1) the form of payment for the Compensation Deferrals made pursuant to such election. A Participant may elect (a) a lump sum payment, or (b) a fixed number of annual installment payments (not to exceed ten). A Participant's election as to the form of payment shall apply to all amounts credited to the Participant's Account for the Plan Year with respect to which the election is made, and except to the limited extent provided in Section 3.6, shall be irrevocable. 3.5 Term of Deferral. Each Participant shall indicate on his or her deferral election made pursuant to Section 3.1 the time for payment for Compensation Deferrals (and deemed investment returns, gains and losses thereon) made pursuant to such election. A Participant may elect a term of deferral equal to any whole number (not less than one) of calendar years specified in his or her deferral election. In addition, pursuant to such procedures as the Committee (in its discretion) may adopt from time to time, a Participant may elect a term of deferral which ends upon the later (or earlier) of the expiration of a specified period or the occurrence of a specific event (for example, the later of ten years or termination of employment with the Company and all Affiliates). A Participant's election as to the term of deferral shall apply to all amounts credited to the Participant's Account for the Plan Year with respect to which the election is made, and except to the limited extent provided in Section 3.6, shall be irrevocable. 7 3.6 Changes in Elections as to Term and Form for Payment. A Participant may change his or her election under Section 3.4 and/or Section 3.5 for amounts credited to the Participant's Account for any Plan Year, provided that any such election will be effective only if (a) such election is made at least two Plan Years prior to the Plan Year in which payment of such amounts is scheduled to commence (without giving effect to such election), (b) the newly elected scheduled payment commencement date is not earlier than the second Plan Year after the Plan Year in which such election is made, and (c) payment of such amounts has not actually commenced. For example, if a Participant initially elected to receive his or 1999 Plan Year deferrals in a lump sum to be paid during the 2003 Plan Year, the Participant instead may elect to receive payment in the form of ten annual installments commencing during the 2004 Plan Year, provided that such election is made on or before December 31, 2001. (i.e., not ---- less than two Plan Years prior to the Plan Year in which payment of such amounts previously was scheduled to commence, and with a newly elected scheduled payment commencement date which is not earlier than the second Plan Year after the Plan Year in which such election is made). SECTION 4 ACCOUNTING 4.1 Participants' Accounts. For each Plan Year, at the direction of the Committee, there shall be established and maintained on the books of the Insurance Company, a separate Account or Accounts for each Participant to which shall be credited all Compensation Deferrals made by the Participant during such Plan Year, and deemed investment returns, gains and losses on such Compensation Deferrals. 4.2 Participants Remain Unsecured Creditors. All amounts credited to a Participant's Account under the Plan shall continue for all purposes to be a part of the general assets of the Insurance Company. Each Participant's interest in the Plan shall make him or her only a general, unsecured creditor of the Insurance Company. 4.3 Accounting Methods. The accounting methods or formulae to be used under the Plan for the purpose of maintaining the Participants' Accounts, including the calculation and crediting (or debiting) of deemed returns, gains and losses, shall be determined by the Committee, in its sole discretion. The accounting methods or formulae selected by the Committee may be revised from time to time. 4.4 Reports. Each Participant shall be furnished with periodic statements of his or her Account, reflecting the status of his or her interest in the Plan, at least annually. 8 SECTION 5 DISTRIBUTIONS 5.1 Normal Time for Distribution. Subject to Sections 5.2 through 5.5 and Section 5.10, distribution of the balance credited to a Participant's Account shall commence as soon as administratively practicable after the end of the term(s) of deferral elected by the Participant under Section 3.5, in accordance with the following rules. If, pursuant to Section 3.4, the Participant elected to receive annual installment payments, his or her first installment shall be equal to the balance then credited to his or her Account, divided by the number of installments to be made. Each subsequent annual installment shall be paid to the Participant as near as administratively practicable to each anniversary of the first installment payment. The amount of each subsequent installment shall be equal to the balance then credited to the Participant's Account, divided by the number of installments remaining to be made. While a Participant's Account is in installment payout status, the unpaid balance credited to the Participant's Account shall continue to be credited (or debited) with deemed investment returns, gains and losses under Section 3.3. 5.2 Change of Control. If there is a Change of Control, the balance then credited to a Participant's Account shall be distributed to him or her in a lump sum as soon as administratively practicable after the date of the Change of Control. Deemed investment returns, gains and losses shall be credited (or debited) prior to any such accelerated distribution in accordance with Section 3.3. The amount of any such accelerated lump sum distribution shall also include any amount that the Participant deferred but which has not yet been credited to his or her Account. 5.3 Special Rule for Death or Disability. If a Participant dies or becomes Disabled, the balance then credited to his or her Account shall be distributed to the Participant (or his or her Beneficiary) at the time and in the form elected by the Participant pursuant to Sections 3.4 and 3.5; provided, however, that the Committee, in its sole discretion, may elect to distribute such amount in a lump sum as soon as administratively practicable after the date of death or Disability. In accordance with Section 3.3, deemed investment returns, gains and losses shall be credited (or debited) prior to any such accelerated distribution. 5.4 Special Rule re Deductibility. Notwithstanding any contrary provision of Section 5.1, any payment scheduled for a particular Plan Year shall not be made in such Plan Year to the extent necessary to avoid application of the deductibility limitation of section 162(m) of the Code. (For this purpose, deductibility shall be determined by adding such payment to all other compensation paid by the Company and its Affiliates to the Participant during the Plan Year.) If, pursuant to the foregoing sentences, any amounts are not paid when originally scheduled, such amounts shall be paid in the first subsequent taxable year in which such payments would not be subject to the deductibility limitation of section 162(m) of the Code. During any such delay in payment, unpaid amounts shall continue to be credited (or debited) with deemed investment returns, gains and losses under Section 3.3. Notwithstanding the foregoing, distribution of a Participant's Account shall be made without regard to the 9 deductibility limitation of section 162(m) of the Code if the time for distribution is accelerated pursuant to Section 5.2 or Section 5.3. 5.5 Latest Permissible Distribution Date. Notwithstanding any contrary provision of this Section 5, any amount which is credited to a Participant's Account on January 15 of the second calendar year following the year in which the Participant terminates employment with the Company and all of its Affiliates shall be distributed to the Participant (or his or her Beneficiary) in a single lump sum as soon as administratively practicable after such January 15. Any such amount shall continue to be credited (or debited) with deemed investment returns, gains and losses until the date of payment. For example, if a Participant terminates employment with the Company and all of its Affiliates during July 2000, and an amount remains credited to his or her Account on January 15, 2002 (after application of the other provisions of Section 5), then such amount (as increased or decreased by deemed investment returns, gains and losses) shall be distributed to the Participant (or his or her Beneficiary) in a lump sum as soon as administratively practicable after January 15, 2002. 5.6 Beneficiary Designations. Each Participant may, pursuant to such procedures as the Committee may specify, designate one or more Beneficiaries. 5.6.1. Spousal Consent. If a Participant designates a person other than or in addition to his or her spouse as a primary Beneficiary, the designation shall be ineffective unless the Participant's spouse consents to the designation. Any spousal consent required under this Section 5.6 shall be ineffective unless it (a) is set forth in writing in a form specified in the discretion of the Committee, (b) acknowledges the effect of the Participant's designation of another person as his or her Beneficiary under the Plan, and (c) is signed by the spouse and witnessed by an authorized agent of the Committee or a notary public. Notwithstanding this consent requirement, if the Participant establishes to the satisfaction of the Committee that written spousal consent may not be obtained because the spouse cannot be located, his or her designation shall be effective without a spousal consent. Any spousal consent required under this Section 5.6 shall be valid only with respect to the spouse who signs the consent. A Participant may revoke his or her Beneficiary designation at any time, provided that such revocation is in writing. 5.6.2. Changes and Failed Designations. A Participant may designate different Beneficiaries (or may revoke a prior Beneficiary designation) at any time by delivering a new designation (or revocation of a prior designation) in accordance with Section 5.6.1. Any designation or revocation shall be effective only if it is received by the Committee. However, when so received, the designation or revocation shall be effective as of the date the notice is executed (whether or not the Participant still is living), but without prejudice to the Committee on account of any payment made before the change is recorded. The last effective designation received by the Committee shall supersede all prior designations. If a Participant dies without having effectively designated a Beneficiary, or if no Beneficiary survives the Participant, the Participant's Account shall be payable to his or her surviving spouse, or, if the Participant is not survived by his or her spouse, the Account shall be paid to his or her estate. 10 5.7 Financial Hardship. In the event that a Participant incurs a Financial Hardship, the Committee, in its sole discretion and notwithstanding any contrary provision of the Plan, may determine that all or part of the Participant's Account shall be paid to him or her immediately; provided, however, that the amount paid to the Participant pursuant to this Section 5.7 shall be limited to the amount reasonably necessary to alleviate the Participant's Financial Hardship. Also, payment under this Section 5.7 may not be made to the extent that the hardship may be relieved by suspension of the Participant's Compensation Deferrals in accordance with Section 2.2. 5.8 Payments to Incompetents. If any individual to whom a benefit is payable under the Plan is a minor or legally incompetent, the Committee shall determine whether payment shall be made directly to the individual, any person acting as his or her custodian or legal guardian under the California Uniform Transfers to Minors Act, his or her legal representative or a near relative, or directly for his or her support, maintenance or education. 5.9 Undistributable Accounts. Each Participant and (in the event of death) his or her Beneficiary shall keep the Committee advised of his or her current address. If the Committee is unable to locate the Participant or Beneficiary to whom a Participant's Account is payable under this Section 5, the Participant's Account shall continue to be credited (or debited) with deemed investment returns, gains and losses in accordance with Section 3.3. Accounts that, in accordance with the preceding sentence, have been undistributable for a period of thirty-five months shall be forfeited as of the end of the thirty- fifth month. If a Participant whose Account was forfeited under this Section 5.9 (or his or her Beneficiary) files a claim for distribution of the Account after the date on which it was forfeited, and if the Committee determines that such claim is valid, then the forfeited balance shall be paid by the Employer in a lump sum cash payment as soon as practicable thereafter (without interest or any deemed investment returns, gains or losses after the date of forfeiture). 5.10 Committee Discretion. Within the specific time periods described in this Section 5, the Committee shall have sole discretion to determine the specific timing of the payment of any Account balance under the Plan. In addition and notwithstanding any contrary provision of the Plan, the Committee, in its sole discretion, may cause the balance credited to a Participant's Account to be paid to him or her in a lump sum at any time following the Participant's termination of employment with all Employers and Affiliates. SECTION 6 PARTICIPANT'S INTEREST IN ACCOUNT 6.1 Compensation Deferral Contributions. Subject to Sections 8.1 (relating to creditor status) and 9.2 (relating to amendment and/or termination of the Plan), a Participant's interest in the balance credited to his or her Account at all times shall be 100% vested and nonforfeitable. 11 SECTION 7 ADMINISTRATION OF THE PLAN 7.1 Plan Administrator. The Company is hereby designated as the administrator of the Plan (within the meaning of section 3(16)(A) of ERISA). 7.2 Committee. The Plan shall be administered by the Committee. The Committee shall have the authority to control and manage the operation and administration of the Plan. Any member of the Committee may resign at any time by notice in writing mailed or delivered to the Secretary of the Company. 7.3 Actions by Committee. Each decision of a majority of the members of the Committee then in office shall constitute the final and binding act of the Committee. The Committee may act with or without a meeting being called or held and shall keep minutes of all meetings held and a record of all actions taken by written consent. 7.4 Powers of Committee. The Committee shall have all powers and discretion necessary or appropriate to supervise the administration of the Plan and to control its operation in accordance with its terms, including, but not by way of limitation, the following powers: (a) To interpret and determine the meaning and validity of the provisions of the Plan and to determine any question arising under, or in connection with, the administration, operation or validity of the Plan or any amendment thereto; (b) To determine the types of bonuses which shall be eligible for deferral under the Plan; (c) To determine any and all considerations affecting the eligibility of any employee to become a Participant or remain a Participant in the Plan; (d) To cause one or more separate Accounts to be maintained for each Participant; (e) To cause Compensation Deferrals and deemed returns, gains and losses to be credited to Participants' Accounts; (f) To establish and revise a method or procedure for the deemed investment of Participants' Accounts, as provided in Section 3.3; (g) To establish and revise an accounting method or formula for the Plan, as provided in Section 4.3; (h) To determine the manner and form in which any distribution is to be made under the Plan; (i) To determine the manner and form for making elections under the Plan; 12 (j) To determine the status and rights of Participants and their spouses, Beneficiaries or estates; (k) To employ such counsel, agents and advisers, and to obtain such legal, clerical and other services, as it may deem necessary or appropriate in carrying out the provisions of the Plan; (l) To establish, from time to time, rules for the performance of its powers and duties and for the administration of the Plan; (m) To arrange for annual distribution to each Participant of a statement of benefits accrued under the Plan; (n) To publish a claims and appeal procedure satisfying the minimum standards of section 503 of ERISA pursuant to which individuals or estates may claim Plan benefits and appeal denials of such claims; (o) To delegate to any one or more of its members or to any other person, severally or jointly, the authority to perform for and on behalf of the Committee one or more of the functions of the Committee under the Plan; (p) To decide all issues regarding the conversion of Participants' Accounts into stock options, the use of such Accounts to exercise stock options or any related matter; and (q) To decide all issues and questions regarding Account balances, and the time, form, manner and amount of distributions to Participants. 7.5 Decisions of Committee. All actions, interpretations, and decisions of the Committee shall be conclusive and binding on all persons, and shall be given the maximum possible deference allowed by law. 7.6 Administrative Expenses. All expenses incurred in the administration of the Plan by the Committee, or otherwise, including legal fees and expenses, shall be paid and borne by the Employers. 7.7 Eligibility to Participate. No member of the Committee who is also an employee of an Employer shall be excluded from participating in the Plan if otherwise eligible, but he or she shall not be entitled, as a member of the Committee, to act or pass upon any matters pertaining specifically to his or her own Account under the Plan. 7.8 Indemnification. Each of the Employers shall, and hereby does, indemnify and hold harmless the members of the Committee, from and against any and all losses, claims, damages or liabilities (including attorneys' fees and amounts paid, with the approval of the Board of Directors, in settlement of any claim) arising out of or resulting from the implementation of a 13 duty, act or decision with respect to the Plan, so long as such duty, act or decision does not involve gross negligence or willful misconduct on the part of any such individual. SECTION 8 FUNDING 8.1 Unfunded Plan. All amounts credited to a Participant's Account under the Plan shall continue for all purposes to be a part of the general assets of the Insurance Company. The interest of the Participant in his or her Account, including his or her right to distribution thereof, shall be an unsecured claim against the general assets of the Insurance Company. Nothing contained in the Plan shall (a) give any Participant or beneficiary any interest in or claim against any specific assets of the Insurance Company, nor (b) prevent the Insurance Company (with the consent of its board of directors) from establishing a grantor trust (within the meaning of subpart E, part I, subchapter J, chapter 1, subtitle A of the Code) to assist the Insurance Company in fulfilling its obligations under the Plan. SECTION 9 MODIFICATION OR TERMINATION OF PLAN 9.1 Employers' Obligations Limited. The Employers intend to continue the Plan indefinitely, and to maintain each Participant's Account until it is scheduled to be paid to him or her in accordance with the provisions of the Plan. However, the Plan is voluntary on the part of the Employers, and the Employers do not guarantee to continue the Plan. The Company at any time may, by amendment of the Plan, suspend Compensation Deferrals or may discontinue Compensation Deferrals, with or without cause. Complete discontinuance of all Compensation Deferrals shall be deemed a termination of the Plan. 9.2 Right to Amend or Terminate. The Board of Directors, in its sole discretion, may amend or terminate the Plan, or any part thereof, at any time and for any reason, provided that no amendment or termination of the Plan shall, without the consent of the Participant, reduce the balance then credited to the Participant's Account. 9.3 Effect of Termination. If the Plan is terminated pursuant to this Section 9, the balances credited to the Accounts of the affected Participants shall be distributed to them at the time and in the manner set forth in Section 5; provided, however, that the Committee, in its sole discretion, may authorize accelerated distribution of Participants' Accounts as of any earlier date. 14 SECTION 10 GENERAL 10.1 Participation by Affiliates. One or more Affiliates of the Company may become participating Employers by adopting the Plan and obtaining approval for such adoption from the Board of Directors. By adopting the Plan, an Affiliate is deemed to agree to all of its terms, including (but not limited to) the provisions granting exclusive authority to the Board of Directors to amend the Plan and the provisions granting exclusive authority to the Committee to administer and interpret the Plan. Any Affiliate may terminate its participation in the Plan at any time. A list of participating Employers, and the effective dates of their participation, is attached hereto as Appendix A. 10.2 Inalienability. In no event may any Participant, Beneficiary, spouse or estate sell, transfer, anticipate, assign, hypothecate, or otherwise dispose of any right or interest under the Plan; and such rights and interests shall not at any time be subject to the claims of creditors nor be liable to attachment, execution or other legal process. Accordingly, for example, a Participant's interest in the Plan is not transferable pursuant to a domestic relations order. 10.3 Rights and Duties. Neither the Employers nor the Committee shall be subject to any liability or duty under the Plan except as expressly provided in the Plan, or for any action taken, omitted or suffered in good faith. 10.4 No Enlargement of Employment Rights. Neither the establishment or maintenance of the Plan, the making of any Compensation Deferrals nor any action of any Employer or the Committee, shall be held or construed to confer upon any individual any right to be continued as an employee of the Employer nor, upon dismissal, any right or interest in any specific assets of the Employers other than as provided in the Plan. Each Employer expressly reserves the right to discharge any employee at any time. 10.5 Apportionment of Costs and Duties. All acts required of the Employers under the Plan may be performed by the Company for itself and its Affiliates, and the costs of the Plan shall be equitably apportioned by the Committee among the Company and the other Employers. Whenever an Employer is permitted or required under the terms of the Plan to do or perform any act, matter or thing, it shall be done and performed by any officer or employee of the Employer who is thereunto duly authorized by the board of directors of the Employer. 10.6 Compensation Deferrals Not Counted Under Other Employee Benefit Plans. Compensation Deferrals under the Plan will not be considered for purposes of contributions or benefits under any other employee benefit plan sponsored by the Employers, except to the extent specifically provided in any such plan. 10.7 Applicable Law. The provisions of the Plan shall be construed, administered and enforced in accordance with ERISA, and to the extent not preempted by ERISA, with the laws of the State of California (other than its conflict of laws provisions). 15 10.8 Severability. If any provision of the Plan is held invalid or unenforceable, its invalidity or unenforceability shall not affect any other provisions of the Plan, and in lieu of each provision which is held invalid or unenforceable, there shall be added as part of the Plan a provision that shall be as similar in terms to such invalid or unenforceable provision as may be possible and be valid, legal, and enforceable. 10.9 Captions. The captions contained in and the table of contents prefixed to the Plan are inserted only as a matter of convenience and for reference and in no way define, limit, enlarge or describe the scope or intent of the Plan nor in any way shall affect the construction of any provision of the Plan. EXECUTION IN WITNESS WHEREOF, The PMI Group, Inc., by its duly authorized officer, has executed this Plan on the date indicated below. THE PMI GROUP, INC. Dated: July 23, 1998 By: Charles Broom ------------------------------------- Title: Asst VP, Human Resources ---------------------------------- 16 APPENDIX A LIST OF PARTICIPATING EMPLOYERS Employer Effective Date of Participation 1. The PMI Group, Inc. July 1, 1997 2. PMI Mortgage Insurance Co. July 1, 1997 3. Residential Guaranty Co. July 1, 1997 4. PMI Mortgage Guaranty Co. July 1, 1997 5. PMI Mortgage Services Inc. July 1, 1997 6. PMI Securities Co. July 1, 1997 17 EX-11.1 5 COMPUTATION OF PER SHARE EARNINGS EXHIBIT 11.1 THE PMI GROUP, INC. AND SUBSIDIARIES COMPUTATION OF RESTATED NET INCOME PER SHARE (1) Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 -------------- -------------- -------------- (In thousands, except for per share data) Basic net income per common share: Net income $190,360 $175,309 $157,918 Average common shares outstanding 31,394 33,386 34,952 -------------- -------------- -------------- Basic net income per common share $ 6.06 $ 5.25 $ 4.52 ============== ============== ============== Diluted net income per common share: Net income $190,360 $175,309 $157,918 -------------- -------------- -------------- Average common shares outstanding 31,394 33,386 34,952 Net shares to be issued upon exercise of dilutive stock options after applying treasury stock method 139 124 88 -------------- -------------- -------------- Average shares outstanding 31,533 33,510 35,040 -------------- -------------- -------------- Diluted net income per common share $ 6.04 $ 5.23 $ 4.51 ============== ============== ==============
(1) Restated to conform with Statement of Financial Accounting Standards No. 128, Earnings per Share. EX-12.1 6 COMPUTATION OF EARNINGS TO FIXED CHARGES EXHIBIT 12.1 THE PMI GROUP, INC. AND SUBSIDIARIES COMPUTATION OF RATIO OF PROFIT TO FIXED CHARGES
Year Ended December 31, ----------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (Dollars in Thousands) Income from continuing operations before income taxes $ 266,948 $ 242,867 $ 222,106 $ 180,541 $ 138,551 ========= ========= ========= ========= ========= Fixed Charges: Rentals-- at computed interest* 2,959 $ 2,549 $ 2,459 $ 2,046 $ 1,584 Interest expense 7,029 6,766 907 - - Distributions on redeemable capital securities 8,311 7,617 - - - --------- --------- --------- --------- --------- Total fixed charges $ 18,299 $ 16,932 $ 3,366 $ 2,046 $ 1,584 ========= ========= ========= ========= ========= Profit before taxes plus fixed charges $ 285,247 $ 259,799 $ 225,472 $ 182,587 $ 140,135 ========= ========= ========= ========= ========= Ratio of adjusted profit to fixed charges 15.6 x 15.3 x 67.0 x 89.2 x 88.5 ========= ========= ========= ========= =========
* Those portions of rent expense that are representative of interest cost EX-13.1 7 SELECTED FINANCIAL DATA, MD&A EXHIBIT 13.1 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this document, other documents filed with the Securities and Exchange Commission, press releases, conferences, or otherwise that are not historical facts, or are preceded by, followed by or that include the words "believes," "expects," "anticipates," "estimates," or similar expressions, and that relate to future plans, events or performance are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include the following: (i) during 1999, management expects the percentage of PMI's risk related to risk-share programs and represented by pool risk to continue to increase as a percentage of total risk. The Fannie Mae and Freddie Mac reduction in mortgage insurance coverage requirements is expected to have a negative impact on the growth rate of direct risk in force; (ii) management anticipates ceded premiums will increase substantially in the future as a result of the expected increase in risk-share programs; (iii) management anticipates the percentage of insurance in force with higher coverage percentages will begin to decrease in 1999 and such decreases should accelerate in the years following due to a reduction in required mortgage insurance by Fannie Mae and Freddie Mac; (iv) although management expects that California should continue to account for a significant portion of total claims paid, management anticipates that with continued improvement in the California economy, increased benefits of loss mitigation efforts and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline; (v) management believes that PMI's total default rate could increase in 1999 due to the continued maturation of its 1994 and 1995 books of business; (vi) management anticipates that contract underwriting will continue to generate a significant percentage of PMI's new insurance written ("NIW"), (vii) The Company believes Year 2000 modifications to its critical mortgage origination and processing applications were implemented successfully and that these systems will be Year 2000 compatible; (viii) the Company has completed remediation and testing of its telephone switches, and management believes that these switches and other hardware and non-information technology systems will be Year 2000 compatible; and (ix) the Company currently believes that the remaining modifications to existing software and conversions to new software utilized by the Company will be implemented successfully and that the Year 2000 issue will not have a material adverse impact on internal systems or operations. When a forward- looking statement includes a statement of the assumptions or bases underlying the forward-looking statement, the Company cautions that, while it believes such assumptions or bases to be reasonable and makes them in good faith, assumed facts or bases almost always vary from actual results, and the difference between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, the Company or its management expresses an expectation or belief as to future results, such expectations or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. The Company's actual results may differ materially from those expressed in any forward-looking statements made by the Company. These forward-looking statements involve a number of risks or uncertainties including, but not limited to, the items addressed in section Q. "Statements and Risk Factors Concerning the Company's Operations and Future Results" (Risk 1 Factors "RF# 1-14") set forth below and other risks detailed from time to time in the Company's periodic filings with the Securities and Exchange Commission. All forward-looking statements of the Company are qualified by and should be read in conjunction with such risk disclosure. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. RESULTS OF CONSOLIDATED OPERATIONS: 1998 versus 1997 Consolidated net income was $190.4 million in 1998, an 8.6% increase over 1997. The growth can be attributed to increases in premiums earned of 8.2% and other income of 155.2% and to a decrease in losses and loss adjustment expenses of 10.9%, partially offset by an increase in other operating expenses, including policy acquisition costs, of 30.8%. Including capital gains, diluted earnings per share increased by 15.5% to $6.04 in 1998. Excluding capital gains, diluted operating earnings per share increased by 14.0% to $5.53. Revenues in 1998 increased by 10.0% to $620.9 million. Mortgage Insurance Operations PMI's NIW increased by 81.7% primarily as a result of the growth in volume of the private mortgage insurance industry as well as the increase in PMI's market share and secondarily to a 2.6% increase in the average insured loan size to $131,700. The members of the private mortgage insurance industry, as reported by the industry's trade association, Mortgage Insurance Companies of America ("MICA"), experienced an increase in total new insurance written of 55.0% to $187.4 billion, benefiting from the record year of total residential mortgage originations, estimated at $1.5 trillion. (Source: Inside Mortgage Finance) The increase was caused primarily by low interest rates, which produced record levels of both refinance activity as well as new and existing home sales. Refinancing as a percentage of PMI's NIW increased to 31.0% in 1998 from 13.8% in 1997. In addition, the private mortgage insurance companies' market share increased to 56.3% of the total low downpayment market (insurable loans) from 54.5% in 1997. (Source: Inside Mortgage Finance) PMI's market share of NIW increased to 14.8% in 1998 from 12.7% in 1997. On a combined basis with CMG Mortgage Insurance Company ("CMG"), market share increased to 16.1% in 1998 compared with 13.8% in 1997. In the fourth quarter of 1998, combined market share increased to 16.4% compared with 13.7% in the fourth quarter of 1997. The increases in market share were primarily due to contract underwriting services, pool insurance products, and risk sharing programs offered by PMI. Pool risk totaled $450.3 million for the year. There was no pool risk written in 1997. Risk in force under risk-share programs with PMI's customers, represented approximately two percent of the $19.3 billion total primary risk in force at December 31, 1998. Risk in force under risk-share programs with PMI's customers, excluding pool insurance, represented 10.2% of total risk in force at December 31, 1998, compared with 2 3.1% at December 31, 1997. During 1999, management expects the percentage of PMI's risk related to risk-share programs and represented by pool risk to continue to increase as a percent of total risk. The Fannie Mae and Freddie Mac reduction in mortgage insurance coverage requirements is expected to have a negative impact on the growth rate of direct risk in force. (See RF10) PMI's cancellations of insurance in force increased by 68.2% to $24.9 billion in 1998 primarily due to mortgage prepayments as a result of low interest rates which caused high levels of refinancing activity. As a result of the higher cancellation activity, PMI's persistency rate decreased to 68.0% as of December 31, 1998, compared with 80.8% as of December 31, 1997. Insurance in force increased by 3.7% in 1998. On a combined basis with CMG, insurance in force grew by 5.9% to $84.9 billion at December 31, 1998. PMI's market share of insurance in force grew by 0.5 percentage points to 15.3%. PMI's risk in force increased by 6.8% and, when combined with CMG, grew by 8.9% to $20.4 billion. The growth rate of risk in force is greater than insurance in force due to terminating policies being replaced by new policies with higher coverage percentages. Mortgage insurance net premiums written grew by 10.1% to $409.8 million in 1998 primarily due to the growth of risk in force of both primary and pool insurance and the continued shift to deeper coverage for primary insurance partially offset by an increase in refunded premiums of 39.2% to $21.9 million as a result of the increase in policy cancellations. Mortgage insurance premiums earned increased 4.5% to $411.9 million in 1998 primarily due to the increase in premiums written. Ceded premiums were $18.3 million in 1998, increasing 15.2% from prior year. Management anticipates ceded premiums will increase substantially in the future as a result of the expected increase in risk-share programs. (See RF7) PMI's monthly product represented 71.6% of risk in force at December 31, 1998, compared with 58.2% at December 31, 1997. Mortgages with original loan-to-value ratios greater than 90% and equal to or less than 95% ("95s") with 30% insurance coverage increased to 34.4% of risk in force as of December 31, 1998, from 28.8% as of December 31, 1997. Mortgages with original loan-to-value ratios greater than 85% and equal to or less than 90% ("90s") with 25% insurance coverage increased to 29.2% of risk in force as of December 31, 1998, compared with 23.6% as of December 31, 1997. Management anticipates the percentage of insurance in force with higher coverage percentages will begin to decrease in 1999 and such decrease should accelerate in the years following due to a reduction in required mortgage insurance by Fannie Mae and Freddie Mac. (See RF3) Mortgage insurance losses and loss adjustment expenses decreased 10.2% to $135.1 million in 1998 primarily due to the continuing improvement of the nationwide housing markets, particularly California, and the corresponding decrease in claim payments. Loans in default decreased by less than one percent to 16,526 at December 31, 1998. PMI's national default rate decreased by 0.07 percentage points to 2.31% at December 31, 1998, primarily due to an increase in policies in force. Direct primary claims paid decreased by 19.5% to $118.4 million due to an 11.6% decrease in the average claim size to approximately $23,300 and an 8.9% decline in the number of claims paid to 5,077 in 1998. The reduction in claims paid is the result of a smaller percentage of claims originating from the California book of business and to increased loss mitigation efforts by PMI and lenders. 3 Default rates on PMI's California policies decreased to 3.15% (representing 3,067 loans in default) at December 31, 1998, from 3.73% (representing 3,987 loans in default) at December 31, 1997. Policies written in California accounted for approximately 48.2% and 64.5% of the total dollar amount of claims paid in 1998 and 1997, respectively. Although management expects that California will continue to account for a significant portion of total claims paid, management anticipates that with continued improvement in the California economy, increased benefits of loss mitigation efforts and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline. (See RF13) Management believes that PMI's total default rate could increase in 1999 due to the continued maturation of its 1994 and 1995 books of business. (See RF12) Mortgage insurance policy acquisition costs incurred and deferred (including, among other field expenses, contract underwriting expenses) increased by 69.3% as a result of the 81.7% increase in NIW. Amortization of policy acquisition costs increased 38.9%. (See Note 5 "Deferred Acquisition Costs" of Notes to Consolidated Financial Statements) New policies processed by contract underwriters represented 35.0% of PMI's NIW in 1998 compared with 21.6% in 1997. Contract underwriting has become the preferred method among many mortgage lenders for processing loan applications. Management anticipates that contract underwriting will continue to generate a significant percentage of PMI's NIW. (See RF7) Other mortgage insurance operating expenses increased by 8.0% to $44.3 million in 1998 from $41.0 million in 1997 resulting from Year 2000 remediation costs of $3.9 million, compared with $0.3 million of such costs in 1997. The mortgage insurance loss ratio declined by 5.4 percentage points to 32.8% in 1998 due to the growth in premiums earned coupled with the decrease in losses and loss adjustment expenses, as discussed above. The expense ratio increased by 2.8 percentage points to 25.5% primarily due to the increase in policy acquisition costs resulting from the growth in NIW and secondarily to Year 2000 remediation costs. Excluding Year 2000 remediation expenses, the expense ratio was 24.6% for 1998 compared to 22.6% for 1997. The combined ratio decreased by 2.6% to 58.3% in 1998. Title Insurance Operations Title insurance premiums earned increased 32.3% to $79.3 million in 1998 primarily due to the record residential mortgage origination volumes, as discussed above, and secondarily to American Pioneer Title Insurance Company's ("APTIC")'s expansion into new states. APTIC was licensed in 39 states at December 31, 1998, a 14.7% increase from December 31, 1997. In 1998, 77.3% of APTIC's premiums earned came from its Florida operations, compared with 81.6% in 1997. Underwriting and other expenses increased 30.1% to $69.1 million because of an increase in agency fees and commissions related to the increase in premiums earned. The title insurance combined ratio decreased by 3.9 percentage points to 87.9%. Other In 1998, the Company's net investment income increased by $1.5 million to $84.7 million primarily due to a $1.8 million increase in equity earnings. Investments in affiliates increased to $60.5 million at year-end 1998 from $17.0 million at year-end 1997. The average book value of the investment portfolio increased 1.2% and the yield decreased from 6.14% in 1997 to 6.06% in 1998. 4 Other income, primarily contract underwriting revenues generated by PMI Mortgage Services Co. ("MSC"), increased by 155.0% to $20.4 million in 1998 while other expenses, primarily expenses incurred by MSC, increased by 27.6% to $142.6 million. These increases are the result of increased contract underwriting services provided to the Company's mortgage insurance customers. (See RF7) The Company's effective tax rate increased to 28.7% in 1998 from 27.8% in 1997 as a result of a decrease in the proportion of tax-exempt investment income relative to total income. 1997 versus 1996 Consolidated net income in 1997 was $175.3 million, an 11.0% increase over 1996. The increase was attributable primarily to increases in premiums earned of 10.0% and secondarily to investment income of 23.3%. There was also an increase in realized capital gains of 37.0%, partially offset primarily by an increase in underwriting and other expenses of 23.1%, and secondarily to an increase of $13.5 million in interest-related costs. Premiums earned increased from the growth in mortgage insurance renewal premiums, partially offset by the effect of the termination and commutation of a reinsurance treaty with Centre Reinsurance Company of New York and Centre Reinsurance International Company ("Centre Re") recorded in the fourth quarter of 1996. The 1996 results of operations, including premiums earned, losses and loss adjustment expenses and underwriting expenses, were impacted by the Centre Re termination as discussed below. Diluted earnings per share increased by 16.0% in 1997, which was affected by the repurchase of 2.1 million shares of common stock in 1997. Excluding capital gains, diluted earnings per share increased by 14.4% to $4.85 in 1997. Revenues in 1997 increased by 12.6% to $564.6 million. Mortgage Insurance Operations PMI's NIW decreased by 14.5% to $15.3 billion in 1997 resulting from the number of new mortgage insurance policies issued decreasing by 16.6% to 119,200 policies, partially offset by a 2.6% increase in the average loan size to $128,400. The primary factor contributing to the decrease in new policies issued was a decline in market share. PMI's market share of NIW decreased to 12.7% in 1997 from 14.1% in 1996. On a combined basis with CMG, market share was 13.8% in 1997 compared with 14.7% in 1996. The decline in market share was primarily due to the availability of a pool insurance product not offered by PMI for the majority of 1997 and secondarily to increases in product and underwriting competition in the California market. The secondary factor contributing to the decrease in new policies issued was the decline in the total volume of insured loans in the private mortgage insurance industry in 1997 compared with 1996. The private mortgage insurance industry experienced a decline in total NIW of 4.8% to $120.9 billion in 1997 from $127.0 billion in 1996. PMI's cancellations of insurance in force increased 23.3% to $14.8 billion in 1997 primarily due to an increase in refinancing activity throughout the industry brought on by lower interest rates. In addition, management believes that, in response to proposed mortgage insurance cancellation 5 legislation, servicers were reviewing their loan portfolios and requesting cancellations on loans with current loan-to-value ratios of 80% or less. PMI's persistency rate decreased 2.5 percentage points to 80.8% as of December 31, 1997 due primarily to the cancellations discussed above. Insurance in force grew at a rate of 0.6% and 8.3% during 1997 and 1996, respectively, to a total of $77.8 billion at December 31, 1997. The year-over-year decline in the growth rate of insurance in force was due primarily to lower NIW and higher policy cancellations in 1997 compared with 1996. However, the growth rate of risk in force was 4.4% in 1997 and was greater than the growth rate in insurance in force because terminating policies were being replaced by new policies with higher coverage percentages, and accordingly, higher premium rates. Mortgage insurance net premiums written increased 6.4% to $372.1 million in 1997 primarily due to higher average premium rates and higher average loan sizes, and also to the growth of risk in force from one year prior, offset primarily by the effect of the Centre Re termination in 1996 and also to a decrease in new premiums written. Excluding the impact of the additional profit commission realized on the Centre Re termination, net premiums written increased by 15.6%. New premiums written decreased by 38.9% to $13.2 million in 1997 while renewal premiums increased by 9.6% to $378.4 million. The decrease in new premiums written during 1997 resulted primarily from the decrease in NIW from the 1996 level. Renewal premiums increased primarily from a shift in the composition of policies in force to loans with higher premium rates and secondarily to the growth of risk in force. Mortgages defined as 95s with 30% insurance coverage increased to 28.8% of risk in force as of December 31, 1997, from 21.9% as of December 31, 1996. Similarly 90s with 25% insurance coverage increased to 23.6% of risk in force in 1997 compared with 19.6% in 1996. Mortgage insurance premiums earned increased 9.6% to $394.0 million in 1997 primarily due to higher premium rates and higher average loan sizes and secondarily to the growth in risk in force from one year prior, offset primarily by the effect of the Centre Re termination in 1996 and also to the decrease in NIW from the 1996 level. Excluding the impact of the Centre Re termination, net premiums earned increased by 15.5%. Mortgage insurance losses and loss adjustment expenses decreased slightly to $150.4 million in 1997 from $150.6 million in 1996. This decrease was due primarily to the effect of the Centre Re termination in 1996. Prior to the impact of the Centre Re termination, mortgage insurance losses and loss adjustment expenses would have increased by 10.6% due to an increase in the number of loans in default caused by the growth and maturation of insurance in force. Primary claims paid by PMI increased slightly, by 2.8%, to approximately $147 million; however, the average claim size decreased by 4.3% to $26,400 due primarily to a smaller percentage of claims originating from the California book of business, and also to increased loss mitigation activity. PMI's default rate increased to 2.38% at December 31, 1997, from 2.19% at December 31, 1996. This increase was due primarily to the policy cancellations discussed above, and secondarily to normal delinquency development in states where PMI expanded its market presence, and also to the maturation of PMI's 1993 and 1994 books of business. The default rates on PMI's California policies decreased to 3.73% (representing 3,987 loans in default) at December 31, 1997, from 3.81% (representing 4,261 loans in default) at December 6 31, 1996. Policies written in California accounted for approximately 64% and 73% of the total dollar amount of claims paid in 1997 and 1996, respectively. Mortgage insurance underwriting and other expenses increased 31.1% to $84.4 million in 1997 primarily due to the effect of Centre Re Termination and ceding commissions in 1996, and secondarily to an increase in contract underwriting expenses. Excluding the impact of the 1996 Centre Re transactions, 1997 expenses increased by 11.9% over 1996. Contract underwriting processed loans represented 21.6% of PMI's NIW in 1997 compared to 13.0% in 1996. The mortgage insurance loss ratio decreased by 3.7 percentage points to 38.2% in 1997 primarily due to the growth in net premiums earned, and also to the decrease in losses and loss adjustment expenses discussed above. The expense ratio increased 4.3 percentage points to 22.7% primarily due to the Centre Re transactions. The result was a 0.6 percentage point increase in the combined ratio to 60.9%. Excluding the 1996 Centre Re transactions, the 1996 expense ratio was 23.4% and the 1996 loss ratio was 39.9%, resulting in a combined ratio of 63.3%. Interest expense of $6.8 million was incurred in 1997 related to the long-term debt issued by the Company in November 1996. The Company incurred an additional $7.6 million of expenses related to distributions on the redeemable preferred capital securities issued by the Company in February 1997. Title Insurance Operations Title insurance premiums earned increased 12.6% to $59.9 million in 1997 due to increasing current markets combined with successful ongoing expansion efforts into new states. Underwriting and other expenses increased 10.6% to $53.1 million directly because of the increase in fees and commissions payable to third parties based on premiums earned. The title insurance combined ratio decreased to 91.8% in 1997 from 93.5% in 1996. Other The Company's net investment income increased 23.3% in 1997 to $83.1 million primarily the result of the growth in the average amount of invested assets. This growth was due primarily to the $198.3 million of combined proceeds from the November 1996 debt offering and the February 1997 redeemable preferred capital securities offering, secondarily to positive cash flows generated by operating activities, and also to the collection of $53.6 million in connection with the Centre Re Termination, partially offset by the $120 million common stock repurchases in 1997. The average investment yield (pretax) decreased to 6.14% in 1997 from 6.21% in 1996 due to declining interest rates in 1997. Realized capital gains (net of losses) increased by 37.1% to $19.6 million due primarily to the sale of approximately $50.0 million of equity securities in the first quarter of 1997. Other income, primarily revenues generated by MSC, increased by 15.9% to $8.0 million in 1997 while other expenses, primarily incurred by MSC, increased by 29.4% to $17.6 million primarily due to expanded ancillary services, primarily contract underwriting. The Company's effective tax rate decreased by 1.1 percentage points to 27.8% in 1997. The benefits of tax-preference investment income and other permanent differences reduced the 7 effective rates below the statutory rate of 35% during both periods. The decrease in the effective tax rate was due to an increase in tax-exempt income and to a decrease in the state income tax provision during 1997. Liquidity, Capital Resources and Financial Condition Liquidity and capital resource considerations are different for The PMI Group, Inc. ("TPG") and PMI, its principal insurance operating subsidiary. TPG's principal sources of funds are dividends from PMI and APTIC, investment income and funds that may be raised from time to time in the capital markets. PMI's ability to pay dividends to TPG is limited, among other restrictions, under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay dividends out of available surplus and (ii) without prior approval of the Arizona Insurance Director, such dividends during any 12-month period may not exceed the lesser of 10% of policyholders' surplus as of the preceding year end, or the last calendar year's investment income. The laws of Florida limit the payment of dividends by APTIC to TPG in any one year to 10% of available and accumulated surplus derived from realized net operating profits and net realized capital gains. In addition to the dividend restrictions described above, the Company's credit agreements limit the payment of dividends by PMI, and various credit rating agencies and insurance regulatory authorities have broad discretion to limit the payment of dividends to TPG by PMI or APTIC. During 1998, APTIC declared and paid a cash dividend of $3.2 million to TPG, substantially the full amount of a dividend that can be paid by APTIC in 1998 without prior permission from the Florida Department of Insurance. PMI declared and paid extraordinary dividends of $100 million to TPG in 1998. TPG has two bank credit lines available totaling $50.0 million. At December 31, 1998, there were no outstanding borrowings under the credit lines. TPG's principal uses of funds are common stock repurchases, the payment of dividends to shareholders, funding of acquisitions, additions to its investment portfolio, investments in subsidiaries, and the payment of interest. The $150 million stock buy-back program authorized by the TPG Board of Directors in November 1997 was completed in the third quarter of 1998. In November 1998, the Company announced a stock repurchase program in the amount of $100 million. As of December 31, 1998, TPG had approximately $56.1 million of available funds. This amount has decreased from the December 31, 1997 balance of $134.2 million due to the investment in RAM Reinsurance Company Ltd. ("RAM Re") and the common stock repurchases through 1998, offset by dividends received from PMI and APTIC. The principal sources of funds for PMI are premiums received on new and renewal business and amounts earned from the investment of this cash flow. The principal uses of funds by PMI are the payment of claims and related expenses, policy acquisition costs and other operating expenses, investment in subsidiaries, and dividends to TPG. PMI generates positive cash flows from operations as a result of premiums being received in advance of the payment of claims. Cash flows generated from PMI's operating activities totaled $154.0 million and $180.1 million 8 in 1998 and 1997, respectively. The 1997 amount includes the collection of $53.6 million as a result of a termination and commutation of a reinsurance treaty. The Company's invested assets increased by $41.6 million at December 31, 1998 due to cash flows from consolidated operations of $178.1 million offset by stock repurchases of $152.9 million and dividends paid of $6.2 million. Consolidated reserves for losses and loss adjustment expenses increased by 6.4% in 1998 primarily due to the 7.8% increase in PMI's primary reserve per default to $12,500 at December 31, 1998 and to the buildup of pool loss reserves. Consolidated shareholders' equity increased by $36.3 million in 1998, consisting of increases of $190.4 million from net income, $2.6 million from stock option activity, and $2.5 million from other comprehensive income net of unrealized gains on investments, offset by common stock repurchases of $152.9 million, and dividends declared of $6.2 million. PMI's statutory risk-to-capital ratio at December 31, 1998 was 14.9:1, compared with 14.6:1 at December 31, 1997. (See RF9) Year 2000 Issues Impact of the Year 2000 Issue. The Company's business processes are highly automated and dependent upon the consistent and accurate functioning of its computer systems and the computer systems of its customers. As a result, the Company is directing significant resources toward mitigating its exposure to the so-called "Year 2000 issue." The Year 2000 issue arises from the failure of computer software and hardware to process dates into and through the year 2000: the number "00," for example, would be read as "1900" rather than "2000." The technical problem is multifaceted and is composed of several different potential deficiencies including, among others: (1) the inability of hardware to interpret years greater than 1999; (2) the failure of software to process date data from, into, and between the twentieth and twenty-first centuries; (3) the inability of the number "99" to register an actual date (i.e., 1999) rather than indefinite or unknown information (i.e., an employee's date of retirement, if unknown, would be characterized as "99-99-99"); (4) the inability of systems to recognize that the year 2000 is a leap year; and (5) the failure of systems that are otherwise Year 2000 compliant to transfer data between each other because each system has used a different "fix," and the methods are incompatible with each other. If any of these deficiencies occur, the system may produce miscalculations and/or "crash" and be unable to transfer or process data, causing disruption in one or more aspects of the Company's operations. The problem also affects many of the microprocessors that control systems and equipment. For purposes of this discussion, "Year 2000 compatible" means that the computer hardware, software or device in question will function in year 2000 without modification or adjustment or will function in 2000 with a one-time manual adjustment. However, there can be no assurance that any such year 2000 compatible hardware, software or device will function properly when interacting with any year 2000 noncompatible hardware, software or device. State of Readiness. The Company has in place a Year 2000 project plan to address the Year 2000 issue. The plan consists of three phases. The first phase involved collecting data with 9 respect to date processing issues, determining the project scope, identification of resources to implement remediation, budgeting and completion of the formal project plan. This phase was completed in early 1998 and included a priority ranking designed to direct resources to the most critical systems first. As a result of its first phase assessment, the Company determined that it will be required to modify or replace a significant portion of its software so that software will be Year 2000 compatible. The Company also determined that remediation of the critical mortgage insurance origination and processing applications used by PMI and CMG needed to be substantially completed by the first business day of 1999 in order to avoid possible date calculation errors in 1999 and to satisfy the requirements of the government sponsored enterprises ("GSEs") and the federal and state regulators of the Company's customers. The Federal Financial Institutions Examination Council guidelines for banks and thrifts set various interim milestones for third party service providers such as the Company, with final testing and substantial implementation required by June 30, 1999. Remediation of the Company's less critical applications is expected to be completed during 1999. To date, PMI and CMG have met all readiness deadlines or targets established by the GSEs and other regulators. The second phase, which involves project staff procurement, code remediation and unit testing, test plan development, Year 2000 policies and procedures development and vendor readiness assessment, is substantially complete. The third phase, which involves string and system testing and system installation, is substantially complete. The Company completed remediation and testing of the critical mortgage origination and processing applications referred to above prior to its deadline of the first business day of 1999 and has converted its database to the remediated software. The Company believes Year 2000 modifications to its critical mortgage origination and processing applications were implemented successfully and that these systems will be Year 2000 compatible. (See RF1) Additional testing, including industry-sponsored testing and testing of customer interfaces, is expected to continue through 1999. The Company has completed remediation and testing of its telephone switches, and management believes that these switches and other hardware and non-information technology systems will be Year 2000 compatible. (See RF1) Risks of Year 2000 Noncompatibility and Infrastructure Risks. The Company currently believes that the remaining modifications to existing software and conversions to new software utilized by the Company will be implemented successfully and that the Year 2000 issue will not have a material adverse impact on internal systems or operations. (See RF1) If, however, the Company's past or future remediation efforts prove to be either inadequate or ineffective, significant disruptions to the Company's operations could ensue which could have a material adverse effect on the Company's liquidity, financial condition and results of operations. Furthermore, the Company relies on financial institutions, government agencies, utility companies, telecommunications service companies and other service providers outside of its control. There can be no assurance that such third parties will not suffer a Year 2000 business disruption and it is conceivable that such failures could, in turn, have a material adverse effect on the Company's liquidity, financial condition and results of operations. Risk Related to Vendors and Customers. As part of its Year 2000 project plan, the Company has initiated communications with all of its large customers and significant vendors to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 issues. The Company's vulnerability would likely result from the inability of the Company's or customers' systems to process data received from the other, which could disrupt the Company's mortgage insurance origination and claims processing, and/or a disruption in the 10 supply of goods and services procured from suppliers. Currently, a substantial majority of the Company's mortgage insurance business is originated through non- electronic channels, which serves to mitigate this type of customer risk, although the Company anticipates that electronic originations will increase in future periods. The Company has begun to receive responses from suppliers and customers but has not independently confirmed the information received from third parties with respect to their Year 2000 compliance status. The Company plans to follow up with suppliers and customers that have not responded to its initial inquiries. The Company's total Year 2000 project cost and estimates include the estimated costs and time associated with assessing the impact of third parties' Year 2000 issues, and are based in part upon such unconfirmed information. Because of the large number of variables involved, the Company cannot provide an estimate of the damage it might suffer if any of the Company's significant customers or vendors failed to remediate their Year 2000 issues, although management believes that the business disruption likely to result from any prolonged Year 2000 non-compliance by customers or suppliers could have a material adverse effect on the Company's liquidity, financial condition and results of operations. (See RF1) Costs to Address the Year 2000 Issue. The Company is utilizing both internal and external personnel and resources to implement its Year 2000 project plan. Currently, no planned material projects involving information or non-information technology systems have been delayed or are anticipated to be delayed as a result of the redirection of resources to the Year 2000 remediation effort. The Company plans to complete its Year 2000 issue remediation project at a total external cost of approximately $4.5 million, which will be funded from operating cash flow and is being expensed as incurred. As of December 31, 1998, the Company has incurred and expensed approximately $3.9 million in external costs related to its Year 2000 project plan and remediation efforts. The estimated costs do not include any potential costs related to customer or other claims, or potential amounts related to executing contingency plans. The Company does not separately track the internal costs incurred in connection with the Year 2000 project plan, which are principally payroll costs for employees working on the project. Contingency Plans. The Company is currently assessing possible contingency plans designed to limit, to the extent possible, the business disruption and financial effects of a failure by the Company to complete its Year 2000 remediation project in a timely manner. Although no formal contingency plan is yet in place, the Company has considered its likely response in certain circumstances. For example, if any of the Company's critical systems, such as the mortgage insurance system's origination or billing applications, are disrupted due to the Year 2000 issue, it is possible that the Company might need to process data manually. The Company's intention in this event would be to procure clerical personnel from temporary recruitment firms to process data. Hiring such temporary personnel would materially increase the Company's personnel expense and have a corresponding negative effect on operating income. In the event of a major system disruption, the Company will have access to duplicate records of critical data from the Company's systems which are maintained and stored at an offsite location as a routine procedure related to the Company's disaster recovery program. These duplicate records could be of assistance in any Year 2000 recovery operation. The Company's contingency assessment will continue through 1999 as the Company learns more about the preparations and vulnerabilities of third parties regarding the Year 2000 issue and a formal contingency plan is expected to be in place by June 30, 1999. (See RF1) The discussion above is designated as a Year 2000 Readiness Disclosure as defined by the Year 2000 Information and Readiness Disclosure Act of 1998. 11 STATEMENTS AND RISK FACTORS CONCERNING THE COMPANY'S OPERATIONS AND FUTURE RESULTS General Conditions (RF1) Several factors such as economic recessions, declining housing values, higher unemployment rates, deteriorating borrower credit, rising interest rates, increases in refinance activity caused by declining interest rates, changes in legislation affecting the mortgage insurance industry, or combinations of such factors might affect the mortgage insurance industry and demand for housing in general and could materially and adversely affect the Company's financial condition and results of operations. Such economic events could materially and adversely impact the demand for mortgage insurance, cause claims on policies issued by PMI to increase, and/or cause a similar adverse increase in PMI's loss experience. Other factors that may influence the amount of NIW by PMI include: mortgage insurance industry volumes of new business; the impact of competitive underwriting criteria and product offerings and services, including mortgage pool insurance and contract underwriting services; the ability to recruit and maintain a sufficient number of qualified underwriters; the effect of risk- sharing structured transactions; changes in the performance of the financial markets; PMI's claims-paying ability rating; general economic conditions that affect the demand for or acceptance of the Company's products; changes in government housing policy; changes in government regulations or interpretations regarding the Real Estate Settlement Procedures Act and customer consolidation. PMI's financial condition and results of operations may materially and adversely be impacted by changes in legislation which affects the ability of Fannie Mae or Freddie Mac to offer a substitute for mortgage insurance, including self- insurance and alternative forms of credit support, or for the FHA or the VA to increase statutory lending limits or other expansion of eligibility for the FHA and VA. (See RF2). PMI's financial condition and results of operations may materially and adversely be impacted by changes in legislation, statutory charters and regulations governing banks and savings institutions to form reinsurance subsidiaries or permit the offering of other products which do not require mortgage insurance. In addition, PMI's financial condition and results of operations may materially and adversely be impacted by a reduction in the amount of mortgage insurance coverage required by Fannie Mae and Freddie Mac. (See RF3) The costs of Year 2000 remediation, the dates on which the Company estimates that it will complete such remediation and possible risks associated with the Year 2000 issue are based upon the Company's current estimates and are subject to various uncertainties that could cause the actual results to differ materially from the Company's expectations. Such uncertainties include, among others, the success of the Company in identifying systems that are not Year 2000 compliant, the nature and amount of programming required to remediate each affected system, the nature and adequacy of testing performed by the Company, the availability of qualified personnel, consultants and other resources, and the success of the Year 2000 remediation efforts of others. If the Company's recently completed remediation of its mission critical mortgage insurance origination and application processing process is faulty or fails for any reason to be Year 2000 compliant, this circumstance could adversely impact its business operations and could 12 have a material adverse affect on the Company's financial condition, liquidity and results of operations. See Management Discussion and Analysis - Year 2000 Issues. Market Share and Competition (RF2) The Company's financial condition and results of operations could be materially and adversely affected by a decline in its market share, or a decline in market share of the private mortgage insurance industry as a whole. Numerous factors bear on the relative position of the private mortgage insurance industry versus government and quasi-governmental competition as well as the competition of lending institutions that choose to remain uninsured, self-insure through affiliates, or offer residential mortgage products that do not require mortgage insurance. The impact of competitive underwriting criteria and product offerings, including mortgage pool insurance and contract underwriting, has a direct impact on the Company's market share. Further, several of the Company's competitors have greater direct or indirect capital reserves that provide them with potentially greater flexibility than the Company in addressing competitive issues. PMI competes directly with federal and state governmental and quasi-governmental agencies, principally the FHA and, to a lesser degree, the VA. The Office of the Comptroller of the Currency has granted permission to certain national banks to form a reinsurance company as a wholly-owned operating subsidiary for the purpose of reinsuring mortgage insurance written on loans originated or purchased by such bank. The Federal Reserve Board is in the process of considering whether similar activities are permitted for bank holding companies. The Office of Thrift Supervision has also recently granted permission for subsidiaries of thrift institutions to reinsure private mortgage insurance coverage on loans originated or purchased by affiliates of such thrift's parent organization. The reinsurance subsidiaries of national banks, savings institutions, or bank holding companies could become significant competitors of the Company in the future. Mortgage lenders, other than banks, thrifts or their affiliates, are forming reinsurance affiliates that are typically regulated solely by the insurance authority of their state of domicile. Management believes that such reinsurance affiliates will increase competition in the mortgage insurance industry and may materially and adversely impact PMI's market share. PMI offers various risk-sharing structured transactions, including a captive reinsurance program as part of its strategic relationships with its customers. PMI's customers have indicated an increasing demand for such products. PMI's captive reinsurance program allows a reinsurance company, generally an affiliate of the lender, to assume mortgage insurance default losses either on a quota share basis, or at a specified entry point up to a maximum aggregate exposure, up to an agreed upon amount of total coverage. An increasing percentage of PMI's NIW is being generated by customers which have captive reinsurance programs, and it is expected that this will continue and increase. Based on the current structure, such products have the potential of reducing the Company's business revenue as more premiums are ceded to customer captives. There can be no assurance that PMI's risk-sharing structured transactions will continue to be accepted by its customers. The inability of the Company to provide acceptable risk-sharing structured transactions to its customers would likely have an adverse effect on the competitive position of PMI and consequently could materially and adversely affect the Company's financial condition, liquidity and results of operations. Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10% second mortgage lien, and 10% of the purchase price from borrower's funds ("80/10/10"). This 80/10/10 product 13 competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. The Federal Deposit Insurance Corporation and other banking regulators recently approved rules to be effective April 1, 1999 that would require national banks to hold almost twice as much risk-based capital to cover possible defaults on the 80/10/10 products when the lender holds the first and second mortgage. State-chartered banks already are subject to the higher capital requirement. If the 80/10/10 product becomes a widely accepted alternative to mortgage insurance, it could have a material and adverse impact on the Company's financial condition and results of operations. Legislation and regulatory changes affecting the FHA have affected demand for private mortgage insurance. Effective January 1, 1999, the Department of Housing and Urban Development announced an increase in the maximum individual loan amount that FHA can insure to $208,800 from $197,620. The maximum individual loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of 1999, signed into law on October 21, 1998, among other items, streamlined the FHA downpayment formula by eliminating tiered minimum cash investment requirements and establishing maximum loan-to-value ratios based on loan size and closing costs, making FHA insurance more competitive with private mortgage insurance in areas with higher home prices. Although management believes that it is too early to ascertain the impact of the increase in the maximum individual loan amount the FHA can insure, any increase in the maximum loan amount would likely have an adverse effect on the competitive position of PMI and, consequently, could materially and adversely affect the Company's financial condition and results of operations. Fannie Mae and Freddie Mac (RF3) The GSEs are permitted by statute to purchase conventional high-LTV mortgages from lenders who obtain mortgage insurance on those loans. Fannie Mae and Freddie Mac have some discretion to increase or decrease the amount of private mortgage insurance coverage they require on loans. Fannie Mae and Freddie Mac both recently announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSEs' automated underwriting services, Loan Prospector/(SM)/ and Desktop Underwriter/(TM)/, respectively. Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage options provide for: (i) across-the-board reductions in required MI coverage on 30-year fixed-rate loans recommended for approval by GSE's automated underwriting services to the levels in effect in 1994; (ii) reduction in required MI coverage, for loans with only a 5 percent down payment (a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down payment (a 90 percent LTV loan), from 25 percent to 17 percent of the mortgage loan covered by MI.. In addition, the GSE's announced programs to further reduce MI coverage upon the payment of an additional fee by the lender. Under this option, a 95 percent LTV loan will require 18 percent of the mortgage loan have mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12 percent of the mortgage loan have mortgage insurance. In order for the home buyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. 14 Management believes it is too early to assess impact of the Fannie Mae and Freddie Mac reduction of required levels of mortgage insurance on the Company's financial condition and results of operation. If the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, however, such reduction could have a materially adverse impact on the Company's financial condition and results of operation. During October 1998, Freddie Mac sought to amend its charter to allow it to use any method of default loss protection that is financially equal or superior, on an individual or pooled basis, to the protection provided by private mortgage insurance companies. The legislation containing the proposed charter amendment was subsequently rescinded. Currently, Freddie Mac can purchase loans with downpayments of less than 20%, only if the loans are insured or use other limited methods to protect against default. Subsequent to the withdrawal of the legislation, Freddie Mac announced that it would pursue a permanent charter amendment that would allow Freddie Mac to utilize alternative forms of default loss protection, such as spread accounts, or otherwise forego the use of private mortgage insurance on higher loan-to- value mortgages. In addition, Fannie Mae announced it is interested in pursuing new risk management options and is working with mortgage insurers and lenders on appropriate risk management and dispersion of risk, which may include a reduction in the use of mortgage insurance. Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of mortgage insurance generally provide that a borrower's written request to cancel mortgage insurance should be honored if: (a) the borrower has a satisfactory payment record, no payment more than 30 days delinquent in the 12-month period preceding the request for cancellation; and (b) the unpaid principal balance of the mortgage is not greater than 80% of the original value of the property. (See RF4 for a discussion of recent Federal legislation providing for guidelines for automatic mortgage insurance cancellation) The GSEs are the predominant purchasers and sellers of conventional mortgage loans in the United States, providing a direct link between the primary mortgage origination markets and the capital markets. Because loan originators prefer to make loans that may be marketed in the secondary market to Fannie Mae and/or Freddie Mac they are motivated to purchase mortgage insurance from insurers deemed eligible by the GSEs. Although management believes that it is too early to ascertain the impact of the increase in the maximum individual loan amount the GSEs can insure, management believes any increase in the maximum loan amount would likely increase the number of loans eligible for mortgage insurance and may have the effect of increasing the size of the mortgage insurance market, and have a positive effect on the competitive position of PMI and consequently could materially affect the Company's financial condition and results of operations. Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for such insurers to be eligible to insure loans sold to such agencies. Under Fannie Mae and Freddie Mac regulations, PMI needs to maintain at least an "AA-" or equivalent claims-paying ability rating in order to provide mortgage insurance on loans purchased by the GSEs. Failure to maintain such a rating would effectively cause PMI to be ineligible to provide mortgage insurance. A loss of PMI's existing eligibility status, either due to a failure to maintain a minimum claims-paying ability rating from the various rating agencies or non-compliance with other eligibility requirements, would have a material, adverse effect on the Company's financial condition and results of operations. (See RF2) Insurance in Force (RF4) A significant percentage of PMI's premiums earned is generated from its existing insurance in force and not from new insurance written. PMI's policies for insurance coverage typically have a policy duration of six to eight years. Insurance coverage may be canceled by the policy owner or servicer of the loan at any time. PMI has no control over the owner's or servicer's decision to cancel insurance coverage and self-insure or place coverage with another mortgage insurance company. There can be no assurance that policies for insurance coverage originated in a particular year or for a particular customer will not be canceled at a later time or that the 15 Company will be able to regain such insurance coverage at a later time. As a result, the Company's financial condition and results of operation could be materially and adversely affected by greater than anticipated policy cancellations or lower than projected persistency resulting in declines in insurance in force. Upon request by an insured, PMI must cancel the mortgage insurance for a mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"), which is effective on July 29, 1999, provides for the automatic termination, or cancellation upon a borrower's request, of private mortgage insurance upon satisfaction of certain conditions. The Act applies to owner- occupied residential mortgage loans regardless of lien priority, with borrower-paid mortgage insurance, closed after the effective date of the Act. FHA loans are not covered by the Act. Under the Act, automatic termination of mortgage insurance would generally occur once the loan-to-value ratio ("LTV") reaches 78%. A borrower may generally request cancellation of mortgage insurance once the LTV reaches 80% of the home's original value, or when actual payments reduce the loan balance to 80% of the home's original value, whichever occurs earlier. For borrower initiated cancellation of mortgage insurance, the borrower must have a good payment history. Good payment history generally requires that there have been no payments during the 12-month period preceding the loan's cancellation date 30 days or more past due, or 60 days or more past due during the 12-month period beginning 24 months before the loan's cancellation date. Loans which are deemed "high risk" by the GSEs, require automatic termination of mortgage insurance coverage once the LTV is first scheduled to reach 77% of the original value of the property without regard to the actual outstanding balance. The Act preempts all but more protective, preexisting state laws. Protected state laws are preempted if inconsistent with the Act. Protected state laws are consistent with the Act if they require: (i) termination of mortgage insurance at an earlier date or higher mortgage principal balance than required by the Act, or (ii) disclosure of more, earlier, or more frequent information. States which enacted mortgage insurance cancellation laws on or before January 2, 1998, have until July 29, 2000 to make their statutes consistent with the Act. States that currently have mortgage insurance cancellation or notification laws include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New York, Texas and Washington. Management is uncertain about the impact of the Act on PMI's insurance in force, but believes any reduction in premiums attributed to the Act's required cancellation of mortgage insurance, will not have a significant impact on the Company's financial condition and results of operation for the foreseeable future. (See RF10) During an environment of falling interest rates, an increasing number of borrowers refinance their mortgage loans. PMI and other mortgage insurance companies generally experience an increase in the prepayment rate of insurance in force, resulting from policy cancellations of older books of business with higher rates of interest. Although PMI has a history of expanding business during low interest rate environments, the resulting increase of NIW may ultimately prove to be inadequate to compensate for the loss of insurance in force arising from policy cancellations. A decrease in persistency, resulting from policy cancellations of older books of business affected by refinancings (which are affected, among other things, by decreases in interest rates) may materially and adversely impact the level or rate of growth of insurance in force or risk in force and consequently have similar impacts on the Company's financial condition and results of operations. Rating Agencies (RF5) PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc., "AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit Rating Co. These ratings are subject to revisions or withdrawal at any time by the assigning rating organization. The ratings by the organizations are based upon factors relevant to PMI's policyholders, principally PMI's capital resources as computed by the rating agencies, and are not applicable to the Company's common stock or outstanding debt. 16 Rating agencies generally assess capital charges on pool insurance policies based on price and structure. One published methodology for assessing the capital requirement for pool insurance is based on the real estate depression which occurred in oil producing states during the mid-1980's. Management believes the current capital charge that could be levied on pool insurance risk by one rating agency is approximately $1.00 of capital for each $1.40 of pool insurance risk. In comparison, primary mortgage insurance regulators specifically limit the amount of insurance risk that may be written by PMI according to a number of financial tests, including limiting risk, to a multiple of 25 times PMI's statutory capital (which includes the contingency reserve). The rating agencies could change their view as to the capital charges that are assessed on pool insurance products at any time. (See RF10) Management believes that a significant reduction in PMI's claims-paying ratings could have a material, adverse effect on the Company's financial condition and results of operations. (See RF6) Liquidity (RF6) In the mortgage guaranty insurance industry, liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations, including premiums received and investment income, in order to meet its financial commitments, which are principally obligations under the insurance policies it has written. Liquidity requirements are significantly influenced by the level and severity of claims. TPG's principal sources of funds are dividends from PMI and APTIC, investment income and funds that may be raised from time to time in the capital markets. Numerous factors bear on the Company's ability to maintain and meet its capital and liquidity needs, including the performance of the financial markets, standards and factors used by various credit rating agencies, financial covenants in credit agreements, and standards imposed by state insurance regulators relating to the payment of dividends by insurance companies. Any significant change in the performance of the financial markets negatively affecting the Company's ability to secure sources of capital, or changes in the standards used by credit rating agencies which adversely impact PMI's claims- paying ability rating, or changes in the insurance laws of Arizona, Florida or Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at currently permissible levels, could adversely affect the Company's ability to maintain capital resources to meet its business needs, and thereby have a material, adverse affect on the Company's financial condition, liquidity and results of operations. Contract Underwriting Services; New Products (RF7) The Company provides contract underwriting services for a fee that enable customers to improve the efficiency and quality of their operations by outsourcing all or part of their mortgage loan underwriting. As a part of its contract underwriting services, PMI provides remedies which may include the assumption of some of the costs of repurchasing insured and uninsured loans from the GSEs and other investors. Generally, the scope of these remedies are in addition to those contained in PMI's master primary insurance policies. Due to the increasing demand of contract underwriting services, the limited number of underwriting personnel available, and heavy price competition among mortgage insurance companies, PMI's inability to recruit and maintain a sufficient number of qualified underwriters, or any significant increase in the cost PMI incurs to 17 satisfy remedy obligations for underwriting services, could materially and adversely affect its market share and materially and adversely affect the Company's financial condition and results of operations. TPG and PMI, from time to time, introduce new mortgage insurance products or programs. The Company's financial condition and results of operations could be materially and adversely affected if PMI or the Company experiences delays in introducing competitive new products and programs. In addition, for any introduced product, there can be no assurance that such products, including any mortgage pool type products, or programs will be as profitable as the Company's existing products and programs. New York Department of Insurance (RF8) In February 1999, the New York Department of Insurance stated in Circular Letter No. 2, addressed to all private mortgage insurers licensed in New York that certain pool risk-share and structured products and programs would be considered to be illegal under New York law. PMI believes that it complies with the requirements of Circular Letter No. 2 with respect to transactions that are governed by it. In the event the New York Department of Insurance determined PMI was not in compliance with Circular Letter No. 2, it could materially and adversely affect the Company's financial condition and results of operations. Risk-to-Capital Ratio (RF9) The State of Arizona, and other regulators specifically limit the amount of insurance risk that may be written by PMI, by a variety of financial factors. Other factors affecting PMI's risk-to-capital ratio include: (i) regulatory review and oversight by the State of Arizona, PMI's state of domicile for insurance regulatory purposes; (ii) limitations under the Runoff Support Agreement with Allstate, which prohibit PMI from paying any dividends if, after the payment of any such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; (iii) TPG's credit agreements; and (iv) TPG's and PMI's credit or claims-paying ability ratings which generally require that the rating agencies' risk-to-capital ratio not exceed 20 to 1. Significant losses could cause a material reduction in statutory capital, causing an increase in the risk-to-capital ratio and thereby limit PMI's ability to write new business. The inability to write new business could materially and adversely affect the Company's financial condition and results of operations. Changes in Composition of Insurance Risk Written; Pool Insurance (RF10) The composition of PMI's NIW has included an increasing percentage of mortgages with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December 31, 1998, 46.3% of PMI's risk in force consisted of 95s, which, in PMI's experience, have had a claims frequency approximately twice that of mortgages with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At December 31, 1998, 3.3% of PMI's risk in force consisted of 97s which have even higher risk characteristics than 95s and greater uncertainty as to pricing adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which, although priced higher, have risk characteristics that exceed the risk characteristics associated with PMI's book of business as a whole. Since the fourth quarter of 1997, PMI has offered a new pool insurance product. Pool 18 insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions and generally covers the loss on a defaulted mortgage loan that exceeds the claim payment under the primary coverage, if primary insurance is required on that mortgage loan. Pool insurance also generally covers the total loss on a defaulted mortgage loan which did not require primary insurance, in each case up to a stated aggregate loss limit. New pool risk written was $450 million for the year ended December 31, 1998. Management is uncertain about the amount of new pool risk which will be written in 1999, but believes total new 1999 pool risk will be less than in 1998. Although PMI charges higher premium rates for loans that have higher risk characteristics, including ARMs, 95s, 97s and pool insurance products, the premiums earned on such products, and the associated investment income, may ultimately prove to be inadequate to compensate for future losses from such products. Such losses could materially and adversely affect the Company's financial condition and results of operations. (See RF5) Potential Increase in Claims (RF11) Mortgage insurance coverage generally cannot be canceled by PMI and remains renewable at the option of the insured until required to be canceled under applicable Federal or state laws for the life of the loan. As a result, the impact of increased claims from policies originated in a particular year generally cannot be offset by premium increases on policies in force or mitigated by nonrenewal of insurance coverage. There can be no assurance, however, that the premiums charged will be adequate to compensate PMI for the risks and costs associated with the coverage provided to its customers. (See RF5) Loss Reserves (RF12) PMI establishes loss reserves based upon estimates of the claim rate and average claim amounts, as well as the estimated costs, including legal and other fees, of settling claims. Such reserves are based on estimates, which are regularly reviewed and updated. There can be no assurance that PMI's reserves will prove to be adequate to cover ultimate loss development on incurred defaults. The Company's financial condition and results of operations could be materially and adversely affected if PMI's reserve estimates are insufficient to cover the actual related claims paid and expenses incurred. Regional Concentration (RF13) In addition to nationwide economic conditions, PMI could be particularly affected by economic downturns in specific regions where a large portion of its business is concentrated, particularly California, Florida, and Texas, where PMI has 17.6%, 7.3% and 7.2% of its risk in force concentrated and where the default rate on all PMI policies in force is 3.15%, 3.08% and 2.18% compared with 2.31% nationwide as of December 31, 1998. Continuing Relationships with Allstate and Affiliate (RF14) In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage Insurance Company ("Forestview") whereby Forestview agreed to reinsure all liabilities (net of amounts collected from third party reinsurers and indemnitors) in connection with PMI's mortgage pool insurance business in exchange for premiums received. In 1994, Forestview also agreed that as soon as practicable after November 1, 1994, Forestview and PMI would seek regulatory approval 19 for the Reinsurance Treaty to be deemed to be an assumption agreement and that, upon receipt of the requisite approvals, Forestview would assume such liabilities. Forestview's claims-paying ability is currently rated "AA" by Fitch IBCA. Forestview's previous claims-paying ability rating of "AA" (Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in 1997. These ratings are subject to revisions or withdrawal at any time by the assigning rating organization. Management is uncertain at this time what impact the withdrawal of the claims-paying ability rating will have on the parties' ability to timely consummate the assumption transaction. Pursuant to this agreement, PMI ceded $9.0 million of pool premiums to Forestview and Forestview reimbursed PMI for pool claims on the covered policies in the amount of $26.8 million in 1998. The failure of Forestview to meet its contractual commitments would materially and adversely affect the Company's financial condition and results of operations. On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff Support Agreement") with Allstate Insurance Company ("Allstate") to replace various capital support commitments that Allstate had previously provided to PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI prior to October 28, 1994, if PMI's financial condition deteriorates below specified levels, or if a third party brings a claim thereunder. Alternatively, Allstate may make contributions directly to PMI or TPG. In the event that Allstate makes payments or contributions under the Runoff Support Agreement (which possibility management believes is remote), Allstate would receive subordinated debt or preferred stock of PMI or TPG in return. No payment obligation arose under the Runoff Support Agreement. 20 Consolidated Statements of O p e r a t i o n s
Year Ended December 31, (In thousands, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ Revenues Premiums earned $ 491,226 $ 453,948 $ 412,738 Investment income, less investment expense 84,681 83,136 67,442 Realized capital gains 24,636 19,584 14,296 Other income 20,366 7,979 6,948 ----------------------------------------------- Total revenues 620,909 564,647 501,424 ----------------------------------------------- Losses and Losses and loss adjustment expenses 135,716 152,257 152,409 Expenses Policy acquisition costs 60,280 43,395 46,192 Underwriting and other operating expenses 142,625 111,745 79,810 Interest expense 7,029 6,766 907 Distributions on preferred capital securities 8,311 7,617 - ----------------------------------------------- Total losses and expenses 353,961 321,780 279,318 ----------------------------------------------- Income before income taxes 266,948 242,867 222,106 Income tax expense 76,588 67,558 64,188 ----------------------------------------------- Net income $ 190,360 $ 175,309 $ 157,918 =============================================== Per Share Basic net income per common share $ 6.06 $ 5.25 $ 4.52 =============================================== Diluted net income per common share $ 6.04 $ 5.23 $ 4.51 ===============================================
See notes to consolidated financial statements. 21 Consolidated B a l a n c e S h e e t s
As of December 31, (Dollars in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Assets Investments: Available for sale, at market: Fixed income securities (amortized cost $1,268,625 and $1,234,178) $ 1,356,869 $ 1,308,768 Equity securities: Common (cost $34,129 and $38,221) 58,785 73,596 Preferred (cost $17,240 and $12,049) 17,706 12,360 Common stock of affiliates, at underlying book value 60,450 16,987 Short-term investments 38,414 78,890 --------------------------------- Total investments 1,532,224 1,490,601 Cash 9,757 11,101 Accrued investment income 20,150 20,794 Reinsurance recoverable and prepaid premiums 42,102 31,676 Premiums receivable 24,367 19,756 Receivable from affiliate 2,229 451 Receivable from Allstate 23,657 16,822 Deferred policy acquisition costs 61,605 37,864 Property and equipment, net 37,630 31,393 Other assets 24,149 26,145 --------------------------------- Total assets $ 1,777,870 $ 1,686,603 ================================= Liabilities Reserve for losses and loss adjustment expenses $ 215,259 $ 202,387 Unearned premiums 94,886 94,150 Long-term debt 99,476 99,409 Reinsurance balances payable 14,764 11,828 Deferred income taxes 96,730 76,395 Other liabilities and accrued expenses 60,200 42,248 --------------------------------- Total liabilities 581,315 526,417 --------------------------------- Commitments and contingent liabilities (Note 11) - - Company-obligated mandatorily redeemable preferred capital securities of subsidiary trust holding solely junior subordinated deferrable interest debenture of the Company 99,040 99,006 Shareholders' Preferred stock - $.01 par value; 5,000,000 shares authorized - - Equity Common stock - $.01 par value; 125,000,000 shares authorized, 35,196,002 and 35,145,247 issued 352 351 Additional paid-in capital 265,040 262,448 Accumulated other comprehensive income 74,462 71,936 Retained earnings 1,060,724 876,588 --------------------------------- 1,400,578 1,211,323 Less treasury stock (4,917,401 and 2,684,000 shares at cost) 303,063 150,143 --------------------------------- Total shareholders' equity 1,097,515 1,061,180 --------------------------------- Total liabilities and shareholders' equity $ 1,777,870 $ 1,686,603 =================================
See notes to consolidated financial statements. 22 Consolidated Statements of S h a r e h o l d e r s' E q u i t y
Year Ended December 31, (In thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- Common Balance, beginning of year $ 351 $ 350 $ 350 Stock Stock grants and exercise of stock options 1 1 - ----------------------------------------------- Balance, end of year 352 351 350 ----------------------------------------------- Additional Balance, beginning of year 262,448 258,059 256,507 Paid-in Stock grants and exercise of stock options 2,592 4,389 1,552 ----------------------------------------------- Capital Balance, end of year 265,040 262,448 258,059 ----------------------------------------------- Accumulated Balance, beginning of year 71,936 50,709 56,761 ----------------------------------------------- Other Unrealized gains on investments: Comprehensive Unrealized holding gains arising during period Income (net of tax of $9,982, $18,285, and $1,745) 18,539 33,957 3,240 Less: reclassification adjustment for gains included in net income (net of tax of $8,623, $6,854, and $5,004) (16,013) (12,730) (9,292) ----------------------------------------------- Other comprehensive income (loss), net of tax 2,526 21,227 (6,052) ----------------------------------------------- Balance, end of year 74,462 71,936 50,709 ----------------------------------------------- Retained Balance, beginning of year 876,588 707,885 556,969 Earnings Net income 190,360 175,309 157,918 Dividends declared (6,224) (6,606) (7,002) ----------------------------------------------- Balance, end of year 1,060,724 876,588 707,885 ----------------------------------------------- Treasury Balance, beginning of year (150,143) (30,141) (84) Stock Purchases of The PMI Group, Inc. common stock (152,920) (120,002) (30,057) ----------------------------------------------- Balance, end of year (303,063) (150,143) (30,141) ----------------------------------------------- Total shareholders' equity $ 1,097,515 $ 1,061,180 $ 986,862 =============================================== Comprehensive Net income $ 190,360 $ 175,309 $ 157,918 Income Other comprehensive income (loss), net of tax 2,526 21,227 (6,052) ----------------------------------------------- Comprehensive income $ 192,886 $ 196,536 $ 151,866 ===============================================
See notes to consolidated financial statements. 23 Consolidated Statements of C a s h F l o w s
Year Ended December 31, (In thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ Cash Net income $ 190,360 $ 175,309 $ 157,918 Flows Reconciliation of net income to net cash provided by from operating activities: Operating Realized capital gains, net (24,636) (19,584) (14,296) Activities Equity in earnings of affiliates (3,225) (1,455) (192) Depreciation and amortization 6,282 4,679 3,283 Changes in: Reserve for losses and loss adjustment expenses 12,872 2,613 7,687 Unearned premiums 736 (22,801) (23,371) Deferred policy acquisition costs (23,741) (6,231) (8,647) Accrued investment income 644 (1,355) (1,072) Reinsurance balances payable 2,936 (1,467) (5,446) Reinsurance recoverable and prepaid premiums (10,426) 51,703 (5,372) Premiums receivable (4,611) (5,109) (14,647) Income taxes 19,444 14,179 1,915 Receivable from affiliate (1,778) 127 (454) Receivable from Allstate (6,835) - (2,089) Other 20,079 (4,070) 6,589 -------------------------------------------- Net cash provided by operating activities 178,101 186,538 101,806 -------------------------------------------- Cash Proceeds from sales of equity securities 75,181 82,008 97,104 Flows Investment collections of fixed income securities 54,374 13,590 32,595 from Proceeds from sales of fixed income securities 120,404 367,865 211,945 Investing Purchases of fixed income securities (207,686) (573,627) (415,162) Activities Purchases of equity securities (53,092) (33,010) (77,634) Net decrease in short-term investments 40,476 2,986 434 Investment in affiliates (40,024) (3,600) (1,350) Purchases of property and equipment (12,417) (13,687) (10,213) -------------------------------------------- Net cash used in investing activities (22,784) (157,475) (162,281) -------------------------------------------- Cash Issuance of redeemable preferred capital securities - 99,000 - Flows Issuance of long-term debt - - 99,337 from Proceeds from exercise of stock options 2,592 3,181 1,135 Financing Dividends paid to shareholders (6,333) (6,733) (7,002) Activities Purchases of The PMI Group, Inc. common stock (152,920) (120,002) (30,057) -------------------------------------------- Net cash provided by (used in) financing activities (156,661) (24,554) 63,413 -------------------------------------------- Net increase (decrease) in cash (1,344) 4,509 2,938 Cash at beginning of year 11,101 6,592 3,654 -------------------------------------------- Cash at end of year $ 9,757 $ 11,101 $ 6,592 ============================================
See notes to consolidated financial statements. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION Basis of Presentation - The accompanying consolidated financial statements include the accounts of The PMI Group, Inc. ("TPG"), its wholly owned subsidiaries, PMI Mortgage Insurance Co. ("PMI"), Residential Guaranty Co. ("RGC"), American Pioneer Title Insurance Company ("APTIC"), PMI Mortgage Guaranty Co. ("PMG"), and PMI Capital I ("PCI"), PMI's wholly owned subsidiaries PMI Mortgage Services Co. ("MSC") and PMI Securities Co. ("SEC"), collectively referred to as the "Company." All material intercompany transactions and balances have been eliminated in consolidation. Formation of Company - TPG was incorporated in December 1993. After obtaining the required regulatory approvals, on November 28, 1994, Allstate Insurance Company ("Allstate") contributed all of the outstanding common stock of PMI to TPG. Allstate had previously been the direct owner of all of the common stock of PMI. Allstate is a wholly owned subsidiary of The Allstate Corporation ("Allstate Corp."). On April 18, 1995, Allstate, which had been the sole shareholder of the Company, sold 24.5 million shares of the Company's common stock, representing 70% of the outstanding shares of common stock, for approximately $784.0 million (net of related underwriting discount) in an underwritten public offering registered under the Securities Act of 1933. Concurrent with the stock offering, Allstate Corp. sold a new issue of 6.76% exchangeable notes due in April 1998. On April 15, 1998, Allstate Corp. exchanged 8,602,650 shares of TPG common stock to redeem the 6.76% exchangeable notes due April 15, 1998. After the exchange, Allstate held approximately 1,897,350 shares of TPG common stock, which has subsequently been sold by Allstate. NOTE 2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business -The Company, through PMI, primarily writes residential mortgage guaranty insurance ("primary insurance"). During 1997, PMI also began offering a mortgage pool insurance product, which differs in a number of respects from the pool insurance products offered through 1993 ("Old Pool" See Note 6). In addition, the Company writes title insurance through APTIC. Primary mortgage insurance provides protection to mortgage lenders against losses in the event of borrower default and assists lenders in selling mortgage loans in the secondary market. Pool insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions. Title insurance protects the insured party against losses resulting from title defects, liens and encumbrances existing as of the effective date of the policy. Basis of Accounting - The financial statements have been prepared on the basis of generally accepted accounting principles ("GAAP"), which vary from statutory accounting practices prescribed or permitted by insurance regulatory authorities (See Note 14). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Investments - The Company has designated its entire portfolio of fixed income and equity securities as available for sale. Such securities are carried at market value with unrealized gains and losses, net of deferred income taxes, reported as a component of accumulated other comprehensive income. In September 1994, PMI acquired 45% of the common stock of CMG Mortgage Insurance Company ("CMG") from CUNA Mutual Investment Corp. ("CMIC"). On October 1, 1998, PMI increased its equity investment in CMG to 50% by obtaining additional shares of common stock at a total cost of $4.8 million. CMIC continues to own the remaining 50% of the common stock of CMG. In addition, TPG owns 22.3% of RAM Holdings Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM Re"). Such affiliated investments are reported in accordance with the equity method of accounting. Investment income consists primarily of interest and dividends. Interest is recognized on an accrual basis and dividends are recorded on the date of declaration. Realized capital gains and losses are determined on a specific-identification basis. Property and Equipment - Property and equipment (including software) is carried at cost less accumulated depreciation. The Company provides for depreciation using the straight-line method over the estimated useful lives of the assets, generally 3 to 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10 years for equipment and 40 years for real property. Accumulated depreciation on property and equipment was $38.9 million and $33.1 million at December 31, 1998 and 1997, respectively. Insurance Accounting - Primary mortgage insurance policies are contracts that are non-cancelable by the insurer, are renewable at a fixed price at the insured's option, and provide for the payment of premiums on either a monthly, annual or single payment basis. Upon renewal by the insured, the Company is not able to re-underwrite or re-price its policies. Premiums written on a single premium and an annual premium basis are initially deferred as unearned premiums and earned over the policy term. Premiums written on policies covering more than one year (single premium plans) are amortized over the policy life in relation to the expiration of risk. Premiums written on annual payment policies are earned on a monthly pro rata basis. Premiums written on monthly payment policies are earned in the period to which they relate, and any unreceived portion is recorded in premiums receivable. Title insurance premiums are recognized as revenue on the effective date of the title insurance policy. Fee income of the non-insurance subsidiaries is earned as the services are provided. Certain costs of acquiring mortgage insurance business, including compensation, premium taxes and other underwriting expenses, are deferred, to the extent recoverable, and amortized over 24 months (see Note 5, "Deferred Acquisition Costs"). The reserve for losses and loss adjustment expenses is the estimated cost of settling claims related to notices of default on insured loans that have been reported to the Company as well as loan defaults that have occurred but have not been reported. Estimates are based on an evaluation of claim rates, claim amounts, and salvage recoverable. Reserves for title insurance claims are based on estimates of the amounts required to settle such claims, including expenses for defending claims for which notice has been received and an amount estimated for claims not yet reported. Management believes that the reserve for losses and loss adjustment expenses at December 31, 1998 is appropriately established in the aggregate and is adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by that date. The establishment of appropriate reserves is an inherently uncertain process. Such reserves are necessarily based on estimates and the ultimate net cost may vary from such estimates. These estimates are regularly reviewed and updated using the most current information available. Any resulting adjustments, which may be material, are reflected in current operations. Income per Common Share - Basic earnings per share (EPS) excludes dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The weighted average common shares outstanding for computing basic EPS were 31,393,782 for 1998, 33,385,828 for 1997 and 34,951,764 for 1996. The weighted average common shares outstanding for computing diluted EPS includes only stock options issued by the Company which have a dilutive impact and are outstanding for the period, and had the potential effect of increasing common shares to 31,532,710 for 1998, 33,510,261 for 1997 and 35,039,976 for 1996. Net income available to common shareholders does not change for computing diluted EPS. Income Taxes - The Company accounts for income taxes using the liability method, whereby deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the currently enacted tax rates. The principal assets and liabilities giving rise to such differences are presented in Note 7. Concentration of Risk - A substantial portion of PMI's business is generated within the State of California. For the year ended December 31, 1998, 14.9% of new insurance written was in California. In addition, California's book of business represented 17.6% of total risk in force at December 31, 1998. Stock-Based Compensation - The Company accounts for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees (see Note 13). New Accounting Pronouncements - In 1998, PMI adopted Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, and SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. SFAS No. 130 requires that an enterprise report, by major component and as a single total, the change in its net assets during the period from non-owner 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS sources. SFAS No. 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. SFAS No. 132 revises the disclosure information and format for presentation of pension and other postretirement benefits. Adoption of these statements did not impact the Company's financial position, results of operations or cash flows for the periods presented. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments. The statement is not expected to have a significant effect on PMI's financial position or results of operations based on current operating activities. Reclassification - Certain prior year amounts have been reclassified to conform to current year presentation. NOTE 3. INVESTMENTS Market Values - The amortized cost and estimated market values for fixed income securities are shown below:
Amortized Gross Unrealized Market ---------------- (In thousands) Cost Gains (Losses) Value - ------------------------------------------------------------------------------------------------------------------------- At December 31, 1998 U. S. government and agencies $ 53,918 $ 2,060 $ - $ 55,978 Municipals 1,110,665 83,363 (290) 1,193,738 Corporate bonds 104,042 3,451 (340) 107,153 ---------------------------------------------------------------------------------- Total $ 1,268,625 $ 88,874 $ (630) $ 1,356,869 ================================================================================== At December 31, 1997 U. S. government and agencies $ 42,017 $ 1,233 $ - $ 43,250 Municipals 1,044,964 71,369 (17) 1,116,316 Corporate bonds 147,197 2,269 (264) 149,202 ---------------------------------------------------------------------------------- Total $ 1,234,178 $ 74,871 $ (281) $ 1,308,768 ==================================================================================
Scheduled Maturities - The scheduled maturities for fixed income securities are as follows at December 31, 1998:
Amortized Market (In thousands) Cost Value - ------------------------------------------------------------------------------- Due in one year or less $ 6,826 $ 6,878 Due after one year through five years 62,650 64,945 Due after five years through ten years 148,382 157,887 Due after ten years 993,592 1,069,145 Other 57,175 58,014 -------------------------------------- Total $ 1,268,625 $ 1,356,869 ======================================
Actual maturities may differ from those scheduled as a result of calls by the issuers prior to maturity. Investment Concentration and Other Items - The Company maintains a diversified portfolio of municipal bonds. At December 31, 1998 and 1997, the following states represented the largest concentrations in the portfolio (expressed as a percentage of the carrying value of all municipal bond holdings). Holdings in no other state exceed 5.0% of the portfolio at December 31, for the respective years. 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1998 1997 - --------------------------------------------------------- Illinois 13.2% 13.4% Washington 12.0 13.3 Texas 12.0 13.0 New York 8.6 7.7 Massachusetts 7.3 6.0 California 6.5 6.9 Indiana 6.1 5.4 Pennsylvania 5.5 5.3
At December 31, 1998, fixed income securities with a market value of $10.2 million were on deposit with regulatory authorities as required by law. Unrealized Net Gains on Investments - Unrealized net gains on investments included in accumulated other comprehensive income at December 31, 1998, are as follows:
Net Market Gross Unrealized Unrealized (In thousands) Cost Value Gains (Losses) Gains - -------------------------------------------------------------------------------------------------------------------------- Fixed income securities $ 1,268,625 $ 1,356,869 $ 88,874 $ (630) $ 88,244 Common stocks 34,129 58,785 25,220 (564) 24,656 Preferred stocks 17,240 17,706 697 (231) 466 Investment in affiliates 59,723 60,450 727 - 727 ---------------------------------------------------------------------------------------- Total $ 1,379,717 $ 1,493,810 $ 115,518 $ (1,425) 114,093 ========================================================================= Less deferred income taxes 39,631 --------------- Total $ 74,462 ===============
The difference between cost and market value of the investment in affiliates reflects net unrealized gains on the affiliates' investment portfolio. The stated market value does not necessarily represent the fair value of the affiliates' common stock held by the Company. The change in net unrealized gains, net of deferred income taxes, included in other comprehensive income for fixed income securities and equity securities are as follows:
(In thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Fixed income securities $ 8,874 $ 20,572 $ (11,777) Equity securities (6,565) 517 5,895 Investment in affiliates 217 138 (170) ---------------------------------------------------- Total $ 2,526 $ 21,227 $ (6,052) ====================================================
28 Draft NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Investment Income - Investment income by investment type is as follows:
(In thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Fixed income securities $ 76,427 $ 74,641 $ 63,715 Equity securities 2,466 1,476 2,136 Common stock of affiliates 3,225 1,455 192 Short-term 3,442 6,332 2,119 ---------------------------------------------------- Investment income, before expenses 85,560 83,904 68,162 Less investment expense 879 768 720 ---------------------------------------------------- Investment income, less investment expense $ 84,681 $ 83,136 $ 67,442 ====================================================
Realized Capital Gains and Losses. Net realized capital gains (losses) are as follows:
(In thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Fixed income securities $ 1,481 $ (777) $ 2,072 Equity securities 23,155 20,188 12,024 Short-term - 173 200 ------------------------------------------------------------- Realized capital gains -- net, before taxes 24,636 19,584 14,296 Less income taxes 8,623 6,854 5,004 ------------------------------------------------------------- Realized capital gains, net of taxes $ 16,013 $ 12,730 $ 9,292 =============================================================
Gross realized capital gains and losses on investments are as follows:
(In thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------- Gross realized capital gains $ 27,810 $ 26,167 $ 19,842 Gross realized capital losses (3,174) (6,583) (5,546) ---------------------------------------------------- Net realized capital gains $ 24,636 $ 19,584 $ 14,296 ====================================================
29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. LOSS RESERVES The following table is a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses for each of the last three years:
(In thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Balance, January 1 $ 202,387 $ 199,774 $ 192,087 Less reinsurance recoverable 6,067 5,287 17,899 ------------------------------------------------------------ Net balance, January 1 196,320 194,487 174,188 ------------------------------------------------------------ Losses and loss adjustment expenses (principally in respect of defaulting occurring in) Current year 146,884 158,147 161,740 Prior years (11,168) (5,890) (9,331) ------------------------------------------------------------ Total losses and loss adjustment expenses 135,716 152,257 152,409 ------------------------------------------------------------ Losses and loss adjustment expense payments (principally in respect of defaulting occurring in) Current year 12,503 27,700 23,353 Prior years 111,056 122,724 108,757 ------------------------------------------------------------ Total payments 123,559 150,424 132,110 ------------------------------------------------------------ Net balance, December 31 208,477 196,320 194,487 Plus reinsurance recoverable 6,782 6,067 5,287 ------------------------------------------------------------ Balance, December 31 $ 215,259 $ 202,387 $ 199,774 ============================================================
As a result of changes in estimates of ultimate losses resulting from insured events in prior years, the provision for losses and loss adjustment expenses (net of reinsurance recoverable) decreased by $11.2 million, $5.9 million and $9.3 million in 1998, 1997 and 1996, respectively, due primarily to lower than expected losses in California. Such re-estimates were based on management's analysis of various economic trends (including the real estate market and unemployment rates) and their effect on recent claim rate and claim severity experience. NOTE 5. DEFERRED ACQUISITION COSTS ("DAC") PMI defers certain costs related to the acquisition of primary mortgage insurance and amortizes these costs against related premium revenue in order to match costs and revenues in accordance with GAAP. These acquisition costs vary with, and are primarily related to, the acquisition of new business. Specific costs PMI defers include field underwriting, field sales, and national accounts. To the extent PMI or any of its subsidiaries are compensated by customers for contract underwriting, those underwriting costs are not deferred. DAC is amortized on an accelerated basis over 24 months rather than the 5-7 year average policy life. Management believes this amortization method is appropriately conservative, and is used so that deferred costs will have been fully amortized prior to the peak claims paying period. The DAC asset is affected by: (a) acquisition costs deferred in a period, and (b) amortization of previously deferred costs in such period. In periods where there is growth in new business (and therefore acquisition costs), the DAC asset will increase because the amount of acquisition costs being deferred exceeds the amount being amortized to expense. The following table reconciles beginning and ending DAC for the years ended December 31, 1998, 1997 and 1996: 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Beginning DAC balance $ 37,864 $ 31,633 $ 22,986 Acquisition costs incurred and deferred 84,021 49,626 54,839 Amortization of deferred costs (60,280) (43,395) (46,192) ------------ ------------ ------------ Ending DAC balance $ 61,605 $ 37,864 $ 31,633 ============ ============ ============
NOTE 6. REINSURANCE PMI cedes reinsurance to reduce net risk in force to meet regulatory risk-to-capital requirements and to comply with the regulatory maximum policy coverage percentage limitation of 25%. Certain of the Company's reinsurance arrangements have adjustable features, including experience account refunds, which depend on the loss experience of the underlying business. While such estimates are based on the Company's actuarial analysis of the applicable business, the amounts the Company will ultimately recover could differ materially from amounts recorded in reinsurance recoverable. The reinsurance agreement with Capital Mortgage Reinsurance Company of New York was terminated effective December 31, 1997 and is in run-off through December 31, 2006 on policies existing prior to January 1, 1998. As a result of this reinsurance treaty termination, the Company is no longer ceding primary reinsurance to third party reinsurers (except under captive reinsurance arrangements) on policies written after December 31, 1997. In December 1993, the Company decided to cease writing Old Pool business (except for honoring certain commitments in existence prior to the discontinuation of this business). Concurrently, the Company entered into a reinsurance agreement with Forestview Mortgage Insurance Co. ("Forestview"), a wholly owned subsidiary of Allstate, to cede all future Old Pool net premiums and net losses from PMI to Forestview. As a result of this ceding agreement, the Old Pool business had no significant impact on the Company's results of operations for the years ended December 31, 1998, 1997 and 1996. The Board of Directors of Allstate has resolved that Allstate will make capital contributions to Forestview as necessary to maintain Forestview's risk-to-capital ratio below 20.0 to 1. In accordance with accounting for discontinued operations, Old Pool insurance assets (unpaid losses recoverable and paid claims receivable from reinsurers) and liabilities (loss reserves and premiums payable) have been netted in the accompanying consolidated balance sheets, resulting in a net receivable from reinsurers of $2.7 million and $4.1 million included in other assets at December 31, 1998 and 1997, respectively. Gross Old Pool reinsurance recoverables and receivables from Forestview and other reinsurers are as follows at December 31:
(in thousands) 1998 1997 - -------------------------------------------------------------------- Forestview $ 45,918 $ 89,580 Other reinsurers 19,308 23,565 ------------------------------- Total $ 65,226 $ 113,145 ===============================
Reinsurance recoverable on paid primary losses from reinsurers was $6.8 million and $6.1 million at December 31, 1998 and 1997, respectively. Prepaid primary reinsurance premiums from non-affiliated reinsurers were $2.1 million and $3.0 million at December 31, 1998 and 1997, respectively. The effects of reinsurance on the primary premiums written, premiums earned and losses and loss adjustment expenses of the Company's operations for the year ended December 31 are as follows: 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------ Premiums written Direct $ 498,828 $ 435,971 $ 404,528 Assumed 7,141 1,383 (901) Ceded (16,869) (5,302) (607) ------------------------------------ Premiums written, net of reinsurance $ 489,100 $ 432,052 $ 403,020 ==================================== Premiums earned Direct $ 506,096 $ 458,972 $ 425,831 Assumed 3,101 1,182 634 Ceded (17,971) (6,206) (13,727) ------------------------------------ Premiums earned, net of reinsurance $ 491,226 $ 453,948 $ 412,738 ==================================== Losses and loss adjustment expenses Direct $ 140,705 $ 157,012 $ 157,203 Assumed 176 219 (267) Ceded (5,165) (4,974) (4,527) ------------------------------------ Losses and loss adjustment expenses, net of reinsurance $ 135,716 $ 152,257 $ 152,409 ====================================
Reinsurance ceding arrangements do not discharge the Company from its obligations as the primary insurer. NOTE 7. INCOME TAXES The components of income tax expense are as follows:
(In thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------- Current $ 7,302 $ 3,859 $ 9,056 Deferred 69,286 63,699 55,132 ------------------------------------------------- Total income tax expense $ 76,588 $ 67,558 $ 64,188 =================================================
A reconciliation of the statutory federal income tax rate to the effective tax rate reported on income from operations before taxes is as follows:
1998 1997 1996 - -------------------------------------------------------------------------------------- Statutory federal income tax rate 35.0% 35.0% 35.0% Tax-exempt income (7.2) (7.5) (7.1) State income tax (net) 0.4 0.2 0.9 Other 0.5 0.1 0.1 ------------------------------------------------- Effective income tax rate 28.7% 27.8% 28.9% =================================================
On April 18, 1995 the Company and its subsidiaries separated from Allstate (See Note 1). Effective April 11, 1995 the Company and its subsidiaries file a consolidated income tax return. Prior to that date, the Company was part of the consolidated return of Sears, Roebuck and Co. ("Sears"), the former parent company of Allstate Corp. The Company's share of consolidated federal income tax liability prior to April 11, 1995 was determined under a tax sharing agreement as part of the Sears tax group. Under the tax sharing agreement, the Company has continuing rights and obligations to Allstate and Sears for the tax effect of any changes in taxable income relating to the periods during which the Company was part of the Sears tax group. At December 31, 1998 the Company had income taxes receivable of $16.8 million ($23.6 million including interest) from Allstate related to the filing of an amended return for prior years. Section 832(e) of the Internal Revenue Code permits mortgage guaranty insurers to deduct, within certain limitations, additions to statutory contingency reserves (See Note 14). This provision was enacted to enable mortgage guaranty insurers to increase statutory unassigned surplus through the purchase of non-interest bearing "tax and loss bonds" from the federal government. The tax and loss bonds purchased are limited to the tax benefit of the deduction for additions to the contingency 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS reserves. The Company purchased tax and loss bonds of $47.4 million, $50.7 million and $50.4 million in 1998, 1997 and 1996, respectively. The Company paid income taxes of $8.4 million, $8.4 million and $8.2 million in 1998, 1997 and 1996, respectively. Included in these amounts are federal income tax payments to Allstate under the tax sharing agreement of $0.7 million in 1996. The components of the deferred income tax assets and liabilities at December 31 are as follows:
(In thousands) 1998 1997 - -------------------------------------------------------------------------------- Deferred tax assets: Discount on loss reserves $ 4,422 $ 3,743 Unearned premium reserves 4,181 6,591 Alternative minimum tax credit carryforward 31,870 23,687 Pension costs 3,131 3,037 Other assets 4,355 2,197 ---------------------------- Total deferred tax assets 47,959 39,255 ============================ Deferred tax liabilities: Statutory contingency reserves 72,817 56,730 Policy acquisition costs 21,562 13,253 Unrealized net gains on investments 39,631 38,738 Software development costs 7,423 5,550 Other liabilities 3,256 1,379 ---------------------------- Total deferred tax liabilities 144,689 115,650 ---------------------------- Net deferred tax liability $ 96,730 $ 76,395 ============================
NOTE 8. FINANCIAL INSTRUMENTS In the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. The estimated fair value amounts of certain liabilities indicated below have been determined by using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value and, accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange.
1998 1997 - ------------------------------------------------------------------------------------------------------------------------- Carrying Estimated Carrying Estimated (In thousands) Value Fair Value Value Fair Value - ---------------------------------------------------------------------------- ------------------------------------- 6.75% Long-term debt $ 99,476 $ 103,997 $ 99,409 $ 100,983 8.309% Redeemable preferred capital securities $ 99,040 $ 107,075 $ 99,006 $ 107,875
A number of the Company's significant assets and liabilities, including deferred policy acquisition costs, property and equipment, loss reserves, unearned premiums and deferred income taxes are not considered financial instruments. 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9. BENEFIT PLANS As of April 18, 1995, all full-time employees and certain part-time employees of the Company participate in The PMI Group, Inc. Retirement Plan ("Plan"), a noncontributory defined benefit plan. The Plan has been funded by the Company to the fullest extent permitted by federal income tax rules and regulations. Also, employees earning in excess of $150,000 per year participate in The PMI Group, Inc. Supplemental Employee Retirement Plan, a noncontributory defined benefit plan. Benefits under both plans are based upon the employee's length of service, average annual compensation and estimated social security retirement benefits. The Company provides certain health care and life insurance benefits for retired employees ("OPEB Plan"). Generally, qualified employees may become eligible for these benefits if they retire in accordance with the Company's established retirement policy and are continuously insured under the Company's group plans or other approved plans for 10 or more years prior to retirement. The Company shares the cost of the retiree medical benefits with retirees based on years of service with the Company's share being subject to a 5% limit on annual medical cost inflation after retirement. The Company has the right to modify or terminate these plans. The following table presents certain information regarding the Plan and the OPEB Plan as of December 31: 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pension Benefits Other Benefits ---------------- -------------- (In thousands, except percentages) 1998 1997 1996 1998 1997 1996 ------- ------- ------- ------- ------- ------- Change in benefit obligation Benefit obligation at January 1, $ 11,381 $ 6,659 N/A $ 3,112 $ 2,782 N/A Service cost 3,796 3,424 N/A 434 387 N/A Interest cost 1,074 759 N/A 255 217 N/A Actuarial loss (gain) 2,861 875 N/A 435 (269) N/A Benefits paid (736) (336) N/A (17) (5) N/A ------------------------ ------------------------ Benefit obligation at December 31, 18,376 11,381 4,219 3,112 ------------------------ ------------------------ Change in plan assets Fair value of plan assets at January 1, 5,204 2,896 N/A - - N/A Actual return on plan assets 366 180 N/A - - N/A Company contribution 4,043 2,464 N/A 17 5 N/A Benefits paid (736) (336) N/A (17) (5) N/A ------------------------ ------------------------ Fair value of plan assets at December 31, 8,877 5,204 - - ------------------------ ------------------------ Funded status Funded status of plan at December 31, (9,499) (6,177) N/A (4,219) (3,112) N/A Unrecognized actuarial loss (gain) 3,583 505 N/A (320) (781) N/A Unrecognized prior service cost - - N/A 265 284 N/A ------------------------ ------------------------ Accrued and recognized benefit cost $ (5,916) $ (5,672) $ (4,274) $ (3,609) ======================== ======================== Components of net periodic benefit cost Service cost $ 3,796 $ 3,424 $ 3,282 $ 434 $ 387 $ 438 Interest cost 1,074 759 484 255 217 215 Expected return on assets (515) (295) (147) - - - Prior service cost amortization - - - 20 20 20 Actuarial loss (gain) recognized (68) (95) 6 (26) (28) - ------------------------------------------------------------------------ Net periodic benefit cost $ 4,287 $ 3,793 $ 3,625 $ 683 $ 596 $ 673 ======================================================================== Weighted-average assumptions Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50% Expected return on plan assets 8.50% 8.50% 8.50% N/A N/A N/A Rate of compensation increase 5.50% 5.50% 5.50% N/A N/A N/A Health care cost trend on covered charges N/A N/A N/A 6.00% 6.00% 6.00%
35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sensitivity of retiree welfare results. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
1-Percentage- 1-Percentage (In thousands) Point Increase Point Decrease - --------------------------------------------------------------------------------------------------------------- Effect on total of service and interest cost components $ 184 $ 145 Effect on accumulated postretirement benefit obligation 863 577
Savings and Profit Sharing Plan. As of April 18, 1995, employees of the Company were eligible to participate in The PMI Group, Inc. Savings and Profit Sharing Plan ("401K Plan") covering both salaried and hourly employees. Eligible employees who participate in the 401K Plan receive, within certain limits, matching Company contributions. Costs relating to the 401K Plan amounted to $2.1 million, $1.2 million and $1.1 million for 1998, 1997 and 1996, respectively. NOTE 10. DEBT AND CREDIT FACILITIES Long-term Debt - On November 15, 1996, the Company issued unsecured debt securities in the face amount of $100.0 million ("Notes"). The Notes mature and are payable on November 15, 2006 and are not redeemable prior to maturity. No sinking fund is required or provided for prior to maturity. Interest on the Notes is 6.75% and is payable semiannually. Interest payments of $6.8 million were made during both 1998 and 1997. Lines of Credit - The Company has two lines of credit agreements ("Lines"), each in the amount of $25.0 million. The Lines have final maturities of February 2001 and December 2001 and commitment fees of 8.0 and 6.5 basis points, respectively. Both Lines may be used for general corporate purposes. There were no amounts outstanding on the Lines at December 31, 1998 or 1997. NOTE 11. COMMITMENTS AND CONTINGENT LIABILITIES Leases - The Company leases certain office facilities and equipment. Minimum rental commitments under non-cancelable operating leases with a remaining term of more than one year as of December 31, 1998 are as follows:
(In thousands) Amount - --------------------------------------------- Year ending December 31: 1999 $ 6,807 2000 7,604 2001 6,311 2002 5,366 2003 4,777 Thereafter 4,309 -------------- Total $ 35,174 ==============
The Company intends to renew its corporate headquarters lease in 1999. Such minimum expected rentals are included in the above amounts. Total rent expense for all leases was $9.0 million, $7.6 million and $7.4 million in 1998, 1997 and 1996, respectively. Legal Proceedings - Various legal actions and regulatory reviews are currently pending that involve the Company. In the opinion of management, the ultimate liability in one or more of these actions is not expected to have a material effect on the financial condition or results of operations of the Company. 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURE OF THE COMPANY On February 4, 1997, TPG, through a wholly-owned trust, privately issued $100.0 million of 8.309% preferred capital securities, Series A ("Capital Securities"). The Capital Securities are redeemable after February 1, 2007, at a premium or upon occurrence of certain tax events, and mature on February 1, 2027. The net proceeds, totaling $99.0 million, were used for general corporate purposes, including common stock repurchases and additions to the investment portfolio. The Capital Securities were issued by PMI Capital I ("Issuer Trust"). The sole asset of the Issuer Trust consists of $103.1 million principal amount of a junior subordinated debenture ("Debenture") issued by TPG to the Issuer Trust. The Debenture bears interest at the rate of 8.309% per annum and matures on February 1, 2027. The amounts due to the Issuer Trust under the Debenture and the related income statement amounts have been eliminated in the Company's consolidated financial statements. Distributions on the Capital Securities occur on February 1 and August 1 of each year. The obligations of TPG under the Debenture and a related guarantee and expense agreement constitute a full and unconditional guarantee by TPG of the Issuer Trust's obligations under the Capital Securities. The Capital Securities are subject to mandatory redemption under certain circumstances. Distribution payments of $8.3 million and $4.2 million were made in 1998 and 1997, respectively. NOTE 13. DIVIDENDS AND SHAREHOLDERS' EQUITY Shareholder Rights Plan - On January 13, 1998, the Company adopted a Shareholder Rights Plan ("Rights Plan"). In general, rights issued under the plan will be exercisable only if a person or group acquires 10% or more of the Company's common stock or announces a tender offer for 10% or more of the common stock. The Rights Plan contains an exception that would allow passive institution investors to acquire up to a 15% ownership interest before the rights would become exercisable. Dividends - The ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company, receipt of dividends from PMI, restrictions contained in the Company's credit agreements and other relevant factors. PMI's ability to pay dividends to TPG is limited under Arizona law. The payment of dividends by PMI without the prior approval of the Arizona State Insurance department is limited to formula amounts based on net income, net investment income, and capital and surplus, including unassigned surplus, determined in accordance with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. Limitations on PMI's risk-to-capital ratio also effectively limit PMI's ability to pay dividends because the payment of dividends reduces statutory capital. Various state regulatory authorities impose a limitation that the risk-to-capital ratio may not exceed 25 to 1. In addition, under a support agreement with Allstate, PMI is prohibited from paying any dividend that would cause its risk-to-capital ratio to equal or exceed 23 to 1 (see Note 16). Management believes that PMI's dividend restrictions have not had, and are not expected to have, a significant impact on TPG's ability to meet its cash obligations. Under the most restrictive dividend limitations, the maximum amount of dividends that PMI can distribute to TPG at December 31, 1998, without prior regulatory approval is $16.5 million. PMI paid ordinary and, after obtaining regulatory approval, extraordinary dividends to TPG totaling $100.0 million and $76.4 million in the years ended December 31, 1998 and 1997, respectively. APTIC paid ordinary dividends to TPG totaling $3.2 million and $2.5 million in the years ended December 31, 1998 and 1997, respectively. Preferred Stock - The Company's restated certificate of incorporation authorizes the Board of Directors to issue up to 5,000,000 shares of preferred stock of TPG in classes or series and to fix the designations, preferences, qualifications, limitations or restrictions of any class or series with respect to the rate and nature of dividends, the price and terms and conditions on which shares may be redeemed, the amount payable in the event of voluntary or involuntary liquidation, the terms and conditions for conversion or exchange into any other class or series of the stock, voting rights and other terms. The Company may issue, without the approval of the holders of common stock, preferred stock which has voting, dividend or liquidation rights superior to the common stock and which may adversely affect the rights of holders of common stock. Pursuant to the Runoff Support Agreement (see Note 16), the Company has agreed that, in the event that Allstate makes a payment contemplated by the Allstate Support Agreements or the Runoff Support Agreement, Allstate will have the right to receive preferred stock of TPG or PMI with a liquidation preference equal to the amount of such payment. Such preferred stock will rank senior in right of payment to the issuer's common stock and, so long as such preferred stock is outstanding, the issuer thereof will be prohibited from paying any dividends or making any other distributions on its common stock. 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity Incentive Plan and Directors Plan - During 1998, the Company amended and restated The PMI Group, Inc. Equity Incentive Plan ("Equity Incentive Plan") and The PMI Group, Inc. Stock Plan for Non-Employee Directors ("Directors Plan"). Pursuant to such plans, an aggregate of 1,500,000 shares of common stock was reserved for issuance to directors, officers, and employees of TPG and its subsidiaries. The Equity Incentive Plan provides for awards of both non-qualified stock options and incentive stock options, stock appreciation rights, restricted stock subject to forfeiture and restrictions on transfer, and performance awards entitling the recipient to receive cash or common stock in the future following the attainment of performance goals determined by the Board of Directors. Generally, options are granted with an exercise price equal to the market value on the date of grant, expire ten years from the date of grant and have a three-year vesting period. The Directors Plan provides that each director who is not an employee of the Company or its subsidiaries will receive an annual grant of up to 300 shares of common stock and will receive stock options for 1,500 shares annually, after an initial option of up to 3,000 shares. The shares will be granted on June 1 of each year or as soon as administratively practicable after each anniversary of the director's commencement of service. The following is a summary of activity in the Equity Incentive Plan and the Directors Plan during 1998 and 1997:
1998 1997 - ----------------------------------------------------------------------------------------------------------- Weighted Weighted Shares Average Shares Average Under Option Exercise Price Under Option Exercise Price ------------------ --------------- --------------- --------------- Options outstanding at beginning of year 616,388 $ 42.30 538,604 $ 36.40 Options granted 366,650 71.04 206,310 54.61 Options exercised (51,928) 35.67 (92,653) 34.33 Options forfeited (21,356) 64.21 (35,873) 43.19 --------------------------------------------------------------------------- Outstanding at end of year 909,754 $ 53.75 616,388 $ 42.30 =========================================================================== Exercisable at year end 402,978 $ 39.07 230,331 $ 35.28 Reserved for future grants 398,145 - 743,439 - - -----------------------------------------------------------------------------------------------------------
Note: The weighted average remaining contractual life of shares under option was 8.0 years (for an exercise price between $32.14 and $76.25) in 1998 and 8.0 years ($32.14 and $67.97) in 1997. ================================================================================ In addition, in February 1999, the Equity Incentive Plan was amended and restated, subject to shareholder approval, to reserve an additional 1,500,000 shares for issuance. As discussed in Note 2, the Company accounts for stock-based compensation under APB No. 25 and its related interpretations. SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro-forma net income and earnings per share had the Company adopted the fair value method as of the beginning of fiscal year 1995. The fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 0.26% and 0.28% for the 1998 options, 0.29% to 0.37% for the 1997 options, and 0.35% to 0.44% for the 1996 options; expected volatility range of 21.92% and 23.15% for the 1998 options, 20.61% to 21.90% for the 1997 options and 21.08% to 23.12% for the 1996 options; risk-free interest rates of 5.45% and 5.58% for the 1998 options, 6.06%, 6.43%, 6.36%, 6.18% and 5.86% for the 1997 options and 5.40%, 5.83%, 6.51%, 6.53% and 6.54% for the 1996 options; and an expected life of four years following the vesting. Forfeitures are recognized as they occur. 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS If the computed fair values of the 1998, 1997 and 1996 awards had been amortized to expense over the vesting period of the awards, the Company's net income, basic net income per share and diluted net income per share would have been reduced to the pro forma amounts indicated below:
(In thousands, except per share amounts) 1998 1997 1996 - ----------------------------------------------- ----------------- ---------------- ------------- Net income: As reported $ 190,360 $ 175,309 $ 157,918 Pro-forma 187,776 174,487 157,663 Basic earnings per share: As reported $ 6.06 $ 5.25 $ 4.52 Pro-forma 5.98 5.23 4.51 Diluted earnings per share: As reported $ 6.04 $ 5.23 $ 4.51 Pro-forma 5.95 5.21 4.50
NOTE 14. STATUTORY ACCOUNTING The Company's insurance subsidiaries prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by their respective state's Department of Insurance, which is a comprehensive basis of accounting other than GAAP. The principles used in determining statutory financial amounts differ from GAAP primarily for the following reasons: Under statutory accounting practices, mortgage guaranty insurance companies are required to establish each year a contingency reserve equal to 50% of premiums earned in such year. Such amount must be maintained in the contingency reserve for 10 years after which time it is released to unassigned surplus. Prior to 10 years, the contingency reserve may be reduced with regulatory approval to the extent that losses in any calendar year exceed 35% of earned premiums for such year. Under GAAP, the contingency reserve is not permitted. Under statutory accounting practices, insurance policy acquisition costs are charged against operations in the year incurred. Under GAAP, these costs are deferred and amortized over 24 months. (See Note 5, "Deferred Acquisition Costs.") Statutory financial statements only include a provision for current income taxes due, and purchases of tax and loss bonds are accounted for as investments. GAAP financial statements provide for deferred income taxes including the purchase of tax and loss bonds, which are recorded as a deferral of the income tax provision. Under statutory accounting practices, certain assets, designated as nonadmitted assets, are charged directly against statutory surplus. Such assets are reflected on the GAAP financial statements. Under statutory accounting practices, fixed maturity investments in good standing are valued at amortized cost. Under GAAP, those investments which the Company does not have the ability or intent to hold to maturity are considered to be available for sale and are recorded at market, with the unrealized gain or loss recognized, net of tax, as an increase or decrease to accumulated other comprehensive income. The statutory net income, statutory surplus and contingency reserve liability of PMI as of and for the years ended December 31 are as follows:
(In thousands) 1998 1997 1996 - ---------------------------------------------------------------------------- Statutory net income $ 214,040 $ 227,148 $ 202,584 --------------------------------------- Statutory surplus $ 165,459 $ 274,864 $ 313,635 --------------------------------------- Contingency reserve liability $ 1,028,440 $ 839,478 $ 674,841 ---------------------------------------
39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The differences between the statutory net income and equity presented above for PMI and the consolidated net income and equity presented on a GAAP basis primarily represent the differences between GAAP and statutory accounting practices as well as the results of operations and equity of other Company subsidiaries. NOTE 15. BUSINESS SEGMENTS The Company's reportable operating segments include Mortgage Guaranty Insurance and Title Insurance. The Mortgage Guaranty Insurance segment includes PMI, PMG, RGC and Residential Insurance Co. The Title Insurance segment consists of the results for APTIC. The Other segment includes TPG, MSC, PCI, and SEC. Key products for each of the reportable segments are disclosed in Note 2, "Business and Summary of Significant Accounting Policies." The Other segment includes the income and expenses of the holding company, the results from the business of contract underwriting and software licensing, and the activity of an inactive broker-dealer. The accounting policies of the segments are the same as disclosed in Note 2, "Business and Summary of Significant Accounting Policies." Intersegment transactions are not significant. The Company evaluates performance primarily based on segment net income. The following tables present information about reported segment income (loss) and segment assets for the periods indicated.
Mortgage 1998 Guaranty Title Intersegment Consolidated (in thousands) Insurance Insurance Other Adjustments Total - ---------------------------------------------------------------------------------------------------------------------------------- Premiums earned $ 411,922 $ 79,304 $ - $ - $ 491,226 =========== =========== =========== =========== =========== Net underwriting income (expenses) before tax-external customers $ 172,414 $ 9,606 $ (9,049) $ - $ 172,971 Investment and other income 97,989 1,427 6,676 - 106,092 Equity in earnings of affiliates - - 392 2,833 3,225 Interest expense (3) - (7,026) - (7,029) Distributions on preferred capital securities - - (8,311) - (8,311) ----------- ----------- ----------- ----------- ----------- Income (loss) before income tax expense 270,400 11,033 (17,318) 2,833 266,948 Income tax expense (benefit) 78,732 4,182 (6,326) - 76,588 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 191,668 $ 6,851 $ (10,992) $ 2,833 $ 190,360 =========== =========== =========== =========== =========== Total assets $1,643,482 $ 42,165 $ 92,223 $ - $1,777,870 =========== =========== =========== =========== =========== - ----------------------------------------------------------------------------------------------------------------------------------
40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Mortgage 1997 Guaranty Title Intersegment Consolidated (in thousands) Insurance Insurance Other Adjustments Total - ---------------------------------------------------------------------------------------------------------------------------------- Premiums earned $ 394,010 $ 59,938 $ - $ - $ 453,948 =========== =========== =========== =========== =========== Net underwriting income (expenses) before tax-external customers $ 159,360 $ 4,992 $ (9,906) $ - $ 154,446 Investment and other income 93,625 1,257 6,467 - 101,349 Equity in earnings of affiliates - - - 1,455 1,455 Interest expense - - (6,766) - (6,766) Distributions on preferred capital securities - - (7,617) - (7,617) ----------- ----------- ----------- ----------- ----------- Income (loss) before income tax expense 252,985 6,249 (17,822) 1,455 242,867 Income tax expense (benefit) 72,099 2,218 (6,759) - 67,558 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 180,886 $ 4,031 $ (11,063) $ 1,455 $ 175,309 =========== =========== =========== =========== =========== Total assets $1,503,596 $ 37,050 $ 145,957 $ - $1,686,603 =========== =========== =========== =========== =========== - ----------------------------------------------------------------------------------------------------------------------------------
Mortgage 1996 Guaranty Title Intersegment Consolidated (in thousands) Insurance Insurance Other Adjustments Total - ---------------------------------------------------------------------------------------------------------------------------------- Premiums earned $ 359,527 $ 53,211 $ - $ - $ 412,738 =========== =========== =========== =========== =========== Net underwriting income (expenses) before tax-external customers $ 144,189 $ 3,433 $ (7,035) $ - $ 140,587 Investment and other income 78,365 1,162 2,707 - 82,234 Equity in earnings of affiliates - - - 192 192 Interest expense - - (907) - (907) ----------- ----------- ----------- ----------- ----------- Income (loss) before income tax expense 222,554 4,595 (5,235) 192 222,106 Income tax expense (benefit) 63,113 1,591 (516) - 64,188 ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 159,441 $ 3,004 $ (4,719) $ 192 $ 157,918 =========== =========== =========== =========== =========== Total assets $1,369,166 $ 33,408 $ 107,345 $ - $1,509,919 =========== =========== =========== =========== =========== - ----------------------------------------------------------------------------------------------------------------------------------
The Company did not have any major customers that accounted for more than 10% of its consolidated revenues for any of the years presented. The Company does not have any material revenues and assets attributed to or located outside the United States. NOTE 16. CAPITAL SUPPORT AGREEMENTS PMI's claims-paying ratings from certain national rating agencies have, in the past, been based in significant part on various capital support commitments from Allstate and Sears ("Allstate Support Agreements"). On October 27, 1994, the Allstate Support Agreements were terminated with respect to policies issued after October 27, 1994, but continue in modified form (as so modified, the "Runoff Support Agreement") for policies written prior to such termination. Under the terms of the Runoff Support Agreement, Allstate may, at its option, either directly pay or cause to be paid, claims relating to policies written during the terms of the respective Allstate Support Agreements if PMI fails to pay such claims or, in lieu thereof, make 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS contributions directly to PMI or TPG. In the event any amounts were so paid or contributed (which possibility management believes is remote), Allstate would receive subordinated debt or preferred stock of PMI or TPG in return. The Runoff Support Agreement contains certain covenants, including covenants that (i) PMI will write no new business after its risk-to-capital ratio equals or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and (iii) on the date that any of the following events occur: (A) PMI's risk-to-capital ratio exceeds 24.5 to 1, (B) Allstate shall have paid any claims relating to PMI policies directly to a policyholder or by paying an amount equal to such claims to PMI (or to TPG for contribution to PMI) pursuant to the Runoff Support Agreement, or (C) any regulatory order is issued restricting or prohibiting PMI from making full or timely payments under policies, PMI will transfer substantially all of its assets in excess of $50.0 million to a trust account established for the payment of claims. On June 6, 1996, a CMG Capital Support Agreement was executed by PMI and CMIC whereby both parties agreed to contribute funds, subject to certain limitations, so as to maintain CMG's risk-to-capital ratio at or below 18.0 to 1. In addition, the agreement specifies that under certain circumstances, PMI and CMIC will each contribute up to an additional $4.4 million to CMG, over and above obligations, net of prior contributions, of $0.9 million each, agreed to in a shareholder agreement dated September 30, 1998. At December 31, 1998 CMG's risk-to-capital ratio was 15.8 to 1. NOTE 17. QUARTERLY RESULTS (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter ---------------- --------------- --------------- --------------- 1998 1997 1998 1997 1998 1997 1998 1997 - -------------------------------------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Revenues $ 150,634 $ 147,546 $ 147,469 $ 132,909 $ 167,409 $ 141,204 $ 155,397 $ 142,988 =============================================================================================== Net income $ 45,768 $ 49,172 $ 46,787 $ 42,279 $ 53,728 $ 41,913 $ 44,077 $ 41,945 =============================================================================================== Basic EPS $ 1.41 $ 1.44 $ 1.47 $ 1.26 $ 1.74 $ 1.26 $ 1.45 $ 1.29 =============================================================================================== Diluted EPS $ 1.40 $ 1.43 $ 1.46 $ 1.25 $ 1.73 $ 1.26 $ 1.45 $ 1.28 =============================================================================================== Diluted operating EPS * $ 1.24 $ 1.09 $ 1.41 $ 1.24 $ 1.43 $ 1.25 $ 1.45 $ 1.27 ===============================================================================================
* Diluted operating earnings per share represents diluted earnings per share excluding realized capital gains and their related income tax effect. Earnings per share is computed independently for the quarters presented. Therefore, the sum of the quarterly earnings per share amounts may not equal the total computed for the year. 42 R e p o r t o f R e p o r t o f M a n a g e m e n t I n d e p e n d e n t A u d i t o r s To the Board Of Directors and Shareholders To the Shareholders of The PMI Group, Inc. of The PMI Group, Inc. The consolidated financial statements of We have audited the accompanying The PMI Group, Inc. and subsidiaries have consolidated balance sheets of The PMI been prepared by management and have been Group, Inc. and subsidiaries ("Company") audited by the Company's independent as of December 31, 1998 and 1997, and the auditors, Deloitte & Touche LLP, whose related consolidated statements of report appears on this page. Management operations, shareholders' equity and cash is responsible for the consolidated flows for each of the three years in the financial statements, which have been period ended December 31, 1998. These prepared in conformity with generally consolidated financial statements are the accepted accounting principles and include responsibility of the Company's amounts based on management's judgments. management. Our responsibility is to express an opinion on these consolidated Management is also responsible for financial statements based on our audits. maintaining internal control systems designed to provide reasonable assurance, We conducted our audits in accordance with at appropriate cost, that assets are generally accepted auditing standards. safeguarded and that transactions are Those standards require that we plan and executed and recorded in accordance with perform the audit to obtain reasonable established policies and procedures. The assurance about whether the consolidated Company's systems are under continuing financial statements are free of material review and are supported by, among other misstatement. An audit includes things, business conduct and other written examining, on a test basis, evidence guidelines, an internal audit function and supporting the amounts and disclosures in the selection and training of qualified the consolidated financial statements. An personnel. audit also includes assessing the accounting principles used and significant The Board of Directors, through its Audit estimates made by management, as well as Committee, oversees management's financial evaluating the overall financial statement reporting responsibilities. The Audit presentation. We believe that our audits Committee meets regularly with the provide a reasonable basis for our opinion. independent auditors, representatives of management and the internal auditors to In our opinion, such consolidated discuss and make inquiries into their financial statements present fairly, in activities. Both the independent auditors all material respects, the financial and the internal auditors have free access position of The PMI Group, Inc. and to the Audit Committee, with and without subsidiaries as of December 31, 1998 and management representatives in attendance. 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally W. Roger Haughton accepted accounting principles. Chairman and Chief Executive Officer John M. Lorenzen, Jr. Deloitte & Touche LLP Executive Vice President and Chief San Francisco, California Financial Officer January 20, 1999 January 20, 1999
43 Ten Year Summary of Financial and Operating Data (Dollars in thousands, except per share data or otherwise noted)
1998 1997 1996 1995 1994 ------------- ------------- ------------ ------------ ------------ Summary of Consolidated Operations: Net premiums written $ 489,100 $ 432,052 $ 403,020 $ 314,021 $ 277,747 ============= ============= ============ ============ ============ Premiums earned $ 491,226 $ 453,948 $ 412,738 $ 328,756 $ 296,345 Investment income, less investment expense 84,681 83,136 67,442 62,041 56,774 Realized capital gains, net 24,636 19,584 14,296 11,934 3,064 Other income 20,366 7,979 6,948 2,309 3,802 ------------- ------------- ------------ ------------ ------------ Total revenues 620,909 564,647 501,424 405,040 359,985 Total losses and expenses(1) 353,961 321,780 279,318 224,499 221,434 ------------- ------------- ------------ ------------ ------------ Income from continuing operations before taxes 266,948 242,867 222,106 180,541 138,551 Income (loss) from discontinued operations - - - - - Income tax expense (benefit)(2) 76,588 67,558 64,188 45,310 32,419 ------------- ------------- ------------ ------------ ------------ Net income $ 190,360 $ 175,309 $ 157,918 $ 135,231 $ 106,132 ============= ============= ============ ============ ============ Mortgage Insurance Operating Ratios: Loss ratio 32.8% 38.2% 41.9% 38.5% 40.5% Expense ratio 25.5% 22.7% 18.4% 24.9% 30.1% ------------- ------------- ------------ ------------ ------------ Combined ratio 58.3% 60.9% 60.3% 63.4% 70.6% ============= ============= ============ ============ ============ Consolidated Balance Sheet Data: Total assets $ 1,777,870 $ 1,686,603 $ 1,509,919 $ 1,304,440 $ 1,097,421 Reserve for losses and loss adjustment expenses $ 215,259 $ 202,387 $ 199,774 $ 192,087 $ 173,885 Long-term debt $ 99,476 $ 99,409 $ 99,342 $ - $ - Preferred capital securities of subsidiary trust $ 99,040 $ 99,006 $ - $ - $ - Shareholders' equity $ 1,097,515 $ 1,061,180 $ 986,862 $ 870,503 $ 687,178 Per Share Data: Net income Basic $ 6.06 $ 5.25 $ 4.52 $ 3.86 $ 3.03 Diluted(3) $ 6.04 $ 5.23 $ 4.51 $ 3.85 $ 3.03 Shareholders' equity $ 36.25 $ 32.69 $ 28.60 $ 24.87 $ 19.63 Cash dividends declared $ 0.20 $ 0.20 $ 0.20 $ 0.15 $ - PMI Operating and Statutory Data: Number of policies in force 714,210 698,831 700,084 657,800 612,806 Default rate 2.31% 2.38% 2.19% 1.98% 1.88% Persistency 68.0% 80.8% 83.3% 86.4% 83.6% Direct primary insurance in force (in millions) $ 80,682 $ 77,787 $ 77,312 $ 71,430 $ 65,982 Direct primary risk in force (in millions) $ 19,324 $ 18,092 $ 17,336 $ 15,130 $ 13,243 Statutory capital $ 1,193,699 $ 1,114,342 $ 988,475 $ 824,156 $ 659,402 Risk-to-capital ratio 14.9:1 14.6:1 15.9:1 15.8:1 17.7:1 New insurance written (NIW) $ 27,820,065 $ 15,307,147 $17,882,702 $14,459,260 $18,441,612 Policies issued 211,161 119,190 142,900 119,631 156,055 NIW market share 14.8% 12.7% 14.1% 13.2% 14.0%
Ten Year Summary of Financial and Operating Data (Continued) (Dollars in thousands, except per share data or otherwise noted)
1993 1992 1991 1990 1989 ------------- ------------- ------------ ------------ ------------ Summary of Consolidated Operations: Net premiums written $ 291,089 $ 208,602 $ 143,305 $ 120,532 $ 102,940 ============= ============= ============ ============ ============ Premiums earned $ 268,554 $ 173,039 $ 120,195 $ 101,913 $ 91,447 Investment income, less investment expense 45,733 40,847 40,402 38,261 35,943 Realized capital gains, net 1,229 686 1,335 (524) (437) Other income - - - - - ------------- ------------- ------------ ------------ ------------ Total revenues 315,516 214,572 161,932 139,650 126,953 Total losses and expenses(1) 202,543 119,912 39,879 78,979 86,572 ------------- ------------- ------------ ------------ ------------ Income from continuing operations before taxes 112,973 94,660 122,053 60,671 40,381 Income (loss) from discontinued operations (28,863) 6,726 3,709 1,562 974 Income tax expense (benefit)(2) 24,305 (10,911) 69,661 9,649 2,535 ------------- ------------- ------------ ------------ ------------ Net income $ 59,805 $ 112,297 $ 56,101 $ 52,584 $ 38,820 ============= ============= ============ ============ ============ Mortgage Insurance Operating Ratios: Loss ratio 41.4% 33.2% 3.1% 47.4% 61.8% Expense ratio 28.2% 27.0% 25.3% 25.5% 29.2% ------------- ------------- ------------ ------------ ------------ Combined ratio 69.6% 60.2% 28.4% 72.9% 91.0% ============= ============= ============ ============ ============ Consolidated Balance Sheet Data: Total assets $ 985,129 $ 815,136 $ 663,215 $ 569,550 $ 493,853 Reserve for losses and loss adjustment expenses $ 135,471 $ 94,002 $ 78,045 $ 115,805 $ 125,210 Long-term debt $ - $ - $ - $ - $ - Preferred capital securities of subsidiary trust $ - $ - $ - $ - $ - Shareholders' equity $ 575,300 $ 513,583 $ 399,489 $ 338,632 $ 286,591 Per Share Data: Net income Basic $ 1.71 $ 3.21 $ 1.60 $ 1.50 $ 1.11 Diluted(3) $ 1.71 $ 3.21 $ 1.60 $ 1.50 $ 1.11 Shareholders' equity $ 16.44 $ 14.67 $ 11.41 $ 9.68 $ 8.19 Cash dividends declared $ - $ - $ - $ - $ - PMI Operating and Statutory Data: Number of policies in force 543,924 428,745 347,232 313,035 300,429 Default rate 1.81% 2.03% 2.38% 2.38% 2.46% Persistency 70.0% 74.6% 85.2% 86.5% 85.9% Direct primary insurance in force (in millions) $ 56,991 $ 43,698 $ 31,982 $ 26,938 $ 24,448 Direct primary risk in force (in millions) $ 11,267 $ 8,676 $ 6,481 $ 5,554 $ 5,152 Statutory capital $ 494,621 $ 456,931 $ 372,568 $ 314,037 $ 272,687 Risk-to-capital ratio 20.8:1 19.0:1 18.8:1 18.6:1 19.5:1 New insurance written (NIW) $25,469,907 $19,463,000 $ 8,663,000 $ 5,795,000 $ 5,117,000 Policies issued 207,356 161,893 75,095 49,943 45,134 NIW market share 18.6% 19.4% 15.9% 14.9% 13.7%
(1) In 1991, the Company significantly revised its estimate for losses and loss adjustment expense, reducing total losses by $42.1 million and the loss ratio by 35 percentage points, and increasing income from continuing operations by $27.8 million. (2) During 1991, the Company increased its tax liabilities and income tax expense by $40.9 million in light of an unfavorable judgment by the U.S. Tax Court. In 1992, the 1991 judgment was overturned, and the Company re- evaluated its tax balances and reduced its tax liabilities and income tax expense by $30.9 million. (3) Diluted earnings per share per Statement of Financial Accounting Standards No. 128, "Earnings per Share." EX-21 8 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 ------------ THE PMI GROUP, INC. - SUBSIDIARIES Name Under Which Subsidiary Does Jurisdiction of Subsidiary Name Business (If Different) Incorporation - --------------- ----------------------- --------------- PMI Mortgage Insurance Co. Arizona Residential Guaranty Co. Arizona American Pioneer Title Insurance Company Chelsea Title Company Florida PMI Mortgage Services Co. California PMI Capital I Delaware PMI Mortgage Guaranty Co. Arizona PMI Securities Co. Delaware Residential Insurance Co. Arizona CLM Technologies, Ltd. California PMI Capital Corporation Delaware TPG Segregated Portfolio Company Cayman Islands TPG Insurance Co. Vermont PMI PAC Arizona EX-23.1 9 INDEPENDENT AUDITORS' CONSENT EXHIBIT 23.1 ------------ INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33- 92636, No. 33-99378, No. 333-47473, and No. 333-66829 of The PMI Group, Inc. (the "Company") on Form S-8 and Registration Statements No. 333-48035, and No. 333-67125 of the Company on Form S-3 and Registration Statement No. 333-29777 of the Company on Form S-4 of our reports dated January 20, 1999 appearing in and incorporated by reference in this Annual Report on Form 10-K of the Company for the year ended December 31, 1998. /s/ Deloitte & Touche LLP San Francisco, California March 26, 1999 57 EX-27 10 FINANCIAL DATA SCHEDULE
7 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1,356,869 0 0 136,941 0 0 1,532,224 9,757 42,102 61,605 1,777,870 215,259 94,886 0 0 99,476 0 0 352 1,097,163 1,777,870 491,226 84,681 24,636 20,366 135,716 60,280 142,625 266,948 76,588 190,360 0 0 0 190,360 6.06 6.04 196,320 146,884 (11,168) 12,503 111,056 208,477 0
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