-----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, Q5MFTdbdMsumen2fz3mO3n+Z0HTWLK76jMF83U0EtaDh0wOSrcRZtIOyaMY2Dbgb 5Ow4DhWtLpYi6NJ1QkcZvA== 0000929624-00-000472.txt : 20000331 0000929624-00-000472.hdr.sgml : 20000331 ACCESSION NUMBER: 0000929624-00-000472 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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: 586059 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, 1999 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 executive offices) Identification No.)
(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 29, 2000 was $1,609,540,560 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 29, 2000: 44,324,697. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Stockholders for the fiscal year ended December 31, 1999 are incorporated by reference into Items 6 through 8 of Part II. Portions of the Proxy Statement for registrant's 2000 Annual Meeting of Stockholders to be held on May 18, 2000 are incorporated by reference into Items 10 through 13 of Part III. The Exhibit Index is located on page 67. 1 TABLE OF CONTENTS PART I.................................................................................................. 3 Cautionary Statement Item 1. Business......................................................................................... 3 A. General........................................................................................ 3 B. Products....................................................................................... 4 C. Industry Overview.............................................................................. 8 D. Competition and Market Share................................................................... 11 E. Customers...................................................................................... 15 F. U.S. Business Composition...................................................................... 15 G. Sales, Product Development and Underwriting Personnel.......................................... 17 H. Underwriting Practices......................................................................... 18 I. Affordable Housing............................................................................. 23 J. Defaults and Claims............................................................................ 24 K. Reinsurance.................................................................................... 34 L. Claims Paying Ability Ratings.................................................................. 35 M. Investment Portfolio........................................................................... 35 N. Other Business................................................................................. 36 O. Regulation..................................................................................... 38 P. Employees...................................................................................... 44 Q. Cautionary Statements and Investment Considerations............................................ 44 Item 2. Properties....................................................................................... 49 Item 3. Legal Proceedings................................................................................ 49 Item 4. Submission of Matters to a Vote of Security Holders.............................................. 50 PART II.................................................................................................... 52 Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........................ 52 Common Stock........................................................................................ 52 Preferred Stock..................................................................................... 52 Shareholder Rights Plans............................................................................ 52 Payment of Dividends and Policy..................................................................... 53 Item 6. Selected Financial Data.......................................................................... 53 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 53 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................... 53 Item 8. Financial Statements and Supplementary Data...................................................... 53 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 54 PART III................................................................................................... 54 Item 10. Directors and Executive Officers of the Registrant.............................................. 54 Item 11. Executive Compensation.......................................................................... 54 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................. 54 Item 13. Certain Relationships and Related Transactions.................................................. 54 PART IV.................................................................................................... 54 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 54 INDEX TO EXHIBITS.......................................................................................... 67
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. 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. "Cautionary Statements and Investment Considerations" ("IC# 1-15") 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 and indirect 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, PMI Mortgage Guaranty Co. ("PMG"), an Arizona corporation, TPG Segregated Portfolio Company ("TSPC"), a Cayman Islands corporation, and PMI's wholly owned subsidiaries PMI Mortgage Insurance Ltd ("PMI Ltd"), an Australian mortgage insurance company. TPG also conducts title insurance business through its wholly-owned subsidiary American Pioneer Title Insurance Company ("APTIC"), a Florida 3 corporation. 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. ("SECO"), a Delaware 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 direct and indirect wholly-owned 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 and TPG owns 24.9% of RAM Holdings Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM Re"), a financial guaranty reinsurance company based in Bermuda. CMG and RAM Re are accounted for on the equity method in the Company's consolidated financial statements. TPG, through PMI and CMG, is one of the leading residential mortgage insurers in the United States. In addition to international and domestic 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. At December 31, 1999, the Company's total assets were $2.1 billion and its shareholders' equity was $1.2 billion. B. Products Domestic 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 less than 20% 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"). During 1999, 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 insurance coverage ranging from 12% to 25%, and 95s and 97s have insurance coverage ranging from 18% to 35%. Fannie Mae and Freddie Mac are collectively referred to as government-sponsored enterprises ("GSEs"). The GSEs' reduced mortgage insurance coverage levels require additional fees to be paid by the borrower at origination. (See "D. Competition and Market Share", below and IC3.) The coverage percentage insured by PMI is determined by the lender, usually to comply with investor 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. 4 Primary Insurance PMI provides primary insurance coverage, insuring mortgage 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 original loan amount. In lieu of paying the calculated claim amount, PMI has the option of: (i) paying the entire loss 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 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, 1999. The average coverage percentage for PMI was 25% and 24% of NIW for the year ended December 31, 1999 and 1998, respectively. 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 and PMG to provide reinsurance of such deep coverage to PMI and CMG. (See "K. Reinsurance", below.) At December 31, 1999, PMI's average coverage percentage on insurance in force was 24.4%. (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. The GSEs current guidelines regarding cancellation of mortgage insurance generally provide that a borrower's written request to cancel mortgage insurance should be honored if the borrower has a satisfactory payment record and the principal balance is not greater than 80% of the original value of the property. In addition, the Home Owners Protection Act of 1998 provides for automatic termination, or cancellation of mortgage insurance upon a borrower's request upon satisfaction of certain conditions (See IC4). 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. 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. 5 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 95.9% of NIW in 1999. During April 1999, PMI began offering 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 that require the payment of an additional fee for a further reduction in mortgage insurance coverage (See "D. Competition and Market Share", below and IC3). 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). During May 1999, PMI began offering its Super Single/ SM/ product that provides coverage on 97% LTV loans. 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 3.0% of NIW in 1999. 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 1.1% of NIW in 1999. Pool Insurance During the fourth quarter of 1997, PMI began offering a pool insurance product, primarily to Fannie Mae and Freddie Mac, as part of PMI's value added strategy. This product was also sold to state housing finance authorities. 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 risk written for this product was $231 million and $450 million for the years ended December 31, 1999 and 1998, respectively. 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 6 geographic diversification and lower LTVs. The average stop loss limit for this product as of December 31, 1999 was 1.07%. Risk in force under pool insurance programs with PMI's customers represented approximately three percent of the $21.2 billion total primary risk in force at December 31, 1999 (See IC10.). In July 1999, the California Department of Insurance approved a Recapture Agreement between PMI and Forestview Mortgage Insurance Company ("Forestview") relating to mortgage pool policies written prior to 1994. As a result of the commutation and recapture of the Reinsurance Agreement with Forestview, PMI received $45.5 million in cash in consideration of the recapture liability (consisting of the returned unearned premium reserve, and the reimbursement of the reserve for losses), the roll back of 1999 reinsurance transactions, and the settlement of reimbursable fees and prepaid expenses. In connection with the Recapture Agreement, PMI assumed mortgage insurance obligations of approximately $42.8 million, net of expense allocations, previously insured by Forestview. Risk in force for the recaptured Forestview portfolio was $1.41 billion at December 31, 1999. 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 IC2 and IC8.) Joint Venture CMG Mortgage Insurance Company ("CMG") offers mortgage guaranty insurance for loans originated by credit unions. CMG is operated as a joint venture equally owned between PMI and CUNA Mutual Investment Corporation (''CMIC''). PMI and CMIC provide services to CMG, with CMIC providing primarily sales and marketing services and PMI providing primarily 7 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. CMG's claims-paying ability is currently rated AA by both Fitch IBCA and by Duff & Phelps Credit Rating Co. As of December 31, 1999, 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, 1999, CMG had $5.8 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. International The Company also provides mortgage guaranty insurance and reinsurance in Australia, New Zealand and Hong Kong, which is described in more detail under "Section N. Other Businesses." 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.) 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 8 legislation, Freddie Mac announced that it would pursue a charter amendment that would allow it to utilize alternative forms of default loss protection or otherwise forego the use of private mortgage insurance on higher loan-to-value mortgages. Currently, Freddie Mac can purchase loans with down payments of less than 20% only if the loans are insured or use other limited methods to protect against default (See IC3). 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 IC5.) 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 IC2 and IC3.) Since 1992, Fannie Mae and Freddie Mac have been subject to oversight legislation for GSEs by the Department of Housing & Urban Development (HUD) 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. Recently, HUD announced new affordable housing goals for the GSEs. Under the new goals beginning for year 2001, at least 50% of all loans purchased by the GSEs must support low- and moderate-income homebuyers. The GSEs' current goal for affordable housing is that at least 48% of the units financed by each GSE be low- and moderate-income housing, and that approximately 24% 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%). Under the proposal, this target would increase up to 31 percent. The special affordable housing goal, which measures funding for families with very-low household income or living in low-income areas, would increase from 14 percent to 20 percent. The proposed goals are subject to review by the Office of Management and Budget and would be subject to a public comment period prior to final revisions or enactment by HUD. 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. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, requires the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop a risk-based capital regulations for the GSEs. In April 1999, a notice of proposed rulemaking was published in the 9 Federal Register announcing OFHEO's development of proposed risk-based capital regulations. The regulation specifies a risk-based capital stress test that, when applied to the GSEs, determines the amount of capital that a GSE must hold to maintain positive capital throughout a 10-year period of severe economic conditions. The proposed regulations could require a GSE to hold more than double the capital it presently maintains for loans with loan-to-value ratios ("LTV") of 95 percent or higher. Further, the proposed capital regulations could treat more favorably credit enhancements issued by private mortgage insurance companies with a claims-paying ability rating of AAA compared with those companies with a rating lower than AAA (See IC3). Freddie Mac's and Fannie Mae's automated underwriting services, Loan Prospector/SM/ and Desktop Underwriter, 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 became 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 IC4, below.) 10 D. Competition and Market Share The U.S. private mortgage insurance industry consists of eight active mortgage insurers, including Mortgage Guaranty Insurance Corporation ("MGIC"), GE Capital Mortgage Insurance Corporation ("GEMICO"), an affiliate of GE Capital Corporation, United Guaranty Residential Insurance Company ("UGC"), an affiliate of American International Group, Inc., and Radian Group, Inc. (Radian"). PMI, including CMG, is the third largest private mortgage insurer in the United States based on new primary insurance written in 1999. (Source: Inside Mortgage Finance.) In 1999, MGIC possessed the largest share of the private mortgage insurance market, with approximately 24.3% of NIW, and Radian, PMI, GEMICO and UGC had market shares of approximately 17.5%, 16.3%, 15.2% and 14.4%, respectively. (Source: Inside Mortgage Finance.) PMI's 1999 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 IC2.) 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, ------------------------------------------------------------ 1999 1998 1997 1996 1995 -------- --------- --------- --------- ---------- Mortgage Guaranty Insurance Corp. 24.3 % 23.1 % 26.4 % 25.5 % 27.4 Radian Guaranty Inc. (1) 17.5 19.4 17.8 15.7 14.9 PMI Mortgage Insurance Co. (2) 16.3 16.2 13.8 14.7 13.5 GE Capital Mortgage Insurance Co. 15.2 16.4 16.5 18.5 20.1 United Guaranty Corp. 14.4 12.7 12.8 12.7 12.9 Republic Mortgage Insurance Co. 10.0 9.7 10.3 11.2 9.7 Triad Guaranty Insurance Corp. 2.3 2.5 2.4 1.7 1.5 -------- -------- ------- ------- ------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ======== ======== ======= ======= =======
Source: Inside Mortgage Finance (1) Formerly CMAC & Amerin; market share data prior to the merger represents combined pro forma results of CMAC & Amerin. (2) Includes CMG. The following table indicates the market share by private mortgage insurer for each quarter in 1999: 11
Private Mortgage Insurance Industry Market Share 1999 by Quarter -------------------------------------------------------------------------------- 4Q 1999 3Q 1999 2Q 1999 1Q 1999 -------------------- ------------------ ---------------- ---------------- Mortgage Guaranty Insurance Corp. 24.5 % 24.4 % 24.5 % 23.9 % PMI Mortgage Insurance Co. (1) 16.6 16.1 16.5 15.9 United Guaranty Corp. 16.3 14.2 13.8 13.7 Radian Guaranty Inc. (2) 16.3 17.6 17.9 18.1 GE Capital Mortgage Insurance Corp. 14.8 15.1 15.8 14.9 Republic Mortgage Insurance Co. 9.3 10.4 9.2 10.8 Triad Guaranty Insurance Corp. 2.2 2.2 2.3 2.7 --------------------- ------------------ ---------------- ---------------- Total 100.0 % 100.0 % 100.0 % 100.0 % ===================== ================== =============== ===============
Source: Inside Mortgage Finance (1) Includes CMG. (2) Formerly CMAC & Amerin; market share data prior to the merger represents combined pro forma results of CMAC & Amerin 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 combined to accounted for 47.6%, 43.7%, 45.6%, and 44.8% for 1999, 1998, 1997 and 1996, respectively, of all loans insured or guaranteed/(2)./ On January 1, 2000, the Department of Housing and Urban Development announced a proposed increase in the maximum individual loan amount that FHA can insure to $219,849 from $208,800. The maximum individual loan amount that the VA can insure is $203,150 (See IC2). 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, 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 IC2.) 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, ----------------------------------------------------------------------------- 1999 1998 1997 1996 1995 -------------- ------------- ------------ ----------- ------------ FHA/VA 47.6 43.7 % 45.6 % 44.8 % 38.5 % Private Mortgage Insurance 52.4 56.3 % 54.4 55.2 61.5 % -------------- ------------- ------------ ----------- ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ============== ============= ============= =========== ============
12 Source: Inside Mortgage Finance Fannie Mae and Freddie Mac announced an increase in the maximum single-family principal balance loan limit eligible for their purchase from $240,000 to $252,700 effective in 2000. 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.) Freddie Mac and Fannie Mae both introduced programs in 1999 that offer reduced mortgage insurance coverage availability for lenders that generally deliver loans approved by the GSE's automated underwriting services, Loan Prospector/SM/ and Desktop Underwriter, 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 homebuyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. Through 1999 the reduced MI coverage programs have not produced any significant volume (See IC3.) 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. In addition, the Gramm-Leach-Bliley Act of 1999, among other things, allows bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, and allows insurers and other financial service companies to acquire banks (See "O. Regulation", IC2 and IC15.) 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% 13 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, as well as similar type products, competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. On March 8, 2000, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and other banking regulators issued a proposal to amend their risk-based capital standards to treat direct credit substitutes and recourse obligations consistently and would incorporate the use of credit ratings as an indicator of a bank's risk of loss. It is believed that the proposal would increase the amount of capital national banks and thrifts would be required to hold for 80/10/10 and similar products when the lender holds the first and second mortgage. State-chartered banks already are subject to the higher capital requirement (See IC2). 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. PMI is also 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", IC4 and IC8.) The Gramm-Leach-Bliley Act of 1999 (the "Act") became effective on March 11, 2000 and allows, among other things, bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, and allows insurers and other financial service companies to acquire banks. The Act allows a bank holding company to form an insurance subsidiary, licensed under state insurance law, to issue insurance products directly, including mortgage insurance. However, any such mortgage insurance subsidiary would be subject to and governed by state insurance regulations, including capital and reserve requirements, diversification of risk and restrictions on the payments of dividends. Further, before any loans insured by the subsidiary are eligible for purchase by the GSEs, the insurance subsidiary must meet Fannie Mae and Freddie Mac eligibility standards, which currently require, among other things, a claims-paying ability rating of at least AA-, and the establishment of comprehensive operating policies, procedures and processes. Coinciding with the effective date of the Act, several national banks announced that they meet the criteria to own financial subsidiaries, including sufficient capitalization and stated plans to create one or more operating subsidiaries. Two national bank holding companies indicated that they intend to use their financial subsidiaries to sell insurance. The Federal Reserve Board recently issued a proposed rule to allow state-chartered banks that are members of the Federal Reserve System own financial subsidiaries. The proposed rule is designed to establish parity 14 between state member banks and national banks. Because of the many aspects of the Act which require clarification and promulgation of specific regulations, the Company is not yet able to ascertain the full impact of the Act on the Company (See IC15). 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, 1999, 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, 1999, total mortgage originations according to the Mortgage Bankers Association of America were estimated to be $1.3 trillion compared to $1.5 trillion for the year ended December 31, 1998. E. Customers PMI insures mortgage loans funded by mortgage originators. Mortgage originators include mortgage bankers, savings institutions, commercial banks and other mortgage lenders. For the year ended December 31, 1999, 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. Because the GSEs are the predominant purchasers and sellers of conventional mortgage loans in the United States, Fannie Mae and Freddie Mac are the beneficiary of the majority of the Company's mortgage insurance coverage. F. United States 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 with another mortgage insurance company. However, the GSE's have restrictions on changing mortgage insurance providers. 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 1995 to 1999. The relatively low interest rates during this period resulted in an increasing percentage of mortgages insured by PMI at a 15 fixed rate of interest, representing 91.4% of direct primary risk in force at December 31, 1999, up from 76.8% at year-end 1995. 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 34.4% for the year ended December 31, 1998 to 37.6%, for the year ended December 31, 1999. During the period between 1998 and 1999, PMI's direct primary risk in force increased by 9.8% from $19.3 billion at December 31, 1998 to $21.2 billion at December 31, 1999. During 1999, 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. However, during 1999, PMI's percentage of insurance in force with higher coverage levels continued to increase as mortgage lenders and investors continue to prefer MI policies with the higher coverage percentages. If the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, this shift could have a materially adverse impact on the Company's financial condition and results of operations. (See "D. Competition and Market Share", above and IC3.) 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, 1999, 46.7% 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"). "). At December 31, 1999, 48.4% of PMI's risk in force consisted of 90s and below. PMI also offers coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At December 31, 1999, 4.9% of PMI's risk in force consisted of 97s that have even higher risk characteristics than 95s and greater uncertainty as to pricing adequacy. PMI's NIW also includes coverage for 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. Although PMI charges higher premium rates for loans that have higher risk characteristics, including ARMs, 95s and 97s, 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 IC10.). 16 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: Direct Risk in Force
As of December 31, -------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- ---------- ---------- ---------- Direct Risk in Force (In millions) $ 21,159 $ 19,324 $ 18,092 $ 17,336 $ 15,130 --------- --------- ---------- ---------- ---------- Lender Concentration: Top 10 Lenders (by original applicant) 36.1 % 30.0 % 27.8 % 26.0 % 22.5 % ========= ========= ========= ========== ========== LTV: 97s 4.9 % 3.3 % 1.8 % 0.0 % 0.0 % 95s 46.7 46.3 46.2 44.7 40.6 90s and below 48.4 50.4 52.0 55.3 59.4 --------- --------- --------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========= ========== ========== Average Coverage Percentage 24.4 % 23.9 % 24.3 % 22.4 % 21.2 % ========= ========= ========= ========== ========== Loan Type: Fixed 91.4 % 89.7 % 83.3 % 80.6 % 76.8 % ARM 7.9 9.2 15.2 17.7 21.3 ARM (scheduled/potential negative amortization) 0.7 1.1 1.5 1.7 1.9 --------- --------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========== ========== ========== Mortgage Term: 15 years and under 4.4 % 5.3 % 6.3 % 9.4 % 8.6 % Over 15 years 95.6 94.7 93.7 90.6 91.4 --------- --------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========== ========== ========== Property Type: Single-family detached 87.5 % 87.1 % 86.3 % 86.7 % 86.7 % Condominium 6.1 6.4 6.8 6.9 7.1 Other 6.4 6.5 6.9 6.4 6.2 --------- --------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========== ========== ========== Occupancy Status: Primary residence 98.0 % 98.6 % 99.0 % 99.2 % 99.3 % Second home 1.2 1.0 0.8 0.6 0.5 Non-owner occupied 0.8 0.4 0.2 0.2 0.2 --------- --------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========== ========== ========== Loan Amount: $100,000 or less 24.0 % 26.4 % 27.3 % 28.3 % 28.8 % Over $100,000 and up to $250,000 68.6 66.1 65.6 64.8 64.3 Over $250,000 7.4 7.5 7.1 6.9 6.9 --------- --------- ---------- ---------- ---------- Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % ========= ========= ========== ========== ==========
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, 1999, PMI had 30 sales and underwriting service field and satellite offices located in 26 states. PMI's sales force receives compensation comprised of a base salary with incentive compensation tied to performance objectives. PMI's Product Development and Pricing 17 Department has primary responsibility for advertising, sales materials, pricing and the creation of new products and services. PMI's product development and underwriting personnel at the director level and above, 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, automated mortgage scoring systems and automated underwriting 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 - Technology and Underwriting Practices" 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. CPC was designated to centralize the processing of data input and to enhance operational productivity and efficiency, customer service and expense management. New policies processed at the CPC represented 54.1% of PMI's NIW in 1999 compared with 38.3% in 1998. During 1999, applications processed at the CPC represented 64% of all applications compared with 47.0% in 1998. 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 28.8% of PMI's NIW in 1999 compared with 35.0% in 1998. 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. 18 . 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 reduced 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. 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 IC12.) 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 19 submitted under this program. (See "G. 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 1999, 56.6% of applications received were approved by the automated underwriting systems. In 1998, 62.2% 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 1998 at approximately 4.5% for the year ended December 31, 1999. 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 56.2% and 52.7% of PMI's NIW in 1999 and 1998, respectively, and represented 44.1% of PMI's total risk in force at December 31, 1999. 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 20 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. Technology and Underwriting Practices In September 1999, PMI began offering its products and services via the Internet. PMI customers can order mortgage insurance directly from their Web sites using an embedded link that "frames" e-PMI, which is PMI's all-purpose, electronic delivery channel for mortgage insurance origination within the site and provides access to PMI's online services under the customer's own branded image. Framing, which provides connectivity to the e-PMI channel, is available by request and tailored to a lender's specifications. Currently it offers users immediate, real-time access to mortgage insurance origination services and mortgage insurance rates. PMI offers e-PMI as a value-added service to better meet the online mortgage origination needs of its customers. PMI will be seeking to offer expanded services in the future through the phased introduction of new capabilities to include access to Desktop Underwriter and Loan Prospector(SM) decisioning, contract underwriting services, pmiAURA(SM)scoring, and access to WEB-CONNECT(SM), PMI's online servicing update product. 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 while reducing underwriting costs. pmiAURA(SM) 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. The individual underwriter will then make the final decision on those files referred by pmiAURA(SM). The pmiAURA(SM) database contains performance data on over 2.8 million loans, and includes economic and demographic information to enhance its predictive power. The pmiAURA(SM) system generates three types of scores: a loan risk score that 21 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 fifth generation includes a revised credit score indicator that provides an enhanced predictor of the relative likelihood of default by a mortgage borrower. The pmiTERRA(SM) system complements 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. 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. Currently, e-PMI customers are not offered access to the GSEs automated underwriting programs. 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. Currently, pmiAURA(SM), is approved by all four Wall Street rating agencies as an effective tool for establishing levels of credit support needed on securities backed by non- 22 conforming, conventional loans. During 1999, PMI developed a modified version of pmiAURA(SM) for users of Desktop Underwriter(TM) to evaluate FHA loans. I. Affordable Housing In recent years expanding home ownership opportunities for low and moderate- income borrowers and communities has taken on an increased priority. PMI and its lender customers have placed increased importance on this business. PMI's approach to low-mod, or affordable lending, is to develop products and services which assist responsible borrowers who may not have qualified using traditional underwriting practices. These "non-traditional" underwriting standards assist home buyers in verifying their ability to meet obligations in a timely and conscientious manner, rather than accommodating borrowers who have historically not managed their affairs in a responsible manner. The beneficiaries of these programs have included recent immigrants who have not yet established traditional credit histories; borrowers not accustomed to using traditional savings institutions, and home buyers who although consistently employed, lack the normally desired job stability due the nature of their employment. To further promote affordable housing, PMI has entered into risk-sharing arrangements with certain institutional lenders. PMI refers to such arrangements as Layered Co-insurance. Layered Co-insurance is utilized primarily by financial institutions to meet Community Reinvestment Act (CRA) lending goals. Under such arrangements, the mortgage insurance is structured so that financial responsibility is shared between the lender and PMI. Typically, PMI is responsible for the first, and usually expected, loss layer, as well as a third catastrophic layer, with the lender assuming a predetermined second loss layer. PMI has also established partnerships with numerous national organizations to mitigate affordable housing risks and expand the understanding of the responsibilities of home ownership. These community partners include the San Francisco based Consumer Credit Counseling Services, Neighborhood Reinvestment Corp. and the affiliated Neighborhood Housing Services of America, and the National American Indian Housing Conference. In addition, PMI has developed partnerships with local organizations in an effort to expand home ownership opportunities and promote community revitalization. These organizations include the Oakland, California based Hispanic Unity Council, the San Francisco China Town Community Development Corporation, the Orange County Affordable Home Ownership Alliance, as well as several Native American nations, including the Chickasaw, Choctaw, Cherokee and Navajo. In 1999 PMI's work with the Native American nations was recognized by Social Compact, a nonprofit organization that promotes grassroots strategies that attract private investment to lower-income communities. Programs offered under PMI's affordable housing initiatives receive the same credit and actuarial analysis as all other standard programs. Loans to low and moderate income borrowers 23 and communities accounted for approximately 30% of NIW. Additionally, the percentage of this production that relied on "special" affordable underwriting guidelines as designated as such by lenders was 8.8% of new risk written in 1999, as compared to 6.5% in 1998. Management believes that affordable housing loans have higher risks than its other insured business. As a result, PMI has instituted various programs, including borrower counseling and risk-sharing approaches, seeking to mitigate the higher risk characteristics of such loans. J. Defaults and Claims Defaults PMI's default rate has decreased to 2.12% at December 31, 1999 from the December 31, 1998 rate of 2.31%. This decrease was primarily due to an improvement in the national economy, and particularly California, and to an increase in policies in force. (See IC12 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 1999 by PMI insureds was within approximately 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 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. U.S. Historical Domestic Default Rates Total Insured Loans in Force
Year Ended December 31, --------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------ ----------- ----------- ------------ ------------ Number of Insured Loans in Force 749,591 714,210 698,831 700,084 657,800 Number of Loans in Default 15,893 16,528 16,638 15,326 13,022 Default Rate 2.12 % 2.31 % 2.38 % 2.19 % 1.98 %
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, 1999. 24 Default Rates by Region(1)
As of Period End, ------------------------------------------------------------------------------------------------ 1999 1998 --------------------------------- --------------------------------- Region 4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1st Q 1997 1996 1995 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Pacific(2) 2.31 % 2.31 % 2.28 % 2.64 % 2.69 % 2.67 % 2.72 % 3.03 % 3.14 % 3.22 % 3.34 % New England(3) 1.88 1.51 1.55 1.69 1.79 1.68 1.64 1.81 1.81 1.80 1.93 Northeast(4) 2.64 2.62 2.54 2.87 2.91 2.77 2.68 2.88 2.79 2.52 2.22 South Central(5) 1.81 1.74 1.64 1.78 1.92 1.78 1.73 1.87 1.98 1.67 1.51 Mid-Atlantic(6) 2.11 2.17 2.04 2.21 2.37 2.23 2.22 2.40 2.35 2.03 1.65 Great Lakes(7) 1.95 1.91 1.85 1.91 1.98 1.94 1.88 1.88 1.86 1.82 1.21 Southeast(8) 2.31 2.18 2.02 2.25 2.39 2.16 2.10 2.35 2.31 1.93 1.53 North Central(9) 1.67 1.70 1.67 1.88 1.96 1.91 1.78 1.95 1.95 1.61 1.31 Plains(10) 1.65 1.78 1.59 1.76 1.73 1.63 1.45 1.53 1.56 1.21 0.89 Total Portfolio 2.12 2.07 1.99 2.22 2.31 2.20 2.16 2.36 2.38 2.19 1.98
(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. 25 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, ------------------- --------------------------------------------------- 1999 1999 1998 1997 1996 1995 ---------------- -------- -------- -------- -------- -------- California 15.61 % 2.59 % 3.15 % 3.73 % 3.81 % 4.08 % Florida 7.50 3.00 3.08 2.93 2.40 1.92 Texas 7.27 2.06 2.18 2.25 2.04 1.85 New York 4.86 2.85 2.98 2.94 2.59 2.30 Illinois 4.73 2.01 2.35 2.56 2.14 1.84 Washington 4.72 1.62 1.58 1.66 1.58 1.21 Pennsylvania 4.03 2.38 2.64 2.38 2.13 1.91 Georgia 3.91 1.95 2.01 1.87 2.59 2.26 Virginia 3.71 1.42 1.55 1.67 1.54 1.18 Massachusetts 3.54 1.49 1.67 1.67 1.73 1.91 Total Portfolio 100.00 % 2.12 % 2.31 % 2.38 % 2.19 % 1.98 %
(1) Top ten states as determined by total risk in force as of December 31, 1999. Default rates are shown by states based on location of the underlying property. Default rates on PMI's California policies decreased to 2.59% (representing 2,382 loans in default) at December 31, 1999, from 3.15% (representing 3,067 loans in default) at December 31, 1998. 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 29% and 48% of the total dollar amount of claims paid for the year ended December 31, 1999 and 1998, respectively. The following table sets forth the dispersion of PMI's primary insurance in force and risk in force as of December 31, 1999, by year of policy origination since PMI began operations in 1972. 26 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) 1972-1992 $ 6,176,358 7% $ 1,249,042 6% 1993 7,451,202 9% 1,501,696 7% 1994 4,606,852 5% 988,217 5% 1995 4,632,861 5% 1,222,687 6% 1996 6,539,999 8% 1,742,731 8% 1997 8,173,685 9% 2,160,348 10% 1998 23,171,725 27% 5,822,036 28% 1999 25,923,340 30% 6,459,515 31% ------------------- --------- -------------------- --------- Total Portfolio $ 86,676,022 100% $ 21,146,272 100% =================== ========= ==================== =========
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 27% of PMI's insurance in force at December 31, 1999. This portion of PMI's book of business is in its expected peak claim period. Despite increasing coverage percentages and increasing mortgage principal amounts, direct primary claims paid by PMI in 1999 decreased to $79.6 million compared with $118.4 million in 1998. 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, 1999, by year of policy origination and average coupon rate. 27 Insurance in Force by Policy Year and Average Coupon Rate As of December 31, 1999 ------------------------------------------------- Policy Average Percent Year Rate (1) IIF of Total ---------- --------------- --------- 1972 - 1992 8.81 6,176,358 7.1 1993 7.39 7,451,202 8.6 1994 7.82 4,606,852 5.3 1995 8.03 4,632,861 5.3 1996 7.87 6,539,999 7.5 1997 7.81 8,173,685 9.4 1998 7.14 23,171,725 26.7 1999 7.42 % $ 25,976,313 30.0 -------------- --------- Total $ 86,728,995 100.0 % ============== ========= (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 28 of its claim payment. Generally, however, PMI settles by paying the coverage percentage multiplied by the claim amount. In 1999 and 1998, PMI settled 29.3% and 22.1%, respectively, of the primary claims processed for payment on the basis of a prearranged sale. In 1999 and 1998, PMI exercised the option to acquire the property on less than 8.0 and 3.6%, respectively, of the primary claims processed for payment. At December 31, 1999 and 1998, PMI owned $13.0 million and $8.6 million, respectively, 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 76.3% in 1999. 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 an automated claim-for-loss worksheet programs, 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; pmiWEB-CONNECT/SM/ is an enhanced version of pmi-CONNECT and 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. Loss Payment Ratios 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 29 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. 30
Years Percentage of Cumulative Losses Paid Since to Cumulative Premiums Written Policy Issue Policy Issue Year --------------------------------------------------------------------------- 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 --------------------------------------------------------------------------- (in percents) 1 0.4 0.4 0.9 0.3 0.2 - 0.1 - - - 2 11.8 23.3 38.1 14.8 9.8 4.5 1.5 0.4 0.1 0.3 3 39.2 90.4 112.1 47.3 44.0 18.7 5.2 2.0 2.0 3.6 4 74.2 139.3 166.3 83.0 83.1 35.2 8.7 5.1 6.1 10.8 5 95.5 168.3 180.9 129.3 114.3 47.4 12.2 9.7 11.6 21.9 6 100.8 168.0 229.6 165.9 127.1 56.4 15.6 13.1 18.5 32.4 7 90.8 184.8 251.0 177.5 135.9 60.7 18.5 17.5 23.1 40.3 8 98.5 197.3 265.4 184.6 139.3 63.0 21.3 20.7 26.2 45.7 9 107.8 203.6 265.7 187.7 141.9 65.0 24.1 23.0 29.1 49.6 10 111.4 205.6 264.4 189.8 142.6 65.3 25.8 25.1 31.5 51.7 11 113.0 207.1 263.8 191.0 142.9 65.9 27.4 26.5 33.6 52.8 12 114.1 208.8 264.4 191.3 142.6 65.8 28.4 27.8 34.6 13 114.6 208.9 263.3 191.1 142.1 65.8 28.8 28.4 14 115.0 209.8 262.2 190.6 141.7 65.9 29.0 15 115.1 209.5 261.5 190.1 141.5 66.0 16 115.3 209.2 260.8 189.8 141.3 17 115.5 208.9 260.4 189.5 18 115.5 208.5 259.8 19 115.5 208.1 20 115.4 --------------------------------------------------------------------------- 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 --------------------------------------------------------------------------- (in percents) 1 - - - - - 0.1 - - - 0.1 2 0.7 0.8 1.1 1.0 1.0 2.8 2.9 2.3 1.2 3 7.1 6.6 6.9 5.5 6.5 10.4 8.3 5.8 4 17.8 16.9 16.3 13.4 13.7 15.4 11.9 5 31.7 28.9 28.3 18.7 18.0 18.2 6 41.8 39.8 36.1 21.1 20.1 7 50.5 47.4 40.3 21.9 8 56.2 51.3 41.5 9 59.2 52.7 10 60.9
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. For policy years from 1993 through present, cumulative losses have been developing at a favorable rate for the Company due to improving economic conditions. 31 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. 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 IC12.) 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, 32 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 IC12.) 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:
1999 1998 1997 ------------- -------------- ------------ (In thousands) Balance, January 1 $ 215,259 $ 202,387 $ 199,774 Less reinsurance recoverable 6,782 6,067 5,287 ------------- ------------- ----------- Net balance, January 1 208,477 196,320 194,487 ------------- ------------- ----------- Losses and loss adjustment expenses incurred (principally in respect of defaults occurring in) Current year 159,293 146,884 158,147 Prior years (46,611) (11,168) (5,890) ------------- ------------- ----------- Total losses and loss adjustment expenses 112,682 135,716 152,257 ------------- ------------- ----------- Losses and loss adjustment expense payments (principally in respect of defaults occurring in) Current year 1,798 12,503 27,700 Prior years 95,797 111,056 122,724 ------------- ------------- ----------- Total payments 97,595 123,559 150,424 ------------- ------------- ----------- Plus acquisition of Forestview Reserves 42,528 - - Plus acquisition of Pinebrook Reserves 1,093 - - Plus acquisition of PMI Ltd 4,473 - - ------------- ------------- ----------- Net balance, December 31 271,658 208,477 196,320 Plus reinsurance recoverable 10,342 6,782 6,067 Balance, December 31 $ 282,000 $ 215,259 $ 202,387 ============= ============= ===========
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 $46.6 million in 1999 due to the impact of a favorable interest rate environment on loss 33 mitigation activities and to lower than expected claims in California. The provision for losses and loss adjustment expenses decreased by $11.2 million and $5.9 million in 1998 and 1997, respectively, due primarily to lower than expected 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. Effective August 20, 1999, PMI entered into an excess-of-loss reinsurance treaty relating to aggregate stop loss limit pool insurance contracts issued by PMI to the GSEs during 1997 and 1998. The participating reinsurers have claims-paying ratings of AA or AAA from Standard and Poor's. (See Part II, Item 8, Financial Statements Note 7--"Reinsurance.") Reinsurance Subsidiaries; RGC, RIC, and PMG 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, and PMG 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 IC2 and IC8). 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 reinsures the 34 remaining risk though its affiliates, including RGC, PMG and RIC, which was formed and licensed to transact mortgage insurance in 1999. (See "B. Products", above; "O. Regulation" and IC2, IC7, and IC8.) 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 IBCA, 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"). During March 2000, S&P affirmed the AA+ financial strength rating and claims paying ability rating of PMI. During March 1999, Moody's announced that it changed PMI's and TPG's rating outlook from stable to negative, stating such action was based on TPG's stock repurchases, PMI's writing of GSE pool and diversification into new sectors. 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 IC3 and IC5.) M. Investment Portfolio Cash flow from the Company's investment portfolio represented approximately 35% of its total cash flow from operations during 1999, and pre-tax income from the investment portfolio represented 33% of the Company's total pre-tax operating income. 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, 1999, based on market value, approximately 96% of the Company's total investment portfolio was invested in securities rated "A" or better, with 64% rated "AAA" and 22% rated "AA," in each case by at least one nationally recognized securities rating organization. 35 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. At December 31, 1999, approximately 94% of the Company's investment portfolio was managed internally. At December 31, 1999, the consolidated market value of the Company's investment portfolio was approximately $1.8 billion. At December 31, 1999, municipal securities represented 81.4% of the market value of the total investment portfolio. Securities due in less than one year, within one to five years, within five to ten years; after ten years, and other represented 0.9%, 10.2%, 13.8%, 72.1%, and 3.0%, respectively, of such total market value. The Company's net pre-tax investment income (excluding capital gains) was $95.1 million for the year ended December 31, 1999, which represented a pre-tax yield of 5.9% for the year, a decline from 6.06% for 1998. This decrease was the result of a decline in the average interest rate on investments in 1999 as compared to 1998. Net realized capital gains on the investment portfolio were $509 thousand and $24.6 million for 1999 and 1998, respectively. (See Part II, Item 8, Financial Statements Note 3--"Investments.") N. Other Businesses In March 1999, TPG announced a plan to diversify its revenue sources through strategic investments and the development of international mortgage insurance operations. During the first quarter of 1999, PMI commenced operations in Hong Kong. In August 1999, PMI completed the acquisition of MGICA Ltd., an Australian mortgage guaranty insurer, and subsequently renamed the company PMI Mortgage Insurance Ltd. ("PMI Ltd."). TPG also increased its financial investment in RAM Re by approximately $15 million. In addition, the company provides title insurance. Total revenues recognized for the year ended December 31, 1999 from TPG's businesses other than U. S. mortgage guaranty insurance constituted approximately 21.5% of the Company's consolidated revenues, compared with approximately 17.4% and 13.8%, in 1998 and 1997, respectively. PMI Ltd. On August 6, 1999 the Company acquired PMI Ltd. for approximately $78.0 million. PMI Ltd. is the second largest mortgage guaranty insurer in Australia and New Zealand as measured by annual insurance written. Substantially all of PMI Ltd.'s new insurance written and insurance in force consists of single premium payment policies. PMI Ltd. is regulated in Australia by the Australian Prudential Regulatory Authority. For the year ended December 31, 1999, PMI Ltd.'s NIW totaled $4.5 billion and insurance in force was $19.2 billion. PMI Ltd's reserves were $3.7 million. Australian mortgage guaranty insurance generally provides 100% insurance coverage. PMI Ltd. contributed $6.7 million of net income for the period August 6, 1999 through December 31, 1999. 36 Hong Kong During 1999, PMI opened an office in Hong Kong and began to reinsure residential mortgages in Hong Kong. PMI entered into an agreement with the Hong Kong mortgage corporation ("HKMC"), a public sector entity created to add liquidity to the Hong Kong residential mortgage market. HKMC is the direct insurer of residential mortgages with LTVs of up to 85%, with PMI providing reinsurance coverage on amounts over 70% LTV. For the year ended 1999, PMI reinsured $189 million of loans. RAM Re TPG is 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 the first quarter of 1998. Three executives of the Company serve as directors of Ram Re. American Pioneer Title Insurance Co. 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 41 states and the District of Columbia. Although APTIC is currently writing business in 33 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 1999, APTIC is ranked 5th among the 28 active title insurers conducting business in the State of Florida. For the year ended December 31, 1999, 72.9% 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 95.2% and 93.8% of APTIC's premiums earned for the years ended December 31, 1999 and 1998, respectively. PMI Mortgage Services Co. MSC provides a variety of technical products and mortgage underwriting services through a staff of underwriters in 30 field offices. The Customer Technology Division of MSC provides technical products and services to PMI's customers. This department licenses the use of 37 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 customers. Contract underwriting on-site is generally more expensive for the Company than underwriting a loan in- house, and is a popular method among mortgage lenders for processing loan applications. Contract underwriting processed loans represented 28.8% of PMI's NIW for the year ended December 31, 1999 compared to 35.0% for the year ended December 31, 1998 (See H. Underwriting Practices, above). 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 non-insurance 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. 38 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. TPG is an insurance holding company under the laws of the State of Arizona based on its affiliation with PMI, PMG, RGC, RIC, RAM Re and PMI Ltd. 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 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 non-management 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 39 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, 1999, PMI had statutory policyholders' surplus of $134.1 million and statutory contingency reserve of $1.24 billion. (See Part II, Item 8, Financial Statements Note 14--"Statutory Accounting.") Dividends. PMI's ability to pay dividends is limited, among other things, by 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 $13.4 million in 2000 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. 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 40 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 entire indebtedness to the insured. Coverage in excess of 25% 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"), effective 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 41 notification laws include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New York, Texas and Washington. 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 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, RESPA, the Community Reinvestment Act, and the Fair Housing Act. Fannie Mae and Freddie Mac are also subject to RESPA and 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. Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the "Act") became effective on March 11, 2000 and allows, among other things, bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, and allows insurers and other financial service companies to acquire banks. The Act allows a bank holding company to form an insurance subsidiary, licensed under state insurance law, to issue insurance products directly, including mortgage insurance. However, any such mortgage insurance subsidiary would be subject to and governed by state insurance regulations, including capital and reserve requirements, diversification of risk and restrictions on the payments of dividends. Because of the many aspects of the Act which require clarification and promulgation of specific regulations, the Company is not yet able to ascertain the full impact of the Act on the Company (See IC15). 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 42 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 IC3.) Fannie Mae and Freddie Mac announced an increase in the maximum single-family principal balance loan limit eligible for their purchase from $240,000 to $252,700 effective in 2000. 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% 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 have mortgage insurance coverage. Similarly, a 90% LTV loan will require 12 % of the mortgage loan have mortgage insurance. In order for the homebuyer to have MI at these levels, such loans would require a payment at closing or a higher note rate. 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. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 directed the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop risk-based capital regulations for the GSEs. Based on the initial regulations published in April 1999, the GSEs will be subjected to a risk-based capital stress test that will determine the amount of capital that a GSE must hold to maintain positive capital throughout a 10-year period of severe economic conditions. The proposed regulations could increase that amount of capital the GSEs are presently required to maintain for certain loans with loan-to-value ratios ("LTV") of 95 percent or higher. Because of the numerous aspects of the OFHEO proposal which require clarification and which are likely to be revised before being declared effective, it is considered extremely unlikely that OFHEO will be able to finalize a rule before 2001. 43 National Association of Insurance Commissioners (NAIC). 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, 1999, TPG, including its subsidiaries had 1,029 full and part- time employees; 734 persons perform services primarily for PMI, 17 perform services primarily for CMG and an additional 278 persons are employed by APTIC. TPG's employees are not unionized and TPG considers its employee relations to be good. In addition, MSC had 345 temporary workers and contract underwriters at December 31, 1999. Q. CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS GENERAL ECONOMIC CONDITIONS (IC1) Changes in economic conditions, including economic recessions, declining housing values, higher unemployment rates, deteriorating borrower credit, rising interest rates, increases in refinance activity caused by declining interest rates, or combinations of these factors could reduce the demand for mortgage insurance, cause claims on policies issued by PMI to increase, and increase PMI's loss experience. MARKET SHARE AND COMPETITION (IC2) The Company's financial condition and results of operations could be harmed 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 mortgage insurance industry is highly competitive. Several of the Company's competitors in the mortgage insurance industry have greater direct or indirect capital reserves that provide them with potentially greater flexibility than the Company. PMI also competes directly with federal and state governmental and quasi- governmental agencies, principally the FHA and, to a lesser degree, the VA. In addition, the captive reinsurance subsidiaries of national banks, savings institutions, or bank holding companies could become significant competitors of the Company in the future. Other mortgage lenders are also forming reinsurance affiliates that compete with the Company. The Gramm-Leach-Bliley Act of 1999 could lead to additional significant competitors of the Company in the future. On October 4 1999, the Federal Housing Finance Board adopted resolutions which authorizes each Federal Home Loan Bank ("FHLB") to offer programs to fund or purchase single-family conforming mortgage loans originated by participating member institutions under the single-family member mortgage assets program program. Under this program, each FHLB is also authorized to provide credit enhancement for eligible loans. Any expansion of the FHLBs' ability to issue mortgage insurance or use alternatives to mortgage insurance could reduce the demand for private mortgage insurance and harm the Company's financial condition 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, as well as similar products, competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. If the 80/10/10 product or a similar product becomes a widely accepted alternative to mortgage insurance, the Company's financial condition and results of operations could suffer. Legislation and regulatory changes affecting the FHA have affected demand for private mortgage insurance. In particular, increases in the maximum loan amount that the FHA can insure can reduce the demand for private mortgage insurance. For example, management believes the decline in the MICA members' share of the mortgage insurance business from 56.3% at December 31, 1998 to approximately 52.4% at December 31, 1999 resulted in part from the increase in the maximum individual loan amount the FHA can insure. The Department of Housing and Urban Development has announced a proposed increase in the maximum individual loan amount that FHA can insure to $219,849 from $208,800. If this increase is approved, demand for private mortgage insurance could decrease. In addition, the Omnibus Spending Bill of 1999, signed into law on October 21, 1998, streamlined the FHA down-payment formula and made FHA insurance more competitive with private mortgage insurance in areas with higher home prices. FANNIE MAE AND FREDDIE MAC (IC3) Fannie Mae and Freddie Mac are collectively referred to as government-sponsored enterprises ("GSEs"). The GSEs are permitted by charter 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, provided the minimum insurance coverage requirement is met. During 1999, Fannie Mae and Freddie Mac separately announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSEs' automated underwriting services. Although management has not seen any significant movement towards the reduced coverage programs offered by the GSEs' to date, if the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, the reduction could harm the Company's financial condition and results of operations. On April 13, 1999 the Office of Federal Housing Enterprise Oversight announced proposed risk-based capital regulations, which could treat more favorably credit enhancements issued by private mortgage insurance companies with a claims-paying ability rating of AAA or higher compared with those companies with an AA or lower rating. Any shifts in the GSE's preferences for private mortgage insurance to other forms of credit enhancement, including a tiering of mortgage insurers based on their credit rating, could harm the Company's financial condition and results of operations. Freddie Mac has made several announcements that it would pursue a permanent charter amendment that would allow it to utilize alternative forms of default loss protection 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 approaches, which may include a reduction in the use of mortgage insurance. 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. A loss of PMI's existing eligibility status, either due to a failure to maintain the 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. INSURANCE IN FORCE (IC4) A significant percentage of PMI's premiums earned is generated from its existing insurance in force and not from new insurance written. The policy owner or servicer of the loan may cancel insurance coverage at any time. A decline in insurance in force as a result of a decrease in persistency due to policy cancellations of older books of business could harm the Company's financial condition and results of operations. The Home Owners Protection Act of 1998, 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. Management is uncertain about the impact of this 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 operations. During an environment of falling interest rates, an increasing number of borrowers refinance their mortgage loans and PMI generally experiences 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 RATING AGENCIES (IC5) 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. On March 10, 2000, Standard & Poor's affirmed the AA+ financial strength rating and claims-paying ability rating of PMI. During June 1999, Moody's affirmed the Aa2 financial strength rating and claims-paying ability rating of PMI. During March 1999, Moody's announced that it changed PMI's and TPG's rating outlook from stable to negative, stating such action was based on TPG's stock repurchases, PMI's writing of GSE pool and diversification into new sectors. A reduction in PMI's claims-paying ratings below AA-would seriously harm effect the Company's financial condition and results of operations (See IC3). LIQUIDITY (IC6) 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 level and severity of claims experienced by the Company's insurance subsidiaries, 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 these factors could adversely affect the Company's ability to maintain capital resources to meet its business needs. CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS (IC7) 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. The Company also generally agrees to assume the cost of repurchasing underwritten-deficient loans that have been contract underwritten, a remedy not available under the Company's master primary insurance policies. Due to the demand of contract underwriting services, limitations on the number of available underwriting personnel, 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 its underwriting services obligations, could harm 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 suffer if PMI or the Company experiences delays in introducing competitive new products and programs or if these products or programs are less profitable than the Company's existing products and programs. INSURANCE REGULATORY MATTERS (IC8) On January 31, 2000, the Illinois Department of Insurance issued a letter addressed to all mortgage guaranty insurers licensed in Illinois. The letter states that it may be a violation of Illinois law for mortgage insurers to offer to Illinois mortgage lenders the opportunity to purchase certain notes issued by a mortgage insurer or an affiliate, or to participate in loan guaranty programs. The letter also states that a violation might occur if mortgage insurers offer lenders coverage on pools of mortgage loans at a discounted or below market premium in return for the lenders' referral of primary mortgage insurance business. In addition, the letter stated that, to the extent a performance guaranty actually transfers risk to the lender in return for a fee, the lender may be deemed to be doing an insurance business in Illinois without authorization. The letter announced that any mortgage guaranty insurer that is participating in the described or similar programs in the State of Illinois should cease such participation or alternatively, provide the Department with a description of any similar programs, giving the reason why the provisions of Illinois are not applicable or not violated. PMI is reviewing the Illinois Letter. If the Illinois Department of Insurance were to determine that PMI was not in compliance with Illinois law, the Company's financial condition and results of operations could be harmed 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, the Company's financial condition and results of operations could suffer. RISK-TO-CAPITAL RATIO (IC9) The State of Arizona, PMI's state of domicile for insurance regulatory purposes, and other regulators specifically limit the amount of insurance risk that may be written by PMI, by a variety of financial factors. For example, Arizona law provides that if a mortgage guaranty insurer domiciled in Arizona does not have the amount of minimum policyholders position required, it must cease transacting new business until its minimum policyholders position meets the requirements. Under Arizona law, minimum policyholders position is calculated based on the face amount of the mortgage, the percentage coverage or claim settlement option and the loan to value ratio category, net of reinsurance ceded, but including reinsurance assumed. Other factors affecting PMI's risk-to-capital ratio include: (i) 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; (ii) TPG's credit agreements and the terms of its guaranty of the debt incurred to purchase PMI LTD; and (iii) 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 harm the Company's financial condition and results of operations. CHANGES IN COMPOSITION OF INSURANCE WRITTEN; POOL INSURANCE (IC10) 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, 1999, 46.7% 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, 1999, 4.9% of PMI's risk in force consisted of 97s that 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, which is generally used as an additional credit enhancement for certain secondary market mortgage transactions. New pool risk written was $231 million for the year ended December 31, 1999 and $450 million for the year ended December 31, 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 these products, and the associated investment income, may ultimately prove to be inadequate to compensate for future losses from these products. POTENTIAL INCREASE IN CLAIMS (IC11) Mortgage insurance coverage and premiums 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. LOSS RESERVES (IC12) 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 AND INTERNATIONAL RISKS (IC13) 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 15.6%, 7.5% and 7.3% of its risk in force concentrated and where the default rate on all PMI policies in force is 2.6%, 3.0% and 2.1% compared with 2.1% nationwide as of December 31, 1999. As the Company seeks to expand its business internationally, it will increasingly be subject to risks associated with international operations, including the need for regulatory and third party approvals, challenges retaining key foreign-based employees and maintaining key relationships with customers and business partners in international markets, the economic strength of the mortgage origination markets in targeted foreign markets, including Australia, New Zealand, and Hong Kong, changes in foreign regulations and laws, foreign currency exchange and translation issues, potential increases in the level of defaults and claims on policies insured by foreign-based subsidiaries, and the need to integrate PMI's risk management technology systems and products with those of its foreign operations. CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC14) PMI's customers have indicated an increasing demand for captive reinsurance arrangements, which allow a reinsurance company, generally an affiliate of the lender, to assume a portion of the mortgage insurance default risk in exchange for a portion of the insurance premiums. An increasing percentage of PMI's NIW is being generated by customers with captive reinsurance companies, and management expects that this trend will continue. An increase in captive reinsurance arrangements would decrease in net premiums written which may negatively impact the yield obtained in the Company's net premiums earned for customers with captive reinsurance arrangements. The inability of the Company to provide its customers with acceptable risk-sharing structured transactions, including potentially increasing levels of premium cessions in captive reinsurance arrangements, would likely harm PMI's competitive position. GRAMM-LEACH-BLILEY ACT (IC15) On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of 1999 (the "Act") into law. Among other things, the Act allows bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, and allows insurers and other financial service companies to acquire banks. The Act allows a bank holding company to form an insurance subsidiary, licensed under state insurance law, to issue insurance products directly, including mortgage insurance. The Company expects that, over time, the Act will allow consumers the ability to shop for their insurance, banking and investment needs at one financial services company. The Company believes that the Act may lead to increased competition in the mortgage insurance industry by facilitating the development of new savings and investment products, resulting in the Company's customers offering mortgage insurance directly rather than through captive reinsurance arrangements with the Company's insurance subsidiaries and encouraging large, well-capitalized financial service companies to enter the mortgage insurance business. Item 2. Properties TPG leases its home office in San Francisco, California, which consists of approximately 100,000 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 18,000 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 On December 17, 1999, G. Craig Baynham and Linnie Baynham (collectively, the "Plaintiffs") filed a putative class action suit against PMI Mortgage Insurance Co. ("PMI"). The complaint, 44 captioned G. Craig Baynham and Linnie Baynham v. PMI Mortgage Insurance Co., (case no. CV199-241), was filed in the United States District Court For The Southern District of Georgia, State of Georgia and alleges that PMI entered into agreements or understandings with mortgage lenders that PMI would provide pool insurance or other benefits to the lenders at preferential, below market rates, in return for the lenders' designation of PMI as the mortgage insurer for mortgages originated by the lenders. Based on the alleged conduct, Plaintiffs assert a cause of action on behalf of the proposed class of mortgage insurees against PMI for violation of section 8 of the Real Estate Settlement Procedures Act ("RESPA") 12 U.S.C. (S)2607(a). Plaintiffs seek relief under RESPA's treble damage provision, along with injunctive relief and attorneys' fees and expenses. The complaint also seeks to certify a class of persons who, on or after January 1, 1996 obtained or obtain federally related mortgage loans for single-to four family homes, whose loans include primary mortgage insurance, reinsurance contracts, contract underwriting services, or financing agreements from PMI. The Company understands that several other mortgage insurance companies have been named as defendants in lawsuits with similar allegations recently filed in the same federal court as the case pending against PMI. The Company intends to contest this action vigorously, and based on information presently available to the Company, management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial position or results of operations. Various other 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 1999 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, 1999, including age as of March 31, 2000, and business experience for at least the past five years. W. ROGER HAUGHTON, 52, 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, Underwriting and Actuarial Services 45 departments. Mr. Haughton has a long history of active volunteerism with various affordable housing organizations, including Habitat for Humanity, and serves as chairman of 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, 50, 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. CLAUDE J. SEAMAN, 53, 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., 55, 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, 45, 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. VICTOR J. BACIGALUPI, 56, has been Executive Vice President, General Counsel and Secretary of TPG and PMI since August 1999. Prior thereto he was 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 Executive Vice President, Chief Information Officer of TPG and PMI since March 1, 2000. Prior thereto he was 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. 46 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 PMI. As of December 31, 1999 there were 44,702,080 shares issued and outstanding. As of February 29, 2000 there were 44,324,697 shares issued and outstanding held by approximately 45 stockholders of record and approximately 4,100 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, 1999 and 1998:
1999 1998 -------------------------------------- ------------------------------------- High Low Close High Low Close ---------- ------------- ---------- ---------- ----------- ------------ First quarter 35 7/8 26 43/64 30 59/64 55 59/64 42 1/2 53 53/64 Second quarter 42 3/8 28 11/64 41 7/8 57 45 5/8 48 63/64 Third quarter 47 5/64 39 13/16 40 7/8 50 11/64 27 43/64 30 1/2 Fourth quarter 55 1/2 40 7/8 48 13/16 39 59/64 22 32 59/64
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 47 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 Agreement. (See Part I. "O. Regulation" and Part II, Item 8, Financial Statement Note 14--"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 second quarter of 1999. In connection with the Company's 3-for-2 stock split on August 16, 1999, the quarterly dividend was adjusted and increased to $0.04 per share for the third and fourth quarters of 1999. Item 6. Selected Financial Data The information required by this Item is incorporated by reference from portions of The PMI Group, Inc. 1999 Annual Report to Stockholders under the heading "Eleven 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. 1999 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, 1999, the average duration of the Company's fixed income investment portfolio was 5.3 years, and the Company did not have a significant amount of 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. 1999 Annual Report to Stockholders as part of Exhibit 13.1. 48 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Effective February 17, 2000, the Company's Board of Directors approved the engagement of Ernst & Young LLP as the Company's independent auditors for the fiscal year ending December 31, 2000, subject to the ratification of the Company's stockholders. 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 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. 49 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 December 29, 1999, TPG filed a report on Form 8-K to announce that it issued a press release advising that its mortgage insurance subsidiary, PMI Mortgage Insurance Co. ("PMI") had been named as a defendant in a purported class action lawsuit filed in the United States District Court for the Southern Division of Georgia, Augusta Division, captioned G. Craig Baynham and Linnie Baynham v. PMI Mortgage Insurance Company (Case # CV199-241).; and (ii) On February 23, 2000, TPG filed a report on Form 8-K to announce that on February 17, 2000, its Board of Directors approved the engagement of Ernst & Young LLP as its independent auditors for the fiscal year ending December 31, 2000 to replace the firm of Deloitte & Touche LLP. There were no "reportable events" as that term is described in Item 304(a)(1)(v) of Regulation S-K. 50 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, 1999, 1998 and 1997 N/A 30 Consolidated Balance Sheets as of December 31, 1999 and 1998 N/A 31 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997 N/A 32 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 N/A 33 Notes to Consolidated Financial Statements N/A 34-53 Report of Independent Auditors N/A 56 Financial Statement Schedules ----------------------------- Report of Independent Auditors on Financial Statement 54 N/A Schedules as of and for the specified years in the three-year period ended December 31, 1999: Schedule I-Summary of investments other than in related 55 N/A parties Schedule II-Condensed financial information of Registrant 56-59 N/A Schedule III-Supplementary insurance information 60 N/A Schedule IV-reinsurance 61 N/A
51 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 28th day of March, 2000. 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 28, 2000 by the following persons on behalf of the registrant and in the capacities indicated.
/s/ W. Roger Haughton Chairman of the Board and - --------------------- Chief Executive Officer March 28, 2000 W. Roger Haughton /s/ John M. Lorenzen, Jr. Executive Vice President, March 28, 2000 - ------------------------- Chief Financial Officer, John M. Lorenzen, Jr. and Assistant Secretary (Principal Financial Officer) /s/ William A. Seymore Vice President, Controller March 28, 2000 - ---------------------- (Controller and Principal William A. Seymore Accounting Officer) /s/ James C. Castle Director March 28, 2000 - ------------------- Dr. James C. Castle Director March __, 2000 - ------------------- Donald C. Clark /s/ Wayne E. Hedien Director March 28, 2000 - ------------------- Wayne E. Hedien /s/ Raymond L. Ocampo Jr. Director March 28, 2000 - ------------------------- Raymond L. Ocampo Jr. /s/ John D. Roach Director March 28, 2000 - ----------------- John D. Roach /s/ Kenneth T. Rosen Director March 28, 2000 - -------------------- Dr. Kenneth T. Rosen /s/ Richard L. Thomas Director March 28, 2000 - --------------------- Richard L. Thomas
52
/s/ Mary Lee Widener Director March 28, 2000 - -------------------- Mary Lee Widener /s/ Ronald H. Zech Director March 28, 2000 - ------------------ Ronald H. Zech
53 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, 1999 and 1998, and for each of the three years in the period ended December 31, 1999, and have issued our report thereon dated January 20, 2000; such consolidated financial statements and report are included in your 1999 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, 2000 54 THE PMI GROUP, INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1999
Amount at which Type of Investment Amortized Market Shown in the ------------------ Cost Value Balance Sheet ---------------- --------------- --------------- (In thousands) Fixed maturities: Bonds: United States government and government agencies and authorities $ 87,223 $ 84,047 $ 84,047 States, municipalities and political subdivisions 1,260,409 1,261,308 1,261,308 All other corporate 137,764 133,955 133,955 ---------------- --------------- --------------- Total fixed maturities 1,485,396 $ 1,479,310 1,479,310 ---------------- =============== --------------- Equity securities: Common stocks: Banks, trust and insurance companies 3,189 $ 4,483 4,483 Industrial, miscellaneous and all other 41,525 79,407 79,407 Non-redeemable preferred stocks 17,660 17,582 17,582 ---------------- --------------- --------------- Total equity securities 62,374 $ 101,472 101,472 ---------------- =============== --------------- Short-term investments 145,087 145,093 ---------------- --------------- Total investments, other than related party $ 1,692,857 $ 1,725,875 ================ ===============
55 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS PARENT COMPANY ONLY December 31, 1999 and 1998
1999 1998 ------------- ------------- (Dollars in thousands) ASSETS ------ Investment portfolio, available for sale, at market value: Fixed income securities (cost - $32,745 and $50,578) $ 31,696 $ 51,904 Short-term investments 60,973 3,722 Common Stock of affiliate, at underlying book value 36,746 20,471 ------------- ------------- Total investments 129,415 76,097 ------------- ------------- Cash 407 473 Investment in subsidiaries, at equity in net assets 1,279,336 1,217,738 Other assets 14,685 12,491 ------------- ------------- Total assets $ 1,423,843 $ 1,306,799 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Liabilities: Long-term debt $ 99,542 $ 99,476 Accounts payable - affiliates 1,630 1,678 Other liabilities 3,235 5,997 ------------- ------------- Total liabilities 104,407 107,151 ------------- ------------- Commitments and contingent liabilities (Note A) - - Junior subordinated deferrable interest debenture held solely by subsidiary trust 102,168 102,133 Shareholders' equity: Preferred stock-$.01 par value; 5,000,000 shares authorized - - Common stock -- $.01 par value; 125,000,000 shares authorized, 52,793,777 and 35,196,002 shares issued 528 352 Additional paid-in capital 265,828 265,040 Accumulated other comprehensive income 20,186 74,462 Retained earnings 1,258,617 1,060,724 ------------- ------------- 1,545,159 1,400,578 Less treasury stock (8,091,924 and 4,917,401 shares at cost) 327,891 303,063 ------------- ------------- Total shareholders' equity 1,217,268 1,097,515 ------------- ------------- Total liabilities and shareholders' equity $ 1,423,843 $ 1,306,799 ============= =============
See accompanying supplementary notes to Parent company condensed financial statements. 56 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS PARENT COMPANY ONLY December 31, 1999, 1998 and 1997
1999 1998 1997 -------------- -------------- -------------- (In thousands) Revenue: Equity in undistributed net income of subsidiaries $ 112,029 $ 90,696 $ 101,488 Subsidiary dividends 97,339 103,200 78,863 Investment income, net 8,913 9,600 8,990 Capital gains (losses), net 329 1,045 (2,405) -------------- -------------- -------------- Total revenue 218,610 204,541 186,936 -------------- -------------- -------------- Expenses: Operating expenses 6,456 722 642 Interest expense 15,810 15,592 14,618 -------------- -------------- -------------- Total expenses 22,266 16,314 15,260 -------------- -------------- -------------- Income before tax 196,344 188,227 171,676 Income tax expense (benefit) (8,122) (2,133) (3,633) -------------- -------------- -------------- Net income $ 204,466 $ 190,360 $ 175,309 ============== ============== ==============
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME PARENT COMPANY ONLY Years Ended December 31, 1999, 1998 and 1997 (in thousands)
1999 1998 1997 -------------- -------------- -------------- Net income $ 204,466 $ 190,360 $ 175,309 ------------ ------------ ----------- Other comprehensive income net of tax: Unrealized gain on investments: Unrealized holding gains (losses) arising during period (54,062) 3,205 19,664 Less: reclassification adjustment for (gains) losses included in net income (214) (679) 1,563 ------------ ------------ ----------- Other comprehensive income (loss), net of tax (54,276) 2,526 21,227 ------------ ------------ ----------- Comprehensive income $ 150,190 $ 192,886 $ 196,536 ============ ============ ===========
See accompanying supplementary notes to Parent company condensed financial statements. 57 THE PMI GROUP, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STAEMENTS OF CASH FLOWS PARENT COMPANY ONLY December 31, 1999, 1998 and 1997
1999 1998 1997 --------------- ---------------- --------------- (In thousands) Cash flows from operating activities: Net income $ 204,466 $ 190,360 $ 175,309 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization 278 1,063 848 Equity in net income of subsidiaries (209,368) (193,896) (180,351) Capital (gains) losses, net (329) (1,045) 2,405 Increase (decrease) in payable to affiliates (48) 565 (4,246) Other (7,435) 2,282 (10,437) ------------- ------------- ------------ Net cash provided by (used in) operating activities (12,436) (671) (16,472) ------------- ------------- ------------ Cash flows from investing activities: Dividends from subsidiaries 97,339 103,200 78,863 Investment in affiliates (16,878) (24,173) (13,093) Purchases of fixed income securities (3,887) (1,000) (92,350) Investment collections of fixed income securities - 6,271 5,000 Proceeds from sales of fixed income securities 22,110 40,522 46,667 Proceeds from sales of equity securities - 93 - Net (increase) decrease in short-term investments (57,251) 32,455 13,200 ------------- ------------- ------------ Net cash provided by (used in) investing activities 41,433 157,368 38,287 ------------- ------------- ------------ Cash flows from financing activities: Issuance of junior subordinated debentures - - 102,093 Dividends paid to shareholders (5,199) (6,333) (6,733) Proceeds from exercise of stock options 964 2,592 3,181 Purchase of The PMI Group, Inc. common stock (24,828) (152,920) (120,002) ------------- ------------- ------------ Net cash provided by (used in) financing activities (29,063) (156,661) (21,461) ------------- ------------- ------------ Net increase (decrease) in cash (66) 36 354 Cash at beginning of year 473 437 83 ------------- ------------- ------------ Cash at end of year $ 407 $ 473 $ 437 ============= ============= ============
See accompanying supplementary notes to Parent company condensed financial statements. 58 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 9, 11 and 12 related to long-term obligations, commitments and contingent liabilities and the junior subordinated debenture) appearing on pages 40-42 of The PMI Group, Inc. 1999 Annual Report to Shareholders. Note B During 1999, 1998 and 1997, TPG received $97.3 million, $103.2 million, and $78.9 million, respectively, of ordinary and extraordinary cash dividends from subsidiaries. 59 THE PMI GROUP, INC. SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION As of and for the Years Ended December 31, 1999, 1998 and 1997
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) 1999 MI (1) $ 67,281 $ 269,931 $ 102,022 $ 447,214 $ 80,922 $ 110,465 $ 80,252 $ 54,017 $ 459,065 Inter- national (2) 2,298 3,714 80,067 11,291 3,673 1,213 - 4,472 12,071 Title - 8,355 - 100,118 1,634 1,004 - 88,244 100,118 Other (3) - - - - 8,913 - - 23,506 - ----------- ----------- ----------- ----------- ---------- ------------ ----------- ----------- ------------ Total $ 69,579 $ 282,000 $ 182,089 $ 558,623 $ 95,142 $ 112,682 $ 80,252 $ 170,239 $ 571,254 =========== =========== =========== =========== ========== ============ =========== =========== ============ 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 (3) - - - - 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 (3) - - - - 8,872 - - 17,708 - ----------- ----------- ----------- ----------- ---------- ------------ ----------- ----------- ------------ Total $ 37,864 $ 202,387 $ 94,150 $ 453,948 $ 83,136 $ 152,257 $ 43,395 $ 111,745 $ 432,052 =========== =========== =========== =========== ========== ============ =========== =========== ============
(1) Represents Domestic Mortgage Insurance Operations (2) Represents International Mortgage Insurance Operations (3) Represents ancillary services and parent company investment income. The 1997 amounts have been restated to conform to the SFAS 131 presentation of segments. 60 THE PMI GROUP, INC. AND SUBSIDIARIES SCHEDULE IV - REINSURANCE Years Ended December 31, 1999, 1998 and 1997
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) 1999 Consolidated Mortgage Guaranty $ 474,096 $ 22,034 $ 6,443 $ 458,505 1.4% Title 100,355 239 2 100,118 0.0% ------------ ----------- ----------- ----------- ------- Total $ 574,451 $ 22,273 $ 6,445 $ 558,623 1.2% ============ =========== =========== =========== ======= 1998 Consolidated 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 Consolidated 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% ============ =========== =========== =========== =======
61 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. 4.5(j) Credit Agreement, dated as of August 3, 1999 by and among PMI Mortgage Insurance Australia (Holdings) Pty Limited, The PMI Group, Inc., and Bank of America, N.A. The Company agrees to furnish to the Securities and Exchange Commission, upon request, copies of all instruments defining the rights of holders of long-term debt of the Company where the total amount of securities authorized under each issue does not exceed ten percent of the Company's total assets. 4.6(j) Credit Agreement, dated as of February 1, 1996, between The PMI Group, Inc., and The Chase Manhattan Bank, as amended. The Company agrees to furnish to the Securities and Exchange Commission, upon request, copies of all instruments defining the rights of holders of long-term debt of the Company where the total amount of securities authorized under each issue does not exceed ten percent of the Company's total assets. 4.7(j) Credit Agreement, dated as of February 13, 1996, between The PMI Group, Inc., and Bank of America National Trust and Savings Association, as amended. The Company agrees to furnish to the Securities and Exchange Commission, upon request, copies of all instruments defining the rights of holders of long-term debt of the Company where the total amount of securities authorized under each issue does not exceed ten percent of the Company's total assets. 10.1(i) * PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of February 18, 1999 10.2* The PMI Group, Inc. Equity Incentive Plan. (Restated as of August 16, 1999) 10.3* The PMI Group, Inc. Stock Plan for Non-Employee Directors. (restated as of August 16, 1999). 10.4(k) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended & restated as of July 21, 1999). 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.
62 10.8(b) Runoff Support Agreement dated October 28, 1994 between Allstate Insurance Company, the Registrant and PMI Mortgage Insurance Co. 10.9(b) Form of Tax Sharing Agreement among the Registrant, the Registrant's subsidiaries, The Allstate Corporation, Allstate Insurance Company and Sears, Roebuck and Co. 10.10(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty effective January 1, 1991 issued to PMI Mortgage Insurance Co. by Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover"). 10.11(a) First Amendment to Mortgage Insurance Variable Quota Share Reinsurance Treaty made as of January 1, 1992 between Hannover and PMI Mortgage Insurance Co. 10.12(j) Supplemental Employee Retirement Plan (amended and restated as of May 20, 1999). 10.13(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 10.14(a) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.15(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January 1, 1994 issued to PMI Mortgage Insurance Co. by Hannover. 10.16 The PMI Group, Inc. Retirement Plan (amended and restated as of February 17, 2000). 10.17(j) The PMI Group, Inc., Additional Benefit Plan dated as of February 18, 1999 10.18(e) The Guarantee Agreement, dated February 4, 1997 between The PMI Group, Inc. (As Guarantor) and The Bank of New York (As Trustee). 10.19(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. 10.20* The PMI Group, Inc., Employee Stock Purchase Plan (restated as of August 16, 1999) 10.21(e) Form of Change of Control Employment Agreement 10.22(k) The PMI Group, Inc., Officer Deferred Compensation Plan. (amended and restated as of September 16, 1999) 10.23 Excess of Loss Reinsurance Treaty effective August 20, 1999 issued by PMI Mortgage Insurance Co. to reinsurers. The Company agrees to furnish to the Securities and Exchange Commission, upon request, copies of all agreements defining the rights of reinsurers of pool insurance contracts where the total amount of premiums paid does not exceed ten percent of the Company's total assets. 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 1999 Annual Report to Shareholders. 21.1 Subsidiaries of the Registrant.
63 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"). (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. (i) Previously filed with Form 10-K, filed with the SEC on March 30, 1999. (j) Previously filed with Form 10-Q, filed with the SEC on August 16, 1999. (k) Previously filed with the Company's Form S-8 Registration Statement (No. 333-32190) which became effective on March 10, 2000. * Compensatory or benefit plan in which certain executive officers or Directors of The PMI Group, Inc., or its subsidiaries are eligible to participate. 64 EX-10.2 2 THE PMI GROUP, INC. EQUITY INCENTIVE PLAN THE PMI GROUP, INC. EQUITY INCENTIVE PLAN (August 16, 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 SECTION 3 ADMINISTRATION................................................ 6
-i- TABLE OF CONTENTS (continued)
Page 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................................................. 8 5.1 Grant of Options.................................................. 8 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........................................................... 10 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................................ 11 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........................................... 12 SECTION 6 RESTRICTED STOCK.............................................. 12 6.1 Grant of Restricted Stock......................................... 12 6.2 Restricted Stock Agreement........................................ 12 6.3 Transferability................................................... 12 6.4 Other Restrictions................................................ 12
-ii- TABLE OF CONTENTS (continued)
Page 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............... 15 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................................................. 16 8.1 No Effect on Employment or Service................................ 16 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.............................................. 18 SECTION 10 LEGAL CONSTRUCTION............................................ 18 10.1 Gender and Number................................................. 18 10.2 Severability...................................................... 18 10.3 Requirements of Law............................................... 18 10.4 Governing Law..................................................... 18 10.5 Captions.......................................................... 18
-iii- THE PMI GROUP, INC. EQUITY INCENTIVE PLAN (August 16, 1999 Restatement) SECTION 1 BACKGROUND, PURPOSE AND DURATION 1.1 Effective Date. The PMI Group, Inc. having established the Plan, -------------- hereby amends and restates the Plan on the occasion of the Company's 3-for-2 stock split, effective as of August 16, 1999. Except for changes relating to the stock split, 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 2.9. 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 who were the beneficial owners, respectively, of the Outstanding Company Common Stock and 2 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 2.9, 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. 2.9 "Company" means The PMI Group, Inc., a Delaware corporation, or ------- any successor thereto. 3 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. 2.21 "Nonqualified Stock Option" means an option to purchase Shares ------------------------- which is not intended to be an Incentive Stock Option. 4 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." 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. 5 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 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. Except 6 as provided in Section 4.3, after an Award has been granted, the Committee shall not reduce the Exercise Price of the Award (or cancel the Award and grant a substitute Award having a lower Exercise Price). 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 4,350,000. Notwithstanding the preceding, the aggregate number of Shares subject to Awards of Restricted Stock granted under the Plan shall not exceed 135,000 and the aggregate number of Shares subject to Awards of Performance Units and Performance Shares granted under the Plan shall not exceed 135,000. 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 and class of Shares which may be delivered under the Plan, the number, class, and price 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 300,000 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. 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 9 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 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. 10 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. 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 11 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 15,000 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, may ---------------------- legend 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 15,000 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 14 section 162(m) of the Code, the Committee, in its discretion, may determine that the performance 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 15 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. 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 16 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. 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. 17 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. 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: August __, 1999 By _________________________ Name: Charles F. Broom Title: Vice President, Human Resources 19 EX-10.3 3 STOCK PLAN FOR NON-EMPLOYEE DIRECTORS THE PMI GROUP, INC. STOCK PLAN FOR NON-EMPLOYEE DIRECTORS (Amended and Restated as of August 16, 1999) TABLE OF CONTENTS
Page SECTION 1 PURPOSE........................................................................... 1 1.1 Purpose of the Plan............................................................... 1 SECTION 2 DEFINITIONS....................................................................... 1 SECTION 3 ADMINISTRATION.................................................................... 2 3.1 The Committee..................................................................... 2 3.2 Authority of the Committee........................................................ 2 3.3 Decisions Binding................................................................. 3 SECTION 4 SHARES SUBJECT TO THE PLAN........................................................ 3 4.1 Number of Shares.................................................................. 3 4.2 Lapsed Awards..................................................................... 3 4.3 Adjustments in Awards and Authorized Shares....................................... 3 SECTION 5 STOCK OPTIONS..................................................................... 3 5.1 Granting of Options............................................................... 3 5.2 Terms of Options.................................................................. 4 5.3 Payment........................................................................... 4 5.4 Deferral of Option Proceeds....................................................... 5 5.5 Options are not Incentive Stock Options........................................... 6 SECTION 6 RESTRICTED STOCK.................................................................. 6 6.1 Grant of Restricted Stock to Directors Serving on the 1996 Grant Date............. 6 6.2 Grant of Restricted Stock for Directors first elected after the 1996 Grant Date.............................................................................. 6 6.3 Restricted Stock Escrow........................................................... 6 6.4 Voting and other Rights........................................................... 7 6.5 Cash Payment for Income Taxes..................................................... 7 SECTION 7 MISCELLANEOUS..................................................................... 7 7.1 No Effect on Service.............................................................. 7 7.2 Indemnification................................................................... 7 7.3 Successors........................................................................ 7 7.4 Beneficiary Designations.......................................................... 7 7.5 Nontransferability of Awards...................................................... 8 7.6 No Rights as Stockholder.......................................................... 8
-i- Page 7.7 Withholding Requirements.......................................................... 8 SECTION 8 AMENDMENT, TERMINATION, AND DURATION.............................................. 8 8.1 Amendment or Termination.......................................................... 8 8.2 Duration of the Plan.............................................................. 8 SECTION 9 LEGAL CONSTRUCTION................................................................ 8 9.1 Gender and Number................................................................. 8 9.2 Severability...................................................................... 8 9.3 Requirements of Law............................................................... 8 9.4 Compliance with Rule 16b-3........................................................ 9 9.5 Governing Law..................................................................... 9 9.6 Captions.......................................................................... 9
-ii- THE PMI GROUP, INC. STOCK PLAN FOR NON-EMPLOYEE DIRECTORS THE PMI GROUP, INC., hereby amends and restates The PMI Group, Inc. Stock Plan for Non-Employee Directors on the occasion of the Company's 3-for-2 stock split, effective as of August 16, 1999. SECTION 1 PURPOSE 1.1 Purpose of the Plan. The Plan is intended to closely align the ------------------- interests of the Non-Employee Directors with the interests of the Company's stockholders. This is achieved by making a significant portion of Non-Employee Director compensation directly related to the total return performance of the Shares. The Plan also is intended to encourage Share ownership on the part of Non-Employee Directors. 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 "Award" means, individually or collectively, a grant under the Plan of Options, Restricted Stock, or cash. 2.2 "Board" means the Board of Directors of the Company. 2.3 "Committee" means the committee appointed pursuant to Section 3.1 to administer the Plan. 2.4 "Company" means The PMI Group, Inc., a Delaware corporation, or any successor thereto. 2.5 "Director" means any individual who is a member of the Board. 2.6 "Disability" means a permanent and total disability, as determined by the Committee (in its discretion) in accordance with uniform and non- discriminatory standards adopted by the Committee from time to time. 2.7 "Exercise Price" means the price at which a Share may be purchased by a Participant pursuant to the exercise of an Option. 2.8 "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. 2.9 "Grant Date" means, with respect to 1996 and each subsequent calendar year, the first business day in June of each such year. For example, for 1996, the Grant Date is June 3, 1996 (i.e., the first business day in June 1996). With respect to a particular Award, "Grant Date" means the particular Grant Date on which the Award was granted. Notwithstanding the preceding, a Non- Employee Director who is first elected or appointed on other than the first business day in June, shall have an initial Grant Date coincident with the date of their commencement of service on the Board. 2.10 "Non-Employee Director" means a Director who is an employee of neither the Company nor of any Subsidiary. 2.11 "Option" means an option to purchase Shares granted pursuant to Section 5. 2.12 "Option Agreement" means the written agreement setting forth the terms and provisions applicable to each Option granted under the Plan. 2.13 "Participant" means a Non-Employee Director who has an outstanding Award. 2.14 "Plan" means The PMI Group, Inc. Stock Plan for Non-Employee Directors, as set forth in this instrument and as hereafter amended from time to time. 2.15 "Restricted Stock" means an Award of Shares granted pursuant to Section 6. 2.16 "Shares" means the shares of the Company's common stock, $0.01 par value. 2.17 "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. 2.18 "Termination of Service" means a cessation of the Participant's service on the Board for any reason. SECTION 3 ADMINISTRATION 3.1 The Committee. The Plan shall be administered by the Committee. The ------------- Committee shall consist of one or more Directors who shall be appointed by, and serve at the pleasure of, the Company's Chief Executive Officer. The Committee shall be comprised solely of a Director or Directors who are not eligible to receive Awards under the Plan. 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) interpret the Plan and the Awards, (b) adopt rules for the administration, interpretation and application of the Plan as are consistent therewith, (c) interpret, amend or revoke any such rules, and (d) adopt such procedures and subplans as are necessary or 2 appropriate to permit participation in the Plan by Non-Employee Directors who are foreign nationals or employed outside of the United States. 3.3 Decisions Binding. All determinations and decisions made by the ----------------- Committee 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 150,000. Shares issued under the Plan may be either authorized but unissued Shares or treasury Shares, provided, however, that only treasury Shares may be issued upon exercise of the portion of each Option granted on or after May 20, 1999 that pertains to the additional 1,500 Shares covered by Options granted on or after such date. 4.2 Lapsed Awards. If an Award terminates or expires for any reason, any ------------- Shares subject to such Award again shall be available to be the subject of an Award. 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 and class of Shares which may be delivered under the Plan, and the number, class, and Exercise Price of Shares subject to outstanding Awards and future grants, in such manner as the Committee (in its sole discretion) shall determine to be appropriate to prevent the dilution or diminution of such Awards. Notwithstanding the preceding, the number of Shares subject to any Award always shall be a whole number. SECTION 5 STOCK OPTIONS 5.1 Granting of Options. ------------------- 5.1.1 Directors serving on the 1996 Grant Date. Each Non-Employee ---------------------------------------- Director who is such on the 1996 Grant Date, automatically shall receive, as of the 1996 Grant Date only, an Option to purchase 4,500 Shares. Each Non-Employee who has received an Option pursuant to the preceding sentence also automatically shall receive, as of each subsequent Grant Date, an Option to purchase 2,250 Shares, provided that the individual shall receive an Option on any such Grant Date only if he or she both (a) is a Non-Employee Director on the Grant Date, and (b) has served as a Non-Employee Director for the entire period since the last Grant Date. 5.1.2 Directors first elected or appointed after the 1996 Grant Date. -------------------------------------------------------------- Each Non-Employee Director who first becomes such after the 1996 Grant Date but before May 20, 1999, automatically shall receive on his or her initial Grant Date only (a) an Option to purchase 2,250 Shares, plus (b) an option to purchase up to an additional 2,250 Shares (prorated based on the number of full months of service which remain until the next Grant Date). A Director joining the 3 Board on or before the 15th day of the month will receive credit for service for the full month. Each Non-Employee Director who first becomes such on or after May 20, 1999 automatically shall receive on his or her initial Grant Date only an Option to purchase 6,000 Shares. Each Non-Employee Director who first becomes such after the 1996 Grant Date also shall automatically receive, as of each subsequent Grant Date, an Option to purchase 2,250 Shares (3,750 Shares for grants made on or after May 20, 1999) annually, provided that the individual shall receive an Option on any such Grant Date only if he or she both (y) is a Non-Employee Director on the Grant Date, and (z) has served as a Non-Employee Director for the entire period since the last Grant Date. 5.2 Terms of Options. ---------------- 5.2.1 Option Agreement. Each Option granted pursuant to this Section ---------------- 5 shall be evidenced by a written Option Agreement (satisfactory to the Committee) which shall be executed by the Optionee and the Company. 5.2.2 Exercise Price. The Exercise Price for the Shares subject to -------------- each Option shall be 100% of the Fair Market Value of such Shares on the applicable Grant Date. 5.2.3 Exercisability. -------------- (a) Each Option granted to a Non-Employee Director in his or her initial year of Board service pursuant to Sections 5.1.2(a) and (b) (e.g. up to 6,000 shares) shall become exercisable in three equal annual installments, commencing on the first anniversary of the applicable Grant Date; (b) For each Non-Employee Director who automatically receives, as of each subsequent Grant Date, an Option to purchase 2,250 Shares (3,750 Shares for grants made on or after May 20, 1999) annually, any such outstanding Option, and such awards granted on or after July 23, 1998 shall become exercisable as to 100% of the Shares subject to such Option in full on the first anniversary of the applicable Grant Date. Notwithstanding the foregoing, with respect to any outstanding Option, and awards granted on or after May 21, 1998, upon a Non-Employee Director's death, disability, retirement, resignation or non-reelection to the Board of Directors, all unvested options held by such person shall immediately become exercisable. However, except as specifically set forth above, if a Participant incurs a Termination of Service prior to his or her Option(s) becoming fully exercisable, the Option(s) (or portions thereof) which are not exercisable on the date of Termination of Service shall immediately expire. 5.2.4 Expiration of Options. Subject to the last sentence of Section --------------------- 5.2.3, each Option shall terminate upon the first to occur of the following events: (a) The expiration of ten (10) years from the applicable Grant Date; 4 (b) The expiration of three (3) months from the date of the Participant's Termination of Service prior to age 70 for any reason other than the Participant's death or Disability, provided that the Committee, in its discretion, may extend such three-month period to a maximum of the ten (10) years; (c) The expiration of two (2) years from the date of the Participant's Termination of Service by reason of Disability, or (d) The expiration of five (5) years from the date of the Participant's Termination of Service at or after age 70 for any reason other than the Participant's death or Disability. 5.2.5 Death of Director. Notwithstanding Section 5.2.4, if a ----------------- Director dies prior to the expiration of his or her Option(s) in accordance with Section 5.2.4, his or her Option(s) which are exercisable on the date of his or her death shall terminate two (2) years after the date of death. 5.3 Payment. Options shall be exercised by the Participant's delivery of ------- a written notice of exercise (satisfactory to the Committee) to the Company in care of VP Human Resources Department, with a copy to General Counsel, Legal Department, 601 Montgomery Street, San Francisco, California 94111, or at such other address as Company may hereafter designate in writing, setting forth the number of Shares with respect to which the Option is to be exercised, and 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. 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. 5.4 Deferral of Option Proceeds. --------------------------- (a) Notwithstanding anything herein to the contrary, a Participant granted an Option hereunder who is eligible to defer income under the Company's Directors' 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 5.4(a)(ii) or (iii), provided, in either such case, that Shares tendered or applied in exercise of such Option shall have been held by the Participant for at least six 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 5.4, a deferral election made by a Participant hereunder shall be void and shall not be given effect unless (i) the Participant's deferral election is made at least six 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 full calendar months prior to the calendar month in which the option is exercised, and (iii) the Participant is serving as a Non-Employee Director 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 calendar 5 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, as defined below, 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 an account in the name of the Participant on the books and records of the Company (a "Deferred Option Compensation Account") at the date of exercise. A separate Deferred Option Compensation Account shall be maintained with respect to each effective deferral election. (b) For purposes of this Section 5.4, a "Stock Unit" is a bookkeeping entry initially representing an amount equivalent to the fair market value of one Share. Stock Units represent an unfunded and unsecured obligation of the Company, except as otherwise provided for by the Committee. Settlement 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 is made hereunder, provided, however, that in no event shall settlement occur more than 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 a Stock Unit is settled, the number of Shares represented by a Stock Unit shall be subject to adjustment pursuant to Section 4.3. (c) 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. (d) 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. (e) To the extent determined by the Committee, any amount deferred under this Section 5.4, 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 said plan shall govern the operation and administration of deferred amounts hereunder and Deferred Option Compensation Accounts, to the extent not inconsistent with the provisions of this Section 5.4. 5.5 Options are not Incentive Stock Options. Options are not intended to --------------------------------------- be incentive stock options within the meaning of Section 422 of the Code. SECTION 6 RESTRICTED STOCK 6.1 Grant of Restricted Stock to Directors Serving on the 1996 Grant Date. --------------------------------------------------------------------- Each Non-Employee Director who is such on a Grant Date, automatically shall receive, as of such Grant Date, an Award of 450 Shares of Restricted Stock. Notwithstanding the preceding, the number of Shares granted to any Non-Employee Director on any Grant Date shall be reduced if 6 and as necessary so that the Fair Market Value of the Shares does not exceed $30,000 on the Grant Date. 6.2 Grant of Restricted Stock for Directors first elected after the 1996 -------------------------------------------------------------------- Grant Date. Each Non-Employee Director who first becomes such after the 1996 - ---------- Grant Date, automatically shall receive on his or her initial Grant Date only (a) an Award of 37.5 Shares of Restricted Stock for each full month of service on the Board until the next Grant Date and, (b) as of each subsequent Grant Date on which the Non-Employee Director is such, an Award of 450 Shares of Restricted Stock. Notwithstanding the preceding, the number of Shares granted to any Non- Employee Director on any Grant Date shall be reduced if and as necessary so that the Fair Market Value of the Shares does not exceed $30,000 on the Grant Date. A Director joining the Board on or before the 15th day of the month will receive credit for service for the full month. 6.3 Restricted Stock Escrow. For purposes of compliance with Section 9.4, ----------------------- Shares of Restricted Stock shall not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated by the Participant until six months after the applicable Grant Date. Unless the Committee determines otherwise, Shares of Restricted Stock shall be either (a) held by the Company as escrow agent until such six-month period expires, or (b) affixed with an appropriate legend restricting the sale, transfer, pledge, assignment, or other alienation or hypothecation of such Shares by the Participant until expiration of the six month period. 6.4 Voting and other Rights. After Shares of Restricted Stock have been ----------------------- granted, the Participant may exercise full voting rights with respect to such Shares. A Participant shall be entitled to receive all dividends and other distributions paid with respect to such Shares. If any such dividends or distributions are paid in Shares, the Shares shall be subject to the same restrictions on transferability that are provided in Section 6.2. 6.5 Cash Payment for Income Taxes. As soon as practicable after each ----------------------------- Grant Date, the Company shall pay to each Non-Employee Director, in cash or its equivalent, an amount equal to the expected increase in his or her federal, state and local income tax liability due to the Shares granted to the Participant on such Grant Date. The formula for determining each such cash payment shall be adopted by the Committee (in its discretion) from time to time, but in each case shall assume that the maximum prevailing income tax rates apply to the Participant. SECTION 7 MISCELLANEOUS 7.1 No Effect on Service. Nothing in the Plan shall (a) create any -------------------- obligation on the part of the Board to nominate any Participant for reelection by the Company's stockholders, or (b) interfere with or limit in any way the right of the Company to terminate any Participant's service. 7.2 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 7 or she may be involved by reason of any action taken or failure to act under the Plan or any Option 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. 7.3 Successors. All obligations of the Company under the Plan 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. 7.4 Beneficiary Designations. If permitted by the Committee, a ------------------------ Participant 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 Option Agreement, any unexercised vested Award may be exercised by the administrator or executor of the Participant's estate. 7.5 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 7.4. 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, to the extent provided in the Plan and in a manner specified by the Committee, transfer an Option by bona fide gift and not for any consideration, to a member of the Participant's immediate family or to a trust for the exclusive benefit of the Participant and/or a member or members of the Participant's immediate family. 7.6 No Rights as Stockholder. Except to the limited extent provided in ------------------------ Section 6.4, 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, beneficiary or Company (as escrow agent). 7.7 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 8 Federal, state, and local taxes (including the Participant's FICA obligation) required to be withheld with respect to such Award (or exercise thereof). SECTION 8 AMENDMENT, TERMINATION, AND DURATION 8.1 Amendment 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 Award theretofore granted to such Participant. 8.2 Duration of the Plan. The Plan shall commence on the date specified -------------------- herein, and subject to Section 8.1 (regarding the Board's right to amend or terminate the Plan), shall remain in effect thereafter. SECTION 9 LEGAL CONSTRUCTION 9.1 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. 9.2 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. 9.3 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. 9.4 Compliance with Rule 16b-3. For the purpose of ensuring that -------------------------- transactions under the Plan do not subject Participants to liability under Section 16(b) of the Securities Exchange Act of 1934, as amended (the "1934 Act"), all transactions under the Plan are intended to comply with all applicable conditions of Rule 16b-3 promulgated under the 1934 Act, and any future regulation amending, supplementing or superseding such regulation. To the extent any provision of the Plan, Option Agreement or action by the Committee or a Participant fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. 9.5 Governing Law. The Plan and all Option Agreements shall be construed ------------- in accordance with and governed by the laws of the State of California without giving effect to any choice or conflict of law provision or rule (whether of the State of California or otherwise) which would cause the application of the laws of any jurisdiction other than the State of California. 9.6 Captions. Captions provided herein are 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 ------ -------------------------- Title: 10 EX-10.16 4 THE PMI GROUP, INC. RETIREMENT PLAN THE PMI GROUP, INC. RETIREMENT PLAN (Amended and Restated as of February 17, 2000 - Effective January 1, 1998) TABLE OF CONTENTS
Page ---- INTRODUCTION.............................................................................................................. 1 ARTICLE 1 DEFINITIONS..................................................................................................... 2 1.01 "Accrued Benefit".............................................................................................. 2 1.02 "Active Participant"........................................................................................... 2 1.03 "Actuarial Equivalent"......................................................................................... 2 1.04 "Actuary"...................................................................................................... 2 1.05 "Adjustment Factor"............................................................................................ 2 1.06 "Affiliated Employer".......................................................................................... 2 1.07 "Applicable Interest Rate"..................................................................................... 2 1.08 "Beneficiary".................................................................................................. 2 1.09 "Benefit Accrual Service"...................................................................................... 2 1.10 "Benefit Commencement Date".................................................................................... 3 1.11 "Board" or "Board of Directors"................................................................................ 3 1.12 "Break in Service"............................................................................................. 3 1.13 "Code"......................................................................................................... 3 1.14 "Committee".................................................................................................... 3 1.15 "Compensation"................................................................................................. 3 1.16 "Covered Compensation"......................................................................................... 4 1.17 "Deferred Vested Benefit"...................................................................................... 4 1.18 "Early Retirement Benefit"..................................................................................... 4 1.19 "Early Retirement Date"........................................................................................ 4 1.20 "Effective Date"............................................................................................... 4 1.21 "Eligible Employee"............................................................................................ 4 1.22 "Employee"..................................................................................................... 5 1.23 "Employee's Age"............................................................................................... 5 1.24 "Employer"..................................................................................................... 5 1.25 "Employment Commencement Date"................................................................................. 5 1.26 "ERISA"........................................................................................................ 5 1.27 "Final Average Compensation"................................................................................... 5 1.28 "Fund"......................................................................................................... 5 1.29 "Funding Agent"................................................................................................ 6 1.30 "Highly Compensated Employee" and "Highly Compensated Former Employee"......................................... 6 1.31 "Hour of Service".............................................................................................. 6 1.32 "Joint Annuitant".............................................................................................. 6 1.33 "Joint & Survivor Annuity"..................................................................................... 6 1.34 "Leased Employee".............................................................................................. 6 1.35 "Limitation Year".............................................................................................. 6 1.36 "Maternity or Paternity Absence"............................................................................... 6 1.37 "Named Fiduciary".............................................................................................. 6
-i- TABLE OF CONTENTS (continued)
Page ---- 1.38 "Normal Retirement Age"......................................................................................... 6 1.39 "Normal Retirement Benefit"..................................................................................... 6 1.40 "Normal Retirement Date"........................................................................................ 7 1.41 "One-Year Break in Service"..................................................................................... 7 1.42 "Participant"................................................................................................... 7 1.43 "Participating Employer"........................................................................................ 7 1.44 "Participation"................................................................................................. 7 1.45 "Period of Benefit Accrual Service"............................................................................. 7 1.46 "Period of Service"............................................................................................. 7 1.47 "Plan".......................................................................................................... 7 1.48 "Plan Sponsor".................................................................................................. 7 1.49 "Plan Year"..................................................................................................... 7 1.50 "Postponed Retirement Benefit".................................................................................. 7 1.51 "Postponed Retirement Date"..................................................................................... 7 1.52 "Predecessor Employer".......................................................................................... 8 1.53 "Predecessor to this Plan"...................................................................................... 8 1.54 "Qualified Joint & Survivor Annuity"............................................................................ 8 1.55 "Reemployment Date"............................................................................................. 8 1.56 "Retirement Date"............................................................................................... 8 1.57 "Severance Period".............................................................................................. 8 1.58 "Spouse"........................................................................................................ 8 1.59 "Termination"................................................................................................... 8 1.60 "Termination Date".............................................................................................. 8 1.61 "Trust"......................................................................................................... 9 1.62 "Trustee"....................................................................................................... 9 1.63 "Year of Benefit Accrual Service"............................................................................... 9 1.64 "Year of Eligibility Service"................................................................................... 9 1.65 "Year of Vesting Service"....................................................................................... 9 ARTICLE 2 SERVICE COUNTING RULES........................................................................................... 10 2.01 Period of Service -- General Rule.............................................................................. 10 2.02 Period of Service -- Computation............................................................................... 10 2.03 Eligibility Service............................................................................................ 11 2.04 Benefit Accrual Service........................................................................................ 11 2.05 Service -- General Rule........................................................................................ 11 ARTICLE 3 ELIGIBILITY FOR PARTICIPATION AND TRANSFERS..................................................................... 12 3.01 Eligibility to Become a Participant............................................................................ 12 3.02 Eligibility Service Disregarded................................................................................ 12
-ii- TABLE OF CONTENTS (continued) 3.03 Transfer to Another Plan...................................................................................... 13 ARTICLE 4 RETIREMENT ELIGIBILITY AND SUSPENSION OF BENEFITS.............................................................. 14 4.01 Retirement.................................................................................................... 14 4.02 Suspension of Benefits -- Postponed Retirement................................................................ 14 4.03 Suspension of Benefits -- Rehires............................................................................. 14 4.04 Suspension of Benefit Notice.................................................................................. 14 4.05 Section 203(a)(3)(B) Service.................................................................................. 14 4.06 Recommencement of Benefits.................................................................................... 15 4.07 Required Commencement at Age 70 1/2........................................................................... 15 4.08 Required Commencement -- Conditions........................................................................... 15 4.09 Blocking...................................................................................................... 15 ARTICLE 5 AMOUNT OF RETIREMENT BENEFIT................................................................................... 16 5.01 Normal Retirement Benefit..................................................................................... 16 5.02 Postponed Retirement Benefit.................................................................................. 18 5.03 Early Retirement Benefit...................................................................................... 18 5.04 Accrued Benefit -- Participant Who Has Attained Retirement Age................................................ 19 5.05 Accrued Benefit -- Who has Not Attained Retirement Age shall be:.............................................. 19 5.06 Adjustment for Suspension of Benefits......................................................................... 19 ARTICLE 6 REQUIRED BENEFIT LIMITATIONS................................................................................... 20 6.01 Code Section 415 Limits....................................................................................... 20 6.02 Special Limitation for 25 Highest-Paid Employees.............................................................. 21 6.03 Exceptions to Special Limitation.............................................................................. 22 6.04 Distributions Allowed if Security Furnished................................................................... 22 6.05 Plan Termination Limit........................................................................................ 22 6.06 Highly Compensated Employee or Former Employee................................................................ 22 6.07 Definitions................................................................................................... 23 ARTICLE 7 VESTING........................................................................................................ 24 7.01 General Rule.................................................................................................. 24 7.02 Vesting at Normal Retirement Age.............................................................................. 24 7.03 Vesting Before Normal Retirement Age.......................................................................... 24 7.04 Vesting Upon Plan Termination................................................................................. 24 7.05 Vesting Service Disregarded................................................................................... 24 7.06 Repayment of Cash-Out......................................................................................... 25 7.07 Vesting Service............................................................................................... 26
-iii- TABLE OF CONTENTS (continued) ARTICLE 8 QUALIFIED PRERETIREMENT SURVIVOR ANNUITY....................................................................... 27 8.01 Automatic Preretirement Spousal Death Benefit................................................................. 27 ARTICLE 9 FORMS OF BENEFIT............................................................................................... 29 9.01 Qualified Joint & Survivor Annuity............................................................................ 29 9.02 Involuntary Lump Sum Payment.................................................................................. 29 9.03 Right to Elect................................................................................................ 29 9.04 Election of Forms............................................................................................. 29 9.05 Optional Forms of Retirement Benefit.......................................................................... 30 9.06 Beneficiary................................................................................................... 31 9.07 Eligible Rollover Distributions............................................................................... 32 ARTICLE 10 FUNDING....................................................................................................... 34 10.01 Funding Agreement............................................................................................. 34 10.02 Non-Diversion of the Fund..................................................................................... 34 ARTICLE 11 PLAN ADMINISTRATION........................................................................................... 35 11.01 Appointment of Committee...................................................................................... 35 11.02 Powers and Duties............................................................................................. 35 11.03 Actions by the Committee...................................................................................... 36 11.04 Interested Committee Members.................................................................................. 36 11.05 Indemnification............................................................................................... 36 11.06 Conclusiveness of Action...................................................................................... 37 11.07 Payment of Expenses........................................................................................... 37 11.08 Claim Procedure............................................................................................... 37 ARTICLE 12 FUNDING POLICY AND CONTRIBUTIONS.............................................................................. 38 12.01 Employer Contributions........................................................................................ 38 12.02 Participant Contributions..................................................................................... 38 12.03 Contingent Nature of Contributions............................................................................ 38 ARTICLE 13 AMENDMENT, TERMINATION AND MERGER OF THE PLAN................................................................. 39 13.01 Right to Amend the Plan....................................................................................... 39 13.02 Right to Terminate the Plan................................................................................... 39 13.03 Allocation of Assets and Surplus.............................................................................. 39 13.04 Plan Mergers, Consolidations, and Transfers................................................................... 39 13.05 Amendment of Vesting Schedule................................................................................. 40
-iv- TABLE OF CONTENTS (continued) ARTICLE 14 TOP-HEAVY PLAN PROVISIONS..................................................................................... 41 14.01 General Rule.................................................................................................. 41 14.02 Vesting Provision............................................................................................. 41 14.03 Minimum Benefit Provision..................................................................................... 41 14.04 Change in 415(e) Limits....................................................................................... 42 14.05 Coordination With Other Plans................................................................................. 42 14.06 Top-Heavy and Super Top-Heavy Plan Definition................................................................. 42 14.07 Key Employee.................................................................................................. 45 14.08 Non-Key Employee.............................................................................................. 46 14.09 Collective Bargaining Rules................................................................................... 46 ARTICLE 15 MISCELLANEOUS................................................................................................. 47 15.01 Limitation on Distributions................................................................................... 47 15.02 Limitation on Reversion of Contributions...................................................................... 47 15.03 Voluntary Plan................................................................................................ 47 15.04 Nonalienation of Benefits..................................................................................... 48 15.05 Inability to Receive Benefits................................................................................. 48 15.06 Missing Persons............................................................................................... 48 15.07 Military Service.............................................................................................. 48 15.08 Limitation of Third-Party Rights.............................................................................. 48 15.09 Invalid Provisions............................................................................................ 48 15.10 One Plan...................................................................................................... 49 15.11 Use and Form of Words......................................................................................... 49 15.12 Headings...................................................................................................... 49 15.13 Governing Law................................................................................................. 49
-v- INTRODUCTION ------------ The PMI Group, Inc., having established The PMI Group, Inc. Retirement Plan (the "Plan") effective as of April 1, 1995, and having amended the Plan on three subsequent occasions, hereby amends and restates the Plan in its entirety, effective as of January 1, 1998 (except as otherwise provided herein). The Plan is intended to qualify under Section 401(a) of the Internal Revenue Code of 1986, as amended. ARTICLE 1 DEFINITIONS ----------- 1.01 "Accrued Benefit" shall mean the amount of annual pension benefit, payable --------------- as a straight life annuity, commencing at Normal Retirement Age, as shall be considered accrued at any time for a Participant in accordance with the provisions of Article 5. 1.02 "Active Participant" shall mean a Participant who also is an Eligible ------------------ Employee. 1.03 "Actuarial Equivalent" shall mean a benefit of equivalent current values -------------------- to the benefit that would otherwise have been provided to the Participant, determined on the basis of appropriate actuarial assumptions and methods that may differ from those used in establishing Plan costs and liabilities. Interest shall be eight percent per annum and mortality shall be the "applicable mortality table" described in Section 417(e)(3) of the Code; provided, however, that the interest used for determining lump sums shall be the Applicable Interest Rate. 1.04 "Actuary" shall mean that individual who is an "enrolled actuary" as ------- defined in Section 7701(a)(35) of the Code or that firm of actuaries that has on its staff such an actuary, appointed by the Committee. 1.05 "Adjustment Factor" shall mean the cost of living adjustment factor ----------------- prescribed by the Secretary of the Treasury under Section 415(d) of the Code for years beginning after December 31, 1987, applied to such items and in such manner as the Secretary shall prescribe. 1.06 "Affiliated Employer" shall mean the Plan Sponsor and any corporation, ------------------- trade, or business, which, together with the Plan Sponsor, is a member of a "controlled group of corporations," a group under "common control," or an "affiliated service group," all as determined under Sections 414(b), (c), (m), (o) of the Code, provided that solely for purposes of Section 6.01, the rule set forth in Section 415(h) of the Code also shall apply. 1.07 "Applicable Interest Rate" shall be the average daily interest rate on ------------------------ 30-year Treasury securities for the fifth month preceding the start of the Plan Year. 1.08 "Beneficiary" shall mean that person or persons or entity or entities ----------- (including a trust) or estate that shall be entitled to receive benefits payable pursuant to the provisions of this Plan by virtue of a Participant's death, pursuant to the provisions of Article 9. 1.09 "Benefit Accrual Service" shall mean the period of service of a ----------------------- Participant that is used to calculate the amount of the Participant's Accrued Benefit, determined in accordance with Article 2. 2 1.10 "Benefit Commencement Date" shall mean the first day of the month ------------------------- coincident with or following the date of Termination or the date when the Participant first becomes eligible to begin to receive benefits unless the Participant elects to postpone receiving benefits until a later date, even though the first payment may not actually have been made at that date. 1.11 "Board" or "Board of Directors" shall mean the Board of Directors of The ----------------------------- PMI Group, Inc. except that any action that could be taken by the Board may also be taken by a duly authorized Committee of the Board. 1.12 "Break in Service" shall mean a Termination followed by the completion ---------------- of a One-Year Break in Service. 1.13 "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. 1.14 "Committee" shall mean the committee of individuals appointed by the --------- Board to be responsible for the operations and administration of the Plan in accordance with the provisions of Article 11. 1.15 "Compensation" shall mean an Employee's wages, salaries, fees for ------------ professional services, and other amounts received (without regard to whether or not an amount is paid in cash) for services actually rendered in the course of employment with the Employer to the extent that amounts are includable in gross income. Compensation shall also include any remuneration that is currently excluded from the Participant's gross income by reason of the application of Sections 125 and 129, 401(k) or 402(h)(1)(B) of the Code. Notwithstanding the foregoing, Compensation with respect to any Employee shall exclude: (a) Any compensation directly paid or payable as fringe benefits; (b) Any contributions made by the Employer for or on account of the Employees under this Plan, or under any other employee benefit plan other than as specifically excepted herein; (c) Any compensation paid or payable by reason of services performed prior to the date the Employee becomes a Participant; (d) Any compensation paid or payable by reason of services performed after the date the Employee ceased to be a Participant; (e) Any compensation paid as part of a severance agreement; (f) Any compensation paid in lieu of vacation not taken; 3 (g) Amounts in excess of $150,000, as indexed for cost of living in accordance with Sections 401(a)(17) and 415(d) of the Code (e.g., $160,000 for 1998 and 1999, and $170,000 for 2000); and (h) Any equity-based compensation (including, but not limited to, stock options, restricted or unrestricted stock and performance shares) under the Plan Sponsor's Equity Incentive Plan or any similar equity- based plan or arrangement sponsored by an Affiliated Employer, whether such compensation is paid in shares of stock or cash. 1.16 "Covered Compensation" shall mean, with respect to any Participant, the -------------------- average of the contribution and benefit bases in effect under Section 230 of the Social Security Act for each year in the 35-year period ending with the year in which the Participant attains Social Security retirement age, as calculated under Section 401(l)(5)(e)(i) of the Code using the unrounded values. 1.17 "Deferred Vested Benefit" shall mean the benefit to which a vested ----------------------- Participant would be entitled after a Break in Service, as calculated in accordance with Article 5. 1.18 "Early Retirement Benefit" shall mean the benefit to which a Participant ------------------------ would be entitled in the event of his retirement at his or her Early Retirement Date, as calculated in accordance with Article 5. 1.19 "Early Retirement Date" shall mean the date on which a Participant --------------------- becomes eligible and elects to retire with an early retirement benefit under the Plan, as determined in accordance with Section 5.03. 1.20 "Effective Date" shall mean January 1, 1998, except as otherwise provided -------------- herein; provided however, that any provision of the Plan required as a result of the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997, the Uruguay Round Agreements Act of 1994, the Uniformed Services Employment and Reemployment Rights Act of 1994 or any other applicable legislation, shall be effective as of the date specified in such legislation. 1.21 "Eligible Employee" shall mean every Employee of an Employer except an ----------------- Employee: (a) who is an individual included in a unit of Employees whose compensation and conditions of employment are established by the terms of a collective bargaining agreement between an Employer and employee representatives, as described in Section 7701(a)(46) of the Code, where retirement benefits were the subject of good faith bargaining, unless and until such collective bargaining agreement provides that the Plan will apply to such individual; or (b) who is an individual included in a unit or class of Employees who are excluded from coverage by the Plan pursuant to the policies and records of the Plan Sponsor; or 4 (c) who, as to any period of time, is classified or treated by an Employer as an independent contractor, a consultant, a Leased Employee, or an employee of an employment agency or any entity other than an Employer, even if such individual is subsequently determined to have been a common-law employee of an Employer during such period. 1.22 "Employee" shall mean an individual who is (a) employed by an Employer or -------- Affiliated Employer as a common-law employee, or (b) a Leased Employee. However, if Leased Employees constitute less than 20% of the nonhighly compensated work force (within the meaning of Section 414(n)(5)(c)(ii) of the Code), the term "Employee" shall not include those Leased Employees who are covered by a plan described in Section 414(n)(5) of the Code. 1.23 "Employee's Age" shall mean, for the purposes of calculations involving -------------- the age of the Employee, the following. The Employee shall be assumed to have been born on the first day of the month coincident with or following the Employee's date of birth and shall be assumed to have lived through the last day of the month in which the date of the event for which the Employee's age is being calculated occurs. Using the above assumptions, the Employee's Age shall be defined to be the number of months divided by 12 and rounded to three decimal places. Linear interpolation shall be used, where necessary, in calculations involving the Employee's Age. 1.24 "Employer" shall mean The PMI Group, Inc. and any other Affiliated -------- Employer that, with the consent of the Board, shall adopt this Plan for its Eligible Employees, but only for the period during which consent is in effect. "Employer" when used in this Plan shall refer to such adopting entities either individually or collectively, as the context may require. 1.25 "Employment Commencement Date" shall mean the date on which the Employee ---------------------------- first is credited with an Hour of Service. 1.26 "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. 1.27 "Final Average Compensation" shall mean the highest amount obtainable by -------------------------- the annual Compensation of a Participant paid in any five consecutive calendar years out of the last ten calendar years. In calculating Final Average Compensation for a Participant who is being credited with Service under Section 2.01(d) of this Plan (relating to a Participant receiving benefits under a long-term disability plan), it shall be assumed that such Participant continued to earn at the rate equal to his Final Average Compensation as calculated under this Section on the date he first commenced to receive Service credit under Section 2.01(d). 1.28 "Fund" shall mean any fund provided for in a trust arrangement or an ---- insurance contract or a combination of both, which is held by a Funding Agent, to which contributions under the 5 Plan on and after the Effective Date will be made, and out of which benefits are paid to the Participants or otherwise provided for. 1.29 "Funding Agent" shall mean a Trustee or insurance company or any duly ------------- appointed successor or successors selected to hold a Fund. 1.30 "Highly Compensated Employee" and "Highly Compensated Former Employee" --------------------------- ---------------------------------- shall mean an Employee who is determined to be a Highly Compensated Employee or Highly Compensated Former Employee under the provisions of Article 6 of this Plan. 1.31 "Hour of Service" shall mean each hour for which an Employee is directly --------------- or indirectly paid or entitled to payment by an Employer or Affiliated Employer for the performance of duties in accordance with Department of Labor Regulation Section 2530.200b-2(a)(1). 1.32 "Joint Annuitant" shall mean the Beneficiary who will receive retirement --------------- benefits after the death of the Participant on the basis of the provisions of a Joint & Survivor Annuity, as described in Article 9. 1.33 "Joint & Survivor Annuity" shall mean a retirement benefit under which ------------------------ equal monthly installments are payable during the joint lifetimes of the retired Participant and the Joint Annuitant, and under which, upon the earlier death of the retired Participant, the same amount, or 50 percent as elected by the Participant prior to his Benefit Commencement Date, continues to be paid to the Joint Annuitant for the Joint Annuitant's lifetime. 1.34 "Leased Employee" shall mean an individual who is a leased employee --------------- (within the meaning of Section 414(n)(2) of the Code) of an Affiliated Employer. 1.35 "Limitation Year" shall mean the 12-month period ending on each December --------------- 31. 1.36 "Maternity or Paternity Absence" means an absence from employment by ------------------------------ reason of the pregnancy of an Employee, the birth of a child of the Employee, the placement of a child in connection with the child's adoption by the Employee, or the caring for a child during the period immediately following the birth or adoption, which the Employee certifies to the Employee. 1.37 "Named Fiduciary" shall mean a fiduciary designated as such under the --------------- provisions of Article 11. 1.38 "Normal Retirement Age" shall mean the age at which the Employee reaches --------------------- his Normal Retirement Date as defined in Section 1.41. 1.39 "Normal Retirement Benefit" shall mean the benefit to which a Participant ------------------------- would be entitled in the event of the Participant's retirement on the Participant's Normal Retirement Date, as calculated in accordance with Article 5. 6 1.40 "Normal Retirement Date" shall mean the first day of the month ---------------------- coincident with or following the Participant's 65th birthday. 1.41 "One-Year Break in Service" shall mean a Severance Period of 12 ------------------------- consecutive months. 1.42 "Participant" shall mean any Eligible Employee who becomes a Participant ----------- in the Plan pursuant to Article 3 and shall include any individual who has separated from Service or ceased to be an Eligible Employee and for whom there is still a liability under the Plan. 1.43 "Participating Employer" shall mean any Affiliated Employer that has ---------------------- elected, with the approval of the Board, to participate in the Plan as to some or all of its Eligible Employees by adopting this Plan and the funding agreement described in Section 10.01 of this Plan. Such employees shall be considered Eligible Employees under the Plan and, for the purposes of their benefits under the Plan, the Participating Employer shall be included in the definition of Employer. 1.44 "Participation" shall mean Service while an Active Participant. ------------- 1.45 "Period of Benefit Accrual Service" shall mean as to each Participant, --------------------------------- each period beginning on the date of his or her commencement as an Eligible Employee and ending on his or her next Termination Date. 1.46 "Period of Service" shall mean as to each Employee (a) each period ----------------- beginning on his or her Employment Commencement Date or Reemployment Date and ending on his or her next Termination Date, and (b) to the extent not counted under (a), each absence of twelve (12) months or less from service with all Employers and Affiliated Employers, which began by reason of, or within which occurred, such Employee's resignation, retirement, discharge or death. For purposes of applying this Section 1.46, an Employee's Period of Service shall include periods of employment with any other employer which is a "predecessor employer" of an Affiliated Employer (within the meaning of Section 414(a) of the Code). 1.47 "Plan" shall mean The PMI Group, Inc. Retirement Plan, as embodied herein, ---- and any amendments thereto. 1.48 "Plan Sponsor" shall mean The PMI Group, Inc. ------------ 1.49 "Plan Year" shall mean the period beginning January 1 and ending --------- December 31. 1.50 "Postponed Retirement Benefit" shall mean the benefit to which a ---------------------------- Participant would be entitled in the event of his retirement after his Normal Retirement Date, as calculated in accordance with Article 5. 1.51 "Postponed Retirement Date" shall mean the first day of the calendar ------------------------- month coincident with or next following the Participant's Termination Date, if such date is later than the Participant's Normal Retirement Date. 7 1.52 "Predecessor Employer" shall mean, with respect to an Employee, one or -------------------- more of the following organizations or units, if the Employee was previously employed by them: PMI Mortgage Insurance Company, American Pioneer Title Insurance Company, PMI Mortgage Services Company, and PMI Reinsurance Company. 1.53 "Predecessor to this Plan" shall mean any plan for which this Plan is a ------------------------ restatement, any plan that has been merged into this Plan or any Predecessor to this Plan, or any other plan sponsored by an entity that became an Affiliated Employer by acquisition or merger, and that adopted this Plan or a Predecessor to this Plan for any of its employees who had been participants in such other plan. 1.54 "Qualified Joint & Survivor Annuity" shall mean, for a married ---------------------------------- Participant, a Joint and Survivor Annuity with the Participant's Spouse as Joint Annuitant and a 50 percent survivor benefit. For a single Participant it shall mean a benefit payable in the form of an annuity for the life of the Participant. The Qualified Joint & Survivor Annuity for a married Participant shall be at least the Actuarial Equivalent, determined under the applicable factors of Article 9 of the Participant's Accrued Benefit or, if greater in Actuarial Equivalent value, any optional form of benefit then available to the Participant under the Plan. 1.55 "Reemployment Date" shall mean the date on which an Employee first ----------------- completes an Hour of Service after a Termination Date. 1.56 "Retirement Date" shall mean a Participant's Normal, Early or Postponed --------------- Retirement Date. 1.57 "Severance Period" shall mean each period beginning on an Employee's ---------------- Termination Date and ending on his or her next Reemployment Date. 1.58 "Spouse" shall mean the person to whom the Participant is legally married ------ on the date the Participant receives the Participant's benefit payment from the Plan, or the Participant's date of death, if earlier. 1.59 "Termination" shall mean the cessation of active employment with the ----------- Employer or an Affiliated Employer. 1.60 "Termination Date" shall mean the earlier of (a) the date on which an ---------------- Employee dies, resigns, retires or is discharged from employment with all Employers and Affiliated Employers, or (b) the first anniversary of the first date of a period in which an Employee remains absent from service with all Employers and Affiliated Employers for any reason other than his or her death, resignation, retirement or discharge, or if the absence is on account of a Maternity or Paternity Absence, the second anniversary of the first date of the Employee's absence from service with all Employers and Affiliated Employers. In accordance with Treas. Reg. Section 1.410(a)- 9, the period between the first and second anniversaries of absence from service as the result of Maternity or Paternity Absence (the "Second Year") is neither a Period of Service nor a Severance Period. Accordingly, an Employee shall receive no credit for a Year of Benefit Accrual Service, a Year of Eligibility 8 Service or a Year of Vesting Service during the Employee's Second Year, but the Employee's Severance Period shall not commence until the end of the Second Year. 1.61 "Trust" shall mean any trust established under an agreement between the ----- Employer and a Trustee under which any portion of the Fund is held, and shall include any and all amendments to the Trust agreement. 1.62 "Trustee" shall mean any trustee holding any portion of the Fund under a ------- Trust agreement forming a part of the Plan. 1.63 "Year of Benefit Accrual Service" shall mean a 12-month Period of ------------------------------- Benefit Accrual Service. Subject to Section 2.04, an Employee's total number of Years of Benefit Accrual Service shall be calculated by assuming that the Employee (a) was hired on the first day of the month coincident with or following the Employee's actual date of hire, and (b) incurred a Termination Date on the last day of the month in which the Employee's actual Termination Date occurs. Years of Benefit Accrual Service shall be calculated by dividing the number of months determined in the preceding sentence by 12, and rounding down to three decimal places. Linear interpolation shall be used where necessary. 1.64 "Year of Eligibility Service" shall mean a 12-month Period of Service. --------------------------- Subject to Section 3.02, and Employee's total number of Years of Eligibility Service shall be calculated by assuming that the Employee (a) was hired on the first day of the month coincident with or following the Employee's actual date of hire, and (b) incurred a Termination Date on the last day of the month in which the Employee's actual Termination Date occurs. Years of Eligibility Service shall be calculated by dividing the number of months determined in the preceding sentence by 12, and rounding down to three decimal places. Linear interpolation shall be used where necessary. 1.65 "Year of Vesting Service" shall mean a 12-month Period of Service. ----------------------- Subject to Section 7.05, an Employee's total number of Years of Vesting Service shall be calculated by assuming that the Employee (a) was hired on the first day of the month coincident with or following the Employee's actual date of hire, and (b) incurred a Termination Date on the last day of the month in which the Employee's actual Termination Date occurs. Years of Vesting Service shall be calculated by dividing the number of months determined in the preceding sentence by 12, and rounding down to three decimal places. Linear interpolation shall be used where necessary. 9 ARTICLE 2 SERVICE COUNTING RULES ---------------------- 2.01 Period of Service -- General Rule. An Employee shall be credited with a --------------------------------- Period of Service for: (a) Each period for which a person is directly or indirectly paid, or entitled to payment, by an Affiliated Employer or a Predecessor Employer for the performance of duties. This Service shall be credited to the person during the appropriate Computation Period in which the duties are performed; (b) Each period for which a person is directly or indirectly paid, or entitled to payment, by an Affiliated Employer or a Predecessor Employer for reasons other than for the performance of duties (such as vacation, holiday, illness, incapacity including disability, jury duty, military duty, leave of absence, or a leave of absence pursuant to the Family Leave Act, or layoff). This Service shall be credited to the Employee during the Computation Period in which the nonperformance of duties occurs, but the total credit for any single continuous period during which the employee performs no duties (whether or not in a single Computation Period) of such Service shall not exceed 501 hours. The computation of non-work hours described in this subsection will be computed in accordance with the provisions of the Department of Labor Regulation Section 2530.200b-2; (c) Each period for which back pay, irrespective of mitigation of damages, has been either awarded or agreed to by an Affiliated Employer or Predecessor Employer. This Service will be credited to the person for the Plan Year to which the award or agreement pertains; (d) Each period for which an Employee is not paid or entitled to payment but during which he normally would have performed duties for a Participating Employer during any period for which he is eligible to receive benefits under the long-term disability plan of a Participating Employer; and (e) Each period for which an Employee is not paid or entitled to pay but during which the Employee is absent for a period of military service for which reemployment rights are protected by law, but only if the Employee returns to employment within the time required by law. 2.02 Period of Service -- Computation. For the purpose of calculating Service -------------------------------- under the Plan, an Employee shall be assumed to have been hired on the first day of the month coincident with or following the Employee's date of hire and shall be assumed to have been terminated on the last day of the month in which the Employee's date of termination or retirement occurs. 10 Using the above assumptions, Service shall be defined to be the number of months of Service divided by 12 and rounded to three decimal places. Linear interpolation shall be used, where necessary, in calculations involving Service. 2.03 Eligibility Service. An Eligible Employee shall be credited with a Year ------------------- of Eligibility Service if the Participant performs 12 months of Service during the Computation Period commencing with the date of the Participant's hire or most recent rehire following a Break in Service or, if the Participant fails to perform 12 months of Service in that Computation Period, the Participant shall be credited with a Year of Eligibility Service if the Participant performs 12 months of Service in any Computation Period commencing after his hire or rehire date. If a Participant incurs a Break in Service, Eligibility Service prior to his Termination Date shall not be counted until the Participant performs a Year of Eligibility Service following his Break in Service. 2.04 Benefit Accrual Service. Benefit Accrual Service shall include any ----------------------- Period of Service except in the case of an employee who was a participant in the Allstate Retirement Plan on April 1, 1995. Such prior Allstate Retirement Plan participant shall not receive any Benefit Accrual Service prior to May 1, 1995. Employees hired by the Employer between May 2, 1994 and April 30, 1995 shall begin receiving Benefit Accrual Service on their original hire date with the Employer and will participate in the Plan one year from their original hire date with the Employer. 2.05 Service -- General Rule. A Participant shall be credited with a Year of ----------------------- Service for purposes of this Plan other than for determining eligibility if the Participant performs 12 months of Service during a Plan Year, except that a Year of Service shall not be credited for any Plan Years prior to a Break in Service in any of the following cases: (a) Rehire Rule -- The Participant has not been credited with one Year of ----------- Eligibility Service following his date of rehire, or (b) Cash-Out Rule -- The Participant has previously received a ------------- distribution of the present value of his entire nonforfeitable benefit, following his Termination Date, unless the Participant has repaid in full the distribution, with interest in accordance with Section 7.06 of this Plan. For the purposes of this rule, a Participant who is not entitled to a Deferred Vested Benefit upon his Termination Date shall be considered to be cashed out upon his Termination Date, or (c) Rule of Parity -- The Participant was not entitled to a Deferred -------------- Vested Benefit at his Termination Date and has incurred a number of consecutive One-Year Breaks in Service equal to the greater of five or the number of Years of Service credited to him prior to the first of such consecutive One-Year Breaks in Service. 11 ARTICLE 3 ELIGIBILITY FOR PARTICIPATION AND TRANSFERS ------------------------------------------- 3.01 Eligibility to Become a Participant. Each individual who was a ----------------------------------- Participant in the Plan on the day before the Effective Date and is an Eligible Employee on the Effective Date, shall automatically continue as a Participant on the Effective Date. Each other Eligible Employee shall become a Participant in the Plan on the first day of the calendar month that follows the first date on which he has completed one Year of Eligibility Service. 3.02 Eligibility Service Disregarded. The Years of Eligibility Service of a ------------------------------- terminated Participant who is reemployed shall be determined in accordance with the following rules. (a) One-Year Break in Service Before Completing One Year of Eligibility ------------------------------------------------------------------- Service. If an Employee incurs a One-Year Break in Service before ------- completing one Year of Eligibility Service, he or she shall be treated as a new Employee, upon subsequent reemployment, for the purpose of determining eligibility for participation in the Plan. Thus, such an Employee must satisfy the requirements of Section 3.01 after his or her Reemployment Date in order to become a Participant in the Plan, and any service before the One-Year Break in Service shall be disregarded. (b) Reemployment of Terminated Participants. --------------------------------------- (1) Prior Service Disregarded. If a Participant incurs a One-Year ------------------------- Break in Service, and his or her vested percentage interest in his or her Accrued Benefit under the Plan was 0% when the One- Year Break in Service began, and the number of his or her consecutive One-Year Breaks in Service exceeds the greater of (i) the number of his or her Years of Vesting Service, or (ii) five (5), then he or she must again satisfy the requirements of Section 3.01 after his or her Reemployment Date in order to become a Participant in the Plan, and any service before the One-Year Break in Service shall be disregarded for purposes of eligibility. (2) Prior Service Counted. If a Participant does not incur a --------------------- One-Year Break in Service or incurs a One-Year Break in Service and: (i) his or her vested percentage interest in his or her Accrued Benefit under the Plan was greater than 0% when the One-Year Break in Service began, or (ii) the number of his or her consecutive One-Year Breaks in Service does not exceed the greater of (A) the number of his or her Years of Vesting Service, or (B) five (5), then he or she shall become a Participant in the 12 Plan again on his or her Reemployment Date (provided he or she is reemployed as an Eligible Employee). 3.03 Transfer to Another Plan. A Participant who ceases to be an Eligible ------------------------ Employee without incurring a Termination shall cease to accrue benefits under this Plan as of the date on which he ceased to be an Eligible Employee, and his Accrued Benefit will be frozen as of the close of the Plan Year in which he ceases to be an Eligible Employee, but he shall continue to be a Participant for other purposes under the Plan and, if he continues to remain in the employ of an Affiliated Employer, shall continue to earn Vesting Service. 13 ARTICLE 4 RETIREMENT ELIGIBILITY AND SUSPENSION OF BENEFITS ------------------------------------------------- 4.01 Retirement. A Participant who has reached his Retirement Date shall be ---------- entitled to retire from employment with all Employers and Affiliated Employers and receive benefits in accordance with Article 5. 4.02 Suspension of Benefits -- Postponed Retirement. If a Participant's Service ---------------------------------------------- continues after his Normal Retirement Age and such Service after his Normal Retirement Age constitutes Section 203(a)(3)(B) Service (as defined in Section 4.05), such Participant's benefits will be suspended, provided that the Committee notifies him that his benefits have been suspended in the manner provided by Section 4.04 of this Article. 4.03 Suspension of Benefits -- Rehires. If a person receiving benefits --------------------------------- hereunder is rehired by the Employer, payment of those benefits will be suspended as long as the rehired Employee remains employed with the Employer, provided such Service constitutes Section 203(a)(3)(B) Service (as defined in Section 4.05) and provided that the Committee notifies him that benefits have been suspended, in the manner provided by Section 4.04 of this Article. 4.04 Suspension of Benefit Notice. The notice required under Sections 4.02 or ---------------------------- 4.03 of this Article shall contain: (a) a description of the specific reasons for the suspension of benefit payments, (b) a general description of the Plan's provisions relating to the suspension, (c) a copy of such provisions, (d) a statement to the effect that applicable Department of Labor regulations may be found in Section 2530.203-3 of the Code of Federal Regulations, and (e) a description of the Plan's procedure for affording a review of such suspension. Such notice shall be furnished by personal delivery or first-class mail during the first calendar month in which payments are discontinued. 4.05 Section 203(a)(3)(B) Service. In accordance with Department of Labor ---------------------------- Regulations Section 2530.203-3, "Section 203(a)(3)(B) Service" shall be determined on a monthly basis and an Employee shall be deemed to be in Section 203(a)(3)(B) Service in any month in which he shall perform 40 or more Hours of Service as defined in Department of Labor Regulations Section 2530.200b - 2(a)(1) and (2). An Employee shall have the right to -14- contest the determination of his status in accordance with the procedures set forth in Section 11.08 of this Plan. 4.06 Recommencement of Benefits. Benefits that are suspended in accordance with -------------------------- Section 4.02 or 4.03 of this Article shall be paid in any month in which the Participant is not considered to be in Section 203(a)(3)(B) Service. If an Employee whose benefits are suspended continues or recommences Participation in this Plan and thereafter again becomes entitled to benefits hereunder by virtue of a new Early, Normal, or Postponed Retirement, previously suspended benefits shall not be recommenced, and the Participant shall be entitled only to his Early, Normal, or Postponed Retirement Benefit, as of the Participant's new Early, Normal, or Postponed Retirement Date, adjusted as provided in Section 5.06. 4.07 Required Commencement at Age 70 1/2. A Participant not currently receiving ----------------------------------- benefits under this Plan who attains age 70 1/2 shall commence receiving benefits as if the Participant had retired on December 31 of the calendar year in which the Participant attains age 70 1/2, and had a Benefit Commencement Date of April 1 of the following calendar year. Each December 31 thereafter, and upon the Participant's later actual Postponed Retirement Date, the Participant benefit payment shall be recalculated using the Participant's actual Benefit Accrual Service and actual Final Average Compensation. 4.08 Required Commencement -- Conditions. Notwithstanding any provision of this ----------------------------------- Plan to the contrary, all distributions under the Plan shall be made in accordance with the requirements of Section 401(a)(9) of the Code and the regulations thereunder, including the incidental death benefit requirements of Treasury Regulation Section 1.401(a)(9)-2. The provisions of this Section override any distribution options under the Plan if inconsistent with the requirements of Section 401(a)(9) of the Code. 4.09 Blocking. In the event of a sale of a division or subsidiary of the -------- Employer, a Participant shall not be considered to have attained his Early, Normal or Deferred Retirement Date until he shall have separated from service from the division or subsidiary that was sold by the Employer. In such event, Service with the division or subsidiary that was sold shall be considered Service with the Employer but shall not be Benefit Accrual Service, and all provisions of this Plan shall apply accordingly. -15- ARTICLE 5 AMOUNT OF RETIREMENT BENEFIT ---------------------------- 5.01 Normal Retirement Benefit. ------------------------- (a) A Participant's Normal Retirement Benefit shall be an annual annuity for the life of the Participant, payable monthly, commencing upon the Participant's Normal Retirement Date, equal to a Participant's Base Benefit added to the Participant's Additional Benefit, as described below: (1) "Base Benefit" is equal to 1.55 percent of a Participant's ------------ Final Average Annual Compensation multiplied by the Participant's Years of Benefit Accrual Service. (2) "Additional Benefit" is equal to 0.65 percent of the excess of ----------------- the Final Average Compensation over the Participant's Covered Compensation, multiplied by the Participant's Years of Benefit Accrual Service up to a maximum of 35 years. (3) "Allstate Benefit." A Participant with a frozen benefit fro ---------------- the Allstate Retirement Plan will also receive an additional benefit equal to the following: The PMI Final Average Compensation at the time of termination divided by the Average Annual Allstate Compensation, minus one, times the frozen Allstate benefit. (b) Beefed-Up Benefit. The potentially higher benefit described in this ----------------- Section 5.01(b) is applicable to a Participant (if at all) only if the Participant is neither a Highly Compensated Employee nor a Highly Compensated Former Employee. A Participant who retires from employment with all Employers and Affiliated Employers both (1) before December 31, 1999, and (2) while at least age 55 but less than age 60, shall have his or her Base Benefit and Additional Benefit (as described in Section 5.01(a)) recalculated as provided in this Section 5.01(b). If such recalculated Base Benefit and Additional Benefit exceeds the Base Benefit and Additional Benefit as originally calculated under Section 5.01(a), the Participant shall be entitled to the recalculated Base Benefit and Additional Benefit. (1) The Participant's Final Average Compensation will be calculated as if he or she had continued to work until the earlier of December 31, 1999 or age 60 at his or her Compensation in the last twelve months prior to retirement. -16- (2) For a Participant who was hired at Allstate before 1978, his or her Base Benefit and Additional Benefit will be first decreased by (i) and then increased by (ii): (i) The number of years from termination to the latter of December 31, 1999 or age 60 divided by the number of years of Allstate service prior to January 1, 1978 times the pre-1978 benefit under the Allstate Retirement Plan. (ii) The number of years from termination to the latter of December 31, 1999 or age 60 divided by the number of years of service from January 1, 1988 to April 1, 1995 times the post-1988 benefit under the Allstate Retirement Plan. (c) Bridge Benefit. The benefit described in this Section 5.01(c) is -------------- applicable to a Participant (if at all) only if the Participant is neither a Highly Compensated Employee nor a Highly Compensated Former Employee. If a Participant retires from employment with all Employers and Affiliated Employers after attaining at least age 55 and 20 years of combined service with the Employers and Allstate, but did not have 20 years of service with Allstate on April 1, 1995, the Participant shall be entitled to a temporary annuity equal to: (A) as reduced in (B) payable for the period described in (C) below: (A) The monthly life annuity payable from the Allstate Retirement Plan starting at the Participant's Normal Retirement Date under the Allstate Retirement Plan. (This is the accrued Allstate benefit on April 1, 1995, as communicated by Allstate.) (B) The monthly life annuity will be reduced by one half percent per month (6% per year) for each month the Participant's retirement precedes his or her Normal Retirement under the Allstate Retirement Plan. (C) The monthly life annuity will be paid starting on the first day of the month following retirement under the Plan until the earlier of the Participant's death or the date on which the Participant becomes eligible to receive his or her benefit from the Allstate Retirement Plan. Alternatively, the Participant may elect to have, in the event of his or her death, the monthly life annuity continue to his or her surviving Spouse but not beyond the date when the Participant would have become eligible to receive his or her benefit from the Allstate Retirement Plan. If the Participant elects to have the full benefit continue to his or her Spouse, then the benefit in (B) will be further reduced two percent. If the Participant elects to have half of the benefit continue to his or her Spouse, then the benefit in (B) will be further reduced one percent. -17- 5.02 Postponed Retirement Benefit. A Participant who retires on the Postponed ---------------------------- Retirement Date shall receive a Postponed Retirement Benefit that, subject to the provisions of the optional retirement benefit and the Joint & Survivor Annuity, shall consist of a monthly payment on the first day of each calendar month commencing with the Participant's Postponed Retirement Benefit Date, and ending with the last such payment before the Participant's death, equal to the Participant's Normal Retirement Benefit but with Benefit Accrual Service, Compensation, and Final Average Compensation determined as of the Participant's Postponed Retirement Date. 5.03 Early Retirement Benefit. A Participant who retires from employment with ------------------------ all Employers and Affiliated Employers prior to the Participant's Normal Retirement Date but on or after attaining age 55, and who has completed at such time ten Years of Benefit Accrual Service, shall be entitled to an Early Retirement Benefit of an annual annuity for life, payable monthly, commencing at the date that would have been the Participant's Normal Retirement Date. At the election of the Participant, the Participant may receive the Participant's Early Retirement Benefit as an annuity commencing at the Participant's Early Retirement Date, or at any date thereafter, in a reduced amount calculated by multiplying the Normal Retirement Benefit (based upon the Participant's years of credit Service and Final Average Compensation as of the Participant's Early Retirement Date) calculated under Section 5.01 by the appropriate factor as defined below and using linear interpolation for partial years as necessary. The Base Benefit as described in Section 5.01 will be reduced by 4.8 percent for each year before the Base Retirement Age as defined in the following table:
Year of Birth Base Retirement Age Before 1942 Age 60 1942 - 1944 Age 61 1945 - 1947 Age 62 1948 - 1950 Age 63 1951 - 1953 Age 64 After 1953 Age 65
The Additional Benefit as described in Section 5.01 will be reduced by eight percent for each year of early retirement from age 62 to age 65 and by four percent for each year of early retirement from age 55 to age 62. -18- Notwithstanding the foregoing, Participants electing early retirement prior to December 31, 1999, and prior to their 60th birthday will be eligible for the "Beef Up" provision. Under this provision, a Participant is eligible for a "Beefed Up" benefit if the Participant's date of retirement is one or more calendar years earlier than the earlier of (a) the Participant's 60th birthday, or (b) December 31, 1999. Under the provision, the Participant's Final Average Compensation will be the greater of that which is calculated under Section 1.28 or that which would be calculated under Section 1.28 if the Participant continued to work until the earlier of his 60th birthday or December 31, 1999, and earned in each future year the same as that which he earned in his final full year of employment. 5.04 Accrued Benefit -- Participant Who Has Attained Retirement Age. The -------------------------------------------------------------- Participant's Accrued Benefit shall be the Early, Normal, or Postponed Retirement Benefit to which the Participant would be entitled if he were to retire at such time, payable as an annuity for life commencing at Normal Retirement Age or, if the Participant has attained his Normal Retirement Age, as of the first of the calendar month coincident with or next following the date of calculation. 5.05 Accrued Benefit -- Who has Not Attained Retirement Age shall be: --------------------------------------------------------------- (a) Deferred Vested Benefit. A Participant who has incurred a Break in ----------------------- Service shall be entitled to an annual pension benefit, payable as a straight life annuity commencing at Normal Retirement Date equal to the Participant's Accrued Benefit on his Termination Date, provided that the Participant is vested under the provisions of Article 7, unless such Participant has been cashed out pursuant to Section 9.02. (b) Deferred Vested Benefit -- Early Commencement. A Participant entitled --------------------------------------------- to a Deferred Vested Benefit who has satisfied the Service requirement for entitlement to an Early Retirement Benefit and who subsequently satisfies the age requirements for entitlement to an Early Retirement Benefit shall be entitled to elect to receive his Deferred Vested Benefit at a date prior to the date on which it otherwise would be payable, in an Actuarial Equivalent amount calculated in accordance with the factors defined below and using linear interpolation for partial years as necessary: The Base Benefit and Additional Benefit as described in Section 5.01 will be reduced by eight percent for each year the benefit commences prior to age 65 but after age 60 and an additional four percent for each year the benefit commences prior to age 60. 5.06 Adjustment for Suspension of Benefits. The otherwise payable Early, ------------------------------------- Normal, or Postponed Retirement Benefit of any Participant who had previously become entitled to an Early, Normal, or Postponed Retirement Benefit, but whose benefit payments were suspended pursuant to the provisions of Article 4, shall be reduced by the Actuarial Equivalent of any payments previously made to him. -19- ARTICLE 6 REQUIRED BENEFIT LIMITATIONS ---------------------------- 6.01 Code Section 415 Limits. The benefits otherwise payable to a Participant, ----------------------- or a Beneficiary under this Plan and, where relevant, the Accrued Benefit of a Participant, shall be limited to the extent required, and only to the extent required, by the provisions of Section 415 of the Code and rulings, notices and regulations issued thereunder. To the extent applicable, Section 415 of the Code and rulings, notices, and regulations issued thereunder are hereby incorporated by reference into this Plan. In calculating these limits, the following rules shall apply: (a) Actuarial Equivalencies -- Effective as of April 1, 1995: ----------------------- (1) For purposes of determining the actuarial equivalent of the limitation described in Section 415(b)(2)(C) of the Code (and, except as provided in subparagraph (a)(2) of this Section 6.01, for purposes of determining the actuarial equivalent of the benefit as described in Section 415(b)(2)(B) of the Code), the mortality assumption used shall be the "applicable mortality table" described in Section 417(e)(3) of the Code and the interest rate assumption used shall be not less than the greater of 5% or the interest rate specified in Section 1.03. (2) For purposes of determining the actuarial equivalent of the benefit described in Section 415(b)(2)(B) of the Code for any form of benefit subject to Section 417(e)(3) of the Code, the mortality assumption used shall be the "applicable mortality table" described in Section 417(e)(3) of the Code and the interest rate assumption used shall be not less than the greater of the Applicable Interest Rate or the interest rate specified in Section 1.03. (3) For purposes of determining the actuarial equivalent of the limitation described in Section 415(b)(2)(D) of the Code, the mortality assumption used shall be the "applicable mortality table" described in Section 417(e)(3) of the Code and the interest rate assumption used shall be not greater than the lesser of 5% or the interest rate specified in Section 1.03. (b) Cost-of-Living Adjustments -- If the applicable Section 415 limits -------------------------- are increased after a benefit is in pay status by virtue of an adjustment to those limits reflecting a change in the cost-of-living index, benefit payments to a Participant or his Beneficiary shall be increased automatically to the maximum extent permitted under the revised limits. This increase shall occur only to the extent it would not cause the benefit to exceed the benefit to which the Participant or Beneficiary would have been entitled in the absence of the Section 415 limits. -20- (c) Surviving Spouse Payments -- If, upon the death of a Participant ------------------------- whose benefits were limited under this Section 6.01, the Participant's surviving Spouse shall be entitled to a benefit payment smaller than that which was payable while the Participant was alive, the benefit payments to the spouse shall equal the lesser of (1) and (2) below, where: (1) is the benefit payment that would be payable to the surviving Spouse if benefits under this Plan had not been limited by this Section 6.01, and (2) is the benefit payment that would be payable to the surviving Spouse if the benefit provided under this plan had been a Joint & Survivor Annuity with survivor benefits equal to 50 percent of the amount payable while the Participant was alive, in an amount equal to the maximum limitations provided under this Section 6.01. (d) Reduction for Participation in Defined Contribution Plans -- For any --------------------------------------------------------- Limitation Year beginning prior to December 31, 1999, if the Participant is, or ever has been, covered under one or more qualified defined contribution plans maintained by the Employer or an Affiliated Employer, the combined plan limits of Section 415(e) of the Code shall be calculated by reducing the limits applicable to this Plan first, prior to restricting annual additions to any such defined contribution plan. This subsection (d) shall have no force or effect for any Limitation Year beginning after December 31, 1999. (e) Reduction for Participation in Defined Benefit Plans -- If the ---------------------------------------------------- Participant is entitled to a benefit under any defined benefit plan that is, or ever has been, maintained by the Employer or an Affiliated Employer, the limits under this Section 6.01 shall be applied to the combined benefits payable and the benefit payable hereunder shall be reduced to the extent necessary to make the combined benefits meet the limits under this Section 6.01. (f) Average Compensation -- To calculate Average Compensation for an -------------------- Employee's high three years of service, compensation shall be the Employee's Compensation as defined in Section 1.15, and the three years' average shall be calculated using consecutive calendar years. 6.02 Special Limitation for 25 Highest-Paid Employees. The provision of this ------------------------------------------------ Section 6.02 shall apply to the 25 highest-paid Highly Compensated Employees or Highly Compensated Former Employees for a Plan Year. Subject to Section 6.03, if a benefit becomes or is payable for a Plan Year to such an Employee, it cannot exceed an amount equal to the payments that would be made during the Plan Year on behalf of the Employee under a single life annuity that is the Actuarial Equivalent of the sum of the Employee's Accrued Benefit and any other benefits under the Plan. -21- 6.03 Exceptions to Special Limitation. The provisions of Section 6.02 shall not -------------------------------- apply if: (a) the value of the benefits that would be payable to an Employee described in Section 6.02 are less than one percent of the value of current liabilities, or (b) the value of the assets held in the Fund equals or exceeds, immediately after payment of a benefit to an Employee described in Section 6.02, 110 percent of the value of current liabilities. For purposes of this Section, the value of current liabilities shall be as defined in Section 412(l)(7) of the Code. 6.04 Distributions Allowed if Security Furnished. A benefit that is restricted ------------------------------------------- pursuant to Section 6.02 may be nevertheless distributed if the Employee is obligated to repay the Plan, in the event of a termination of the Plan, any amount necessary for the distributions of assets to satisfy the requirements of Section 401(a)(4) of the Code. The amount the Employee shall be obligated to repay, at any time, shall not exceed a restricted amount, that shall equal, at any measurement date, the excess of the distributions the Employee has received over the amount that the Employee would have received had distributions commenced in a manner that would have not violated the provisions of Section 6.02, both accumulated at a reasonable rate of interest from the date payment was (or would have been) made to the measurement date. The Employee's obligation to repay must be secured by either: (a) an escrow account with an initial value at the date of distribution of at least 125 percent of the restricted amount, and at all times thereafter a value of at least 110 percent of the restricted amount, (b) a bond, issued by a surety approved by the U.S. Treasury as an acceptable surety for federal bonds, of 100 percent of the restricted amount, or (c) a bank letter of credit equal to 100 percent of the restricted amount. 6.05 Plan Termination Limit. In the event of Plan termination the benefit of ---------------------- any Highly Compensated Employee or Highly Compensated Former Employee shall be limited to a benefit that is nondiscriminatory under Section 401(a)(4) of the Code. 6.06 Highly Compensated Employee or Former Employee. The term "Highly ---------------------------------------------- Compensated Employee" shall mean an Employee who performs service during the Determination Year and is described in one or more of the following groups in accordance with IRS regulations: (a) An Employee who is or was a 5-percent owner (within the meaning of Section 414(q)(2) of the Code), at any time during the Determination Year or the Look-Back Year; or (b) An Employee who received Compensation during the Look-Back Year in excess of $80,000 (as adjusted for such Year pursuant to Sections 414(q)(1) and 415(d) of the Code) and was a member of the Top-Paid Group for such Year. The term "Highly Compensated Former Employee" shall mean a former Employee who has a separation year prior to the Determination Year and was a Highly Compensated active Employee for either: (1) such Employee's separation year or (2) any Determination Year ending on or after the Employee's 55th birthday. -22- A separation year is the Determination Year in which the Employee separates from Service. Notwithstanding the foregoing, an Employee who separated from Service before January 1, 1987, is a Highly Compensated Employee only if he was a five-percent owner or received Compensation in excess of $50,000 during (1) the Employee's separation year (or the year preceding such separation year), or (2) any year ending on or after such Employee's 55th birthday (or the last year ending before such Employee's 55th birthday). Notwithstanding anything to the contrary in this Plan, Sections 414(b), (c), (m), (n), and (o) of the Code are applied prior to determining whether an Employee is a Highly Compensated Employee. The above provisions of this Section 6.06 shall be effective as of January 1, 1997. 6.07 Definitions. For purposes of this Section and Section 6.06, ----------- (a) "Compensation" shall mean compensation as defined in Section 414(q)(4) and the regulations thereunder. (b) "Determination Year" shall mean the Plan Year for which the determination of who is Highly Compensated is being made. (c) "Look-Back Year" shall mean the 12-month period preceding the Determination Year. (d) "Top-Paid Group" shall mean the top twenty percent (20%) of all Employees when ranked on the basis of Compensation paid to such Employees during the year under consideration. The number and identity of Employees in the group will be determined in accordance with Section 414(q). (e) The Employer shall have the right to elect to determine Highly Compensated Employees by reference to calendar-year Compensation, in accordance with IRS regulations. If the Employer so elects, the Employer must make such election with respect to all qualified plans it or any Affiliated Employer maintains. -23- ARTICLE 7 VESTING ------- 7.01 General Rule. A Participant who incurs a Break in Service at a time when ------------ he is not entitled to an Early, Normal or Postponed Retirement Benefit under the provisions of Article 5 shall not be entitled to benefits under this Plan except as provided under the provisions of this Article. 7.02 Vesting at Normal Retirement Age. A Participant who has attained Normal -------------------------------- Retirement Age shall be fully vested in his Accrued Benefit. 7.03 Vesting Before Normal Retirement Age. A Participant who incurs a ------------------------------------ Termination at a time when he is not entitled to an Early, Normal or Postponed Retirement Benefit under the provisions of Article 5 shall be entitled to a Deferred Vested Benefit, payable as provided under Article 5, provided the Participant has attained five Years of Vesting Service at the time of Termination. For each Participant who both (a) became an Eligible Employee after April 1, 1995, and (b) prior to April 1, 1995, was employed by PMI for at least twelve (12) months, his or her Period of Service for such employment also shall be counted for purposes of determining his or her Years of Vesting Service. 7.04 Vesting Upon Plan Termination. In the event of termination or partial ----------------------------- termination of this Plan, each affected Participant shall be 100 percent vested in his Accrued Benefit, but only to the extent funded. The foregoing sentence shall not apply to a former Participant who has been cashed out (including those deemed cashed out under Section 7.05(c)) or who has incurred five consecutive One-Year Breaks in Service after his Termination Date. Such a former Participant shall not be entitled to any additional vested benefit upon Termination or partial Termination. 7.05 Vesting Service Disregarded. The Years of Vesting Service of a terminated --------------------------- Participant who is reemployed shall be determined in accordance with the following rules. (a) Prior Service Disregarded. If a Participant incurs a One-Year Break ------------------------- in Service, and his or her vested percentage interest in his or her Accrued Benefit under the Plan was 0% when the One-Year Break in Service began, and the number of his or her consecutive One-Year Breaks in Service exceeds the greater of (1) the number of his or her Years of Vesting Service, or (2) five, then his or her Years of Vesting Service credited before the One-Year Break in Service shall be disregarded. (b) Prior Service Counted. If a Participant does not incur a One-Year --------------------- Break in Service, or incurs a One-Year Break in Service, and: -24- (1) his or her vested percentage interest in his or her Accrued Benefit under the Plan was greater than 0% when the One-Year Break in Service began, or (2) the number of his or her consecutive One-Year Breaks in Service does not exceed the greater of (A) the number of his or her Years of Vesting Service, or (B) five, then the Years of Vesting Service credited before the Participant's termination shall be reinstated, effective as of his or her Reemployment Date. (c) Future Service Disregarded. In determining a Participant's Accrued -------------------------- Benefit and Years of Vesting Service for purposes of the Plan, if the Participant incurs a Termination Date and the nonforfeitable percentage of his or her Accrued Benefit at that time is zero, he shall be deemed to have received a complete distribution of the nonforfeitable portion of his or her Accrued Benefit at the time of his or her Termination Date, and shall immediately forfeit his or her Accrued Benefit. However, such forfeited Accrued Benefit shall be restored if the Participant has a Reemployment Date within five consecutive One-Year Breaks in Service following such Termination Date. The portion of a Participant's Accrued Benefit and Years of Vesting Service previously disregarded by a prior application of this paragraph shall not be counted for the purpose of the preceding sentences. 7.06 Repayment of Cash-Out. If an Employee shall have received a full --------------------- distribution of his nonforfeitable interest in this Plan following his Termination Date, he shall be entitled to repay the amount of that distribution to the Plan together with compound interest at the rate of five percent per annum for any period prior to the first day of the Plan Year beginning on or after January 1, 1988, and at the rate of 120 percent of the applicable federal midterm rate as in effect for the first month of the Plan Year for any Plan Year or portion of a Plan Year that commences on or after January 1, 1988. Any such repayment shall be made prior to the earlier of: (a) The fifth anniversary of the date on which the Employee was rehired by the Employer, or (b) The close of the first period of five consecutive One-Year Breaks in Service following the Participant's Termination Date. A Participant who is deemed to have been cashed out under Section 7.05(c) because he was not entitled to a Deferred Vested Benefit on his Termination Date shall be deemed to have properly made a repayment upon again becoming a Participant. Such a deemed repayment will not restore Years of Service which would not be counted under the provisions of Section 7.05(c) (the Rule of Parity). -25- 7.07 Vesting Service. A Participant shall be credited with a Year of Vesting --------------- Service as provided in Sections 1.66, 7.05 and 7.06, except that Vesting Service shall not include any Year of Service completed prior to the date of establishment of this Plan or the Predecessor to this Plan other than a Participant's service completed with Allstate prior to April 1, 1995, if the Participant was employed by Allstate on March 31, 1995 and by the Employer or an Affiliated Employer on April 1, 1995. -26- ARTICLE 8 QUALIFIED PRERETIREMENT SURVIVOR ANNUITY ---------------------------------------- 8.01 Automatic Preretirement Spousal Death Benefit --------------------------------------------- (a) Except as provided in subsection (b) below, in the event a Participant with a vested right to his Accrued Benefit under the Plan dies before his Benefit Commencement Date, a death benefit shall be provided to the Participant's Spouse as follows: (1) If the Participant at the date of death was eligible to retire and receive a benefit under the Plan at an Early, Normal or Postponed Retirement Date, then his surviving Spouse shall automatically receive a death benefit in an amount equal to one- half of the amount of the retirement benefit that would have been payable to the Spouse if the Participant had retired on the day preceding his death, receiving a benefit in the form of a Joint & Survivor Annuity with a 50 percent survivor annuity to the Spouse. (2) If the Participant at the date of death was not eligible to retire under the Plan and receive a benefit under the Plan at an Early, Normal, or Postponed Retirement Date, then the Participant's surviving Spouse shall receive an Automatic Preretirement Spousal Death Benefit in an amount equal to the amount that would have been payable to the spouse under the normal form of payment under Section 9.01, assuming: (A) the Participant had separated from service on the earlier of his Termination Date or date of his death, (B) the Participant had survived to the earliest date he could have retired and received a benefit under the Plan pursuant to Article 5, (C) the Participant retired on such date with a benefit in the form of a Joint & Survivor Annuity with a 50 percent survivor annuity to the Spouse but calculated using only actual Benefit Accrual Service as of the Participant's date of death, (and if the Participant was only partially vested on his date of death, multiplied by the Participant's vested percentage as determined under Section 7.03 on the date of death), and (D) the Participant died on the day after his Benefit Commencement Date. The Automatic Preretirement Spousal Death Benefit under this Section 8.01(a)(2) shall commence to be paid to the Spouse, unless the Spouse elects otherwise, as of the first day of the month coinciding with or next following the earliest date the -27- Participant could have retired and received a benefit under the Plan pursuant to Article 4, had he not died, and shall be paid up to the first day of the month in which such spouse dies. The Spouse may not delay commencement of the Automatic Preretirement Spousal Death Benefit beyond the Participant's Normal Retirement Date. (b) The Automatic Preretirement Spousal Death Benefit payable under this Article 8 shall be payable after the death of the Participant only if the Spouse had been married to the Participant throughout the one- year period ending on the date of the Participant's death. -28- ARTICLE 9 FORMS OF BENEFIT ---------------- 9.01 Qualified Joint & Survivor Annuity. At the earliest time a Participant ---------------------------------- could become entitled to commence receiving payments of an Early, Normal or Postponed Retirement Benefit or of a Deferred Vested Benefit, other than an involuntary lump sum payment under the provisions of Section 9.02, benefits shall commence in the form of a Qualified Joint & Survivor Annuity (which, for a Participant who has no Spouse, includes a single life annuity) unless the Participant, with the consent of his Spouse, if any, elects otherwise. Any consent of the Participant's Spouse shall be made within 90 days of the date the Qualified Joint & Survivor Annuity would otherwise commence, and shall be executed in accordance with the rules of Section 9.04. 9.02 Involuntary Lump Sum Payment. If at any time a Participant has incurred a ---------------------------- Termination but has not begun to receive benefit payments, and is entitled to a benefit (whether Early, Normal, or Postponed) or to a Deferred Vested Benefit, or a Beneficiary is entitled to a death benefit hereunder, that has an Actuarial Equivalent value of less than $5,000, the Actuarial Equivalent value shall be paid to such Participant or Beneficiary in a lump sum in lieu of, and in full satisfaction of, his benefit under this Plan. Neither the consent of the Beneficiary, the Participant nor of his Spouse shall be necessary to make such payment. Upon the making of such payment, neither the Beneficiary, the Participant nor his Spouse shall have any further benefit under this Plan. Participants deemed to have a zero accrued account benefit at Termination shall be deemed to have been cashed out under this Section 9.02. 9.03 Right to Elect. In lieu of the benefits provided by Section 9.01, the -------------- Participant shall have the right to elect, prior to his Benefit Commencement Date, an alternate form of benefit provided under the terms of this Article 9. If the Participant is married, any such election may be made only with the consent of his Spouse, executed as provided under Section 9.04. Any alternative form of benefit shall be the Actuarial Equivalent of the Participant's Accrued Benefit. 9.04 Election of Forms. A Participant may make or revoke an election of any ----------------- form of benefit to which the Participant is entitled under this Article 9 in writing to the Committee, and such election or revocation shall be subject to the following conditions: (a) The Committee shall furnish to each Participant a general written explanation in nontechnical terms of the availability of the various optional forms of payment under the Plan within a reasonable period of time prior to the earliest date the Participant could retire under the Plan. A Participant has a right to receive, within 30 days after filing a written request with the Committee, a written explanation of the terms and conditions of the Qualified Joint & Survivor Annuity, the Participant's right to make and the effect of an election to waive the Qualified Joint & Survivor Annuity, the -29- rights of the Participant's Spouse (if any), the right to make, and the effect of, a revocation of a previous election to waive the Qualified Joint & Survivor Annuity, and the financial effect upon the Participant, given in terms of dollars per annuity payment. Requests for additional information may be made by the Participant at any time before the 90th day prior to the Benefit Commencement Date. (b) An election to receive an optional form of benefit may be made at any time during the election period. The election period is a period of 90 days prior to the Participant's Benefit Commencement Date. Subject to subsection (c) below, a Participant may make an election not to receive the Qualified Joint & Survivor Annuity, revoke any previous election, and if the Participant so desires, make a new election, until the expiration of the election period. (c) If a Participant is married, an election of a form of benefit other than the Qualified Joint & Survivor Annuity will require the written consent of the Spouse, and such written consent must be witnessed by a notary public (or a representative of the Plan). (d) Any consent by a Spouse obtained under this Section 9.04 shall be effective only with respect to the specific form of benefit elected. Additionally, a married Participant's designation of a Beneficiary other than his or her Spouse shall not be effective unless the election designates a specific Beneficiary which may not be changed without spousal consent. (e) Notwithstanding any provision of the Plan to the contrary, a Participant's Benefit Commencement Date may be less than 30 days after the written explanation described in subsection (a) above is furnished to the Participant, provided that: (1) the Participant has been provided with information that clearly indicates that the Participant has at least 30 days to consider whether to waive the Qualified Joint & Survivor Annuity and elect (with spousal consent, if applicable) a form of distribution other than a Qualified Joint & Survivor Annuity, (2) the Participant is permitted to revoke any affirmative distribution election at least until the Benefit Commencement Date or, if later, at any time prior to the expiration of the 7-day period that begins the day after the explanation of the Qualified Joint & Survivor Annuity is provided to the Participant, (3) the Benefit Commencement Date is a date after the date that the written explanation was provided to the Participant, but may be a date before the date that an affirmative distribution election is made by the Participant, and (4) the distribution must not actually commence before the expiration of the foregoing 7-day period. 9.05 Optional Forms of Retirement Benefit. The optional forms which a ------------------------------------ Participant may elect are any one of the following: (a) 50 Percent or 100 Percent Joint & Survivor Annuitant Option -- An ----------------------------------------------------------- Actuarial Equivalent monthly benefit payable to the Participant for life, and after his death in the amount of 50 percent or 100 percent of such amount (as specified by the -30- Participant prior to commencement of benefits) to the Joint Annuitant for life. Should the Joint Annuitant die prior to the Participant's Benefit Commencement Date, any election of this option shall be automatically canceled. If the Participant should die prior to the Benefit Commencement Date, no payments shall be made under this option to the Joint Annuitant, but if the Joint Annuitant is the Spouse of the Participant, such Spouse will be entitled to the death benefit provided under Article 8. The factor to convert the life annuity to the 50 percent Joint & Survivor Annuitant Option above is 94 percent plus 0.3 percent for each full year that the Joint Annuitant is more than five years older than the Participant not to exceed 99 percent or minus 0.3 percent for each full year that the Joint Annuitant is more than five years younger than the Participant. The factor to convert the life annuity to the 100 percent Joint & Survivor Annuitant Option above is 89 percent plus 0.5 percent for each full year that the Joint Annuitant is more than five years older than the Participant not to exceed 99 percent or minus 0.5 percent for each full year that the Joint Annuitant is more than five years younger than the Participant. (b) Ten-Year Certain and Life Income Option -- An Actuarial Equivalent --------------------------------------- monthly benefit that provides retirement benefit payments to the Participant for his lifetime with a guaranteed minimum period of at least ten. In the event of the death of the Participant after the Benefit Commencement Date, but prior to the Participant's receiving retirement benefit payments for the whole Ten-Year Certain period, the remaining payments for the minimum term of years will be paid to the Participant's Beneficiary. In the event of the death of the Participant prior to the Participant's Benefit Commencement Date, the election of this option shall be void and of no effect. The factor to convert the life annuity to the above option will be 95 percent at age 65 plus 0.4 percent for each full year that the benefit commencement date precedes age 65 or minus 0.7 percent for each full year that the benefit commencement date is postponed past age 65. (c) Straight Life Annuity Option -- A Participant who has a Spouse may ---------------------------- elect to have the Participant's retirement benefit payable in equal, unreduced monthly payments during the Participant's lifetime, with no further payments to any other person after the Participant's death. If this option is elected, the retirement benefit payable to the Participant shall be the amount of retirement benefit determined under the applicable Section(s) of Article 5. (d) Lump Sum Payment Option -- A single payment equal to the Actuarial ----------------------- Equivalent of the Participant's accrued retirement benefit. 9.06 Beneficiary. A Participant may name a Joint Annuitant who is an individual ----------- for a Joint & Survivor Annuity option. For a Ten-Year Certain and Life Income Option, the Participant may elect, in writing, an individual or individuals, or any entity or entities, including -31- corporations, partnerships or trusts, provided that such individuals and entities are ascertainable, and the shares of each are clearly set forth. In the event any Beneficiary predeceases the Participant or is not in existence, not ascertainable, or cannot be located at the date benefits become payable to such beneficiary, benefits shall be paid to such contingent Beneficiary or Beneficiaries as shall have been named by the Participant on the Participant's original beneficiary election, and, if none, the contingent Beneficiary shall be the Participant's estate. 9.07 Eligible Rollover Distributions. ------------------------------- (a) Notwithstanding any provision of the Plan to the contrary that would otherwise limit a distributee's election under this Section, a distributee may elect, at the time and in the manner prescribed by the Committee, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover. (b) Definitions. (1) Eligible rollover distribution -- An eligible rollover ------------------------------ distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee's designated Beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Section 401(a)(9) of the Code; and the portion of any distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to Employer securities). (2) Eligible retirement plan -- An eligible retirement plan is an ------------------------ individual retirement account described in Section 408(a) of the Code, an individual retirement annuity described in Section 408(b) of the Code, an annuity plan described in Section 403(a) of the Code, or a qualified trust described in Section 401(a) of the Code, that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity. (3) Distributee -- A distributee includes an Employee or former ----------- Employee. In addition, the Employee's or former Employee's surviving Spouse and the Employee's or former Employee's Spouse or former Spouse who is the alternate payee under a Qualified Domestic Relations Order, as defined in Section 414(p) of the Code, are distributees with regard to the interest of the Spouse or former Spouse. -32- (4) Direct rollover -- A direct rollover is a payment by the Plan to --------------- the eligible retirement plan specified by the distributee. -33- ARTICLE 10 FUNDING ------- 10.01 Funding Agreement. The Employer has entered into a funding arrangement ----------------- with one or more Funding Agents providing for the administration of the Fund or Funds in which the assets of this Plan are held. The Employer may at any time or from time to time appoint one or more investment managers, as defined under Section 3(38) of ERISA, each of which shall direct the Funding Agent in the investment or reinvestment of all or part of the Fund. 10.02 Non-Diversion of the Fund. To the extent required by law, the principal ------------------------- or income of any Fund shall be used solely for the exclusive benefit of Participants or Beneficiaries, or to meet the necessary expenses of the Plan, except that upon termination of the Plan, after all the liabilities under the Plan have been satisfied, any property remaining in a Fund after satisfaction of all liabilities under this Plan shall be considered the result of erroneous actuarial computation and shall be distributed by the Funding Agent to the Employer. -34- ARTICLE 11 PLAN ADMINISTRATION ------------------- 11.01 Appointment of Committee.-- A Committee consisting of at least three ------------------------ members shall be appointed by the Board to administer the Plan on behalf of the Board. Vacancies in the Committee shall be filled from time to time by appointment of a new Committee member by the Board. A member of the Committee shall hold office until he gives written notice of his resignation to the Board, until death, or until removal by the Board. 11.02 Powers and Duties. ----------------- (a) The Committee shall have full power and discretion to administer the Plan and to construe and apply all of its provisions on behalf of the Employer. The Committee is the Named Fiduciary within the meaning of Section 402(a) of ERISA for purposes of Plan administration. The Committee's powers and duties, unless properly delegated, shall include, but shall not be limited to: (1) Designating agents to carry out responsibilities relating to the Plan, other than fiduciary responsibilities. (2) Deciding questions relating to eligibility, continuity of employment, and amounts of benefits. (3) Deciding disputes that may arise with regard to the rights of Employees, Participants and their legal representatives, or Beneficiaries under the terms of the Plan. Decisions by the Committee will be deemed final in each case. (4) Obtaining information from the Employer with respect to its Employees as necessary to determine the rights and benefits of Participants under the Plan. The Committee may rely conclusively on such information furnished by the Employer. (5) Compiling and maintaining all records necessary for the Plan. (6) Authorizing the Funding Agent to make payment of all benefits as they become payable under the Plan. (7) Engaging such legal, administrative, consulting, actuarial, investment, accounting, and other professional services as the Committee deems proper. (8) Adopting rules and regulations for the administration of the Plan that are not inconsistent with the Plan. The Committee may, in a nondiscriminatory -35- manner, waive the timing requirements of any notice or other requirements described in the Plan. Any such waiver will not obligate the Committee to waive any subsequent timing or other requirements for other Participants. (9) Interpreting and approving Qualified Domestic Relations Orders, as defined in Section 414(p) of the Code. (10) Making nonsubstantive amendments for the purpose of maintaining the qualified status of the Plan only. (11) Performing other actions provided for in other parts of this Plan. (b) The Employer shall have responsibility for, and shall be the Named Fiduciary for, the following purposes: (1) Selection of the funding media for the Plan, including the power to direct investments and to appoint an investment manager or managers pursuant to Section 402(c) of ERISA. (2) Allocating fiduciary responsibilities, other than trustee responsibilities as defined in Section 405(c) of ERISA, among fiduciaries, and designation of additional fiduciaries. (3) Selection of insurance contracts to provide benefits hereunder, or, if all assets are not held under insurance contracts, the Trustee. (c) The Trustee, if any, shall have responsibility for, and shall be the Named Fiduciary for the care and custody of, and, to the extent investment managers are not appointed by the Employer, management of Plan assets held by such Trustee other than insurance contracts. 11.03 Actions by the Committee. A majority of the members composing the ------------------------ Committee at any time will constitute a quorum. The Committee may act at a meeting, or in writing without a meeting, by the vote or assent of a majority of its members. The Committee will appoint a Committee Chairperson and a Secretary. The Secretary will record all action taken by the Committee. The Committee will have authority to designate in writing one of its members or any other person as the person authorized to execute papers and perform other ministerial duties on behalf of the Committee. 11.04 Interested Committee Members. No member of the Committee will participate ---------------------------- in an action of the Committee on a matter that applies solely to that member. Such matters will be determined by a majority of the remainder of the Committee. 11.05 Indemnification. The Employer, by the adoption of this Plan, indemnifies --------------- and holds the members of the Committee, jointly and severally, harmless from the effects and -36- consequences of their acts, omissions, and conduct in their official capacities, except to the extent that the effects and consequences result from their own willful misconduct, breach of good faith, or gross negligence in the performance of their duties. The foregoing right of indemnification will not be exclusive of other rights to which each such member may be entitled by any contract or other instrument or as a matter of law. 11.06 Conclusiveness of Action. Any action on matters within the discretion of ------------------------ the Committee will be conclusive, final, and binding upon all Participants in the Plan and upon all persons claiming any rights, including Beneficiaries. 11.07 Payment of Expenses. The members of the Committee will serve without ------------------- compensation for their services. The compensation or fees of consultants, actuaries, accountants, counsel and other specialists and any other costs of administering the Plan or Fund, including any premiums due to the Pension Benefit Guaranty Corporation (PBGC), will be paid by the Fund unless, at the discretion of the Employer, paid by the Employer. 11.08 Claim Procedure. Any Participant or Beneficiary may submit a written --------------- application to the Committee for payment of any benefit that may be due him under the Plan. Such application shall set forth the nature of the claim and any information as the Committee may reasonably request. Upon receipt of any such application, the Committee shall determine whether or not the Participant or Beneficiary is entitled to the benefit hereunder. If a claim is denied, in whole or in part, the Committee shall give written notice to any Participant or Beneficiary of the denial of a claim for the commencement, continuation or calculation of amount of retirement benefits under the Plan. The notice shall be given within 90 days after receipt of the Participant's or Beneficiary's application unless special circumstances require an extension for processing the claim. In no event shall such extension exceed a period of 90 days from the end of such initial review period. The notice will be delivered to the claimant or sent to the claimant's last known address, and will include the specific reason or reasons for the denial, a specific reference or references to pertinent Plan provisions on which the denial is based, a description of any additional material or information for the claimant to perfect the claim, which will indicate why such material or information is needed, and an explanation of the Plan's claims review procedure. If the claimant wishes to appeal the claim's denial, the claimant or a duly authorized representative will file a written request with the Committee for a review. This request must be made by the claimant within 60 days after receiving notice of the claim's denial. The claimant or representative may review pertinent documents relating to the claim and its denial and may submit issues and comments in writing to the Committee. Within 60 days after receipt of such a request for review, the Committee shall reconsider the claim and make a decision on the merits of the claim. If circumstances require an extension of time for processing the claim, the 60-day period may be extended but in no event more than 120 days after the receipt of a request for review. The decision on review will be in writing and include specific reasons and references to the pertinent Plan provisions on which the decision is based. -37- ARTICLE 12 FUNDING POLICY AND CONTRIBUTIONS -------------------------------- 12.01 Employer Contributions. The Employer intends to make contributions to fund ---------------------- this Plan at such times and in such amounts as the Actuary shall certify to the Employer as being no less than the amounts required to be contributed under Section 412 of the Code. Any actuarial gains arising under the Plan shall be used to reduce future Employer contributions to the Plan and shall not be applied to increase retirement benefits with respect to remaining Participants. 12.02 Participant Contributions. Participant contributions to the Fund are not ------------------------- permitted. 12.03 Contingent Nature of Contributions. Unless the Employer notifies the ---------------------------------- Committee and the Funding Agent in writing to the contrary, all contributions made to this Plan are conditioned upon their deductibility under Section 404 of the Code. -38- ARTICLE 13 AMENDMENT, TERMINATION AND MERGER OF THE PLAN --------------------------------------------- 13.01 Right to Amend the Plan. The Employer reserves the right to modify, alter ----------------------- or amend this Plan from time to time to any extent that it may deem advisable including, but without limiting the generality of the foregoing, any amendment deemed necessary to ensure the continued qualification of the Plan under Section 401 of the Code or the appropriate provisions of any subsequent revenue law. No such amendment shall increase the duties or responsibilities of a Funding Agent without its consent thereto in writing. No such amendment(s) shall have the effect of reinvesting in the Employer the whole or any part of the principal or income of the Fund or to allow any portion of the principal or income of the Fund to be used for any purposes other than for the exclusive benefit of Participants or Beneficiaries at any time prior to the satisfaction of all the liabilities under the Plan with respect to such persons. No amendment shall (a) reduce a Participant's Accrued Benefit on the effective date of the Plan amendment, (b) eliminate or reduce an early retirement benefit, retirement type subsidy or an optional form of benefit under the Plan with respect to the Participant's Accrued Benefit on the date of the amendment, or (c) reduce a retired Participant's retirement benefit as of the effective date of the amendment. 13.02 Right to Terminate the Plan. The Employer shall have the right to --------------------------- terminate this Plan at any time. In the event of such termination all affected Participants shall be vested as provided in Section 7.04. 13.03 Allocation of Assets and Surplus. In the event the Plan shall be -------------------------------- terminated as provided in Section 13.02 above, the then present value of retirement benefits vested in each Participant shall be determined as of the discontinuance date, and the assets then held by the Funding Agents as reserves for benefits for Participants, Joint Annuitants or Beneficiaries under this Plan shall, subject to any necessary approval by the PBGC be allocated, to the extent that they shall be sufficient, after providing for expenses of administration, in the order of precedence provided for under Section 4044 of ERISA, as modified by the provisions of Treasury Regulation Section 1.414(l)-l(f) or (h) if a special schedule of benefits (as defined in such regulations) is in effect as a result of a plan merger within the five-year period prior to the date of termination. The retirement benefits for which funds have been allocated in accordance with Section 4044 of ERISA shall be provided through the continuance of the existing Fund arrangements or through a new instrument entered into for that purpose and shall be paid either in a lump sum or in equal monthly installments through the purchase of a nontransferable annuity contract(s). After all liabilities of the Plan have been satisfied with respect to all Participants so affected by the Plan's termination, the Employer shall be entitled to any balance of Plan assets that shall remain. 13.04 Plan Mergers, Consolidations, and Transfers. The Plan shall not be ------------------------------------------- automatically terminated by the Employer's acquisition by or merger into any other company, trade or business, but the -39- Plan shall be continued after such merger provided the successor employer agrees to continue the Plan with respect to affected Participants herein. All rights to amend, modify, suspend or terminate the Plan with respect to Participants of the Employer shall be transferred to the successor employer, effective as of the date of the merger or acquisition. The merger or consolidation with, or transfer of the allocable portion of the assets and liabilities of the Fund to any other qualified retirement plan trust shall be permitted only if the benefit each Plan Participant would receive, if the Plan were terminated immediately after such merger or consolidation, or transfer of the allocable portion of the assets and liabilities, would be at least as great as the benefit he would have received had this Plan been terminated immediately before the date of merger, consolidation, or transfer. 13.05 Amendment of Vesting Schedule. If the vesting provisions of this Plan are ----------------------------- amended, including an amendment caused by the expiration of top-heavy status under the terms of Article 14, Participants with three or more Years of Service, or three or more years of employment, whether or not consecutive, at the later of the date the amendment is adopted or becomes effective, shall automatically be vested, from that point forward, in the greater of the amount vested under the vesting schedule as amended or the amount vested under the vesting schedule prior to amendment. -40- ARTICLE 14 TOP-HEAVY PLAN PROVISIONS ------------------------- 14.01 General Rule. For any Plan Year for which this Plan is a "Top-Heavy Plan" ------------ as defined in Section 14.06 below this Plan shall be subject to the provisions of this Article 14. 14.02 Vesting Provision. Each Participant who has completed an Hour of Service ----------------- during the Plan Year in which the Plan is top-heavy and has completed the number of Years of Vesting Service specified in the following table, shall have a vested right to the percentage of his Accrued Benefit under this Plan, correspondingly shown in the following table: Years of Percentage of Vesting Service Accrued Benefit Less than 2 years 0% 2 years 20% 3 years 40% 4 years 60% 5 years 80% 6 or more 100% Each Participant's Deferred Vested Benefit shall not be less than his vested Accrued Benefit determined as of the last day of the last Plan Year in which the Plan was not a Top-Heavy Plan. If the Plan ceases to be a Top-Heavy Plan, an Employee with three or more years of employment, whether or not consecutive, shall have his Deferred Vested Benefit determined either in accordance with this Section 14.02 or Section 7.03, as provided in Section 13.05. Each such Participant shall have the right to elect the applicable schedule within 60 days after the day he is issued written notice by the Committee, or as otherwise provided in accordance with regulations issued under the provisions of the Code relating to changes in the vesting schedule. 14.03 Minimum Benefit Provision. If the Plan is a Top-Heavy Plan in any Plan ------------------------- Year, each Participant who is a Non-Key Employee shall, as of the end of that Plan Year, be entitled to an Accrued Benefit that is at least equal to the Applicable Percentage of the Participant's Average Compensation for Years in the Testing Period. For purposes of this Section: (a) "Applicable Percentage" shall mean the lesser of two percent multiplied by Years of Service of the Participant, or 20 percent; -41- (b) "Average Compensation for Years in the Testing Period" shall mean average annual compensation for that period of five consecutive years that produces the highest average. In determining consecutive years, any year not included as a Year of Service under the provisions of Article 2 shall be ignored. In calculating Average Compensation for Years in the Testing Period, the amount of compensation taken into account shall not exceed $150,000 times the Adjustment Factor applicable at the date such benefits are calculated. 14.04 Change in 415(e) Limits. For any Limitation Year beginning prior to ----------------------- December 31, 1999, if the Plan is a Top-Heavy Plan the combined plan limit of Section 415(e) of the Code shall be applied by substituting "1.0" for "1.25" in Sections 415(e)(2)(b) and 415(e)(3)(b) of the Code. The first sentence of this Section 14.04 will not apply if the Plan is not a Super Top-Heavy Plan, as defined in Section 14.06, and if the Accrued Benefit of each Participant would meet the requirements of Section 14.03 if the Applicable Percentage under that Section were the lesser of (a) or (b) where: (a) is three percent multiplied by Years of Service, and (b) is 20 percent increased by one percent for each year the Plan was subject to the change in 415(e) limits under this Section 14.04, but not to more than 30 percent. 14.05 Coordination With Other Plans. In the event that another defined ----------------------------- contribution or defined benefit plan maintained by the Employer or an Affiliated Employer provides contributions or benefits on behalf of Participants in this Plan, such other plan shall be treated as part of this Plan pursuant to applicable principles (such as Rev. Rul. 81-202 or any successor ruling) in determining whether this Plan satisfies the requirements of Sections 14.02 and 14.03. Such determination shall be made upon the advice of counsel by the Committee. 14.06 Top-Heavy and Super Top-Heavy Plan Definition. This Plan shall be a --------------------------------------------- "Top-Heavy Plan" for any Plan Year if, as of the determination date (as defined in subsection 14.06(a)) the present value of the cumulative Accrued Benefits under the Plan for Participants (including former Participants) who are Key Employees (as defined in Section 14.07) exceeds 60 percent of the present value of the cumulative Accrued Benefits under the Plan for all Participants, excluding former Key Employees, or if this Plan is required to be in an aggregation group (as defined in Section 14.06(c)) which for such Plan Year is a top-heavy group (as defined in Section 14.06(d)). This Plan shall be a "Super Top-Heavy Plan" for any Plan Year if it meets the above definition after substituting "90 percent" for "60 percent." For purposes of this Section: (a) "Determination date" means for any Plan Year the last day of the immediately preceding Plan Year (Except that for the first Plan Year of this Plan the determination date means the last day of such Plan Year). (b) The present value shall be determined as of the most recent valuation date that is within the 12-month period ending on the determination date and as described in the -42- regulations under the Code. Present values for purposes of determining whether this Plan is a Top-Heavy Plan shall be based on the following interest and mortality rates: (1) Interest Rate -- eight percent annually. (2) Mortality Rate -- 1983 Group Annuity Mortality Table for Males. (c) "Aggregation group" means the group of plans, if any, that includes both the group of plans that are required to be aggregated and the group of plans that are permitted to be aggregated. (1) The group of plans that are required to be aggregated (the "required aggregation group") includes: (A) Each plan of an Affiliated Employer in which a Key Employee is a participant, including collectively bargained plans. (B) Each other plan, including collectively bargained plans of an Affiliated Employer, which enables a plan in which a Key Employee is a participant to meet the requirements of the Code prohibiting discrimination as to contributions or benefits in favor of Employees who are officers, shareholders or the highly compensated or prescribing the minimum participation standards. (2) The group of plans that are permitted to be aggregated (the "permissive aggregation group") includes the required aggregation group plus one or more plans of an Affiliated Employer that is not part of the required aggregation group and that the Committee certifies as constituting a plan within the permissive aggregation group. Such plan or plans may be added to the permissive aggregation group only if, after the addition, the aggregation group as a whole continues not to discriminate as to contributions or benefits in favor of officers, shareholders, or the highly- compensated and to meet the minimum participation standards under the Code. (d) "Top-heavy group" means the aggregation group, if as of the applicable determination date, the sum of the present value of the cumulative accrued benefits for Key Employees under all defined benefit plans included in the aggregation group plus the aggregate of the accounts of Key Employees under all defined contribution plans included in the aggregation group exceeds 60 percent of the sum of the present value of the cumulative accrued benefits for all Employees, excluding former Key Employees, under all such defined benefit plans plus the aggregate accounts for all Employees, excluding former Key Employees, under such defined contribution plans. If the aggregation group that is a top-heavy group is a required aggregation group, each plan in the group will be top-heavy. If the aggregation group that is a top-heavy group is a permissive aggregation group, only those plans that are part of the required -43- aggregation group will be treated as top-heavy. If the aggregation group is not a top-heavy group, no plan within such group will be top-heavy. (e) In determining whether this Plan constitutes a "Top-Heavy Plan," the Committee (or its agent) shall make the following adjustments in connection therewith: (1) When more than one plan is aggregated, the Committee shall determine separately for each plan as of each plan's determination date the present value of the accrued benefits or account balance. The results shall then be aggregated adding the results of each plan as of the determination dates for such plans that fall within the same calendar year. (2) In determining the present value of the cumulative Accrued Benefit or the amount of the account of any Employee, such present value or account shall include the amount in dollar value of the aggregate distributions made to such Employee under the applicable plan during the five-year period ending on the determination date, unless reflected in the value of the Accrued Benefit or account balance as of the most recent valuation date. Such amounts shall include distributions to Employees that represented the entire amount credited to their accounts under the applicable plan. (3) Further, in making such determination, such present value or such account shall include any rollover contribution (or similar transfer), as follows: (A) If the rollover contribution (or similar transfer) is initiated by the employee and made to or from a plan maintained by another employer, the plan providing the distribution shall include such distribution in the present value or such account; the plan accepting the distribution shall not include such distribution in the present value or such account unless the plan accepted it before December 31, 1983. (B) If the rollover contribution (or similar transfer) is not initiated by the Employee or made from a plan maintained by another employer, the plan accepting the distribution shall include such distribution in the present value or such account, whether the plan accepted the distribution before or after December 31, 1983; the plan making the distribution shall not include the distribution in the present value or such account. (4) Further, in making such determination, in any case where an individual is a "Non-Key Employee," as defined in Section 14.08 with respect to an applicable plan, but was a Key Employee with respect to such plan for any prior plan year, any accrued benefit and any account of such Employee shall be altogether disregarded. For this purpose, to the extent that a Key Employee is deemed to be a key employee if he met the definition of Key Employee -44- within any of the four preceding plan years, this provision shall apply following the end of such period of time. 14.07 Key Employee. The term "Key Employee" means any Employee or former ------------ Employee under this Plan who, at any time during the Plan Year containing the determination date or during any of the four preceding Plan Years, is or was one of the following: (a) An officer of the Employer having annual compensation greater than 50 percent of the amount in effect under Section 415(b)(1)(A) of the Code for such Plan Year. Whether an individual is an officer shall be determined by the Committee on the basis of all the facts and circumstances, such as an individual's authority, duties and term of office, not on the mere fact that the individual has the title of an officer. For any such Plan Year, there shall be treated as officers no more than the lesser of: (1) 50 Employees, or (2) the greater of three Employees or 10 percent of the Employees. For this purpose, the highest-paid officers shall be selected. (b) One of the ten Employees owning (or considered as owning, within the meaning of the constructive ownership rules of the Code) the largest interests in an Affiliated Employer. An Employee who has some ownership interest is considered to be one of the top ten owners unless at least ten other Employees own a greater interest than the Employee. However, an Employee will not be considered a top ten owner for a Plan Year if the Employee earns less than the amount in effect under Section 415(c)(1)(A) of the Code as in effect for the calendar year in which the determination date falls. (c) Any person who owns (or is considered as owning within the meaning of the constructive ownership rules of the Code) more than five percent of the outstanding stock of an Affiliated Employer or stock possessing more than five percent of the combined total voting power of all stock of the Employer. (d) A one-percent owner of an Affiliated Employer having an annual compensation from the Employer of more than $150,000, and possessing more than five percent of the combined total voting power of all stock of an Affiliated Employer. For purposes of this Section, Compensation means Compensation as defined in Section 415 of the Code. For purposes of parts (a), (b), (c), and (d) of this definition, a Beneficiary of a Key Employee shall be treated as a Key Employee. For purposes of parts (c) and (d), each Affiliated Employer is treated separately in determining ownership percentages; but, in determining the amount of Compensation, each Affiliated Employer is taken into account. -45- 14.08 Non-Key Employee. The term "Non-Key Employee" means any Participant who ---------------- is not a Key Employee. 14.09 Collective Bargaining Rules. The provisions of Sections 14.02, 14.03, and --------------------------- 14.04 do not apply with respect to any Employee included in a unit of Employees covered by a collective bargaining agreement unless the application of such Sections has been agreed upon with the collective bargaining agent. -46- ARTICLE 15 MISCELLANEOUS ------------- 15.01 Limitation on Distributions. Notwithstanding any provision of this Plan --------------------------- regarding payment to Beneficiaries or Participants, or any other person, the Committee may withhold payment to any person if the Committee determines that such payment may expose the Plan to conflicting claims for payment. As a condition for any payments, the Committee may require such consent, representations, releases, waivers or other information as it deems appropriate. The Committee may, in its discretion, comply with the terms of any judgment or other judicial decree, order, settlement or agreement including, but not limited to, a Qualified Domestic Relations Order as defined in Section 414(p) of the Code. 15.02 Limitation on Reversion of Contributions. Except as provided in ---------------------------------------- subsections (a) through (c) below, Employer contributions made under the Plan will be held for the exclusive benefit of Participants, Joint Annuitants or Beneficiaries and may not revert to the Employer. (a) A contribution made by the Employer under a mistake of fact may be returned to the Employer within one year after it is contributed to the Plan, to the extent that it exceeds the amount that would have been contributed, absent the mistake in fact. (b) A contribution conditioned on the Plan's initial qualification under Sections 401(a) and 501(a) of the Code may be returned to the Employer, if the Plan does not qualify, within one year after the date the Plan is denied qualification. (c) A contribution conditioned upon its deductibility under Section 404 of the Code, may be returned, to the extent the deduction is disallowed, to the Employer within one year after the disallowance. Compensation attributable to amounts that may be returned to the Employer pursuant to this Section may not be distributed, but, in the event that there are losses attributable to such amounts, the amount returned to the Employer shall be reduced by the amount of such losses. 15.03 Voluntary Plan. The Plan is purely voluntary on the part of the Employer --------------- and neither the establishment of the Plan nor any Plan amendment nor the creation of any fund or account, nor the payment of any benefits will be construed as giving any Employee or any person legal or equitable right against the Employer, any trustee or other Funding Agent, or the Committee unless specifically provided for in this Plan or conferred by affirmative action of the Committee or the Employer according to the terms and provisions of this Plan. Such actions will not be construed as giving any Employee or Participant the right to be retained in the service of the Employer. All Employees and/or Participants will remain subject to discharge to the same extent as though this Plan had not been established. -47- 15.04 Nonalienation of Benefits. Participants and Beneficiaries are entitled to ------------------------- all the benefits specifically set out under the terms of the Plan, but neither those benefits nor any of the property rights in the Plan are assignable or distributable to any creditor or other claimant of a Participant or Beneficiary. A Participant will not have the right to anticipate, assign, pledge, accelerate, or in any way dispose of or encumber any of the monies or benefits or other property that may be payable or become payable to such Participant or his Beneficiary provided, however, the Committee shall recognize and comply with a valid Qualified Domestic Relations Order as defined in Section 414(p) of the Code. 15.05 Inability to Receive Benefits. If the Committee receives evidence that a ----------------------------- person entitled to receive any payment under the Plan is physically or mentally incompetent to receive payment and to give a valid release, and another person or any institution is maintaining or has custody of such person, and no guardian, committee, or other representative of the estate of such person has been duly appointed by a court of competent jurisdiction, then any distribution made under the Plan may be made to such other person or institution. The release of such other person or institution will be a valid and complete discharge for the payment of such distribution. 15.06 Missing Persons. If the Committee is unable, after reasonable and --------------- diligent effort, to locate a Participant, Joint Annuitant, or Beneficiary where no contingent beneficiary is provided under the Plan, who is entitled to a distribution under the Plan, the distribution due such person will be forfeited after five years. If, however, such a person later files a claim for such benefit, it will be reinstated without any interest earned thereon. In the event that a distribution is due to a Beneficiary where a contingent beneficiary is provided under the Plan (including the situation in which the contingent beneficiary is the Participant's estate), and the Committee is unable, after reasonable and diligent effort, to locate the Beneficiary, the benefit shall be payable to the contingent beneficiary, and such nonlocatable Beneficiary shall have no further claim or interest hereunder. Notification by certified or registered mail to the last known address of the Participant or Beneficiary will be deemed a reasonable and diligent effort to locate such person. 15.07 Military Service. Notwithstanding any provision of this Plan to the ---------------- contrary, contributions, benefits and service credit with respect to qualified military service will be provided in accordance with Section 414(u) of the Code. 15.08 Limitation of Third-Party Rights. Nothing expressed or implied in the -------------------------------- Plan is intended or will be construed to confer upon or give to any person, firm, or association other than the Employer, the Participants or Beneficiaries, and their successors in interest, any right, remedy, or claim under or by reason of this Plan except pursuant to a Qualified Domestic Relations Order as defined in Section 414(p) of the Code. 15.09 Invalid Provisions. In case any provision of this Plan is held illegal or ------------------ invalid for any reason, the illegality or invalidity will not affect the remaining parts of the Plan. The Plan will be construed and enforced as if the illegal and invalid provisions had never been included. -48- 15.10 One Plan. This Plan may be executed in any number of counterparts, each -------- of which will be deemed an original and the counterparts will constitute one and the same instrument and may be sufficiently evidenced by any one counterpart. 15.11 Use and Form of Words. Whenever any words are used herein in the --------------------- masculine gender, they will be construed as though they were also used in the feminine gender in all cases where that gender would apply, and vice versa. Whenever any words are used herein in the singular form, they will be construed as though they were also used in the plural form in all cases where the plural form would apply, and vice versa. 15.12 Headings. Headings to Articles and Sections are inserted solely for -------- convenience and reference, and in the case of any conflict, the text, rather than the headings, shall control. 15.13 Governing Law. The Plan will be governed by and construed according to ------------- the federal laws governing employee benefit plans qualified under the Code and according to the laws of the state of California where such laws are not in conflict with the federal laws. IN WITNESS WHEREOF, The PMI Group, Inc. has adopted this amended and restated Plan effective as of January 1, 1998 (except as otherwise specified herein). THE PMI GROUP, INC. By: ----------------------------- Name: --------------------------- Title: -------------------------- -49- EX-10.20 5 EMPLOYEE STOCK PURCHASE PLAN THE PMI GROUP, INC. EMPLOYEE STOCK PURCHASE PLAN (Amended and Restated as of August 16, 1999) TABLE OF CONTENTS
Page SECTION 1 PURPOSE....................................................................................... 1 SECTION 2 DEFINITIONS................................................................................... 1 2.1 "1934 Act"........................................................................................ 1 2.2 "Board"........................................................................................... 1 2.3 "Code"............................................................................................ 1 2.4 "Committee"....................................................................................... 1 2.5 "Common Stock".................................................................................... 1 2.6 "Company"......................................................................................... 1 2.7 "Compensation".................................................................................... 1 2.8 "Eligible Employee"............................................................................... 1 2.9 "Employee"........................................................................................ 2 2.10 "Employer" or "Employers"........................................................................ 2 2.11 "Enrollment Date"................................................................................ 2 2.12 "Grant Date"..................................................................................... 2 2.13 "Participant".................................................................................... 2 2.14 "Plan"........................................................................................... 2 2.15 "Purchase Date".................................................................................. 2 2.16 "Subsidiary"..................................................................................... 2 SECTION 3 SHARES SUBJECT TO THE PLAN..................................................................... 2 3.1 Number Available.................................................................................. 2 3.2 Adjustments....................................................................................... 2 SECTION 4 ENROLLMENT..................................................................................... 2 4.1 Participation..................................................................................... 2 4.2 Payroll Withholding............................................................................... 3 SECTION 5 OPTIONS TO PURCHASE COMMON STOCK............................................................... 3 5.1 Grant of Option................................................................................... 3 5.2 Duration of Option................................................................................ 3 5.3 Number of Shares Subject to Option................................................................ 3 5.4 Other Terms and Conditions........................................................................ 3 SECTION 6 PURCHASE OF SHARES............................................................................. 4 6.1 Exercise of Option................................................................................ 4 -i-
TABLE OF CONTENTS (continued)
Page 6.2 Delivery of Shares.............................................................................................. 4 6.3 Exhaustion of Shares............................................................................................ 4 SECTION 7 WITHDRAWAL................................................................................................... 4 7.1 Withdrawal....................................................................................................... 4 SECTION 8 CESSATION OF PARTICIPATION................................................................................... 4 8.1 Termination of Status as Eligible Employee....................................................................... 4 SECTION 9 DESIGNATION OF BENEFICIARY................................................................................... 5 9.1 Designation...................................................................................................... 5 9.2 Changes.......................................................................................................... 5 9.3 Failed Designations.............................................................................................. 5 SECTION 10 ADMINISTRATION.............................................................................................. 5 10.1 Plan Administrator............................................................................................... 5 10.2 Actions by Committee............................................................................................. 5 10.3 Powers of Committee.............................................................................................. 5 10.4 Decisions of Committee........................................................................................... 6 10.5 Administrative Expenses.......................................................................................... 6 10.6 Eligibility to Participate....................................................................................... 6 10.7 Indemnification.................................................................................................. 6 SECTION 11 AMENDMENT, TERMINATION, AND DURATION........................................................................ 7 11.1 Amendment, Suspension, or Termination............................................................................ 7 11.2 Duration of the Plan............................................................................................. 7 SECTION 12 GENERAL PROVISIONS.......................................................................................... 7 12.1 Participation by Subsidiaries.................................................................................... 7 12.2 Inalienability................................................................................................... 7 12.3 Severability..................................................................................................... 7 12.4 Requirements of Law.............................................................................................. 7 12.5 Compliance with Rule 16b-3....................................................................................... 7 12.6 No Enlargement of Employment Rights.............................................................................. 8 12.7 Apportionment of Costs and Duties................................................................................ 8 12.8 Construction and Applicable Law.................................................................................. 8 12.9 Captions......................................................................................................... 8 -ii-
TABLE OF CONTENTS (continued)
Page 12.10 EXECUTION............................................................................................. 8 -iii-
THE PMI GROUP, INC. EMPLOYEE STOCK PURCHASE PLAN SECTION 1 PURPOSE The PMI Group, Inc. hereby establishes The PMI Group, Inc. Employee Stock Purchase Plan, effective as of July 23, 1998, in order to provide eligible employees of the Company and its participating Subsidiaries with the opportunity to purchase Common Stock through payroll deductions. The Plan is intended to qualify as an employee stock purchase plan under Section 423(b) of the Code. The Plan is hereby amended and restated on the occasion of the Company's 3-for-2 stock split, effective as of August 16, 1999. SECTION 2 DEFINITIONS 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 "Board" means the Board of Directors of the Company. ----- 2.3 "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 under such Section, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such Section or regulation. 2.4 "Committee" shall mean the committee appointed by the Board to --------- administer 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. As of the effective date of the Plan, the Plan shall be administered by the Compensation and Nominating Committee of the Board. 2.5 "Common Stock" means the common stock of the Company. ------------ 2.6 "Company" means The PMI Group, Inc., a Delaware corporation. ------- 2.7 "Compensation" means a Participant's base salary or regular wages ------------ (including sick pay and vacation pay). The Committee, in its discretion, may (on a uniform and nondiscriminatory basis) establish a different definition of Compensation prior to an Enrollment Date for all options to be granted on such Enrollment Date. 2.8 "Eligible Employee" means every Employee of an Employer, except ----------------- (a) any Employee who immediately after the grant of an option under the Plan, would own stock and/or hold outstanding options to purchase stock possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company or of any Subsidiary of the Company (including stock attributed to such Employee pursuant to Section 424(d) of the Code), or (b) as provided in the following sentence. The Committee, in its discretion, from time to time may, prior to an Enrollment Date for all options to be granted on such Enrollment Date, determine (on a uniform and nondiscriminatory basis) that an Employee shall not be an Eligible Employee if he or she: (1) has not completed at least one year of service since his or her last hire 1 date (or such lesser period of time as may be determined by the Committee in its discretion), (2) customarily works not more than 20 hours per week (or such lesser period of time as may be determined by the Committee in its discretion), (3) customarily works not more than 5 months per calendar year (or such lesser period of time as may be determined by the Committee in its discretion), or (4) is an officer or other manager. 2.9 "Employee" means an individual who is a common-law employee of -------- any Employer, whether such employee is so employed at the time the Plan is adopted or becomes so employed subsequent to the adoption of the Plan. 2.10 "Employer" or "Employers" means any one or all of the Company -------- --------- and those Subsidiaries which, with the consent of the Board, have adopted the Plan. 2.11 "Enrollment Date" means such dates as may be determined by the --------------- Committee (in its discretion and on a uniform and nondiscriminatory basis) from time to time. 2.12 "Grant Date" means any date on which a Participant is granted an ---------- option under the Plan. 2.13 "Participant" means an Eligible Employee who (a) has become a ----------- Participant in the Plan pursuant to Section 4.1 and (b) has not ceased to be a Participant pursuant to Section 8 or Section 9. 2.14 "Plan" means The PMI Group, Inc. Employee Stock Purchase Plan, ---- as set forth in this instrument and as hereafter amended from time to time. 2.15 "Purchase Date" means such dates as may be determined by the ------------- Committee (in its discretion and on a uniform and nondiscriminatory basis) from time to time prior to an Enrollment Date for all options to be granted on such Enrollment Date. 2.16 "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. SECTION 3 SHARES SUBJECT TO THE PLAN 3.1 Number Available. A maximum of 300,000 shares of Common Stock ---------------- shall be available for issuance pursuant to the Plan. Shares sold under the Plan may be newly issued shares or treasury shares. 3.2 Adjustments. In the event of any reorganization, ----------- recapitalization, stock split, reverse stock split, stock dividend, combination of shares, merger, consolidation, offering of rights or other similar change in the capital structure of the Company, the Board may make such adjustment, if any, as it deems appropriate in the number, kind and purchase price of the shares available for purchase under the Plan and in the maximum number of shares subject to any option under the Plan. SECTION 4 ENROLLMENT 4.1 Participation. Each Eligible Employee may elect to become a ------------- Participant by enrolling or re-enrolling in the Plan effective as of any Enrollment Date. In order to enroll, an 2 Eligible Employee must complete, sign and submit to the Company an enrollment form in such form, manner and by such deadline as may be specified by the Committee from time to time (in its discretion and on a nondiscriminatory basis). Any Participant whose option expires and who has not withdrawn from the Plan automatically will be re-enrolled in the Plan on the Enrollment Date immediately following the Purchase Date on which his or her option expires. 4.2 Payroll Withholding. On his or her enrollment form, each ------------------- Participant must elect to make Plan contributions via payroll withholding from his or her Compensation. Pursuant to such procedures as the Committee may specify from time to time, a Participant may elect to have withholding equal to any whole percentage (or such other percentage that the Committee may establish from time to time for all options to be granted on any Enrollment Date). A Participant may elect to increase or decrease his or her rate of payroll withholding by submitting a new enrollment form in accordance with such procedures as may be established by the Committee from time to time. A Participant may stop his or her payroll withholding by submitting a new enrollment form in accordance with such procedures as may be established by the Committee from time to time. In order to be effective as of a specific date, an enrollment form must be received by the Company no later than the deadline specified by the Committee, in its discretion and on a nondiscriminatory basis, from time to time. Any Participant who is automatically re-enrolled in the Plan will be deemed to have elected to continue his or her contributions at the percentage last elected by the Participant. SECTION 5 OPTIONS TO PURCHASE COMMON STOCK 5.1 Grant of Option. On each Enrollment Date on which the --------------- Participant enrolls or re-enrolls in the Plan, he or she shall be granted an option to purchase shares of Common Stock. 5.2 Duration of Option. Each option granted under the Plan shall ------------------ expire on the earliest to occur of (a) the completion of the purchase of shares on the last Purchase Date occurring within 27 months of the Grant Date of such option, (b) such shorter option period as may be established by the Committee from time to time prior to an Enrollment Date for all options to be granted on such Enrollment Date, or (c) the date on which the Participant ceases to be such for any reason. Until otherwise determined by the Committee for all options to be granted on an Enrollment Date, the period referred to in clause (b) in the preceding sentence shall mean the period from the applicable Enrollment Date through the last business day prior to the immediately following Enrollment Date. 5.3 Number of Shares Subject to Option. The number of shares ---------------------------------- available for purchase by each Participant under the option will be established by the Committee from time to time prior to an Enrollment Date for all options to be granted on such Enrollment Date. In addition and notwithstanding the preceding, an option (taken together with all other options then outstanding under this Plan and under all other similar employee stock purchase plans of the Employers) shall not give the Participant the right to purchase shares at a rate which accrues in excess of $25,000 of fair market value at the applicable Grant Dates of such shares in any calendar year during which such Participant is enrolled in the Plan at any time. 5.4 Other Terms and Conditions. Each option shall be subject to the -------------------------- following additional terms and conditions: (a) payment for shares purchased under the option shall be made only through payroll withholding under Section 4.2; 3 (b) purchase of shares upon exercise of the option will be accomplished only in accordance with Section 6.1; (c) the price per share under the option will be determined as provided in Section 6.1; and (d) the option in all respects shall be subject to such other terms and conditions (applied on a uniform and nondiscriminatory basis), as the Committee shall determine from time to time in its discretion. SECTION 6 PURCHASE OF SHARES 6.1 Exercise of Option. Subject to Section 6.2, on each Purchase ------------------ Date, the funds then credited to each Participant's account shall be used to purchase whole shares of Common Stock. Any cash remaining after whole shares of Common Stock have been purchased shall be used to purchase fractional shares of Common Stock. The price per Share of the Shares purchased under any option granted under the Plan shall be eighty-five percent (85%) of the lower of: (a) the average of the high and low price per Share on the Grant Date for such option on the New York Stock Exchange; or (b) the average of the high and low price per Share on the Purchase Date on the New York Stock Exchange. 6.2 Delivery of Shares. As directed by the Committee in its sole ------------------ discretion, shares purchased on any Purchase Date shall be delivered directly to the Participant or to a custodian or broker (if any) designated by the Committee to hold shares for the benefit of the Participants. As determined by the Committee from time to time, such shares shall be delivered as physical certificates or by means of a book entry system. 6.3 Exhaustion of Shares. If at any time the shares available under -------------------- the Plan are over-enrolled, enrollments shall be reduced proportionately to eliminate the over-enrollment. Such reduction method shall be "bottom up", with the result that all option exercises for one share shall be satisfied first, followed by all exercises for two shares, and so on, until all available shares have been exhausted. Any funds that, due to over-enrollment, cannot be applied to the purchase of whole shares shall be refunded to the Participants (without interest thereon). SECTION 7 WITHDRAWAL 7.1 Withdrawal. A Participant may withdraw from the Plan by ---------- submitting a completed enrollment form to the Company. A withdrawal will be effective only if it is received by the Company by the deadline specified by the Committee (in its discretion and on a uniform and nondiscriminatory basis) from time to time. When a withdrawal becomes effective, the Participant's payroll contributions shall cease and all amounts then credited to the Participant's account shall be distributed to him or her (without interest thereon). SECTION 8 CESSATION OF PARTICIPATION 8.1 Termination of Status as Eligible Employee. A Participant shall ------------------------------------------ cease to be a Participant immediately upon the cessation of his or her status as an Eligible Employee (for 4 example, because of his or her termination of employment from all Employers for any reason). As soon as practicable after such cessation, the Participant's payroll contributions shall cease and all amounts then credited to the Participant's account shall be distributed to him or her (without interest thereon). If a Participant is on a Company-approved leave of absence, his or her participation in the Plan shall continue for so long as he or she remains an Eligible Employee and has not withdrawn from the Plan pursuant to Section 7.1. SECTION 9 DESIGNATION OF BENEFICIARY 9.1 Designation. Each Participant may, pursuant to such uniform and ----------- nondiscriminatory procedures as the Committee may specify from time to time, designate one or more Beneficiaries to receive any amounts credited to the Participant's account at the time of his or her death. Notwithstanding any contrary provision of this Section 9, Sections 9.1 and 9.2 shall be operative only after (and for so long as) the Committee determines (on a uniform and nondiscriminatory basis) to permit the designation of Beneficiaries. 9.2 Changes. 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 like manner. 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 designation or revocation 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. 9.3 Failed 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 estate. SECTION 10 ADMINISTRATION 10.1 Plan Administrator. 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. 10.2 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. 10.3 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 discretionary powers: (a) To interpret and determine the meaning and validity of the provisions of the Plan and the options and to determine any question arising under, or in connection with, the administration, operation or validity of the Plan or the options; (b) To determine any and all considerations affecting the eligibility of any employee to become a Participant or to remain a Participant in the Plan; 5 (c) To cause an account or accounts to be maintained for each Participant; (d) To determine the time or times when, and the number of shares for which, options shall be granted; (e) To establish and revise an accounting method or formula for the Plan; (f) To designate a custodian or broker to receive shares purchased under the Plan and to determine the manner and form in which shares are to be delivered to the designated custodian or broker; (g) To determine the status and rights of Participants and their Beneficiaries or estates; (h) To employ such brokers, counsel, agents and advisers, and to obtain such broker, legal, clerical and other services, as it may deem necessary or appropriate in carrying out the provisions of the Plan; (i) To establish, from time to time, rules for the performance of its powers and duties and for the administration of the Plan; (j) To 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; and (k) 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. 10.4 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. 10.5 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, except any stamp duties or transfer taxes applicable to the purchase of shares may be charged to the account of each Participant. Any brokerage fees for the purchase of shares by a Participant shall be paid by the Company, but fees and taxes (including brokerage fees) for the transfer, sale or resale of shares by a Participant, or the issuance of physical share certificates, shall be borne solely by the Participant. 10.6 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. 10.7 Indemnification. Each of the Employers shall, and hereby does, --------------- indemnify and hold harmless the members of the Committee and the Board, from and against any and all losses, claims, damages or liabilities (including attorneys' fees and amounts paid, with the approval of the Board, in settlement of any claim) arising out of or resulting from the implementation of a 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. 6 SECTION 11 AMENDMENT, TERMINATION, AND DURATION 11.1 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. If the Plan is terminated, the Board, in its discretion, may elect to terminate all outstanding options either immediately or upon completion of the purchase of shares on the next Purchase Date, or may elect to permit options to expire in accordance with their terms (and participation to continue through such expiration dates). If the options are terminated prior to expiration, all amounts then credited to Participants' accounts which have not been used to purchase shares shall be returned to the Participants (without interest thereon) as soon as administratively practicable. 11.2 Duration of the Plan. The Plan shall commence on the date -------------------- specified herein, and subject to Section 11.1 (regarding the Board's right to amend or terminate the Plan), shall remain in effect thereafter. SECTION 12 GENERAL PROVISIONS 12.1 Participation by Subsidiaries. One or more Subsidiaries of the ----------------------------- Company may become participating Employers by adopting the Plan and obtaining approval for such adoption from the Board. By adopting the Plan, a Subsidiary shall be deemed to agree to all of its terms, including (but not limited to) the provisions granting exclusive authority (a) to the Board to amend the Plan, and (b) to the Committee to administer and interpret the Plan. An Employer may terminate its participation in the Plan at any time. The liabilities incurred under the Plan to the Participants employed by each Employer shall be solely the liabilities of that Employer, and no other Employer shall be liable for benefits accrued by a Participant during any period when he or she was not employed by such Employer. 12.2 Inalienability. In no event may either a Participant, a former -------------- Participant or his or her 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. 12.3 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. 12.4 Requirements of Law. The granting of options and the issuance ------------------- of shares shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or securities exchanges as the Committee may determine are necessary or appropriate. 12.5 Compliance with Rule 16b-3. Any transactions under this Plan -------------------------- with respect to officers (as defined in Rule 16a-1 promulgated under the 1934 Act) are intended to comply with all applicable conditions of Rule 16b-3. To the extent any provision of the Plan or action by the Committee fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. Notwithstanding any contrary provision of the Plan, if the Committee specifically determines that compliance with Rule 16b-3 no longer is required, all references in the Plan to Rule 16b-3 shall be null and void. 7 12.6 No Enlargement of Employment Rights. Neither the establishment ----------------------------------- or maintenance of the Plan, the granting of options, the purchase of shares, 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, with or without cause. 12.7 Apportionment of Costs and Duties. All acts required of the --------------------------------- Employers under the Plan may be performed by the Company for itself and its Subsidiaries, and the costs of the Plan may 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 Employers who is thereunto duly authorized by the Employers. 12.8 Construction and Applicable Law. The Plan is intended to ------------------------------- qualify as an "employee stock purchase plan" within the meaning of Section 423(b) of the Code. Any provision of the Plan which is inconsistent with Section 423(b) of the Code shall, without further act or amendment by the Company or the Committee, be reformed to comply with the requirements of Section 423(b). The provisions of the Plan shall be construed, administered and enforced in accordance with such Section and with the laws of the State of California (excluding California's conflict of laws provisions). 12.9 Captions. The captions contained in and the table of contents -------- prefixed to the Plan are inserted only as a matter of convenience, 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: __________, 1999 By ____________________________ Title: 8 EX-11.1 6 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, 1999, 1998 and 1997
1999 1998 1997 ---------- ---------- -------- (In thousands, except for per share data) Basic net income per common share: Net income $204,466 $190,360 $175,309 Average common shares outstanding 44,893 47,091 50,079 -------- -------- -------- Basic net income per common share $ 4.55 $ 4.04 $ 3.50 ======== ======== ======== Diluted net income per common share: Net income $204,466 $190,360 $175,309 -------- -------- -------- Average common shares outstanding 44,893 47,091 50,079 Net shares to be issued upon exercise of dilutive stock options after applying treasury stock method 351 208 186 -------- -------- -------- Average shares outstanding 45,244 47,299 50,265 -------- -------- -------- Diluted net income per common share $ 4.52 $ 4.02 $ 3.49 ======== ======== ========
(1) Restated to conform with Statement of Financial Accounting Standards No. 128, Earnings per Share. EX-12.1 7 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, --------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------ ------------ ------------ --------------- ------------- (Dollars in Thousands) Income from continuing operations before income taxes $ 290,086 $ 266,948 $ 242,867 $ 222,106 $ 180,541 ============ ============ ============ =============== ============= Fixed Charges: Rentals-- at computed interest* $ 2,760 $ 2,959 $ 2,549 $ 2,459 $ 2,046 Interest expense 8,554 7,029 6,766 907 - Distributions on redeemable capital securities 8,311 8,311 7,617 - - ------------ ------------ ------------ --------------- ------------- Total fixed charges $ 19,625 $ 18,299 $ 16,932 $ 3,366 $ 2,046 ============ ============ ============ =============== ============= Profit before taxes plus fixed charges $ 309,711 $ 285,247 $ 259,799 $ 225,472 $ 182,587 ============ ============ ============ =============== ============= Ratio of adjusted profit to fixed charges 15.8 15.6 15.3 x 67.0 89.2 ============ ============ ============ =============== =============
* Those portions of rent expense that are representative of interest cost EX-13.1 8 SUPPLEMENTARY DATA PORTIONS OF 1999 ANNUAL REPORT EXHIBIT 13.1 Item 6. Selected Financial Data Eleven Year Summary of Financial and Operating Data (Dollars in thousands, except per share data or otherwise noted)
1999 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- ---- Summary of Consolidated Operations: Net premiums written ................... $ 571,253 $ 489,100 $ 432,052 $ 403,020 $ 314,021 $ 277,747 =========== =========== =========== =========== =========== =========== Premiums earned ........................ $ 558,623 $ 491,226 $ 453,948 $ 412,738 $ 328,756 $ 296,345 Investment income, less investment expense ................... 95,142 84,681 83,136 67,442 62,041 56,774 Realized capital gains, net ............ 509 24,636 19,584 14,296 11,934 3,064 Other income ........................... 15,850 20,366 7,979 6,948 2,309 3,802 ----------- ----------- ----------- ----------- ----------- ----------- Total revenues ......................... 670,124 620,909 564,647 501,424 405,040 359,985 Total losses and expenses (1) .......... 380,038 353,961 321,780 279,318 224,499 221,434 ----------- ----------- ----------- ----------- ----------- ----------- Income from continuing operations before taxes .............. 290,086 266,948 242,867 222,106 180,541 138,551 Income (loss) from discontinued operations .............. -- -- -- -- -- -- Income tax expense (benefit) (2) ....... 85,620 76,588 67,558 64,188 45,310 32,419 ----------- ----------- ----------- ----------- ----------- ----------- Net income ............................. $ 204,466 $ 190,360 $ 175,309 $ 157,918 $ 135,231 $ 106,132 =========== =========== =========== =========== =========== =========== U.S. Mortgage Insurance Operating Ratios: Loss ratio ............................. 24.7% 32.8% 38.2% 41.9% 38.5% 40.5% Expense ratio .......................... 29.2% 25.5% 22.7% 18.4% 24.9% 30.1% ----------- ----------- ----------- ----------- ----------- ----------- Combined ratio ......................... 53.9% 58.3% 60.9% 60.3% 63.4% 70.6% =========== =========== =========== =========== =========== =========== Consolidated Balance Sheet Data: Total assets ........................... $ 2,101,762 $ 1,777,870 $ 1,686,603 $ 1,509,919 $ 1,304,440 $ 1,097,421 Reserve for losses and loss adjustment expenses .................. $ 282,000 $ 215,259 $ 202,387 $ 199,774 $ 192,087 $ 173,885 Long-term debt ......................... $ 145,367 $ 99,476 $ 99,409 $ 99,342 $ -- $ -- Preferred capital securities of subsidiary trust .................. $ 99,075 $ 99,040 $ 99,006 $ -- $ -- $ -- Shareholders' equity ................... $ 1,217,268 $ 1,097,515 $ 1,061,180 $ 986,862 $ 870,503 $ 687,178 Shares Outstanding (thousands).......... 44,702 45,418 48,692 51,765 52,515 52,500 Per Share Data: Net income Operating ........................... $ 4.51 $ 3.69 $ 3.23 $ 2.83 $ 2.43 $ 1.98 Basic ............................... $ 4.55 $ 4.04 $ 3.50 $ 3.01 $ 2.58 $ 2.02 Diluted (3) ......................... $ 4.52 $ 4.02 $ 3.49 $ 3.00 $ 2.57 $ 2.02 Shareholders' equity ................... $ 27.23 $ 24.16 $ 21.79 $ 19.06 $ 16.58 $ 13.09 Price/Earnings Ratio (4) ............... 10.8 8.9 14.9 13.0 12.5 -- Stock Price(5): Close ................. 48 13/16 32 59/64 48 13/64 36 59/64 30 11/64 -- High .................. 55 1/2 57 49 21/64 40 35 43/64 -- Low ................... 26 43/64 22 31 53/64 26 37/64 24 Cash dividends declared ................ $ 0.14 $ 0.13 $ 0.13 $ 0.13 $ 0.10 $ -- PMI Operating and Statutory Data: Number of policies in force ............ 749,985 714,210 698,831 700,084 657,800 612,806 Default rate ........................... 2.12% 2.31% 2.38% 2.19% 1.98% 1.88% Persistency ............................ 71.9% 68.0% 80.8% 83.3% 86.4% 83.6% Direct primary insurance in force (in millions) ............... $ 86,729 $ 80,682 $ 77,787 $ 77,312 $ 71,430 $ 65,982 Direct primary risk in force (in millions) ........................ $ 21,159 $ 19,324 $ 18,092 $ 17,336 $ 15,130 $ 13,243 Statutory capital ...................... $ 1,372,273 $ 1,193,899 $ 1,114,342 $ 988,475 $ 824,156 $ 659,402 Risk-to-capital ratio .................. 14.8:1 14.9:1 14.6:1 15.9:1 15.8:1 17.7:1 New insurance written (NIW) ............ $28,732,505 $27,820,065 $15,307,147 $17,882,702 $14,459,260 $18,441,612 Policies issued ........................ 219,038 211,161 119,190 142,900 119,631 156,055 Return on Equity ....................... 18.5% 19.0% 18.3% 17.8% 18.1% 17.3% Tax Rate ............................... 29.5% 28.7% 27.8% 28.9% 25.1% 23.4% NIW market share ....................... 16.3% 14.8% 12.7% 14.1% 13.2% 14.0% Total PMI Employees ...................... 1,113 1,016 916 586 578 586
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 ============ ============ ========== =========== =========== U.S. 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 Shares Outstanding ..................... $ 52,500 $ 52,500 $ 52,500 $ 52,500 $ 52,500 Per Share Data: Net income Operating ........................... $ 1.12 $ 2.13 $ 1.05 $ 1.01 $ 0.74 Basic ............................... $ 1.14 $ 2.14 $ 1.07 $ 1.00 $ 0.74 Diluted (3) ......................... $ 1.14 $ 2.14 $ 1.07 $ 1.00 $ 0.74 Shareholders' equity ................... $ 10.96 $ 9.78 $ 7.61 $ 6.45 $ 5.46 Price/Earnings Ratio (4) ............... $ -- $ -- $ -- $ -- $ -- Stock Price(5): Close ................. $ -- $ -- $ -- $ -- $ -- High .................. $ -- $ -- $ -- $ -- $ -- Low ................... $ -- $ -- $ -- $ -- $ -- 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 Return on Equity ....................... 11.0% 24.6% 15.2% 16.8% 13.5% Tax Rate ............................... 21.5% -11.5% 57.1% 15.9% 6.3% NIW market share ....................... 18.6% 19.4% 15.9% 14.9% 13.7% Total PMI Employees ...................... 632 529 410 400 379
(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 judgement 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 earning per share per Statement of Financial Accounting Standards No. 128. "Earnings per Share (4) Based on closed price as of 12/31 on trailing twelve month operating. (5) Close price as of 12/31. High and Low price for trailing twelve month period adjusted for 3-for-2 stock split. (6) Dividends adjusted to reflect 3-for-2 stock split. ITEM 7. 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) that statement that management believes this shift from refinance activity to purchase money generally increases the private mortgage insurance penetration rate; (ii) the statement that management anticipates that with stable to increasing interest rates, the refinancing trend will continue to decrease in 2000; (iii) the statement that management believes any increase in the maximum FHA loan amount could 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; (iv) the statement that during 2000, management expects the percentage of PMI's risk related to risk- share programs, excluding pool risk, to continue to increase as a percentage of total risk; (v) the statement that management is uncertain about the amount of new pool risk that will be written in 2000, but believes total new 2000 pool risk will be less than in 1999; (vi) the statement that management expected the Fannie Mae and Freddie Mac reduction in mortgage insurance coverage requirements would have negatively impacted the growth rate of direct risk in force; however, PMI's percentage of insurance in force with higher coverage percentages continues to increase as mortgage lenders and investors continue to prefer MI policies with higher coverage percentages; (vii) the statement that management anticipates that the percentage of new insurance written ("NIW") subject to captive mortgage reinsurance agreements and other risk-share programs will continue to increase in 2000 and beyond. In addition, the anticipated continued growth of captive reinsurance arrangements is expected to reduce the Company's net premiums written and net premiums earned; (viii) the statement that management anticipates the percentage of insurance in force with higher coverage percentages will continue to increase due to greater acceptance of this product by mortgage lenders and investors; (ix) the statement that although management expects that California should continue to account for a significant portion of total claims paid, management anticipates that with a continuing vibrant California economy, loss mitigation efforts and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline; (x) the statement that management believes that PMI's total default rate could increase in 2000 due to the continued maturation of insurance in force; (xi) the statement that management anticipates that contract underwriting will continue to generate a significant, but 1 decreasing percentage of PMI's NIW in 2000; and (xii) the statement that management expects international mortgage insurance operations to generate a greater percentage of consolidated net income in 2000 and beyond. 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 the section captioned "Cautionary Statements and Investment Considerations" ("IC# 1-15") 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: 1999 versus 1998 Consolidated net income was $204.5 million in 1999, a 7.4% increase over 1998. The growth can be attributed to increases in premiums earned of 13.7%, net investment income of 12.4% and to a decrease in losses and loss adjustment expenses of 17.0%, partially offset by an increase in acquisition, underwriting and other operating expenses of 23.5% and a decrease in realized capital gains of $24.1 million. These results include the operations of PMI Mortgage Insurance Ltd. ("PMI Ltd.", see Footnote 3, "Acquisitions", of the Consolidated Financial Statements) from the acquisition date of August 6 through December 31, 1999, which contributed $6.7 million to net income. Diluted net earnings per share (including realized capital gains) increased by 12.4% to $4.52 in 1999. Excluding capital gains, diluted operating earnings per share increased by 22.2% to $4.51. Consolidated revenues in 1999 increased by 7.9% to $670.1 million. U.S. Mortgage Insurance Operations The Company's primary operating subsidiary, PMI Mortgage Insurance Co. ("PMI"), generated over 90% of consolidated net income, which was derived from mortgage 2 guaranty insurance written in the United States. During 1999, PMI's new insurance written ("NIW") increased by 1.7% to $28.3 billion primarily as a result of the growth in volume of the private mortgage insurance industry and the increase in PMI's market share. During 1999, PMI wrote an additional $0.5 billion of seasoned insurance (mortgages insured over one year after the closing date) not included in NIW. 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 0.8% to a new record level of $188.9 billion. This increase was the result of the second highest year of total residential mortgage originations, estimated at $1.3 trillion compared with $1.5 trillion in 1998 (Source: Inside Mortgage Finance). Total mortgage originations were driven primarily by continued low interest rates in the first half of the year. During the second half of the year, interest rates began to rise, which decreased refinance activity and increased the percentage of "purchase money" originations. This shift from refinance activity to purchase money generally increases the private mortgage insurance penetration rate (the percent of total mortgage originations insured by MICA). MICA's penetration rate increased to 14.7% in 1999 from 12.4% in 1998. Management anticipates that with stable to increasing interest rates, the refinancing trend will continue to decrease in 2000. The increase in new insurance written was partially offset by decline in the private mortgage insurance companies' market share to 52.4% of the total low downpayment market (insurable loans) from 56.3% in 1998. Management believes the decrease resulted in part from the increase in the maximum individual loan amount the FHA can insure. Any increase in the maximum FHA loan amount could 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. PMI's market share of NIW increased to 15.0% in 1999 from 14.8% in 1998 (Source: Inside Mortgage Finance). On a combined basis with CMG Mortgage Insurance Company ("CMG"), market share increased to 16.3% in 1999 compared with 16.1% in 1998. The increases in market share were primarily due to the acceptance by its customers of PMI's value added, risk sharing and GSE pool products. GSE pool risk in force totaled $681.4 million and $450.0 million as of December 31, 1999 and 1998, respectively. Primary risk in force under risk-share programs with PMI's customers, excluding pool insurance, represented 20.2% of total risk in force at December 31, 1999, compared with 10.2% at December 31, 1998. During 2000, management expects the percentage of PMI's risk related to risk-share programs, excluding pool risk, to continue to increase as a percent of total risk. Management is uncertain about the amount of new pool risk that will be written in 2000, but believes total new 2000 pool risk will be less than in 1999. Management expected the Fannie Mae and Freddie Mac reduction in mortgage insurance coverage requirements would have negatively impacted the growth rate of direct risk in force. However, PMI's percentage of insurance in force with higher coverage percentages continues to increase as mortgage lenders and investors continue to prefer MI policies with higher coverage percentages. 3 PMI's cancellations of insurance in force decreased by 10.8% to $22.2 billion in 1999 primarily due to the increase in interest rates during the second half of the year causing the decrease in refinancing activity. As a result of the decrease in policy cancellations, PMI's persistency rate increased to 71.9% as of December 31, 1999, compared with 68.0% as of December 31, 1998. Insurance in force increased by 7.4% to $86.7 billion at December 31, 1999. On a combined basis with CMG, insurance in force grew by 9.0% to $92.5 billion at December 31, 1999. PMI's market share of combined insurance in force increased by 0.2 percentage points to 15.5% (Source: Inside Mortgage Finance). PMI's risk in force increased by 9.5% and, when combined with CMG, grew by 10.8% to $22.6 billion. The growth rate of risk in force is greater than insurance in force and is due to terminating policies being replaced by new policies with higher coverage percentages. Consolidated U.S. mortgage insurance net premiums written (which includes net cessions and refunds) grew by 12.0% to $459.1 million in 1999. This increase was 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, the increase in the persistency rate and to the recapture agreement of the Old Pool business reinsured by Forestview Mortgage Insurance Company ("Forestview", see Footnote 7 "Reinsurance" of the Consolidated Financial Statements). The Forestview old pool risk in force was $1.4 billion at December 31, 1999. Refunded premiums decreased by 28.8% to $15.6 million as a result of the decrease in policy cancellations. Ceded premiums written increased by 32.5% to $22.3 million due to the increasing popularity and usage of captive reinsurance arrangements. Approximately 25% of new insurance written in 1999 was subject to captive mortgage reinsurance agreements. Management anticipates that the percent of NIW subject to captive mortgage reinsurance agreements and other risk-share programs will continue to increase in 2000 and beyond. In addition, the anticipated continued growth of captive reinsurance arrangements is expected to reduce the Company's net premiums written and net premiums earned. Mortgage insurance premiums earned increased 8.6% to $447.2 million in 1999 primarily due to the increase in premiums written, partially offset by an increase in unearned premiums related to Forestview. As discussed above, the percentage of PMI's insurance in force with deeper coverage continued to increase despite new product offerings by Fannie Mae and Freddie Mac. Mortgages with original loan-to-value ratios greater than 95% and equal to or less than 97% ("97s") with 35% insurance coverage increased to 4.5% of risk in force as of December 31, 1999, from 2.9% as of December 31, 1998. Mortgages with original loan-to-value ratios greater than 90% and equal to or less than 95% ("95s") with 30% insurance coverage increased to 37.6% of risk in force as of December 31, 1999, from 34.4% as of December 31, 1998. Mortgages with original loan-to-value ratios greater than 85% and equal to or less than 90% ("90s") with 25% insurance coverage increased to 31.8% of risk in force as of December 31, 1999, compared with 29.2% as of December 31, 1998. Management anticipates the percentage of insurance in force with higher 4 coverage percentages will continue to increase due to greater acceptance of this product by mortgage lenders and investors. Mortgage insurance losses and loss adjustment expenses decreased 18.2% to $110.5 million in 1999 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 3.8% to 15,893 at December 31, 1999. PMI's national default rate decreased by 0.19 percentage points to 2.12% at December 31, 1999, primarily due to an increase in policies in force, along with the decrease in loans in default. Direct primary claims paid decreased by 32.8% to $79.6 million due to a 13.3% decrease in the average claim size to approximately $20,200 and a 22.3% decline in the number of claims paid to 3,945 in 1999. The reduction in average claims size 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. If interest rates continue to rise in 2000, loss mitigation opportunities may decrease. The decrease in the number of claims paid is due to the improvement in nationwide housing markets and the overall national economic expansion. The default rate on PMI's California portfolio decreased to 2.59% (representing 2,382 loans in default) at December 31, 1999, from 3.15% (representing 3,067 loans in default) at December 31, 1998. Policies written in California accounted for approximately 29.3% and 48.2% of the total dollar amount of claims paid in 1999 and 1998, respectively. Although management expects that California will continue to account for a significant portion of total claims paid, management anticipates that with a continuing vibrant California economy, loss mitigation efforts and improved default reinstatement rates, California claims paid as a percentage of total claims paid should continue to decline. Management believes that PMI's total default rate could increase in 2000 due to the maturation of insurance in force. Mortgage insurance policy acquisition costs incurred and deferred (including, among other field expenses, contract underwriting expenses) increased by 2.3% to $85.9 million in 1999 primarily as a result of the 3.3% increase in NIW. Amortization of policy acquisition costs increased 33.2% to $80.3 million primarily due to 1998 and 1999 deferrals (See Note 6 "Deferred Acquisition Costs" of Notes to Consolidated Financial Statements). A significant portion of policy acquisition costs relates to contract underwriting. New policies processed by contract underwriters represented 28.8% of PMI's NIW in 1999 compared with 35.0% in 1998. Contract underwriting is the preferred method among many mortgage lenders for processing loan applications. Management anticipates that contract underwriting will continue to generate a significant, but decreasing, percentage of PMI's NIW in 2000. Underwriting and other mortgage insurance operating expenses increased by 21.9% to $54.0 million in 1999 due primarily to an increase in the amortization of certain obsolete computer equipment and operating 5 systems associated with Y2K remediation efforts, and secondarily to increases in payroll and related costs. The mortgage insurance loss ratio declined by 8.1 percentage points to 24.7% in 1999. The decrease can be attributed to the growth in premiums earned coupled with the decrease in losses and loss adjustment expenses, as discussed above. The expense ratio increased by 3.7 percentage points to 29.2% primarily due to the increase in the amortization of policy acquisition costs and the increase in underwriting and other mortgage insurance expenses, partially offset by the increase in net premiums written. In addition, the increase in captive reinsurance premium cessions negatively affected the expense ratio. The combined ratio decreased by 4.4 percentage points to 53.9% in 1999. International Mortgage Insurance Operations During 1999, the Company commenced operations in Australia and Hong Kong. The Company's Australian affiliate, PMI Ltd., was acquired on August 6, 1999. For the period beginning August 6, 1999 through December 31, 1999, PMI Ltd. generated $12.1 million of net premiums written and $11.3 million in net premiums earned. Mortgage insurance loss expenses since the acquisition were $1.2 million and underwriting and other expenses were $4.5 million. Financial results for the operations in Hong Kong were immaterial during 1999. Management expects international mortgage insurance operations to generate a greater percentage of consolidated net income in 2000 and beyond. Title Insurance Operations Title insurance premiums earned increased 26.2% to $100.1 million in 1999 primarily due to American Pioneer Title Insurance Company's ("APTIC") expansion into new states. APTIC was licensed in 41 states at December 31, 1999. In 1999, 72.9% of APTIC's premiums earned came from its Florida operations, compared with 77.3% in 1998. Underwriting and other expenses increased 27.6% to $88.2 million because of an increase in agency fees and commissions related to the increase in premiums earned. The title insurance combined ratio increased by 1.2 percentage points to 89.1%. Other In 1999, the Company's consolidated net investment income (excluding realized capital gains) increased by $10.4 million to $95.1 million. This increase is primarily due to an increase in the investment portfolio of approximately $250 million (including $160.9 million as a result of PMI Ltd.) and secondarily to an increase in equity earnings of $3.8 million. Investments in affiliates increased to $91.5 million at year-end 1999 from $60.5 million at year-end 1998. The average book yield of the investment portfolio decreased from 6.1% in 1998 to 5.9% in 1999 due to a higher percentage of the portfolio invested in tax-free municipal bonds. Realized capital gains decreased by $24.1 million to $0.5 million due to the restructuring of the investment portfolio in 1998. 6 Other income, primarily contract underwriting revenues generated by PMI Mortgage Services Co. ("MSC"), decreased by 22.1% to $15.9 million in 1999. Contract underwriting revenues decreased by 39.6% as a result of the decrease in refinance activity in the second half of 2000. Operating expenses incurred by MSC decreased by 35.6% to $18.3 million as a result of the decrease in refinance activity in the second half of 2000. The Company's effective tax rate increased to 29.5% in 1999 from 28.7% in 1998 as a result of a decrease in the proportion of tax-exempt investment income relative to total income. 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, 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, 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, 7 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 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. 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. 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 this decrease should accelerate in the years following due to a reduction in required mortgage insurance by Fannie Mae and Freddie Mac. 8 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. 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. 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. 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 6 "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. 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 with 22.6% for 1997. The combined ratio decreased by 2.6% to 58.3% in 1998. 9 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 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. Other income, primarily contract underwriting revenues generated by 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. 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. 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 the lesser of 10% of the policyholder surplus as of the preceding year or the last calendar year's net income, not including realized capital gains. 10 The terms of the $45.8 million credit agreement dated August 3, 1999 executed among TPG, PMI Mortgage Insurance Australia (Holdings) Pty Limited, and Bank of America, N.A., ("Credit Agreement") in connection with the Company's acquisition of PMI Ltd, provide in part that: (i) TPG's consolidated net worth shall not be less than $600 million; (ii) PMI's statutory capital (as defined) shall not be less than $675 million; (iii) the risk to capital ratio shall not exceed 23 to 1; and (iv) TPG's consolidated debt to capital ratio shall not exceed 0.40 to 1.0. Failure to maintain such financial covenants or debt restrictions may be deemed an event of default. Pursuant to the guarantee executed by TPG in connection with the Credit Agreement, if an event of default occurs under the Credit Agreement or under any other indebtedness, all outstanding amounts under the Credit Agreement may be accelerated and become immediately payable by TPG. Further, pursuant to the terms of an indenture for $100 million 6 3/4% senior notes ("Note") issued by TPG on November 15, 1996; and the terms of two lines of credit agreements each in the amount of $25 million ("Credit Lines"), in the event of default under any indebtedness, all outstanding amounts under the Credit Lines and Note may be accelerated and become immediately payable by TPG. At December 31, 1999, there were no outstanding borrowings under the credit lines. In addition to the dividend restrictions described above, the Company's Credit Lines 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 1999, APTIC declared and paid a cash dividend of $3.0 million to TPG, substantially the full amount of a dividend that can be paid by APTIC in 1999 without prior permission from the Florida Department of Insurance. PMI declared and paid extraordinary dividends of $94.4 million to TPG in 1999. 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 company announced a stock repurchase program in the amount of $100.0 million authorized by the TPG Board of Directors in November 1998. During 1999, TPG purchased $24.8 million of the Company's common stock. As of December 31, 1999, TPG had approximately $95 million of available funds. This amount has increased from the December 31, 1998 balance of $55 million due to the receipt of dividends from PMI and APTIC, partially offset by an increase in the investment of RAM Reinsurance Company Ltd. ("RAM Re") and common stock repurchases. 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 11 advance of the payment of claims. Cash flows generated from PMI's operating activities totaled $237.3 million and $154.0 million in 1999 and 1998, respectively. The Company's invested assets increased by $285.1 million at December 31, 1999 due to cash flows from consolidated operations of $314.8 million and the addition of PMI Ltd's investment portfolio of $160.9 million. This increase was offset by a net unrealized loss of $80.2 million, the funds used in the acquisition of PMI Ltd., the common stock repurchases and dividends paid of $5.2 million. Consolidated reserves for losses and loss adjustment expenses increased by 31.0% in 1999 to $282.0 million primarily due to the addition of Old Pool loss reserves of $42.5 million in connection with the recapture agreement with Forestview, and to increases in primary and GSE pool loss reserves. Consolidated shareholders' equity increased by $119.8 million in 1999, consisting of increases of $204.5 million from net income and $1.0 million from stock option activity, offset by $54.3 million from other comprehensive losses net of unrealized gains on investments, common stock repurchases of $24.8 million, and dividends declared of $6.6 million. PMI's statutory risk-to-capital ratio at December 31, 1999 was 14.8:1, compared with 14.9:1 at December 31, 1998. CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS GENERAL ECONOMIC CONDITIONS (IC1) Changes in economic conditions, including economic recessions, declining housing values, higher unemployment rates, deteriorating borrower credit, rising interest rates, increases in refinance activity caused by declining interest rates, or combinations of these factors could reduce the demand for mortgage insurance, cause claims on policies issued by PMI to increase, and increase PMI's loss experience. MARKET SHARE AND COMPETITION (IC2) The Company's financial condition and results of operations could be harmed 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. 12 The mortgage insurance industry is highly competitive. Several of the Company's competitors in the mortgage insurance industry have greater direct or indirect capital reserves that provide them with potentially greater flexibility than the Company. PMI also competes directly with federal and state governmental and quasi- governmental agencies, principally the FHA and, to a lesser degree, the VA. In addition, the captive reinsurance subsidiaries of national banks, savings institutions, or bank holding companies could become significant competitors of the Company in the future. Other mortgage lenders are also forming reinsurance affiliates that compete with the Company. The Gramm-Leach-Bliley Act of 1999 could lead to additional significant competitors of the Company in the future. On October 4 1999, the Federal Housing Finance Board adopted resolutions which authorizes each Federal Home Loan Bank ("FHLB") to offer programs to fund or purchase single-family conforming mortgage loans originated by participating member institutions under the single-family member mortgage assets program program. Under this program, each FHLB is also authorized to provide credit enhancement for eligible loans. Any expansion of the FHLBs' ability to issue mortgage insurance or use alternatives to mortgage insurance could reduce the demand for private mortgage insurance and harm the Company's financial condition 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, as well as similar products, competes with mortgage insurance as an alternative for lenders selling loans in the secondary mortgage market. If the 80/10/10 product or a similar product becomes a widely accepted alternative to mortgage insurance, the Company's financial condition and results of operations could suffer. Legislation and regulatory changes affecting the FHA have affected demand for private mortgage insurance. In particular, increases in the maximum loan amount that the FHA can insure can reduce the demand for private mortgage insurance. For example, management believes the decline in the MICA members' share of the mortgage insurance business from 56.3% at December 31, 1998 to approximately 52.4% at December 31, 1999 resulted in part from the increase in the maximum individual loan amount the FHA can insure. The Department of Housing and Urban Development has announced a proposed increase in the maximum individual loan amount that FHA can insure to $219,849 from $208,800. If this increase is approved, demand for private mortgage insurance could decrease. In addition, the Omnibus Spending Bill of 1999, signed into law on October 21, 1998, streamlined the FHA down-payment formula and made FHA insurance more competitive with private mortgage insurance in areas with higher home prices. 13 FANNIE MAE AND FREDDIE MAC (IC3) Fannie Mae and Freddie Mac are collectively referred to as government-sponsored enterprises ("GSEs"). The GSEs are permitted by charter 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, provided the minimum insurance coverage requirement is met. During 1999, Fannie Mae and Freddie Mac separately announced programs where reduced mortgage insurance coverage will be made available for lenders that deliver loans approved by the GSEs' automated underwriting services. Although management has not seen any significant movement towards the reduced coverage programs offered by the GSEs' to date, if the reduction in required levels of mortgage insurance were to become widely accepted by mortgage lenders and their customers, the reduction could harm the Company's financial condition and results of operations. On April 13, 1999 the Office of Federal Housing Enterprise Oversight announced proposed risk-based capital regulations, which could treat more favorably credit enhancements issued by private mortgage insurance companies with a claims-paying ability rating of AAA or higher compared with those companies with an AA or lower rating. Any shifts in the GSE's preferences for private mortgage insurance to other forms of credit enhancement, including a tiering of mortgage insurers based on their credit rating, could harm the Company's financial condition and results of operations. Freddie Mac has made several announcements that it would pursue a permanent charter amendment that would allow it to utilize alternative forms of default loss protection 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 approaches, which may include a reduction in the use of mortgage insurance. 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. A loss of PMI's existing eligibility status, either due to a failure to maintain the 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. 14 INSURANCE IN FORCE (IC4) A significant percentage of PMI's premiums earned is generated from its existing insurance in force and not from new insurance written. The policy owner or servicer of the loan may cancel insurance coverage at any time. A decline in insurance in force as a result of a decrease in persistency due to policy cancellations of older books of business could harm the Company's financial condition and results of operations. The Home Owners Protection Act of 1998, 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. Management is uncertain about the impact of this 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 operations. During an environment of falling interest rates, an increasing number of borrowers refinance their mortgage loans and PMI generally experiences 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 RATING AGENCIES (IC5) 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. On March 10, 2000, Standard & Poor's affirmed the AA+ financial strength rating and claims-paying ability rating of PMI. During June 1999, Moody's affirmed the Aa2 financial strength rating and claims-paying ability rating of PMI. During March 1999, Moody's announced that it changed PMI's and TPG's rating outlook from stable to negative, stating such action was based on TPG's stock repurchases, PMI's writing of GSE pool and diversification into new sectors. A reduction in PMI's claims-paying ratings below AA-would seriously harm effect the Company's financial condition and results of operations (See IC3). 15 LIQUIDITY (IC6) 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 level and severity of claims experienced by the Company's insurance subsidiaries, 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 these factors could adversely affect the Company's ability to maintain capital resources to meet its business needs. CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS (IC7) 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. The Company also generally agrees to assume the cost of repurchasing underwritten-deficient loans that have been contract underwritten, a remedy not available under the Company's master primary insurance policies. Due to the demand of contract underwriting services, limitations on the number of available underwriting personnel, 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 its underwriting services obligations, could harm 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 suffer if PMI or the Company experiences delays in introducing competitive new products and programs or if these products or programs are less profitable than the Company's existing products and programs. INSURANCE REGULATORY MATTERS (IC8) On January 31, 2000, the Illinois Department of Insurance issued a letter addressed to all mortgage guaranty insurers licensed in Illinois. The letter states that it may be a violation of Illinois law for mortgage insurers to offer to Illinois mortgage lenders the opportunity to purchase certain notes issued by a mortgage insurer or an affiliate, or to participate in loan guaranty programs. The letter also states that a violation might occur if mortgage insurers offer lenders coverage on pools of mortgage loans at a discounted or below market premium in return for the lenders' referral of primary mortgage insurance business. In addition, the letter stated that, to the extent a performance guaranty actually transfers risk to the lender in return for a fee, the lender may be deemed to be doing an insurance business in Illinois without authorization. The letter announced that any 16 mortgage guaranty insurer that is participating in the described or similar programs in the State of Illinois should cease such participation or alternatively, provide the Department with a description of any similar programs, giving the reason why the provisions of Illinois are not applicable or not violated. PMI is reviewing the Illinois Letter. If the Illinois Department of Insurance were to determine that PMI was not in compliance with Illinois law, the Company's financial condition and results of operations could be harmed 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, the Company's financial condition and results of operations could suffer. RISK-TO-CAPITAL RATIO (IC9) The State of Arizona, PMI's state of domicile for insurance regulatory purposes, and other regulators specifically limit the amount of insurance risk that may be written by PMI, by a variety of financial factors. For example, Arizona law provides that if a mortgage guaranty insurer domiciled in Arizona does not have the amount of minimum policyholders position required, it must cease transacting new business until its minimum policyholders position meets the requirements. Under Arizona law, minimum policyholders position is calculated based on the face amount of the mortgage, the percentage coverage or claim settlement option and the loan to value ratio category, net of reinsurance ceded, but including reinsurance assumed. Other factors affecting PMI's risk-to-capital ratio include: (i) 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; (ii) TPG's credit agreements and the terms of its guaranty of the debt incurred to purchase PMI LTD; and (iii) 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 harm the Company's financial condition and results of operations. CHANGES IN COMPOSITION OF INSURANCE WRITTEN; POOL INSURANCE (IC10) 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, 1999, 46.7% of PMI's risk in force consisted of 95s, which, in PMI's experience, have had a 17 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, 1999, 4.9% of PMI's risk in force consisted of 97s that 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, which is generally used as an additional credit enhancement for certain secondary market mortgage transactions. New pool risk written was $231 million for the year ended December 31, 1999 and $450 million for the year ended December 31, 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 these products, and the associated investment income, may ultimately prove to be inadequate to compensate for future losses from these products. POTENTIAL INCREASE IN CLAIMS (IC11) Mortgage insurance coverage and premiums 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. LOSS RESERVES (IC12) 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 AND INTERNATIONAL RISKS (IC13) 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 15.6%, 7.5% and 7.3% of its risk in force concentrated and where the default rate on all PMI policies in force is 2.6%, 3.0% and 2.1% compared with 2.1% nationwide as of December 31, 1999. 18 As the Company seeks to expand its business internationally, it will increasingly be subject to risks associated with international operations, including the need for regulatory and third party approvals, challenges retaining key foreign-based employees and maintaining key relationships with customers and business partners in international markets, the economic strength of the mortgage origination markets in targeted foreign markets, including Australia, New Zealand, and Hong Kong, changes in foreign regulations and laws, foreign currency exchange and translation issues, potential increases in the level of defaults and claims on policies insured by foreign-based subsidiaries, and the need to integrate PMI's risk management technology systems and products with those of its foreign operations. CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC14) PMI's customers have indicated an increasing demand for captive reinsurance arrangements, which allow a reinsurance company, generally an affiliate of the lender, to assume a portion of the mortgage insurance default risk in exchange for a portion of the insurance premiums. An increasing percentage of PMI's NIW is being generated by customers with captive reinsurance companies, and management expects that this trend will continue. An increase in captive reinsurance arrangements would decrease in net premiums written which may negatively impact the yield obtained in the Company's net premiums earned for customers with captive reinsurance arrangements. The inability of the Company to provide its customers with acceptable risk-sharing structured transactions, including potentially increasing levels of premium cessions in captive reinsurance arrangements, would likely harm PMI's competitive position. GRAMM-LEACH-BLILEY ACT (IC15) On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of 1999 (the "Act") into law. Among other things, the Act allows bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, and allows insurers and other financial service companies to acquire banks. The Act allows a bank holding company to form an insurance subsidiary, licensed under state insurance law, to issue insurance products directly, including mortgage insurance. The Company expects that, over time, the Act will allow consumers the ability to shop for their insurance, banking and investment needs at one financial services company. The Company believes that the Act may lead to increased competition in the mortgage insurance industry by facilitating the development of new savings and investment products, resulting in the Company's customers offering mortgage insurance directly rather than through captive reinsurance arrangements with the Company's insurance subsidiaries and encouraging large, well-capitalized financial service companies to enter the mortgage insurance business. 19 Consolidated Statements of O p e r a t i o n s
Year Ended December 31, (In thousands, except per share amounts) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Revenues Premiums earned $ 558,623 $ 491,226 $ 453,948 Investment income, less investment expense 95,142 84,681 83,136 Realized capital gains 509 24,636 19,584 Other income 15,850 20,366 7,979 ----------------------------------------------- Total revenues 670,124 620,909 564,647 ----------------------------------------------- Losses and Losses and loss adjustment expenses 112,682 135,716 152,257 Expenses Amortization of policy acquisition costs 80,252 60,280 43,395 Underwriting and other operating expenses 170,239 142,625 111,745 Interest expense 8,554 7,029 6,766 Distributions on preferred capital securities 8,311 8,311 7,617 ----------------------------------------------- Total losses and expenses 380,038 353,961 321,780 ----------------------------------------------- Income before income taxes 290,086 266,948 242,867 Income tax expense 85,620 76,588 67,558 ----------------------------------------------- Net income $ 204,466 $ 190,360 $ 175,309 ============================================== Per Share Basic net income per common share $ 4.55 $ 4.04 $ 3.50 =============================================== Diluted net income per common share $ 4.52 $ 4.02 $ 3.49 ==============================================
See notes to consolidated financial statements 1 Consolidated B a l a n c e S h e e t s
As of December 31, (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------------------------------------- Assets Investments: Available for sale, at fair value: Fixed income securities (amortized cost $1,485,396 and $1,268,625) $ 1,479,310 $ 1,356,869 Equity securities: Common (cost $44,714 and $34,129) 83,890 58,785 Preferred (cost $17,660 and $17,240) 17,582 17,706 Common stock of affiliates, at underlying book value 91,453 60,450 Short-term investments 145,093 38,414 ------------------------------- Total investments 1,817,328 1,532,224 Cash 28,076 9,757 Accrued investment income 22,058 20,150 Reinsurance recoverable and prepaid premiums 50,714 42,102 Premiums receivable 30,659 24,367 Receivable from affiliate 2,996 2,229 Receivable from Allstate - 23,657 Deferred policy acquisition costs 69,579 61,605 Property and equipment, net 40,462 37,630 Other assets 38,890 24,149 ------------------------------- Total assets $ 2,100,762 $ 1,777,870 =============================== Liabilities Reserve for losses and loss adjustment expenses $ 282,000 $ 215,259 Unearned premiums 182,089 94,886 Long-term debt 145,367 99,476 Reinsurance balances payable 25,415 14,764 Deferred income taxes 75,640 96,730 Other liabilities and accrued expenses 73,908 60,200 ------------------------------- Total liabilities 784,419 581,315 ------------------------------- Commitments and contingent liabilities (Note 12) - - Company-obligated mandatorily redeemable preferred capital securities of subsidiary trust holding solely junior subordinated deferrable interest debenture of the Company 99,075 99,040 Shareholders' Preferred stock - $.01 par value; 5,000,000 shares authorized - none issued - - Equity Common stock - $.01 par value; 187,500,000 shares authorized, 52,793,777 and 35,196,002 issued 528 352 Additional paid-in capital 265,828 265,040 Accumulated other comprehensive income 20,186 74,462 Retained earnings 1,258,617 1,060,724 ------------------------------- 1,545,159 1,400,578 Less treasury stock (8,091,924 and 4,917,401 shares at cost) 327,891 303,063 ------------------------------- Total shareholders' equity 1,217,268 1,097,515 ------------------------------- Total liabilities and shareholders' equity $ 2,100,762 $ 1,777,870 ===============================
See notes to consolidated financial statements 2 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) 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- Common Balance, beginning of year $ 352 $ 351 $ 350 Stock 3 for 2 stock split in the form of a stock dividend 176 - - Stock grants and exercise of stock options - 1 1 ------------------------------------------ Balance, end of year 528 352 351 ------------------------------------------ Additional Balance, beginning of year 265,040 262,448 258,059 Paid-in 3 for 2 stock split in the form of a stock dividend (176) - - Capital Stock grants and exercise of stock options 964 2,592 4,389 ------------------------------------------ Balance, end of year 265,828 265,040 262,448 ------------------------------------------ Accumulated Balance, beginning of year 74,462 71,936 50,709 Other Unrealized gains on investments: Comprehensive Income Unrealized holding gains (losses) arising during period [net of tax (tax benefits) of ($29,047), $9,982, and $18,285] (53,945) 18,539 33,957 Less: reclassification adjustment for gains included in net income (net of tax of $178, $8,623, and $6,854) (331) (16,013) (12,730) ------------------------------------------ Other comprehensive income (loss), not of tax (54,276) 2,526 21,227 ------------------------------------------ Balance, end of year 20,186 74,462 71,936 ------------------------------------------ Retained Balance, beginning of year 1,060,724 876,588 707,885 Earnings Net income 204,466 190,360 175,309 Dividends declared (6,573) (6,224) (6,606) ------------------------------------------- Balance, end of year 1,258,617 1,060,724 876,588 ------------------------------------------- Treasury Balance, beginning of year (303,063) (150,143) (30,141) Stock Purchases of The PMI Group, Inc. Common stock (24,828) (152,920) (120,002) ------------------------------------------- Balance, end of year (327,891) (303,063) (150,143) ------------------------------------------- Total shareholders' equity $1,217,268 $1,097,515 $ 1,061,180 =========================================== Comprehensive Net income $ 204,466 $ 190,360 $ 175,309 Income Other comprehensive income (loss), net of tax (54,276) 2,526 21,227 ------------------------------------------- Comprehensive income $ 150,190 $ 192,886 $ 196,536 ===========================================
See notes to consolidated financial statements 3 Consolidated Statements of C a s h F l o w s
Year Ended December 31, (In thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ Cash Net income $ 204,466 $ 190,360 $ 175,309 Flows Reconciliation of net income to net cash provided by from operating activities: Operating Realized capital gains, net (509) (24,636) (19,584) Activities Equity in earnings of affiliates (7,061) (3,225) (1,455) Depreciation and amortization 13,243 6,282 4,679 Changes in: Reserve for losses and loss adjustment expenses 8,142 12,872 2,613 Unearned premiums 13,526 736 (22,801) Deferred policy acquisition costs (7,973) (23,741) (6,231) Accrued investment income (1,903) 644 (1,355) Reinsurance balances payable 4,495 2,936 (1,467) Reinsurance recoverable and prepaid premiums 53,616 (10,426) 51,703 Premiums receivable (6,292) (4,611) (5,109) Income taxes 7,539 19,444 14,179 Receivable from affiliate 3,170 (1,778) 127 Receivable from Allstate 23,657 (6,835) - Other 6,649 20,079 (4,070) ------------------------------------------- Net cash provided by operating activities 314,765 178,101 186,538 ------------------------------------------- Cash Proceeds from sales of equity securities 42,647 75,181 82,008 Flows Investment collections of fixed income securities 3,000 54,374 13,590 from Proceeds from sales of fixed income securities 228,673 120,404 367,865 Investing Purchases of fixed income securities (332,046) (207,686) (573,627) Activities Purchases of equity securities (31,940) (53,092) (33,010) Net (decrease) increase in short-term investments (84,508) 40,476 2,986 Purchase of PMI Ltd. (78,295) - - Purchase of Pinebrook Insurance Company (22,577) - - Investment in affiliates (25,634) (40,024) (3,600) Purchases of property and equipment (12,528) (12,417) (13,687) ------------------------------------------- Net cash used in investing activities (313,208) (22,784) (157,475) ------------------------------------------- Cash Issuance of redeemable preferred capital securities - - 99,000 Flows Issuance of long-term debt 45,825 - - from Proceeds from exercise of stock options 964 2,592 3,181 Financing Dividends paid to shareholders (5,199) (6,333) (6,733) Activities Purchases of The PMI Group, Inc. common stock (24,828) (152,920) (120,002) ------------------------------------------- Net cash provided by (used in) financing activities 16,762 (156,661) (24,554) ------------------------------------------- Net increase (decrease) in cash 18,319 (1,344) 4,509 Cash at beginning of year 9,757 11,101 6,592 ------------------------------------------- Cash at end of year $ 28,076 $ 9,757 $ 11,101 ===========================================
See notes to consolidated financial statements 4 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"), Residential Insurance Co. ("RIC"), TPG Insurance Co. ("TIC"), TPG Segregated Portfolio Co. (Cayman) ("TSPC") and PMI Capital I ("PCI"), PMI's wholly owned subsidiaries PMI Mortgage Insurance Australia (Holdings) Pty Limited ("PMI Holdings"), PMI Mortgage Services Co. ("MSC"), Pinebrook Mortgage Insurance Company (PBK) 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 36.75 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 12,903,975 shares of TPG common stock to redeem the 6.76% exchangeable notes due April 15, 1998. After the exchange, Allstate held approximately 2,846,025 shares of TPG common stock, which have 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 7). 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 15). 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"). CMG offers mortgage guaranty insurance for loans originated by credit unions. On October 1, 1998, PMI increased its equity investment in CMG to 50% through the purchase of 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. On August 31, 1999, PMI and CMIC capitalized CMG Reinsurance Company ("CMG Re") with each party investing $1.5 million for a 50% ownership interest. 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. 5 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 10 years. Accumulated depreciation on property and equipment was $51.4 million and $38.9 million at December 31, 1999 and 1998, respectively. Capitalized Software - Effective in 1999, the Company adopted American Institute of Certified Public Accountants Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which requires capitalization of external and internal direct software development costs incurred during the application development stage. Adoption of this SOP did not have a significant effect as the Company's previous software capitalization policy was substantially consistent with this guidance. 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. Statement of Financial Accounting Standards ("SFAS") No. 60, Accounting and Reporting for Insurance Enterprises, specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums. Consistent with generally accepted accounting principles and industry accounting practices, 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. Costs associated with the acquisition of mortgage insurance business, consisting of compensation, premium taxes and other policy issuance and underwriting expenses, are initially deferred and reported as deferred acquisition costs ("DAC"). Because SFAS 60 specifically excludes mortgage guaranty insurance from its guidance relating to the amortization of deferred policy acquisition costs, amortization of these costs for each underwriting year book of business are charged against revenue in proportion to estimated gross profits over the life of the policies using the guidance provided by SFAS No. 97, Accounting and Reporting by Insurance Enterprises For Certain Long Duration Contracts and for Realized Gains and Losses From the Sale of Investments. The estimate for each underwriting year is updated annually to reflect actual experience and any changes to key assumptions such as persistency or loss development. (See Note 6) 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. SFAS 60 specifically excludes mortgage guaranty insurance from its guidance relating to the reserve for losses. Consistent with generally accepted accounting principles and industry accounting practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. 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, 1999 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. 6 Stock split - The Company had a three-for-two stock split in 1999 in the form of a 50% stock dividend. All earnings per share amounts and stock option information prior to the stock split have been restated to reflect post-split amounts. 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 44,893,250 for 1999, 47,090,673 for 1998 and 50,078,742 for 1997. 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 45,244,060 for 1999, 47,299,065 for 1998 and 50,265,392 for 1997. 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 8. Derivatives - In 1999, the Company entered into an interest rate swap to hedge interest rate risk associated with the acquisition debt described in Note 3 and 11. During 1999, the Company also entered into a foreign currency exchange contract to hedge the foreign currency exchange risk associated with the purchase price of PMI Holdings, the Australia acquisition described in Note 3. The gain on this contract, which was not material, was recognized as an adjustment of the purchase price of the acquired company. Foreign currency translation - The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation Assets and liabilities denominated in non-U.S. dollar currencies are translated into U.S. dollar equivalents using year-end spot foreign exchange rates. Revenues and expenses are translated monthly at amounts which approximate weighted average exchange rates, with resulting gains and losses included in income. The effects of translating operations with a functional currency other than the U.S. dollar are included in accumulated other comprehensive income. Such effects were not material in 1999. Concentration of Risk - A substantial portion of PMI's business is generated within the State of California. For the year ended December 31, 1999, 14.8% of new insurance written was in California. In addition, California's book of business represented 15.6% of total risk in force at December 31, 1999. 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 14). New Accounting Pronouncement - In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which established accounting and reporting standards for derivative instruments. The statement is effective for fiscal quarters beginning after June 15, 2000. Because of the Company's minimal use of derivatives, management anticipates that the adoption of this new statement will not have a significant effect on earnings or the financial position of the Company. Reclassification - Certain prior year amounts have been reclassified to conform to current year presentation. 7 NOTE 3. ACQUISITIONS On August 6, 1999, the Company, through PMI Holdings, a newly formed, wholly owned subsidiary of PMI, acquired all of the outstanding common stock of PMI Mortgage Insurance Ltd. ("PMI Ltd.") for approximately $78.3 million in cash. PMI Ltd. (formerly MGICA, Ltd) is the second largest mortgage guaranty insurer in Australia, as measured by annual insurance written. Substantially all of PMI Ltd.'s mortgage insurance in force consists of single premium payment policies. The acquisition was financed in part by the issuance of PMI Holdings debt of $45.8 million (see Note 11). The acquisition was accounted for under the purchase method of accounting and, accordingly, the consolidated financial statements include the results of PMI Ltd.'s operations from the date of acquisition. The excess of the estimated fair value of net assets acquired over the purchase price of approximately $31.8 million first reduced the value of noncurrent assets acquired, with the remaining $9.6 million of negative goodwill being amortized over approximately 8 years. On December 31, 1999, the Company acquired all of the outstanding common stock of Pinebrook Mortgage Insurance Company ("Pinebrook"), which was a wholly owned subsidiary of Allstate for $22.6 million cash. The purchase price approximates the book value of Pinebrook, which does not differ significantly from fair value. This transaction has been accounted for under the purchase method. Proforma unaudited results of operations for 1999 and 1998 assuming the acquisitions had occurred at the beginning of 1998 are as follows: (In thousands, except per share amounts) 1999 1998 - -------------------------------------------------------------------------------- Revenues $692,585 $583,298 Net income 220,679 215,212 Basic net income per common share 4.92 4.57 Diluted net income per common share 4.87 4.55 NOTE 4. INVESTMENTS Fair Values - The amortized cost and estimated fair values (based on quoted market values) for fixed income securities are shown below:
Amortized Gross Unrealized Market ---------------- (In thousands) Cost Gains (Losses) Value - ----------------------------------------------------------------------------------------------------------- At December 31, 1999 U.S. government and agencies $ 87,223 $ 387 $ (3,563) $ 84,047 Municipals 1,260,409 31,337 (30,438) 1,261,308 Corporate bonds 137,764 49 (3,858) 133,955 ----------- --------- --------- ----------- Total $ 1,485,396 $ 31,773 $ (37,859) $ 1,479,310 =========== ========= ========= =========== 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 =========== ========= ========= ===========
8 Scheduled Maturities - The scheduled maturities for fixed income securities are as follows at December 31, 1999:
Amortized Market (In thousands) Cost Value - -------------------------------------------------------------------------------- Due in one year or less $ 13,218 $ 13,027 Due after one year through five years 154,726 151,460 Due after five years through ten years 202,274 204,500 Due after ten years 1,069,226 1,066,322 Other 45,952 44,001 --------------------------------------- Total $ 1,485,396 $ 1,479,310 ---------------------------------------
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, 1999 and 1998, 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.
1999 1998 - ---------------------------------------------------------------------------- Illinois 13.2% 13.2% Texas 12.2 12.0 Washington 11.5 12.0 New York 9.2 8.6 Massachusetts 6.3 7.3 California 6.1 6.5 Indiana - 6.1 Pennsylvania 5.5 5.5
At December 31, 1999, fixed income and short term securities with a market value of $14.1 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, 1999, are as follows:
Gross Unrealized Net Market ---------------------- Unrealized (In thousands) Cost Value Gains (Losses) Gains - ------------------------------------------------------------------------------------------------------------ Fixed income securities $ 1,485,396 $ 1,479,310 $ 31,773 $ (37,859) $ (6,086) Common stocks 44,714 83,890 40,812 (1,636) 39,176 Preferred stocks 17,660 17,582 157 (235) (78) Short term 145,087 145,093 20 (14) 6 Investment in affiliates 93,283 91,453 - (1,830) (1,830) ------------------------------------------------------------------------------ Total $ 1,786,140 $ 1,817,328 $ 72,762 $ (41,574) 31,188 --------------------------------------------------------------- Less defered income taxes 11,002 ------------ Total $ 20,186 ------------
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 (losses), net of deferred income taxes, included in other comprehensive income for fixed income securities and equity securities are as follows: 9
(In thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------- Fixed income securities $ (61,372) $ 8,874 $ 20,572 Equity securities 8,758 (6,565) 517 Investment in affiliates (1,662) 217 138 ------------------------------------------------------ Total $ (54,276) $ 2,526 $ 21,227 ------------------------------------------------------
Investment Income - Investment income by investment type is as follows:
(In thousands) 1999 1998 1997 - -------------------------------------------------------------------------------------------------------- Fixed income securities $ 82,256 $ 76,427 $ 74,641 Equity securities 2,400 2,466 1,476 Common stock of affiliates 7,061 3,225 1,455 Short-term 4,793 3,442 6,332 ------------------------------------------------------ Investment income, before expenses 96,510 85,560 83,904 Less investment expense 1,368 879 768 ------------------------------------------------------ Investment income, less investment expense $ 95,142 $ 84,681 $ 83,136 ------------------------------------------------------
Realized Capital Gains and Losses. Net realized capital gains and (losses) on investments are as follows:
(In thousands) 1999 1998 1997 - -------------------------------------------------------------------------------------------------------- Fixed income securities $ (4,547) $ 1,481 $ (777) Equity securities 5,046 23,155 20,188 Short-term 10 - 173 ------------------------------------------------------ Realized capital gains -- net, before taxes 509 24,636 19,584 Less income taxes 178 8,623 6,854 ------------------------------------------------------ Realized capital gains, net of taxes $ 331 $ 16,013 $ 12,730 ------------------------------------------------------
Gross realized capital gains and losses on investments are as follows:
(In thousands) 1999 1998 1997 - -------------------------------------------------------------------------------------------------------- Gross realized capital gains $ 8,171 $ 27,810 $ 26,167 Gross realized capital losses (7,662) (3,174) (6,583) ------------------------------------------------------ Net realized capital gains $ 509 $ 24,636 $ 19,584 ------------------------------------------------------
10 NOTE 5. 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) 1999 1998 1997 - -------------------------------------------------------------------------------------------------------------------- Balance, January 1 $ 215,259 $ 202,387 $ 199,774 Less reinsurance recoverable 6,782 6,067 5,287 ------------------------------------------------ Net balance, January 1 208,477 196,320 194,487 ------------------------------------------------ Losses and loss adjustment expenses incurred (principally in respect of defaults occurring in) Current year 159,293 146,884 158,147 Prior years (46,611) (11,168) (5,890) ------------------------------------------------ Total losses and loss adjustment expenses 112,682 135,716 152,257 ------------------------------------------------ Losses and loss adjustment expense payments (principally in respect of defaults occurring in) Current year 1,798 12,503 27,700 Prior years 95,797 111,056 122,724 ------------------------------------------------ Total payments 97,595 123,559 150,424 ------------------------------------------------ Plus acquisition of Forestview Reserves 42,528 - - Plus acquisition of Pinebrook Reserves 1,093 - - Plus acquisition of PMI Ltd 4,473 - - ------------------------------------------------ Net balance, December 31 270,565 208,477 196,320 Plus reinsurance recoverable 10,342 6,782 6,067 ------------------------------------------------ Balance, December 31 $ 282,000 $ 215,259 $ 202,387 ------------------------------------------------
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 $46.6 million in 1999 due the impact of a favorable interest rate environment on loss mitigation activities and to lower than expected claims in California. The provision for losses and loss adjustment expenses decreased by $11.2 million and $5.9 million in 1998 and 1997, respectively, due primarily to lower than expected 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. NOTE 6. DEFERRED ACQUISITION COSTS ("DAC") DAC is amortized against revenue in proportion to the estimated gross profits for each underwriting year book of business over the life of the underlying policies included in each book year. This amortization method is consistent with the methodology outlined in SFAS No. 97, as described in Note 2. 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, 1999, 1998 and 1997: 11
(In thousands) 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------- Beginning DAC balance $ 61,605 $ 37,864 $ 31,633 Accquisition costs incurred and deferred 88,226 84,021 49,626 Amortization of deferred costs (80,252) (60,280) (43,395) ------------ ------------ ------------- Ending DAC balance $ 69,579 $ 61,605 $ 37,864 ============ ============ =============
NOTE 7. REINSURANCE PMI cedes reinsurance to reduce net risk in force to meet regulatory risk-to-capital requirements and to comply with the regulations that limit the maximum coverage to 25% for any single risk. Certain of the Company's reinsurance arrangements have adjustable features, such as contingent commissions or sliding scale commission. Commission adjustments are dependent upon the loss experience of the underlying business. Estimates are based on the Company's actuarial analysis of the applicable business; 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 for policies issued by the company prior to January 1, 1998. The reinsurance on these policies is in run-off through December 31, 2006. As a result of the treaty termination, PMI no longer cedes primary reinsurance to third party reinsurers (except under captive reinsurance arrangements) on policies written after December 31, 1997. In December 1993, PMI decided to cease writing Old Pool business (except for honoring certain commitments in existence prior to the discontinuation of this business). Concurrently, PMI entered into a reinsurance agreement with Forestview Mortgage Insurance Co. ("Forestview"), a wholly owned subsidiary of Allstate, to cede all future Old Pool premiums and net losses from PMI to Forestview. As a result of this ceding agreement, along with another Old Pool ceding agreement with an unaffiliated reinsurer, the Old Pool business had no significant impact on the Company's results of operations for the years ended December 31, 1998 and 1997. In accordance with accounting for discontinued operations, since 1993 Old Pool insurance assets (unpaid losses recoverable and paid claims receivable) and liabilities (loss reserves and premiums payable) have been netted in the consolidated balance sheet at December 31, 1998 resulting in a net Old Pool receivable of $2.7 million which is included in other assets. In July of 1999, PMI and Forestview received regulatory approval of a Recapture Agreement executed in March 1999 to commute the Old Pool reinsurance arrangement retroactive to January 1, 1999. The Recapture Agreement also included the commutation of an insignificant second lien primary insurance arrangement between the parties. On August 13, 1999, PMI received a payment of $45.3 million covering the following (in thousands): Recapture of ceded loss reserves $42,528 Recapture of ceded unearned premiums 1,100 Other settlements 1,672 ------- Total payment received $45,300 ======= PMI established the recaptured ceded loss reserves and ceded unearned premiums as liabilities upon receipt of the cash payment. The other settlements, which primarily represent service fees for administering the Forestview book of business, were included in other income as PMI has no future obligations to provide services to Forestview. As a result of the above Old Pool commutation, all Old Pool assets and liabilities are shown on a gross basis at December 31, 1999. During 1999, PMI entered into a reinsurance arrangement with three reinsurers to provide coverage for a 10- year period in the event of catastrophic losses. PMI paid the reinsurers a total one-time premium of $16.4 million of which a substantial portion will be recovered by PMI should losses not reach catastrophic levels. This agreement does not transfer risk in accordance with FAS113 and therefore is being reported in accordance with SOP 98-7, Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk. 12 Reinsurance recoverable on paid losses from reinsurance was $11.4 million and $6.8 million at December 31, 1999 and 1998 respectively. Prepaid reinsurance premiums from non-affiliated reinsurers were $1.7 million and $2.1 million at December 31, 1999 and 1998, 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:
(In thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------ Premiums written Direct $ 585,771 $ 498,828 $ 435,971 Assumed 8,999 7,141 1,383 Ceded (23,516) (16,869) (5,302) ---------- ---------- --------- Premiums written, net of reinsurance $ 571,254 $ 489,100 $ 432,052 ========== =========== ========= Premiums earned Direct $ 574,451 $ 506,096 $ 458,972 Assumed 6,445 3,101 1,182 Ceded (22,273) (17,971) (6,206) ---------- ---------- --------- Premiums earned net of reinsurance $ 558,623 $ 491,226 $ 453,948 ========== =========== ========= Losses and loss adjustment expenses Direct $ 124,704 $ 140,705 $ 157,012 Assumed 2,882 176 219 Ceded (14,904) (5,165) (4,974) ---------- ---------- --------- Losses and loss adjustment expenses, net of reinsurance $ 112,682 $ 135,716 $ 152,257 ========== =========== =========
Reinsurance ceding arrangements do not discharge the Company from its obligations as the primary insurer in the event of default by the reinsurer. NOTE 8. INCOME TAXES The components of income tax expense are as follows:
(In thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------ Current $ 6,942 $ 7,302 $ 3,859 Deferred 78,678 69,286 63,699 ---------- ---------- --------- Total income tax expense $ 85,620 $ 76,588 $ 67,558 ========== ========== =========
The components of the income tax expense for 1999 include a foreign provision for current tax expense of $4.7 million and deferred tax benefit of $1.2 million related to PMI Ltd. A reconciliation of the statutory federal income tax rate to the effective tax rate reported on income before income taxes is as follows:
1999 1998 1997 - ------------------------------------------------------------------------------------------------------ Statutory federal income tax rate 35.0% 35.0 35.0% Tax-exempt income (6.8) (7.2) (7.5) State income tax (net) 0.5 0.4 0.2 Other 0.8 0.5 0.1 ------ ----- ----- Effective income tax rate 29.5% 28.7% 27.8% ====== ===== =====
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 13 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. In July 1999, the Company received payment for income taxes receivable of $16.8 million (plus 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 15). 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 reserve. The Company purchased tax and loss bonds of $73.5 million, $47.4 million and $50.7 million in 1999, 1998 and 1997, respectively. The Company paid income taxes of $10.5 million, $8.4 million and $8.4 million in 1999, 1998 and 1997, respectively. The components of the deferred income tax assets and liabilities at December 31 are as follows:
(In thousands) 1999 1998 - ------------------------------------------------------------------------------------------------ Deferred tax assets: Discount on loss reserves $ 6,253 $ 4,422 Unearned premium reserves 4,867 4,181 Alternative minimum tax credit carryforward 39,911 31,870 Pension costs 4,406 3,131 Other assets 7,981 4,355 ---------------------------- Total deferred tax assets 63,418 47,959 ---------------------------- Deferred tax liabilities: Statutory contingency reserves 89,092 72,817 Policy acquisition costs 23,549 21,562 Unrealized net gains on investments 11,001 39,631 Software development costs 7,570 7,423 Other liabilities 7,846 3,256 ---------------------------- Total deferred tax liabilities 139,058 144,689 ---------------------------- Net deferred tax liability $ 75,640 $ 96,730 ----------------------------
NOTE 9. 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.
1999 1998 - ------------------------------------------------------------------------------------------------------------------- Carrying Estimated Carrying Estimated (In thousands) Value Fair Value Value Fair Value - ---------------------------------------------------------------------------- -------------------------------- 8.247% Long-term debt $ 99,542 $ 92,252 $ 99,476 $ 103,997 9.322% Redeemable preferred capital securities $ 99,075 $ 90,041 $ 99,040 $ 107,075 7.00% Long-term debt $ 45,825 $ 47,300 $ - $ -
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. 14 NOTE 10. 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, certain employees earning in excess of $160,000 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. Remainder of Page to Remain Blank 15 The following table presents certain information regarding the Plan and the OPEB Plan as of December 31:
Pension Benefits Other Benefits ---------------- -------------- (In thousands, except percentages) 1999 1998 1997 1999 1998 1997 ---- ---- ---- ---- ---- ---- Change in benefit obligation Benefit obligation at January 1, $ 18,376 $ 11,381 $ 6,659 $ 4,219 $ 3,112 $ 2,782 Service cost 5,443 3,796 3,424 578 434 387 Interest cost 1,710 1,074 759 320 255 217 Actuarial loss (gain) 1,046 2,861 875 (1,139) 435 (269) Benefits paid (1,038) (736) (336) (26) (17) (5) ------------------------------------------------------------------------ Benefit obligation at December 31, 25,537 18,376 11,381 3,952 4,219 3,112 ------------------------------------------------------------------------ Change in plan assets Fair value of plan assets at January 1, 8,877 5,204 2,896 - - - Actual return on plan assets 2,397 366 180 - - - Company contribution 3,658 4,043 2,464 26 17 5 Benefits paid (1,038) (736) (336) (26) (17) (5) ------------------------------------------------------------------------ Fair value of plan assets at December 31, 13,894 8,877 5,204 - - - ------------------------------------------------------------------------ Funded status Funded status of plan at December 31, (11,643) (9,499) (6,177) (3,952) (4,219) (3,112) Unrecognized actuarial loss (gain) 2,891 3,583 505 (1,460) (320) (781) Unrecognized prior service cost - - - 245 265 284 ------------------------------------------------------------------------ Accrued and recognized benefit cost $ (8,752) $ (5,916) $ (5,672) $ (5,167) $ (4,274) $ (3,609) ------------------------------------------------------------------------ Components of net periodic benefit cost Service cost $ 5,443 $ 3,796 $ 3,424 $ 578 $ 434 $ 387 Interest cost 1,710 1,074 759 320 255 217 Expected return on assets (893) (515) (295) - - - Prior service cost amortization - - - 20 20 20 Actuarial loss (gain) recognized 234 (68) (95) - (26) (28) ------------------------------------------------------------------------ Net periodic benefit cost $ 6,494 $ 4,287 $ 3,793 $ 918 $ 683 $ 596 ------------------------------------------------------------------------ Weighted-average assumptions Discount rate 8.00% 6.75% 7.25% 8.00% 6.75% 7.25% 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%
Sensitivity of retiree welfare results. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. 16 A one-percentage-point change in assumed health care cost trend rates would have the following effects:
I-Percentage- I-Percentage- (In thousands) Point Increase Point Decrease - ----------------------------------------------------------------------------------------------------------------- Effect on total of service and interest cost components 226 $ 171 Effect on accumulated postretirement benefit obligations 1,163 892
Savings and Profit Sharing Plans. As of April 18, 1995, certain 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 $2.7 million, $2.1 million, and $1.2 million for 1999, 1998 and 1997, respectively. NOTE 11. 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 1999, 1998 and 1997. On August 3, 1999, PMI Holdings, along with TPG as guarantor, entered into a credit agreement with Bank of America, N.A. ("Bank"). PMI Holdings borrowed $45.8 million ("Loan") at a six month adjustable rate which equals the Australia Bank Bill Buying Rate plus a specified margin that is dependant on the TPG's senior debt rating. The proceeds of the Loan were used to finance the purchase of PMI Ltd. Principal payments in equal 10% installments are due annually beginning August 3, 2001 and continue through August 3, 2005. The final 50% principal payment is due August 3, 2006. Concurrently, on August 3, 1999, PMI Holdings along with TPG as guarantor entered into a Swap Transaction ("Swap") with the Bank. The Swap effectively fixed the interest rate on the Loan to 7.0%. The net interest effect of the Swap is reported as an adjustment of interest expense. The fair value of the Swap agreement is not recognized in the financial statements. Other provisions of the Swap do not have a material effect on the Loan. No interest payments were made during 1999. The terms of the Loan, provide, in part, that (1) TPG's consolidated net worth shall not be less than $600 million; (2) PMI's statutory capital (as defined) shall not be less than $675 million; (3) the risk to capital ratio of PMI shall not exceed 23 to 1; and (4) TPG's consolidated debt to capital ratio shall not exceed 0.40 to 1.0. In addition, PMI's and PMI Ltd.'s ability to pay dividends or incur additional indebtedness is restricted. Failure to maintain such financial covenants or debt restrictions may be deemed an event of default. Pursuant to the guarantee executed by TPG in connection with the Loan, if an event of default occurs under the Loan, or under any other indebtedness, all outstanding amounts under the credit agreement may be accelerated and become immediately payable by TPG. 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, 1999 or 1998. 17 NOTE 12. 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, 1999 are as follows:
(In thousands) Amount - ----------------------------------------------------------- Year ending December 31: 2000 $ 8,842 2001 7,412 2002 6,416 2003 5,316 2004 4,550 ----------- Total $ 32,536 ===========
The Company renewed its corporate headquarters lease for 5 years in 1999 with a 5 year renewal option. Such minimum expected rentals are included in the above amounts. Total rent expense for all leases was $9.6 million, $9.0 million and $7.6 million in 1999, 1998 and 1997, respectively. Legal Proceedings - On December 17, 1999, G. Craig Baynham and Linnie Baynham (collectively, the "Plaintiffs") filed a putative class action suit against PMI. The complaint captioned G. Craig Baynham and Linnie Baynham v. PMI Mortgage Insurance Co., (case no. CV199-241) was filed in the United States District Court For The Southern District of Georgia, State of Georgia and alleges that PMI entered into agreements or understandings with mortgage lenders that PMI would provide pool insurance or other benefits to the lenders at preferential, below market rates, in return for the lenders' designation of PMI as the mortgage insurer for mortgages originated by the lenders. Based on the alleged conduct, Plaintiffs assert a cause of action on behalf of the proposed class of mortgage insurees against PMI for violation of section 8 of the Real Estate Settlement Procedures Act ("RESPA") 12 U.S.C. (S)2607(a). Plaintiffs seek relief under RESPA's treble damage provision, along with injunctive relief and attorneys' fees and expenses. The complaint also seeks to certify a class of persons who, on or after January 1, 1996 obtained or obtain federally related mortgage loans for single-to four family homes, whose loans include primary mortgage insurance, reinsurance contracts, contract underwriting services, or financing agreements from PMI. The Company understands that several other mortgage insurance companies have been named as defendants in lawsuits with similar allegations recently filed in the same federal court as the case pending against PMI. The Company intends to contest this action vigorously and based on information presently available to the Company, management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial position or results of operations. Various other 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 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. NOTE 13. 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 18 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 were made in 1999 and 1998, respectively. NOTE 14. 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 institutional 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, indentures, various credit rating agencies and other relevant factors. PMI's ability to pay dividends to TPG is limited, among other restrictions, 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 17). 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, 1999, without prior regulatory approval is $13.4 million. PMI paid ordinary and, after obtaining regulatory approval, extraordinary dividends to TPG totaling $94.3 million and $100.0 million in the years ended December 31, 1999 and 1998, respectively. APTIC paid ordinary dividends to TPG totaling $3.0 million and $3.2 million in the years ended December 31, 1999 and 1998, 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 17), 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. 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") as amended provide for an aggregate of 3,750,000 shares of common stock 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 450 shares of common stock and will receive stock options for 2,250 shares annually, after an initial option of up to 4,500 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. 19 The following is a summary of activity in the Equity Incentive Plan and the Directors Plan during 1999, 1998 and 1997:
1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Shares Average Shares Average Shares Average Under Option Exercise Price Under Option Exercise Price Under Option Exercise Price ------------ -------------- ------------ -------------- ------------ -------------- Options outstanding at beginning of year 1,375,051 $ 35.83 924,582 $ 28.20 807,906 $ 24.27 Options granted 588,756 29.54 549,975 47.36 309,465 36.41 Options exercised (106,120) 25.07 (77,892) 23.78 (138,980) 22.89 Options forfeited (37,192) 42.93 (21,614) 42.81 (53,810) 28.79 ----------------------------------- -------------------------------- ---------------------------- Outstanding at end of year 1,820,495 $ 34.26 1,375,051 $ 35.83 924,582 $ 28.20 ----------------------------------- -------------------------------- ---------------------------- Exercisable at year end 746,398 $ 30.74 604,467 $ 26.05 345,497 $ 23.52 Reserved for future grants 45,654 - 597,218 - 1,115,159 - - ------------------------------------------------------------------------------------------------------------------------------- Note: The weighted average remaining contractual life of shares under option was 8.0 years (for an exercise price between $19.66 and $50.83) in 1999, 8.0 years ($32.14 and $76.25) in 1998 and 8.0 years ($32.14 and $67.97) in 1997. - -----------------------------------------------------------------------------------------------------------------------------------
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 using the fair value method. 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 0.35% for the 1999 options, 0.26% and 0.28% for the 1998 options, and 0.29% to 0.37% for the 1997 options; expected volatility range of 30.77% and 32.52% for the 1999 options, 21.92% and 23.15% for the 1998 options, and 20.61% to 21.90% for the 1997 options; risk-free interest rates of 5.12%, 5.25%, 5.55%, 5.81% and 5.79% for the 1999 options, 5.45% and 5.58% for the 1998 options, and 6.06%, 6.43%, 6.36%, 6.18% and 5.86% for the 1997 options; and an expected life of four years following the vesting. Forfeitures are recognized as they occur. If the computed fair values of the 1999, 1998 and 1997 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) 1999 1998 1997 - -------------------------------------------------- ------------- ---------------- ---------------- Net income: As reported $ 204,466 $ 190,360 $ 175,309 Pro-forma 201,553 187,776 174,487 Basic earnings per share: As reported $ 4.55 $ 4.04 $ 3.50 Pro-forma 4.49 3.99 3.49 Diluted earnings per share: As reported $ 4.52 $ 4.03 $ 3.49 Pro-forma 4.45 3.97 3.47
Equity Stock Purchase Plan - In February 1999, the Company's Board of Directors adopted the 1999 PMI Group, Inc. Employee Stock Purchase Plan (the "ESPP") and shareholder approval was granted during the Company's 1999 Annual Meeting. A total of 300,000 shares of the Company's authorized but unissued common stock has been made available under the ESPP. The ESPP allows eligible employees to purchase shares of the Company's stock at a discount of 15 percent of the beginning-of-period or end-of-period (each period being a six month enrollment period) fair market value of the stock, whichever is lower. Under the ESPP, the Company sold approximately 13,578 shares in 1999. The Company applies APB 25 in accounting for the ESPP. The pro forma effect on the Company's net income and earnings per share had compensation cost been determined under SFAS 123 was deemed immaterial in 1999. 20 NOTE 15. STATUTORY ACCOUNTING The Company's domestic 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 in proportion to the estimated gross profits over the life of the policies. (See Note 6, "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) 1999 1998 1997 - --------------------------------------------------------------------------- Statutory net income $ 270,301 $ 214,040 $ 227,148 ====================================== Statutory surplus $ 134,133 $ 165,459 $ 274,864 ====================================== Contingency reserve liability $1,238,140 $1,028,440 $ 839,478 ====================================== 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. In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification"). The Codification, which is intended to standardize regulatory accounting and reporting for the insurance industry, is proposed to be effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices and it is uncertain when various states will require adoption of Codification for the preparation of statutory financial statements. PMI has not finalized the quantification of the effects of Codification on its statutory financial statements. NOTE 16. BUSINESS SEGMENTS The Company's reportable operating segments include Mortgage Guaranty Insurance, International Mortgage Guaranty Insurance, and Title Insurance. The Mortgage Guaranty Insurance segment includes PMI, RGC,RIC,PMG,TIC and TSP. The Title Insurance segment consists of the results for APTIC. The International Mortgage Guaranty Insurance segment consists of PMI Holdings and PMI Ltd. The Other segment includes TPG, MSC, PCI, and SEC. Key products for each of the 21 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 as of and for the periods indicated.
International Mortgage Mortgage 1999 Guaranty Guaranty Title Consolidated (in thousands) Insurance Insurance Insurance Other Total - -------------------------------------------------------------------------------------------------------------------------------- Premiums earned $ 447,214 $ 11,291 $ 100,118 $ - $ 558,623 ------------ -------------- ---------- --------- ------------ Net underwriting income (expenses) before tax-external customers $ 202,508 $ 6,910 $ 10,897 $ (9,015) $ 211,300 Investment income 79,020 4,611 1,633 3,326 88,590 Equity in earnings of affiliates - - - 7,061 7,061 Interest expense (3) (1,307) - (7,244) (8,554) Distributions on preferred capital securities - - - (8,311) (8,311) ------------ -------------- ---------- --------- ------------ Income (loss) before income tax expense 281,525 10,214 12,530 (14,183) 290,086 Income tax expense (benefit) 88,628 3,469 4,422 (10,899) 85,620 ------------ -------------- ---------- --------- ------------ Net income (loss) $ 192,897 $ 6,745 $ 8,108 $ (3,284) $ 204,466 ------------ -------------- ---------- --------- ------------ Total assets $ 1,764,125 $ 182,586 $ 46,484 $ 107,567 $ 2,100,762 ------------ -------------- ---------- --------- ------------ - --------------------------------------------------------------------------------------------------------------------------------
Mortgage 1998 Guaranty Title Consolidated (in thousands) Insurance Insurance Other 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 income 97,989 1,427 6,676 106,092 Equity in earnings of affiliates - - 3,225 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 (14,485) 266,948 Income tax expense (benefit) 78,732 4,182 (6,326) 76,588 ---------- ---------- ------------ ------------ Net income (loss) $ 191,668 $ 6,851 $ (8,159) $ 190,360 ---------- ---------- ------------ ------------ Total assets $1,643,482 $ 42,165 $ 92,223 $ 1,777,870 ---------- ---------- ------------ ------------ - -------------------------------------------------------------------------------------------------------------
22
Mortgage 1997 Guaranty Title Consolidated (in thousands) Insurance Insurance Other Total - ------------------------------------------------------------------------------------------------------------- Premiums earned $ 394,010 $ 59,938 $ - $ 453,948 ------------- ------------- ------------ --------------- Net underwriting income (expenses) before tax-external customers $ 159,360 $ 4,992 $ (9,822) $ 154,530 Investment and other income 93,625 1,257 6,383 101,265 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 (16,367) 242,867 Income tax expense (benefit) 72,099 2,218 (6,759) 67,558 ------------- ------------- ------------ --------------- Net income (loss) $ 180,886 $ 4,031 $ (9,608) $ 175,309 ------------- ------------- ------------ --------------- Total assets $ 1,503,596 $ 37,050 $ 145,957 $ 1,686,603 ------------- ------------- ------------ --------------- - -------------------------------------------------------------------------------------------------------------
The Company did not have any major customers that accounted for more than 10% of its consolidated revenues for any of the years presented. NOTE 17. 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 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. No payment obligations have arisen under the Runoff Support Agreement. The Runoff Support Agreement provides PMI with additional capital support for rating agency purposes. The Runoff Support Agreement contains certain covenants, including covenants that (i) PMI will write no new business after its risk-to-capital ratio equals or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and (iii) on the date that any of the following events occur: (A) PMI's risk-to-capital ratio exceeds 24.5 to 1, (B) Allstate shall have paid any claims relating to PMI policies directly to a policyholder or by paying an amount equal to such claims to PMI (or to 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 September 30, 1999, a CMG Capital Support Agreement was executed by PMI and CMIC whereby both parties agreed to contribute funds, under specified conditions, so as to maintain CMG's risk-to-capital at or below 18.0 to 1. As a 50% owner of CMG, PMI's obligation under the agreement is limited to an aggregate amount of $15 million, exclusive of capital contributions made prior to September 30, 1999. The previous CMG Capital Support Agreement, dated June 6, 1996, was superceded by execution of the new agreement. On December 31, 1999, CMG's risk-to capital ratio was 16.2 to 1. On June 6, 1999 a Capital Support Agreement was entered into between PMI and PMI Ltd, where by PMI agrees that it will provide funds necessary to ensure that PMI Ltd is able to maintain a sufficient level of capital at all times. In addition, the agreement states that in no event shall the net assets of PMI Ltd be less than 2% of the net aggregate risk of PMI Ltd plus AUD $50,000,000. As of December 31, 1999 the Company was in compliance with all covenants included in its capital support agreements. 23 NOTE 18. QUARTERLY RESULTS (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter -------------- -------------- ------------- --------------- 1999 1998 1999 1998 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Revenues 155,251 150,634 156,173 147,469 178,194 167,409 180,506 155,397 ------------------------------------------------------------------------------- Net income 43,652 45,768 49,459 46,787 54,503 53,728 56,852 44,077 ------------------------------------------------------------------------------- Basic EPS 0.97 0.94 1.10 0.98 1.22 1.16 1.27 0.97 ------------------------------------------------------------------------------- Diluted EPS 0.96 0.94 1.09 0.97 1.21 1.15 1.26 0.97 ------------------------------------------------------------------------------- Diluted operating EPS * 0.96 0.83 1.09 0.94 1.20 0.96 1.26 0.96 -------------------------------------------------------------------------------
* 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. All period have been adjusted to reflect the company's 3 for 2 stock split. 24 EX-21.1 9 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) Cayman Islands TPG Insurance Co. Vermont PMI PAC Arizona PMI Mortgage Insurance Co. Federal PAC Federal PAC The PMI Foundation California PMI Mortgage Insurance Australia (Holdings) Pty Limited Australia PMI Mortgage Insurance Ltd Australia
EX-23.1 10 INDEPENDENT AUDITOR'S CONSENT EXHIBIT 23.1 ------------ INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 333- 92636, No. 333-99378, No. 333-47473, No. 333-66829 No. 333-81679, and No. 333- 32190 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 report dated January 20, 2000 appearing in and incorporated by reference in this Annual Report on Form 10-K of the Company for the year ended December 31, 1999. /s/ Deloitte & Touche LLP San Francisco, California March 20, 2000 65 EX-27.1 11 FINANCIAL DATA SCHEDULE
7 1,000 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 1,479,310 0 0 192,925 0 0 1,817,328 28,076 50,714 69,579 2,100,762 282,000 182,089 0 0 145,367 0 0 528 1,216,740 2,100,762 558,623 95,142 509 15,850 112,682 80,252 170,239 290,086 85,620 204,466 0 0 0 204,466 4.55 4.52 208,477 159,293 (46,611) 1,798 95,797 270,565 0
-----END PRIVACY-ENHANCED MESSAGE-----