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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, 1997
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 94-3199675
(STATE OF SAN FRANCISCO, CALIFORNIA 94111 (I.R.S. EMPLOYER
INCORPORATION) (ADDRESS OF PRINCIPAL EXECUTIVE IDENTIFICATION NO.)
OFFICES)
(415) 788-7878
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH
----------------------------------- REGISTERED
Common Stock, $.01 par value -----------------------------------
New York Stock Exchange
Pacific Exchange
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 27, 1998
was $1,594,665,450 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 27, 1998: 32,419,800
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 1997 are incorporated by reference into Items 6 through 8 of Part
II. Portions of the Proxy Statement for registrant's 1998 Annual Meeting of
Stockholders to be held on May 21, 1998 are incorporated by reference into
Items 10 through 13 of Part III. The Exhibit Index is located on page 46.
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TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I..................................................................... 1
Item 1. Business.......................................................... 1
A. GENERAL............................................................... 1
B. PRODUCTS.............................................................. 1
C. INDUSTRY OVERVIEW..................................................... 3
D. COMPETITION AND MARKET SHARE.......................................... 4
E. CUSTOMERS............................................................. 7
F. BUSINESS COMPOSITION.................................................. 7
G. SALES, MARKETING AND UNDERWRITING PERSONNEL........................... 9
H. UNDERWRITING PRACTICES................................................ 9
I. AFFORDABLE HOUSING.................................................... 12
J. DEFAULTS AND CLAIMS................................................... 13
K. REINSURANCE........................................................... 18
L. CLAIMS-PAYING ABILITY RATINGS......................................... 19
M. INVESTMENT PORTFOLIO.................................................. 20
N. OTHER BUSINESSES...................................................... 20
O. REGULATION............................................................ 22
P. EMPLOYEES............................................................. 26
Q. CAUTIONARY STATEMENT.................................................. 26
R. FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK...... 26
Item 2. Properties........................................................ 31
Item 3. Legal Proceedings................................................. 31
Item 4. Submission of Matters to a Vote of Security Holders............... 31
PART II.................................................................... 33
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.................................................................. 33
Common Stock............................................................. 33
Preferred Stock.......................................................... 33
Payment of Dividends and Policy.......................................... 33
Item 6. Selected Financial Data........................................... 34
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................... 34
Item 7A. Quantative and Qualitative Disclosures About Market Risk......... 34
Item 8. Financial Statements and Supplementary Data....................... 34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure..................................................... 34
PART III................................................................... 35
Item 10. Directors and Executive Officers of the Registrant............... 35
Item 11. Executive Compensation........................................... 35
Item 12. Security Ownership of Certain Beneficial Owners and Management... 35
Item 13. Certain Relationships and Related Transactions................... 35
PART IV.................................................................... 35
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 35
INDEX TO EXHIBITS.......................................................... 46
</TABLE>
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PART I
ITEM 1. BUSINESS
A. GENERAL
The PMI Group, Inc. ("TPG"), a Delaware corporation, is a holding company
which conducts its residential mortgage insurance business through its direct
wholly-owned subsidiaries PMI Mortgage Insurance Co. ("PMI"), an Arizona
corporation, Residential Guaranty Co. ("RGC"), an Arizona corporation, PMI
Mortgage Guaranty Co. ("PMG"), an Arizona corporation, American Pioneer Title
Insurance Company ("APTIC"), a Florida corporation, and PMI Capital I, a
Delaware trust. In addition, PMI owns all of the outstanding common stock of
PMI Mortgage Services Co. ("MSC"), a California corporation which is engaged
in the business of contract underwriting and software licensing, 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, its subsidiaries, MSC and SECO are collectively referred to
as the "Company". PMI also owns 45% of the outstanding shares of common stock
of CMG Mortgage Insurance Company ("CMG"), a Wisconsin corporation, which also
conducts a residential mortgage insurance business. CMG is accounted for on
the equity method in the Company's consolidated financial statements.
TPG, through PMI and CMG, is one of the leading residential mortgage
insurers in the United States. In addition to primary mortgage insurance, TPG,
through the Company, provides title insurance, contract underwriting and
various services and products for the home mortgage finance industry. PMI was
founded in 1972 and was acquired by Allstate Insurance Company ("Allstate") in
1973. In April 1995, Allstate sold approximately seventy percent of the common
stock of TPG in an initial public offering (the "IPO"). The balance of the
Allstate common stock holdings is available to Allstate to redeem its
Exchangeable Notes on April 15, 1998, which Notes were sold to the public
concurrently with the IPO. If Allstate chooses to redeem the Notes with its
remaining holdings of TPG common stock, it is anticipated that Allstate will
continue to own, after the redemption, approximately 1.9 million shares of TPG
common stock. In the event the price of TPG's common stock falls below $41.50
per share during the twenty trading days prior to April 15, 1998, Allstate's
1.9 million share residual interest would be reduced if it chooses to redeem
the Exchangeable Notes for TPG Common Stock rather than cash. Allstate is
required to provide notice by April 6, 1998 to record holders of the
Exchangeable Notes of its irrevocable election to exchange Common Stock or
cash for the 10,500,000 Exchangeable Notes. At December 31, 1997, the
Company's total assets were $1.7 billion and its shareholders' equity was $1.1
billion.
B. PRODUCTS
There are two principal types of private residential mortgage insurance:
"primary" and "pool." Primary mortgage insurance provides coverage for lenders
who receive a down payment of 20% or less from a borrower. This includes
mortgage insurance coverage for lenders for mortgages with: (i) loan-to-value
ratios ("LTVs") in excess of 85% and less than or equal to 90% ("90s"); (ii)
LTVs in excess of 90% and less than or equal to 95% ("95s"); and (iii) LTVs in
excess of 95% and less than or equal to 97% ("97s"). The Federal National
Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac") currently require that 90s have 25% coverage, and
95s and 97s have 30% coverage. Fannie Mae and Freddie Mac are collectively
referred to as government sponsored enterprises ("GSEs"). Pool insurance is
generally used as an additional credit enhancement for certain secondary
market mortgage transactions. Pool insurance generally covers the loss on a
defaulted mortgage loan which exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan, as well as
the total loss on a defaulted mortgage loan which did not require primary
insurance, in each case up to a stated aggregate loss limit.
PRIMARY INSURANCE
PMI issues primary insurance to lenders or investors for first lien mortgage
loans on one-to-four unit residential properties, including condominiums.
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.
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Underwriting Practices", below.) Primary mortgage insurance provides mortgage
default protection to lenders or investors on individual loans. PMI's
obligation to an insured with respect to a claim is determined by applying the
appropriate coverage percentage to the claim amount. In lieu of paying the
coverage percentage of the claim amount, PMI has the option of: (i) paying the
entire claim amount and taking title to the mortgaged property, or (ii) in the
case of certain sales, paying the difference between the sales proceeds
received by the insured and the claim amount up to a maximum of the coverage
percentage. See "J. Defaults and Claims--Claims", below.
PMI offers coverage ranging from 4% to 42% of the total of the outstanding
loan principal, delinquent interest and certain expenses associated with a
default and the subsequent foreclosure of a mortgage loan ("claim amount").
The percentage of the total claim amount subject to payment by PMI in the
event of a claim on a mortgage loan that is 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, 1997. The
average coverage percentage for PMI was 26.1% for the year ended December 31,
1997. 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
and to permit PMI to retain the premiums (and related risk) on deep coverage
business, TPG formed RGC to provide reinsurance of such deep coverage to PMI
and CMG. (See "K. Reinsurance-- RGC", below.) The coverage percentage insured
by PMI is determined by the lender, usually to comply with Fannie Mae and
Freddie Mac requirements to reduce the loss exposure on loans purchased by
them. At December 31, 1997, PMI's average coverage percentage on insurance in
force was 23.3%. See "C. Industry Overview--Fannie Mae and Freddie Mac",
below.
Mortgage insurance coverage cannot be canceled by PMI, except for nonpayment
of premiums or certain material violations of PMI's master policy. Mortgage
insurance coverage can be canceled by the insured at any time. Generally,
mortgage insurance remains renewable at the option of the insured for the life
of the loan at a rate fixed when the insurance on the loan was initially
issued. As a result, the impact of increased claims and incurred losses from
policies originated in a particular year cannot be offset by renewal premium
increases on policies in force or mitigated by nonrenewal of insurance
coverage. (See "R. Factors That May Affect Future Results And Market Price of
Stock"). Mortgage insurance premiums are usually charged to the borrower by
the mortgage lender or loan servicer, which in turn remits the premiums to the
mortgage insurer. PMI has the following basic types of premium payment plans.
Monthly Premium. A premium payment plan in which premiums are paid monthly
over the term of the coverage ("Monthly Premium Plan"). Under PMI's Monthly
Premium Plan 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 MONTHLYSM"). The pmiNU MONTHLYSM plan helps reduces the amount a
borrower would typically have to pay at closing, thereby increasing mortgage
loan affordability. Monthly Premium and pmiNU MONTHLYSM Plans represented
97.5% of NIW in 1997.
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 are made in advance each year thereafter ("Annual Premium
Plan"). Renewal payments generally are collected monthly 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 1.8% of NIW in 1997.
Single Premium. A premium payment plan which requires an initial premium
payment that extends coverage for more than one year and involves a lump-sum
payment at the loan closing ("Single Premium Plan"), which may be refundable
if the coverage is canceled by the insured lender (which generally occurs when
the loan is repaid or the value of the property has increased significantly).
The single premium can be financed by the borrower by adding it to the
principal amount of the mortgage and generally covers the greater of 10 years
or amortization of the underlying loan to an 80% LTV. Single Premium Plans
represented 0.7% of NIW in 1997.
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POOL INSURANCE
During the fourth quarter of 1997, PMI began offering a pool insurance
product to state housing finance authorities and certain lenders as part of
PMI's value added strategy. This product did not generate any significant new
risk written during 1997, but is expected to do so in 1998. See "Q. Cautionary
Statement" and "R. Factors That May Affect Future Results and Market Price of
Stock", below. This product is similar in structure to the pool insurance
product previously offered by PMI during 1990--1993, but has different risk
characteristics, including limits on total exposure, diversification and loan
to value ratios.
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) pmiADVANTAGESM, a lender-paid primary mortgage insurance program that
provides reductions from standard rates based on the quality of the business
generated; (iii) captive reinsurance, a 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) risk protection
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) pmiEXTRASM 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. 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 "R. Factors That May Affect Future Results and Market Price of
Stock", below.
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.
Since 1992, Fannie Mae and Freddie Mac have been subject to oversight
legislation for GSEs which simultaneously tightened their capital requirements
and set goals for affordable housing. Their goals are based on the percentage
of loans purchased by the GSEs, determined by the number of dwelling units
securing such loans. Fannie Mae also expanded its Community Home Buyers
Program to include a commitment to purchase a certain volume of 97s.
TPG believes that the GSEs' announced goals for 1997 were that at least 42%
of the units financed by each GSE be low- and moderate-income housing, and
that 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%). TPG believes
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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.
PMI and other private mortgage insurers are not limited as to the principal
balance of loans for which they may issue mortgage insurance. The maximum
principal balance of loans eligible for purchase by Fannie Mae and Freddie Mac
is currently $227,150. PMI and other private mortgage insurers are affected by
Fannie Mae and Freddie Mac to provide mortgage insurance for such loans. To
the extent Fannie Mae or Freddie Mac reduce the amount private mortgage
insurance coverage they require on loans, 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, will be required to
respond to or comply with such actions. Such actions could have a material
adverse impact on the results of operations and financial condition of the
Company. See "D. Competition and Market Share", "O. Regulation", and "R.
Factors That May Affect Future Results and Market Price of Stock", below.
Freddie Mac's and Fannie Mae's automated underwriting services Loan
ProspectorSM 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.
In 1997, Fannie Mae and Freddie Mac revised their guidelines regarding
cancellation of mortgage guaranty insurance and the procedures its servicers
will be required to follow regarding notifying borrowers of their rights to
discontinue paying for mortgage guaranty coverage. Fannie Mae's and Freddie
Mac's current guidelines generally provide that a borrower's written request
to cancel mortgage insurance should be honored if: (a) the borrower has a
satisfactory payment record i.e., no payment more than 30 days delinquent in
the 12 month period preceding the request for cancellation; and (b) the unpaid
principal balance of the mortgage is not greater than 80% of the original
value of the property. See "O. Regulation", below.
D. COMPETITION AND MARKET SHARE
The U.S. private mortgage insurance industry consists of nine active
mortgage insurers, including Mortgage Guaranty Insurance Corporation ("MGIC"),
GE Capital Mortgage Insurance Corporation ("GEMICO"), an affiliate of GE
Capital Corporation, and United Guaranty Residential Insurance Company
("UGC"), an affiliate of American International Group, Inc. PMI, including
CMG, is the third largest private mortgage insurer in the United States based
on new primary insurance written in 1997 and direct primary insurance in force
at December 31, 1997. (Source: Inside Mortgage Finance.) In 1997, MGIC
possessed the largest share of the private mortgage insurance market, with
approximately 26.5% of new primary insurance written, and GEMICO, PMI and UGC
had market shares of approximately 16.5%, 13.8% and 12.8%, respectively.
(Source: Inside Mortgage Finance.) The decline in PMI's market share in 1997
was primarily due to the availability of a pool insurance product, in which
the GSEs are beneficiaries, not offered by PMI for the majority of 1997, and
secondarily to increases in product and underwriting competition in the
California market. During the fourth quarter of 1997, PMI began offering a
pool insurance product to state housing finance authorities and certain
lenders. This product is similar in structure to the pool insurance product
previously offered by PMI during 1990--1993, but has different
characteristics, including limits on total exposure, diversification and loan
to value ratios. Management presently cannot predict the impact this pool
insurance product will have on PMI's market share. PMI's 1997 market share
percentage includes 1.1% of the market held by CMG. See Part II, Item 7 --
"Management's Discussion And Analysis Of Financial Condition And Results of
Operations"; "R. Factors That May Affect Future Results and Market Price of
Stock", below.
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The following table indicates the market share, based on NIW and private
mortgage insurer over the past five years.
PRIVATE MORTGAGE INSURANCE INDUSTRY MARKET SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995 1994 1993
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Mortgage Guaranty Insurance Corp............. 26.4% 25.5% 27.4% 25.7% 26.9%
GE Capital Mortgage Insurance Corp........... 16.5 18.5 20.1 27.6 24.7
PMI Mortgage Insurance Co.(/1/).............. 13.8 14.7 13.5 13.8 18.5
United Guaranty Corp......................... 12.8 12.7 12.9 13.3 12.7
Commonwealth Mortgage Assurance Co........... 11.3 9.7 9.6 7.8 6.6
Republic Mortgage Insurance co............... 10.3 11.2 9.7 8.7 8.8
Amerin Guaranty Corp......................... 6.5 6.0 5.3 1.9 0.6
Triad Guaranty Insurance Corp................ 2.4 1.7 1.5 1.2 1.2
----- ----- ----- ----- -----
Total...................................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
</TABLE>
Source: Inside Mortgage Finance
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(1) Includes CMG.
PMI and other private mortgage insurers also compete directly with federal
and state governmental and quasi-governmental agencies, principally the FHA
and, to a lesser degree, the VA. These agencies sponsor government-backed
mortgage insurance programs which accounted for 45.6%, 44.8%, and 38.5% for
1997, 1996 and 1995, respectively, of all loans insured or guaranteed(/2/).
The maximum individual loan amount that the FHA can insure is currently
$170,362 and the maximum individual loan amount that the VA can insure is
$203,150. The Clinton administration has recommended and Congress are
considering increasing the single-family loan limit which FHA could purchase
to $227,150. The Company believes that any increase in the FHA loan limit
could adversely affect the competitive position of PMI and consequently could
materially and adversely affect the Company's financial condition and results
of operations. (See "R. Factors That May Affect Future Results and Market
Price of Stock"). Private mortgage insurers have no limit as to 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.
In another proposal, HUD is considering the viability of sharing single-
family mortgage risk between the FHA and other partners, including private
mortgage insurance companies. Any change in legislation which affects the
ability of the FHA or the VA to offer a substitute for mortgage insurance or
increase their statutory lending limits could adversely impact private
mortgage insurers, including PMI. The Company is unable at this time to
predict the scope and content of such proposals, or whether any such proposals
will be enacted into law, and, if enacted, the effect on the Company.
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
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997(/3/) 1996 1995 1994 1993
--------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
FHA/VA........................................ 45.6% 44.8% 38.5% 51.8% 46.9%
Private Mortgage Insurance.................... 54.4 55.2 61.5 48.2 53.1
---- ---- ---- ---- ----
Total....................................... 100% 100% 100% 100% 100%
==== ==== ==== ==== ====
</TABLE>
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(3) Market share data for the year ended December 31, 1997 is estimated.
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During 1997, the maximum single-family principal balance loan limit eligible
for purchase by Fannie Mae and Freddie Mac was increased from $214,600 to
$227,150 effective in 1998. Another proposal would allow Fannie Mae and
Freddie Mac greater flexibility in utilizing substitutes for private mortgage
insurance. Fannie Mae and Freddie Mac also have the discretion to reduce the
amount of private mortgage insurance they require on loans. The increase in
the loan principal balance eligible for purchase by these GSEs as well as the
adoption by the GSE's of private mortgage insurance substitutes or reduction
in the amount of private mortgage insurance coverage could materially and
adversely affect the Company's financial condition and results of operations.
See "R. Factors That May Affect Future Results and Market Price of Stock",
below.
The Office of the Comptroller of the Currency has granted permission to
certain national banks to form reinsurance companies as wholly-owned operating
subsidiaries for the purpose of reinsuring mortgage insurance written on loans
originated or purchased by such bank. The Federal Reserve Board and The Office
of Thrift Supervision are in the process of considering whether similar
activities are permitted for bank holding companies and savings institutions,
respectively. The reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors
of the Company in the future and could have a material adverse impact on the
results of operations and financial condition of the Company. See "D.
Competition and Market Share", "O. Regulation", and "R. Factors That May
Affect Future Results and Market Price of Stock", below.
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 first mortgage lien loans with an 80
percent LTV ratio, a 10 percent second mortgage lien, and 10 percent of the
purchase price from borrower's funds. This 80/10/10 product competes with
mortgage insurance as an alternative for lenders selling loans in the
secondary mortgage market, and if it becomes a widely accepted alternative to
mortgage insurance, it could have a material adverse impact on the Company's
financial condition and results of operations. In addition, Fannie Mae and
Freddie Mac have in certain cases elected to accept a spread account funded
from a portion of the servicing fees or a credit enhancement in lieu of
mortgage insurance. 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 mortgage insurance 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. PMI is pursuing various risk-sharing
arrangements for certain of its customers, including offering various premium
rates based on the risk characteristics, loss performance 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 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 or their
long-term competitive effect. See "K. Reinsurance" and "R. Factors That May
Affect Future Results and Market Price of Stock", below.
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, 1997, 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 majority of 1997, PMI did not offer a pool insurance product.
Management believes PMI's market share declined in 1997 primarily due to the
availability of pool insurance products being offered by other private
mortgage insurance companies. During the fourth quarter of 1997, PMI began
offering a pool insurance product to state housing finance authorities and
certain lenders. Management presently cannot predict the impact this pool
insurance product will have on PMI's market share. See Part II, Item 7--
"Management's Discussion And Analysis Of Financial Condition And Results of
Operations"; "R. Factors That May Affect Future Results and Market Price of
Stock", below.
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For the year ended December 31, 1997, total mortgage originations were
estimated to be $849.7 billion compared to $785.3 billion for the year ended
December 31, 1996. PMI currently expects the total volume of mortgage
originations may reach $1 trillion in 1998. See "Q. Cautionary Statement" and
"R. Factors That May Affect Future Results and Market Price of Stock", below.
E. CUSTOMERS
PMI insures mortgage loans funded by mortgage originators. Mortgage
originators include mortgage bankers, savings institutions, commercial banks
and other mortgage lenders. During 1997 the mortgage origination industry
continued its trend of significant consolidation, resulting in the market
share for mortgage originators being concentrated among a smaller number of
higher volume financial institutions. PMI expects this trend to continue into
1998. See "Q. Cautionary Statement", below.
For the year ended December 31, 1997, 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.
PMI's master policy sets forth the general published terms and conditions of
the mortgage insurance coverage provided by PMI. The master policy does not
obligate the lender to secure insurance from PMI, nor, except in the case of
delegated underwriting, does it obligate PMI to issue insurance on a
particular loan. The master policy requires that the lender apply for
insurance coverage on individual loans and that a certificate be issued for a
loan before coverage becomes effective. See "H. Underwriting Practices",
below.
F. BUSINESS COMPOSITION
The composition of PMI's direct primary risk in force, as summarized in the
following table, reflects several changes over the five-year period from 1993
to 1997. The relatively low interest rates during this period resulted in an
increasing percentage of mortgages insured by PMI at a fixed rate of interest,
representing 83.8% of direct primary risk in force at December 31, 1997, up
from 74.9% at year-end 1993. 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. Historically,
borrowers prefer fixed rate mortgages during periods of low or decreasing
interest rates due to a borrower's desire to lock in what are perceived to be
desirable rates. PMI believes this trend will continue if interest rates
remain at their current levels or decrease. See "Q. Cautionary Statement" and
"R. Factors That May Affect Future Results and Market Price of Stock", below.
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 21.9% for
the year ended December 31, 1996 to 28.8%, for the year ended December 31,
1997. During the period between 1996 and 1997, PMI's amount of direct primary
risk in force increased by 4.4% from $17.3 billion at December 31, 1996 to
$18.1 billion at December 31, 1997. The direct primary risk in force increased
by 14.6% in 1996 from $15.1 billion to $17.3 billion, at December 31, 1995 and
1996, respectively.
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI, and other mortgage insurance
companies, generally experience an increase in the prepayment rate of
insurance in force, resulting from policy cancellations of older books of
business. Although PMI has a history of expanding business during low interest
rate environments, the resulting increase in NIW may ultimately prove to be
inadequate to compensate for the loss of insurance in force arising from
policy cancellations. Any significant decrease in PMI's insurance in force
could materially and adversely affect the Company's financial condition and
results of operations. See "R. Factors That May Affect Future Results and
Market Price of Stock", below.
7
<PAGE>
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
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Direct Risk in Force (In
millions)........................ $18,092 $17,336 $15,130 $13,243 $11,267
======= ======= ======= ======= =======
Lender Concentration:
Top 10 Lenders (by original
applicant)..................... 34.4% 26.0% 22.5% 20.4% 19.5%
======= ======= ======= ======= =======
LTV:
95s(1).......................... 48.0% 44.7% 40.6% 35.7% 31.7%
90s and below(2)................ 52.0 55.3 59.4 64.3 68.3
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Average Coverage Percentage....... 24.3% 22.4% 21.2% 20.1% 19.8%
======= ======= ======= ======= =======
Loan Type:
Fixed........................... 83.3% 80.6% 76.8% 74.4% 75.4%
ARM............................. 15.2 17.7 21.3 23.9 23.3
ARM (scheduled/potential
negative amortization)......... 1.5 1.7 1.9 1.7 1.3
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Mortgage Term:
15 years and under.............. 6.3% 9.4% 8.6% 10.3% 11.5%
Over 15 years................... 93.7 90.6 91.4 89.7 88.5
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Property Type:
Single-family detached.......... 86.3% 86.7% 86.7% 86.3% 85.2%
Condominium..................... 6.8 6.9 7.1 7.5 8.1
Other(3)........................ 6.9 6.4 6.2 6.2 6.7
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Occupancy Status:
Primary residence............... 99.0% 99.2% 99.3% 99.4% 99.3%
Second home..................... 0.8 0.6 0.5 0.3 0.3
Non-owner occupied.............. 0.2 0.2 0.2 0.3 0.4
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Loan Amount:
$100,000 or less................ 27.3% 28.3% 28.8% 29.9% 31.7%
Over $100,000 and up to
$151,725(4).................... 36.5 35.9 35.6 35.7 35.4
Over $151,725 and up to
$203,150(5).................... 22.3 23.8 23.0 22.3 21.1
Over $203,150 and up to
$250,000....................... 6.8 5.1 5.7 5.5 5.4
Over $250,000................... 7.1 6.9 6.9 6.6 6.4
------- ------- ------- ------- -------
TOTAL......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
</TABLE>
- --------
(1) Includes 97s, representing 1.8% of PMI's risk in force as of December 31,
1997.
(2) PMI includes in its classification of 90s, for purposes of applying its
underwriting standards, determining premiums and in the table above, loans
where the borrower makes a down payment of 10% and finances the mortgage
insurance premium payment as part of the loan (thus, increasing the
principal balance of the loan to over 90% LTV). Fannie Mae classifies
these loans as 95s, which has had the effect of limiting the marketability
of these. At December 31, 1997, less than 2.8% of PMI's risk in force
consisted of these types of loans.
(3) Includes two-to-four unit dwellings, townhouses, row houses and
cooperatives.
(4) $151,725 was the maximum individual loan amount that the FHA could insure.
Such amount was increased to $152,363 in the third quarter of 1994,
increased to $160,950 in February 1997, and increased to $170,362 in
February 1998. Currently, a proposal is pending to increase the maximum
individual loan amount that the FHA could insure to $227,150.
(5) $203,150 is the maximum principal balance of loans originated after
November 1, 1992 eligible for purchase by Fannie Mae and Freddie Mac.
After January 1996, the maximum principal balance of loans eligible for
purchase increased to $207,000, further increased to $214,600 as of
February 1997, balance of loans and increased to $227,150 effective in
1998.
8
<PAGE>
G. SALES, MARKETING 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, 1997, PMI had 32 sales
and underwriting service field and satellite offices located in 22 states.
PMI's sales force receives compensation comprised of a base salary with
incentive compensation tied to performance objectives. PMI's Marketing
Department has primary responsibility for advertising, sales materials, and
the creation of new products and services. PMI's marketing and underwriting
management personnel are eligible to participate in a bonus plan; all other
personnel are compensated solely by salary.
PMI's underwriting and sales force have access to electronic data
interchange and automated mortgage scoring systems which give them the ability
to more efficiently process and underwrite both conforming and non-conforming
loans to investors standards. See "H. Underwriting Practices Role of
Technology" below. During 1997, PMI established a Certificate Priority Center
("CPC"), in Dallas Texas, its purpose is to centralize the processing of data
input for PMI's insurance certificates. The CPC was designed to enhance
operational productivitity and efficiency, customer service and expense
management.
The Company 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. Contract underwriting services have
become increasingly important to mortgage lenders as they seek to reduce
costs. Accordingly, contract underwriting generates a significant percentage
of PMI's NIW. Due to the increasing demand of contract underwriting services,
the limited number of underwriting personnel available, and heavy price
competition among mortgage insurance companies, PMI's inability to recruit and
maintain a sufficient number of qualified underwriters could materially and
adversely affect its market share and materially and adversely affect the
Company's financial condition and results of operations. Management
anticipates that contract underwriting will continue to process loans that
will generate a significant percentage of PMI's NIW. See "Q. Cautionary
Statement" and "R. Factors That May Affect Future Results and Market Price of
Stock", below.
H. UNDERWRITING PRACTICES
RISK MANAGEMENT APPROACH
PMI underwrites its primary business based upon the historical performance
of risk factors of individual loan profiles, and utilizes automated
underwriting systems in the risk selection process to assist the underwriter
with decision making. PMI's underwriting process evaluates five categories of
risk:
- Borrower. An evaluation of the borrower's credit history is an integral
part of PMI's risk selection process. In addition to the borrower's
credit history, PMI analyzes several factors, including the borrower's
employment history, income, funds needed for closing, and the details of
the home purchase.
- Loan Characteristics. PMI analyzes four general characteristics of the
loan product to quantify risk: (i) LTV; (ii) type of loan instrument;
(iii) type of property; and (iv) purpose of the loan. Certain categories
of loans are generally not insured by PMI because such loans are deemed
to have an unacceptable level of risk, such as loans with scheduled
negative amortization, and loans originated using limited documentation.
- Property Profile. PMI reviews appraisals regarding methodology used to
determine the property price.
- Housing Market Profile. PMI places significant emphasis on the condition
of regional housing markets in determining its underwriting guidelines.
PMI analyzes the factors that impact housing values in each of its major
markets and closely monitors regional market activity on a quarterly
basis.
- Mortgage Lender. PMI tracks the historical risk performance of all
customers that hold a master policy. This information is factored into
the determination of the loan programs that PMI will approve for various
lenders.
9
<PAGE>
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.
In 1988, PMI developed a report called the Economic Real Estate Trends
("ERET") to assist in analyzing regional and local market conditions. ERET
assigns ratings to 100 Metropolitan Statistical Areas ("MSAs") by tracking and
analyzing a number of economic and housing industry factors on a quarterly
basis. This report is used to help establish territorial underwriting
guidelines which allow PMI to take more or less risk in a given market based
on such market's economic condition. This rating is also incorporated in the
automated appraisal review process during the underwriting evaluation. PMI was
the first mortgage insurance company to provide mortgage originators with
formal territorial underwriting guidelines to address local real estate market
conditions.
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 "R. Factors That May Affect Future Results and Market
Price of Stock", below.
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, or the CPC, 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. The amount of business written under the Quick
Application Program was 9.4% of PMI's NIW in 1997.
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 CPC or by the 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
- -- pmiAURASM and pmiTERRASM. During 1997, 70.6% of applications received were
approved by the automated underwriting systems. In 1996, 59.5% of applications
received were approved by the automated underwriting systems. For 1997 and
1996 over 90% of the approved applications resulted in a commitment for
insurance being issued by PMI. 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 are received.
PMI's Quick Application Program allows selected lenders to submit insurance
applications that do not include all standard documents. The lender is
required to maintain written verification of employment and source of funds
needed for closing and other supporting documentation in its origination file.
PMI may schedule on-site audits of lenders' files on loans submitted under
this program.
10
<PAGE>
PMI's rejection rate declined to approximately 8% for the year ended
December 31, 1997 from 10% for the year ended December 31, 1996, as a result
of improving real estate markets and the continued development of highly
effective risk management and monitoring tools. 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.
ROLE OF TECHNOLOGY
PMI was the first mortgage insurer to receive an application for insurance
electronically through an electronic data interchange ("EDI") link with a
lender. EDI links, through pmiPAPERLESSSM, serve to reduce paperwork for both
PMI and its customers, streamline the process by which mortgage insurance is
applied for, reduce the number of errors associated with re-entering
information, and increase the speed with which PMI is able to respond to
applications, all of which can enhance PMI's relationship with lenders.
In 1987, PMI completed development of the pmiAURASM system in conjunction
with Allstate. The system was initially developed utilizing five years of
performance information from approximately 300,000 borrower profiles. The
system employs claim and risk statistical models to predict the relative
likelihood of default by a mortgage borrower. The pmiAURASM system assigns all
applications received by PMI a risk score predicting the likelihood of
default, and automatically refers certain applications to underwriters based
on higher risk characteristics, territorial underwriting guidelines or other
administrative requirements. PMI has updated the pmiAURASM system database
with performance data of over two million loans, and has added economic and
demographic information to the database in order to enhance the pmiAURAsSM
system predictive power. During 1997, the 4th release of pmiAURASM was
released and will enable the pmiAURASM system to generate three types of
scores: a loan risk score that assesses the risk solely due to the borrower,
loan and property characteristics independent of market risk; a market score
which is a measure of the default risk due solely to the metropolitan area
economic conditions; and the pmiAURASM Score, which combines the information
in the loan risk and market scores. Also, the newest release includes a
revised credit score indicator. PMI intends to further update the model from
time to time. During 1997, the pmiAURASM system was approved by all four Wall
Street rating agencies as an effective tool for establishing levels of credit
support needed on securities backed by non-conforming and conventional loans.
In 1991, the pmiTERRASM system was installed to complement the pmiAURASM
system 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 appraisal model is the economic market acceptability rating
from ERET. This rating allows the pmiTERRASM system to evaluate an appraisal
considering 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(TM), respectively, which are used as
tools by mortgage originators to determine whether Freddie Mac or Fannie Mae
will purchase a loan. PMI works with both agencies in offering its insurance
services through their systems, while utilizing PMI"s proprietary risk
management systems to monitor the risk quality of loans insured through such
systems.
11
<PAGE>
As an added benefit, the pmiAURASM's system 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 the
pmiAURASM system to approximately 30 customers or lenders, including five of
the top 10 mortgage lenders, who use the pmiAURASM system 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 the pmiAURASM system
licensees customer service, technical support and software upgrades.
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 50.3% and 39.9% of PMI's NIW in 1997 and 1996,
respectively, and represented 28.6% of PMI's total risk in force at December
31, 1997. PMI believes the percentage of risk in force written under the PDQ
Program will increase further in the future as the program is expanded to
include additional qualified lenders. Delegated underwriting enables PMI to
meet mortgage lenders' demands for immediate insurance coverage of certain
loans. Such types of programs have now become standard industry practice.
Under the PDQ Program, customers utilize their own PMI-approved underwriting
guidelines and eligibility requirements in determining whether PMI is
committed to insuring a loan. Once the lender notifies PMI of an insured loan,
key loan risk characteristics are evaluated by the pmiAURASM model to monitor
the quality of delegated business on an ongoing basis. Additionally, PMI
audits a representative sample of loans insured by each lender participating
in the PDQ Program on a regular basis to determine compliance with program
requirements. If a lender participating in the program tentatively commits PMI
to insure a loan which fails to meet all of the applicable underwriting
guidelines, PMI is obligated to insure such 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
ProspectorSM system. PMI has currently limited its interface participation
with Loan ProspectorSM 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-
better 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.
I. AFFORDABLE HOUSING
In recent years, PMI has increased its insurance of residential mortgages
identified by its customers as loans secured by properties owned and occupied
by low- and moderate-income borrowers, with minimal borrower downpayment
requirements and utilizing flexible underwriting guidelines ("affordable
housing" loans). The percentage of affordable housing loans designated as such
by lenders was 9.10% of new risk written in 1997, as compared to 11.56% in
1996. Management believes that affordable housing loans have higher risks than
its other insured business. As a result, PMI has instituted various programs
seeking to mitigate the higher risk characteristics of such loans. While early
in the life of such lender-designated loans, on the basis of the information
available, PMI believes that the default rate and claims rate on such loans
will be higher than the average default rate and claims rate on other PMI
books of business.
12
<PAGE>
J. DEFAULTS AND CLAIMS
DEFAULTS
PMI's default rate increased to 2.38% at December 31, 1997 from the December
31, 1996 rate of 2.19%. This increase was due primarily to policy
cancellations and to normal delinquency development in states where PMI has
expanded its market presence and the maturation of PMI's 1993 and 1994 books
of business. Management expects the default rate to increase in 1998. See "R.
Factors That May Affect Future Results and Market Price of Stock" 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 generally within 130 days
after the initial default. Generally, defaults are reported sooner, and the
average time for default reporting in 1997 by PMI insureds was approximately
60 days after 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 generally 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. PMI may also cure a
default by making a mortgage payment to the servicer on behalf of the
borrower.
The following table shows the number of loans insured by PMI, the number of
loans in default and the default rate.
HISTORICAL DEFAULT RATES
TOTAL INSURED LOANS IN FORCE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Number of Insured Loans in Force... 698,831 700,084 657,800 612,806 543,924
Number of Loans in Default......... 16,638 15,326 13,022 11,550 9,842
Default Rate....................... 2.38% 2.19% 1.98% 1.88% 1.81%
</TABLE>
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,
1997.
13
<PAGE>
DEFAULT RATES BY REGION(1)
<TABLE>
<CAPTION>
AS OF PERIOD END,
------------------------------------------------------------------------
1997 1996
-------------------------- --------------------------
4TH Q 3RD Q 2ND Q 1ST Q 4TH Q 3RD Q 2ND Q 1ST Q 1995 1994 1993
REGION ----- ----- ----- ----- ----- ----- ----- ----- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Pacific(2).............. 3.14% 3.17% 3.12% 3.28% 3.22% 3.03% 3.21% 3.39% 3.34% 2.99% 2.39%
New England(3).......... 1.81 1.79 1.82 1.87 1.80 1.77 1.80 2.07 1.93 1.98 2.22
Northeast(4)............ 2.79 2.67 2.57 2.56 2.52 2.38 2.22 2.33 2.22 2.11 2.19
South Central(5)........ 1.98 1.87 1.71 1.68 1.67 1.63 1.55 1.64 1.51 1.76 1.87
Mid-Atlantic............ 2.35 2.29 2.17 2.15 2.03 1.79 1.62 1.75 1.65 1.60 1.60
Great Lakes(7).......... 1.86 1.75 1.56 1.63 1.82 1.68 1.30 1.33 1.21 1.28 1.48
Southeast(8)............ 2.31 2.13 2.05 1.99 1.93 1.77 1.61 1.61 1.53 1.41 1.38
North Central(9)........ 1.95 1.75 1.67 1.65 1.61 1.52 1.38 1.42 1.31 1.03 1.01
Plains(10).............. 1.56 1.56 1.40 1.25 1.21 1.08 1.02 0.81 0.89 0.68 0.72
Total Portfolio......... 2.38 2.29 2.20 2.22 2.19 2.03 1.96 2.07 1.98 1.88 1.81
</TABLE>
- --------
(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.
PMI'S DEFAULT RATES FOR TOP 10 STATES BY TOTAL RISK IN FORCE(1)
<TABLE>
<CAPTION>
PERCENT OF PMI'S
PRIME RISK IN
FORCE AS OF DEFAULT RATE AS OF DECEMBER 31,
DECEMBER 31, --------------------------------------
1997 1997 1996 1995 1994 1993
---------------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
California............ 20.5% 3.73% 3.81% 4.08% 3.72% 2.89%
Florida............... 7.0 2.93 2.40 1.92 1.86 1.79
Texas................. 6.5 2.25 2.04 1.85 2.29 2.21
Virginia.............. 4.3 1.67 1.54 1.18 1.20 1.24
Washington............ 4.6 1.66 1.58 1.21 0.96 0.96
Massachusetts......... 4.2 1.67 1.73 1.91 2.04 2.43
New York.............. 4.5 2.94 2.59 2.30 2.00 1.99
Pennsylvania.......... 4.0 2.38 2.13 1.91 1.72 1.83
Georgia............... 3.8 1.87 2.59 2.26 2.14 2.02
Illinois.............. 3.8 2.56 2.14 1.84 0.60 1.71
Total Portfolio....... 100.0% 2.38% 2.19% 1.98% 1.88% 1.81%
</TABLE>
- --------
(1) Top ten states as determined by total risk in force as of December 31,
1997. Default rates are shown by states based on location of the
underlying property.
Default rates on PMI's California policies decreased to 3.73% (representing
3,991 loans in default) at December 31, 1997, from 3.81% (representing 4,261
loans in default) at December 31, 1996. 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 Policy Servicing", below).
Policies written in California accounted for approximately 64% and 73% of the
total dollar amount of claims paid for the year ended December 31, 1997
14
<PAGE>
and 1996, respectively. Although management expects that California should
continue to account for the majority of total claims paid, management
anticipates that with continued improvement in the California economy,
increased benefits of loss mitigation and improved default reinstatement
rates, California claims paid as a percentage of total claims paid should
continue to decline for the foreseeable future. See "Q. Cautionary Statement"
and "R. Factors That May Affect Future Results and Market Price of Stock",
below.
The following table sets forth the dispersion of PMI's primary insurance in
force and risk in force as of December 31, 1997, by year of policy origination
since PMI began operations in 1972.
INSURANCE AND RISK IN FORCE BY POLICY YEAR
<TABLE>
<CAPTION>
PRIMARY PERCENT PRIMARY PERCENT
POLICY YEAR INSURANCE IN FORCE OF TOTAL RISK IN FORCE OF TOTAL
- ----------- ------------------ -------- ---------------- --------
($ IN THOUSANDS) ($ IN THOUSANDS)
<S> <C> <C> <C> <C>
1972-1990................. $ 4,016,705 5% $ 850,245 5%
1991...................... 2,106,779 3% 419,554 2%
1992...................... 7,671,985 10% 1,488,753 8%
1993...................... 14,487,080 19% 2,882,475 16%
1994...................... 10,387,126 13% 2,210,774 12%
1995...................... 10,402,765 13% 2,706,347 15%
1996...................... 14,697,995 19% 3,868,250 21%
1997...................... 14,016,481 18% 3,665,723 21%
----------- --- ----------- ---
Total Portfolio........... $77,786,916 100% $18,092,121 100%
=========== === =========== ===
</TABLE>
CLAIMS AND POLICY 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, 1992 through December 31, 1995
represents 55.2% of PMI's insurance in force at December 31, 1997, with the
1993 book of business alone representing 18.6%. This substantial volume of
PMI's business is in its expected peak claim period. Consistent with
increasing coverage percentages and increasing mortgage principal amounts,
claim amounts have risen in recent years. Direct primary claims paid in by PMI
1997 were approximately $147 million compared with $143 million in 1996.
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 conditions. 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.
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,
reduced by any applicable payment. 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 primarily by an
uninsured casualty.
15
<PAGE>
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 and (B)
the coverage percentage multiplied by the claim amount, or (iii) paying 100%
of the claim amount in exchange for the insured's conveyance to PMI of good
and marketable title to the property, with PMI then selling the property for
its own account. Properties acquired through the last option are included on
PMI's balance sheet in other assets as residential properties from claim
settlements (also known as "REO"). PMI attempts to choose the claim settlement
option which best mitigates the amount of its claim payment. Generally,
however, PMI settles by paying the coverage percentage multiplied by the claim
amount. In 1997 and 1996, PMI settled 12.3% and 11.0%, respectively, of the
primary claims processed for payment on the basis of a prearranged sale. In
each of 1997 and 1996, PMI exercised the option to acquire the property on
less than 3% of the primary claims processed for payment. At December 31,
1997, PMI owned $4.7 million of REO valued at the lower of cost or estimated
realizable value.
The ratio of the claim paid to the original risk in force relating to such
loan is referred to as claim severity and is a factor that influences PMI's
losses. The main determinants of claim severity are the accrued interest on
the mortgage loan and the foreclosure expenses. These amounts depend in part
on the time required to complete foreclosure, which varies depending on state
laws. Pre-foreclosure sales and other early workout efforts help to reduce
overall severity. The average claim severity level has decreased from 102.7%
in 1993 to 95.8% in the period from 1993 to 1997. Management believes the
claims severity level for 1998 will approximate the 1997 level. See "Q.
Cautionary Statement", and "R. Factors That May Affect Future Results and
Market Price of Stock", below.
TECHNOLOGY FOR CLAIMS AND POLICY SERVICING
Technology is an integral part of the claims and policy servicing process
and PMI believes that technology will continue to take on a greater role in
increasing internal efficiencies and improving customer service. PMI uses a
personal computer-based automated claim-for-loss worksheet program, developed
in 1987, which compiles pertinent data while automatically calculating the
claim amount and predicting the best settlement alternative. To enhance
efficiencies and ease of use for its customers, PMI developed Document Free
ClaimEaseSM, 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 were developed by
PMI in 1995: pmiPHONE-CONNECTSM, which is a voice response application,
enabling the insured to access PMI's database by using their phones to inquire
on the status of their coverages and get information on billings, refunds,
coverage and renewals; pmiPC-CONNECTSM, 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; PMI
is also capable of receiving claims, handling premium billing, and loan sale
transfers via EDI. To contain costs and expand internal efficiencies, PMI uses
optical imaging in its claims functions, allowing PMI to eliminate the
transfer and storage of documents relating to claims. PMI, through its
automatic default reporting process ("ADR"), allows paperless reporting of
default information by the insured. In 1997, approximately 87% of all Notices
of Delinquency were reported using this ADR system, compared to 82% in 1996.
PMI, and other mortgage insurance companies generally experience greater
stress on their processing systems, caused by an increase in policy
cancellations and new business arising during a period of increased loan
refinancing activity, such as occured during the first quarter of 1998. PMI
believes that its claims and policy
16
<PAGE>
servicing department will be able to continue the efficient processing of the
higher volume of customer requests, through reliance on its technology,
including pmiPHONE-CONNECTSM and pmiPC-CONNECTSM. Any significant decrease in
the efficiency of PMI's claims and/or policy servicing operations may be
detrimental to established customer relationships and could materially and
adversely affect its market share and materially and adversely affect the
Company's financial condition and results of operations. See "R. Factors That
May Affect Future Results and Market Price of Stock", below.
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. The
Company's financial condition and results of operations would be adversely
affected to the extent that loss reserves are insufficient to cover the actual
related claims paid and expenses incurred. 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.
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 computed in accordance with commonly accepted loss reserving
standards and principles and meet the requirements of the insurance laws and
regulations of the State of Arizona. 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 "R. Factors That May
Affect Future Results and Market Price of Stock", below.
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
17
<PAGE>
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:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
($ IN THOUSANDS)
<S> <C> <C> <C>
Balance, January 1.............................. $199,774 $192,087 $173,885
Less reinsurance recoverable.................... 5,287 17,899 17,569
-------- -------- --------
Net balance, January 1.......................... 194,487 174,188 156,316
-------- -------- --------
Losses and loss adjustment expenses (principally
in respect of defaults occurring in)
Current year................................... 158,147 161,740 133,536
Prior years.................................... (5,890) (9,331) (20,699)
-------- -------- --------
Total losses and loss adjustment expenses..... 152,257 152,409 112,837
-------- -------- --------
Losses and loss adjustment expense payments
(principally in respect of defaults occurring
in)
Current year................................... 27,700 23,353 16,180
Prior years.................................... 122,724 108,757 78,785
-------- -------- --------
Total payments................................ 150,424 132,110 94,965
-------- -------- --------
Net balance, December 31........................ 196,320 194,487 174,188
Plus reinsurance recoverable.................... 6,067 5,287 17,899
-------- -------- --------
Balance, December 31............................ $202,387 $199,774 $192,087
======== ======== ========
</TABLE>
As a result of changes in estimates of ultimate losses resulting from
insured events in prior years, the provision for losses and loss adjustment
expenses (net of reinsurance recoverables) decreased by $5.9 million, $9.3
million, and $20.7 million in 1997, 1996 and 1995, respectively, due primarily
to lower-than-anticipated losses in California. Such re-estimates were based
on management's analysis of various economic trends (including the real estate
market and unemployment rates) and their effect on recent claim rate and claim
severity experience.
K. REINSURANCE
The use of reinsurance as a source of capital and as a risk management tool
is well established within the mortgage insurance industry. In addition,
certain mortgage insurers, including PMI, have agreed to reinsure portions of
the risk written on loans originated by certain lenders with captive
reinsurance companies affiliated with such lenders. Reinsurance does not
discharge PMI, as the primary insurer, from liability to a policyholder. The
reinsurer simply agrees to indemnify PMI for the reinsurer's share of losses
incurred under a reinsurance agreement, unlike an assumption arrangement,
where the assuming reinsurer's liability to the policyholder is substituted
for that of PMI's.
FORESTVIEW
In December 1993, PMI entered into a Reinsurance Treaty with Forestview
Mortgage Insurance Co. ("Forestview"), a wholly-owned subsidiary of Allstate
Insurance Company whereby Forestview agreed to reinsure all liabilities (net
of amounts collected from third party reinsurers and indemnitors) in
connection with PMI's mortgage pool insurance business in exchange for
premiums received. In 1994, Forestview also agreed that as soon as practicable
after November 1, 1994, Forestview and PMI would seek regulatory approval for
the Reinsurance Treaty to be deemed to be an assumption agreement and that,
upon receipt of the requisite approvals, Forestview would assume such
liabilities. The parties are in the process of seeking regulatory approval to
complete the assumption of the mortgage pool insurance policies. Until
Forestview has assumed directly such mortgage pool insurance policies, PMI
will remain primarily liable on the unassumed policies. Forestview's
18
<PAGE>
previous claims-paying ability rating of "AA" (Excellent) was withdrawn by
Standard and Poor's Rating Services ("S&P"). Management is uncertain at this
time what impact the withdrawal of the claims-paying ability rating will have
on the parties ability to timely consummate the assumption transaction.
Pursuant to this agreement, during 1997 PMI ceded $11.7 million of pool
premiums to Forestview and Forestview reimbursed PMI for claims on the covered
policies in the amount of $61.4 million. It is anticipated that additional
claims significantly in excess of premiums will be paid in 1998 and beyond. As
of December 31, 1997, the Company had an $89.6 million reinsurance recoverable
from Forestview. See "R. Factors That May Affect Future Results and Market
Price of Stock", below.
CAPITAL MORTGAGE
In March 1994, PMI entered into a quota share reinsurance agreement with
Capital Mortgage Reinsurance Company ("Capital Mortgage") (claims-paying
ability rating of "AA+" at December 31, 1997 from S&P) whereby PMI ceded to
Capital Mortgage 5% of PMI's liability under its primary insurance policies
written in 1993 through 1997 (and 5% of the related premiums). This agreement,
which was canceled effective December 31, 1997, provides for a ceding
commission to be paid by Capital Mortgage to PMI relating to premiums ceded.
Capital Mortgage remains liable on a runoff basis for nine years (subject to
either party's right to commute the agreement at six years) and receives
renewal premiums on the ceded portion of the primary insurance in force at the
time of cancellation of the agreement.
RGC
Pursuant to the deep coverage requirements imposed by Fannie Mae and Freddie
Mac, 95s and 97s eligible for sale to such agencies require insurance with a
coverage percentage of 30%, in contrast to the 25% and 28% coverages,
respectively, previously required by these agencies. 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, and, as a result, the
deep coverage portion of such insurance 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 RGC to
provide reinsurance of such deep coverage to PMI and CMG. PMI and CMG use
reinsurance provided by RGC solely for purposes of compliance with statutory
coverage limits. While RGC has the ability to write direct mortgage insurance
and to provide reinsurance to unaffiliated mortgage insurers, TPG currently
intends to have RGC write reinsurance solely for PMI and CMG.
During 1997 PMI began issuing pool insurance to select companies. In
connection with the pool policies issued, PMI may only retain 25% of the risk
covered by such policies. PMI intends to reinsure the remaining risk through
its affiliates, including RGC, PMG and other subsidiaries being formed. Until
such subsidiaries have been licensed by the appropriate regulatory
authorities, PMI will obtain reinsurance coverage from non-affiliated
companies. See "B. Products", above; "O. Regulation" and "R. Factors That May
Affect Future Results and Market Price of Stock", below.
L. CLAIMS-PAYING ABILITY RATINGS
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard
& Poor's Rating Services ("S&P"), "AA+" (Very Strong) by Fitch Investors
Service, Inc. ("Fitch"), "AA+" (Very High) by Duff & Phelps Credit Rating Co.
("Duff & Phelps") and "Aa2" (Excellent) by Moody's Investors Service, Inc.
("Moody's"). PMI's claims-paying ability ratings from the national rating
agencies have been based in significant part on various capital support
commitments from Allstate ("Allstate Support Agreements"). On October 28,
1994, TPG entered into a runoff support agreement with Allstate (the "Runoff
Support Agreement") to replace various capital support commitments that
Allstate had previously provided to PMI. Allstate agreed to pay claims on
certain insurance policies issued by PMI prior to October 28, 1994 if PMI's
financial condition deteriorates below specified levels, or if a third party
brings a claim thereunder or, in the alternative, Allstate may make
contributions directly to PMI or TPG. In the event that Allstate makes
payments or contributions under the Runoff Support Agreement, (which
possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return.
19
<PAGE>
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers
for such insurers to be eligible to insure loans sold to such agencies. Any
change in PMI's existing eligibility status, primary 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 "R.
Factors That May Affect Future Results and Market Price of Stock", below.
M. INVESTMENT PORTFOLIO
Cash flow from the Company's investment portfolio represented approximately
44% of its total cash flow from operations during 1997. 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, 1997, based on
market value, approximately 92.7% of the Company's total investment portfolio
was invested in securities rated "A" or better, with 55.7% rated "AAA" and
26.9% rated "AA," in each case by at least one nationally recognized
securities rating organization.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic and market conditions and the existing or
anticipated financial condition and operating requirements, including the tax
position, of the Company. During 1998, approximately 95% of the Company's
investment portfolio will be managed internally.
At December 31, 1997, the consolidated market value of the Company's
investment portfolio was $1.5 billion. At December 31, 1997, municipal
securities represented 74.9% of the market value of the total investment
portfolio. Fixed income securities due in less than one year, within one to
five years, after ten years, and other represented 0.6%, 6.3%, 14.0%, 75.2%
and 3.9%, respectively, of the total market value of fixed income securities.
The Company's net pre-tax investment income (excluding capital gains) was
$83.1 million for the year ended December 31, 1997, representing an after-tax
yield of 6.0% for the year, a decline from 6.1% for 1996, resulting from a
decline in the average interest rate on investments in 1997 as compared to
1996. Capital gains on the investment portfolio were $19.6 million and $14.3
million for 1997 and 1996, respectively. See "Note 3 to the Consolidated
Financial Statements of the Company", included in Exhibit 13.1 to this Annual
Report on Form 10-K.
N. OTHER BUSINESSES
TPG seeks to supplement its core mortgage insurance business and enhance its
customer relationships through ancillary businesses and may, from time to
time, invest in joint ventures or acquire related businesses. TPG, through
certain subsidiaries, provides title insurance and various services and
products for the home mortgage finance industry, such as contract underwriting
and the licensing of its proprietary underwriting and real estate valuation
systems.
Total revenues recognized for the year ended December 31, 1997 from TPG's
businesses other than PMI constituted approximately 13.8 % of the Company's
consolidated revenues, compared to approximately 12.7% and 10.8%,
respectively, in 1996 and 1995.
RAM RE
During the first quarter of 1998, TPG became a principal investor in a
start-up company named 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
management's belief that PMI's skills in
20
<PAGE>
evaluating mortgage risks are very complementary with RAM Re's business plan.
As part of its Strategic Plan, management may consider other investments in
the credit enhancement segment.
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 34 states and the District of Columbia.
Although APTIC is currently writing business in 23 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 1997, APTIC is ranked 5th among the
27 active title insurers conducting business in the State of Florida. For the
year ended December 31, 1997, 81.6% 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 97.6% and
93.8% of APTIC's premiums earned for the years ended December 31, 1997 and
1996, respectively.
CMG MORTGAGE INSURANCE COMPANY
CMG offers mortgage guaranty insurance for loans originated by credit
unions. CMG is operated as a joint venture between PMI and CUNA Mutual
Investment Corporation ("CMIC"), with PMI having a 45% ownership interest
since September 1994. PMI and CMIC provide services to the venture, with CMIC
providing primarily sales and marketing services and PMI providing primarily
insurance operation services. CMIC is a part of the CUNA Mutual Group, which
provides insurance and selected financial services to credit unions and their
members in the United States and over 50 other countries.
As of December 31, 1997, 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 over 1,000 master policies to
credit union and credit union affiliated organizations nationwide. At December
31, 1997 CMG had over $2.3 billion of primary insurance in force.
Under the terms of the joint venture arrangement, at the end of fifteen year
period starting with the organization of the joint venture or earlier under
certain limited conditions, CMIC has the right to require PMI to sell, and PMI
has the right to require CMIC to purchase, PMI's interest in CMG for an amount
equal to the then current fair market value. For this purpose, fair market
value will be determined by agreement between PMI and CMIC, or failing such
agreement, through appraisal by nationally recognized investment banking
firms.
PMI MORTGAGE SERVICES CO.
MSC, established in 1993, provides a variety of technical products and
mortgage underwriting services through a staff of underwriters in 19 field
offices. The Customer Technology Division of MSC provides technical products
and services to PMI's customers. This department licenses use of the pmiAURASM
system and the pmiTERRASM system 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
21
<PAGE>
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 1997 among mortgage insurance companies for contract
underwriting customers. Contract underwriting is generally more expensive on a
per application basis for the Company than underwriting a loan in-house, and
is becoming an increasingly popular method among mortgage lenders for
processing loan applications. Contract underwriting processed loans
represented 29% of PMI's NIW for the year ended December 31, 1997 compared to
13% for the year ended December 31, 1996. Due to the increasing demand of
contract underwriting services, the limited number of underwriting personnel
available, and heavy price competition among mortgage insurance companies,
PMI's inability to recruit and maintain a sufficient number of qualified
underwriters could materially and adversely affect its market share and
materially and adversely affect the Company's financial condition and results
of operations. Management anticipates that contract underwriting will continue
to process loans that will generate a significant percentage of PMI's NIW. See
"Q. Cautionary Statement" and "R. Factors That May Affect Future Results and
Market Price of Stock", below.
O. REGULATION
State Regulation.
General. TPG and its 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 "M. 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 and its insurance affiliates from directly writing
other types of insurance. However, the noninsurance subsidiaries of TPG are
not generally subject to regulation under state insurance laws except with
respect to transactions with their insurance affiliates.
The Company's title insurance subsidiary, APTIC, is subject to comprehensive
regulation in the states in which it is licensed to transact business. Among
other things, such regulation requires APTIC to adhere to certain financial
standards relating to statutory reserves and other criteria of solvency.
Generally, title insurers are restricted to writing only title insurance, and
may not transact any other kind of insurance. This restriction prohibits APTIC
from using its capital and resources in support of other types of insurance
businesses.
Insurance Holding Company Regulation. All states have enacted legislation
that requires each insurance company in a holding company system to register
with the insurance regulatory authority of its state of domicile and to
furnish to such regulator financial and other information concerning the
operations of companies within the holding company system that may materially
affect the operations, management or financial condition of the insurers
within the system. Most states also regulate transactions between insurance
companies and their parents and affiliates. Generally, such regulations
require that all transactions within a holding company system between an
insurer and its affiliates be fair and reasonable and that the insurer's
statutory policyholders' surplus following any transaction with an affiliate
be both reasonable in relation to its outstanding liabilities and adequate for
its
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needs. In addition, Arizona law requires that the Arizona Director of
Insurance be given 30-days prior notice of certain types of agreements between
an insurance company and an affiliate.
Because TPG is an insurance holding company and PMI, PMG and RGC are Arizona
insurance companies, the Arizona insurance laws regulate, among other things,
certain transactions in TPG'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 or
its subsidiaries 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 TPG or their 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 the
insurance companies. "Control" is presumed to exist if 10% or more of TPG's
voting securities is owned or controlled, directly or indirectly, by a person,
although the Arizona Director of Insurance may find that "control" in fact
does or does not exist where a person owns or controls either a lesser or
greater amount of securities. In addition, since APTIC is domiciled in the
State of Florida, TPG is also regulated as an insurance holding company under
Florida law. The applicable requirements of Florida law are similar to the
provisions of the Arizona insurance laws regulating insurance holding
companies, with the exception that in Florida, regulatory approval must be
obtained prior to the acquisition, directly or indirectly, of 5% or more of
the voting securities of APTIC or TPG. Because CMG is domiciled in Wisconsin,
TPG is also regulated as an insurance holding company under Wisconsin law. The
applicable requirements of Wisconsin law are similar to those of Arizona law
regulating insurance holding companies, except that the hearing to approve a
change in control is optional in Wisconsin. For purposes of Arizona, Florida
and Wisconsin law, "control" means the power to direct or cause the direction
of the management of an insurer, whether through the ownership of voting
securities, by contract other than a commercial contract for goods or
nonmanagement services, or otherwise, unless the power is the result of an
official position with or corporate office held by the person.
Reserves. PMI is required under the insurance laws of Arizona and certain
other states to establish a special contingency reserve with annual additions
of amounts equal to 50% of premiums earned. The insurance laws of the various
states, including Florida, impose additional reserve requirements applicable
to title insurers such as APTIC. For instance, title insurers must maintain,
in addition to reserves for outstanding losses, an unearned premium reserve
computed according to statute and are subject to limitations with respect to
the level of risk they can assume on any one contract. At December 31, 1997,
PMI had statutory policyholders' surplus of $274.9 million and statutory
contingency reserve of $839.5 million. See "Part II, Item 8, Financial
Statements Note 13--"Statutory Accounting."
Dividends. 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. In accordance with
Arizona law, PMI is permitted to pay ordinary dividends to TPG of $27.5
million in 1998 without the prior approval of the Arizona Insurance Director.
See Part II, Item 8, Financial Statements Note 12--"Dividends and Shareholders
Equity."
The laws of Florida limit the payment of dividends by APTIC to TPG in any
one year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains. As a result, APTIC may be
limited in its ability to pay dividends to TPG. 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
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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 requirements. In addition,
Arizona, California, Wisconsin and several other states limit the amount of
risk a mortgage insurer may retain with respect to coverage of an insured loan
to 25% of the insured's claim amount. Coverage in excess of 25% (i.e., deep
coverage) must be reinsured. See "K. Reinsurance" above.
Examination. PMI and its insurance affiliates 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 which 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. Various proposals are being discussed by Congress and certain
federal agencies with respect to the reform or modification of the FHA, but
the nature and extent of actual enacted legislation and possible effects of
such legislation on PMI cannot be predicted.
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 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.
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Mortgage lenders are subject to various laws, including HMDA, the Community
Reinvestment Act and the Fair Housing Act, and Fannie Mae and Freddie Mac are
subject to various laws, including laws relating to government sponsored
enterprises, which may impose obligations or create incentives for increased
lending to low and moderate income persons or in targeted areas.
Fannie Mae and Freddie Mac. TPG and PMI are also indirectly, but
significantly, impacted by laws and regulations affecting originators and
purchasers of mortgage loans, particularly Fannie Mae and Freddie Mac, and
regulations affecting governmental insurers such as the FHA. Private mortgage
insurers, including PMI, are highly dependent upon federal housing legislation
and other laws and regulations which affect the demand for private mortgage
insurance and the housing market generally. The Clinton administration has
recommended and Congress are considering increasing the single-family loan
limit which FHA could purchase to $227,150. The Company believes that any
increase in the FHA loan limit could adversely affect the competitive position
of PMI and consequently could materially and adversely affect the Company's
financial condition and results of operations. (See "R Factors That May Affect
Future Results and Market Price of Stock").
National Association of Insurance Commissioners. The NAIC has developed a
rating system, the Insurance Regulatory Information System ("IRIS"), primarily
intended to assist state insurance departments in overseeing the statutory
financial condition of all insurance companies operating within their
respective states. IRIS consists of 11 key financial ratios which are intended
to indicate unusual fluctuations in an insurer's statutory financial position
and/or operating results.
Indirect Regulation
TPG and PMI are also indirectly, but significantly, impacted by laws and
regulations affecting originators and purchasers of mortgage loans,
particularly Fannie Mae and Freddie Mac, and regulations affecting
governmental insurers such as the FHA. Private mortgage insurers, including
PMI, are highly dependent upon federal housing legislation and other laws and
regulations which affect the demand for private mortgage insurance and the
housing market generally. 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.
Additionally, proposals have been advanced which would allow Fannie Mae and
Freddie Mac additional flexibility in determining the amount and nature of
alternative recourse arrangements or other credit enhancements which they
could utilize as substitutes for private mortgage insurance. Fannie Mae and
Freddie Mae also have the discretion to reduce the amount of private mortgage
insurance they require on loans. The increase in the loan principal balance
eligible for purchase by these GSEs as well as the adoption by the GSE's of
private mortgage insurance substitutes or reduction in the amount of private
mortgage insurance coverage could materially and adversely affect the
Company's financial condition and results of operations. See "R. Factors That
May Affect Future Results and Market Price of Stock", below. The Company
cannot predict if or when any of the foregoing legislation or proposals will
be adopted, but if adopted and depending upon the nature and extent of
revisions made, demand for private mortgage insurance may be adversely
affected. There can be no assurance that other federal laws affecting such
institutions and entities will not change, or that new legislation or
regulations will not be adopted.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. Fannie Mae and Freddie Mac have guidelines which give borrowers
the right to request cancellation of mortgage insurance when specified
conditions are met. In addition, federal legislation and legislation in
approximately a dozen states has been introduced that also addresses these
issues. Proposals concerning borrower notification of their cancellation
rights, cancellation criteria, or the point at which mortgage insurance
premiums may no longer be collected from borrowers, are still being formulated
and their enactment remains uncertain. Statutes giving borrowers cancellation
rights and/or preventing premiums from being paid by borrowers presently exist
in five states, including California. Management presently believes that the
existing statutes will not have a material impact on the Company's financial
condition or results of operations. Management believes it is too early to
ascertain the impact of the enactment of any additional mortgage cancellation
proposals. See "R. Factors That May Affect Future Results and Market Price of
Stock".
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P. EMPLOYEES
At December 31, 1997, TPG, including its subsidiaries had 916 full- and
part-time employees; 584 persons perform services primarily for PMI, 102
perform services primarily for MSC, 10 of which perform services primarily for
CMG and an additional 220 persons are employed by APTIC. TPG's employees are
not unionized and TPG considers its employee relations to be good.
Q. 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, 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 in the "Annual Report on Form 10-K for the year ended
December 31, 1997 include the following: (i) This product did not generate any
significant new risk written during 1997, but is expected to do so in 1998;
(ii) PMI currently expects the total volume of mortgage originations may reach
$1 trillion in 1998; (iii) PMI expects this trend to continue into 1998; (iv)
PMI believes that this trend will continue if interest rates remain at their
current levels or decrease; (v) Management anticipates that contract
underwriting will continue to process loans that generate a significant
percentage of PMI's NCW; (vi) Although management expects that California
should continue to account for the majority of total claims paid, management
anticipates that with continued improvement in the California economy,
increased benefits of loss mitigation and improved default reinstatement
rates, California claims paid as a percentage of total claims paid should
continue to decline for the forseeable future; and (vii) Management believes
that the claims severity level for 1988 will approximate the 1997 level. These
forward-looking statements involve a number of risks or uncertainties
including, but not limited to, the factors set forth in the next section and
in the Company's periodic filings with the Securities and Exchange Commission.
R. FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
GENERAL CONDITIONS
Several factors such as economic recessions, declining housing values,
higher unemployment rates, deteriorating borrower credit, rising interest
rates, increases in refinance activity caused by declining interest rates,
legislation impacting borrowers' rights, or combinations of such factors might
affect the mortgage insurance industry and demand for housing in general and
could materially and adversely affect the Company's financial condition and
results of operations. Such economic events could materially and adversely
impact the demand for mortgage insurance, cause claims on policies issued by
PMI to increase, and/or cause a similar adverse increase in PMI's loss
experience.
Other factors that may influence the amount of NIW by PMI include: mortgage
insurance industry volumes of new business; the impact of competitive
underwriting criteria and product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of risk-
sharing structured transactions; changes in the performance of the financial
markets; general economic conditions that affect the demand for or acceptance
of the Company's products; changes in government housing policy; changes in
government regulations or interpretations regarding RESPA; changes in the
statutory charters, regulations, powers and coverage requirements of GSEs,
banks and savings institutions; and customer consolidation.
MARKET SHARE AND COMPETITION
The Company's financial condition and results of operations could be
materially and adversely affected by a decline in its market share, or a
decline in market share of the private mortgage insurance industry as a whole.
Numerous factors bear on the relative position of the private mortgage
insurance industry versus government and quasi-governmental competition as
well as the competition of lending institutions that choose to remain
uninsured, self-insure through affiliates, or offer residential mortgage
products that do not require mortgage
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insurance. The impact of competitive underwriting criteria and product
offerings, including mortgage pool insurance, has a direct impact on the
Company's market share. Further, several of the Company's competitors have
greater direct or indirect capital reserves that provide them with potentially
greater flexibility than the Company in addressing competitive issues.
PMI competes directly with federal and state governmental and quasi-
governmental agencies, principally the FHA and, to a lesser degree, the VA.
PMI and other private mortgage insurers are also affected by Fannie Mae and
Freddie Mac. These GSEs are permitted by statute to purchase conventional
high-LTV mortgages from lenders who obtain mortgage insurance on those loans.
Further, the Office of the Comptroller of the Currency has granted permission
to certain national banks to form reinsurance companies as wholly-owned
operating subsidiaries for the purpose of reinsuring mortgage insurance
written on loans originated or purchased by such banks. In addition, the
Federal Reserve Board and the Office of Thrift Supervision are in the process
of considering whether similar activities are permitted for bank holding
companies and savings institutions, respectively. The reinsurance subsidiaries
of national banks, savings institutions, or bank holding companies could
become significant competitors of the Company in the future. Mortgage lenders,
other than banks, thrifts or their affiliates, are forming reinsurance
affiliates that are typically regulated solely by the insurance authority of
their state of domicile. Management believes that such reinsurance affiliates
will increase competition in the mortgage insurance industry and may
materially and adversely impact PMI's market share.
Certain lenders originate a first mortgage lien with an 80 percent LTV
ratio, a 10 percent second mortgage lien, and 10 percent of the purchase price
from borrower's funds ("80/10/10"). This 80/10/10 product competes with
mortgage insurance as an alternative for lenders selling loans in the
secondary mortgage market. If the 80/10/10 product becomes a widely accepted
alternative to mortgage insurance, it could have a material and adverse impact
on the Company's financial condition and results of operations.
During 1997, the maximum single-family principal balance loan limit eligible
for purchase by Fannie Mae and Freddie Mac was increased from $214,600 to
$227,150 effective in 1998. Any increase in the loan pricipal balance eligible
for purchase by these GSEs could potentially expand the mortgage insurance
market. Another proposal would allow Fannie Mae and Freddie Mac greater
flexibility in utilizing substitutes for private mortgage insurance. Fannie
Mae and Freddie Mac also have the discretion to reduce the amount of private
mortgage insurance they require on loans. The adoption by the GSE's of private
mortgage insurance substitutes or reduction in the amount of private mortgage
insurance coverage could materially and adversely affect the Company's
financial condition and results of operations.
Legislation and regulatory changes affecting the FHA and certain commercial
banks that forego insurance have affected demand for private mortgage
insurance. PMI and other private mortgage insurers compete directly with
federal and state governmental and quasi-governmental agencies, principally
the FHA and, to a lesser degree, the VA. These agencies sponsor government-
backed mortgage insurance programs which accounted for 45.6%, 44.8%, and 38.5%
for 1997, 1996 and 1995, respectively, of all loans insured or guaranteed. The
maximum individual loan amount that the FHA can insure is currently $170,362
and the maximum individual loan amount that the VA can insure is $203,150. The
Clinton administration and Congress are considering increasing the single-
family loan limit which FHA could purchase to $227,150. The Company believes
that any increase in the FHA loan limit, or other expansion of eligibility for
the FHA and VA would likely have an adverse affect on the competitive position
of PMI and consequently could materially and adversely affect the Company's
financial condition and results of operations.
INSURANCE IN FORCE
A significant percentage of PMI's premiums earned is generated from its
existing insurance in force and not from new insurance written. PMI's policies
for insurance coverage typically have a policy duration of 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. 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
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the Company will be able to regain such insurance coverage at a later time. As
a result, the Company's financial condition and results of operation could be
materially and adversely affected by greater than anticipated policy
cancellations or lower than projected persistency resulting in declines in
insurance in force.
During an environment of falling interest rates, increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies, generally experience an increase in the prepayment rate of
insurance in force, resulting from policy cancellations of older books of
business. 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. Any significant decrease in PMI's insurance in force
could materially and adversely affect the Company's financial condition and
results of operations. See "R. Factors That May Affect Future Results and
Market Price of Stock."
Insurance in force as of December 31, 1997 was $77.8 billion compared with
$77.3 billion as of December 31, 1996. The annualized growth rate of insurance
in force was 0.6% and 8.3% as of December 31, 1997 and 1996, respectively. The
period over period decrease in the growth rate is primarily due to lower NIW
and higher policy cancellations. The lower growth rate in insurance in force
will have an adverse impact on PMI's future renewal premiums.
FANNIE MAE AND FREDDIE MAC; STATE AND FEDERAL MORTGAGE CANCELLATION
LEGISLATION
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers
for such insurers to be eligible to insure loans sold to such agencies. 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.
Although PMI cannot generally cancel its mortgage insurance policies once
issued, PMI must cancel mortgage insurance for a mortgage loan upon the
request of the insured. Fannie Mae and Freddie Mac have guidelines which give
borrowers the right to request cancellation of mortgage insurance when
specified conditions are met. In addition, federal legislation and legislation
in approximately a dozen states has been introduced that also addresses this
issue. Proposals concerning borrower notification of their cancellation
rights, cancellation criteria, or the point at which mortgage insurance
premiums may no longer be charged to borrowers, are still being formulated and
their enactment remains uncertain. Statutes giving borrowers cancellation
rights and/or preventing premiums from being charged to borrowers presently
exist in five states, including California. Management presently believes that
the existing statutes will not have a material impact on the Company's
financial condition or results of operations. Management believes it is too
early to ascertain the impact of the enactment of any additional mortgage
cancellation proposals.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS
The Company 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. Contract underwriting services have
become increasingly important to mortgage lenders as they seek to reduce
costs. Accordingly, contract underwriting generates a significant percentage
of PMI's NIW. Management anticipates that contract underwriting will continue
to process loans that will generate a significant percentage of PMI's NIW. Due
to the increasing demand of contract underwriting services, the limited number
of underwriting personnel available, and heavy price competition among
mortgage insurance companies, PMI's inability to recruit and maintain a
sufficient number of qualified underwriters could materially and adversely
affect its market share and materially and adversely affect the Company's
financial condition and results of operations.
TPG and PMI, from time to time, introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially and adversely affected if PMI or the Company experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including
any mortgage pool type products, or programs will be as profitable as the
Company's existing products and programs.
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YEAR 2000 ISSUES
The Company is heavily dependent upon complex computer systems for all
phases of its operations, including customer service, servicing the insurance
portfolio, risk analysis, underwriting, and loss reserves. Since many of the
Company's older computer software programs recognize only the last two digits
of the year in any date (e.g., "97" for 1997), some software may fail to
operate properly in 1999 or 2000 if the software is not reprogrammed or
replaced (the "Year 2000 Issue"). The Company believes that many of its
suppliers and customers may have Year 2000 Issues that could adversely affect
the Company; however, it is uncertain what impact, if any, such Year 2000
Issues would have on the Company. The Company has commenced a plan intended to
mitigate and/or prevent the adverse internal effects of Year 2000 Issues and
estimates the cost of this work at approximately $3 million. The Company
presently believes that it will be able to resolve its internal Year 2000
Issues in a timely manner and that the cost of addressing such matters will
not have a material effect on the Company's current financial condition,
liquidity or results of operations. Management believes its failure or its
customers or suppliers failure to resolve the Year 2000 Issues in a timely
manner could materially and adversely affect the Company's financial condition
and results of operations. See "R. Factors That May Affect Future Results and
Market Price of Stock."
NEW YORK DEPARTMENT OF INSURANCE
TPG offers a captive reinsurance structure and in the past, offered a risk-
sharing product (a performance note) that was designed to encourage quality
originations and loss mitigation by its customers. To date, neither product
represents a significant portion of the Company's revenues. In March 1997, the
New York Department of Insurance stated in a letter addressed to all private
mortgage insurers that both captive reinsurance structures and the use of a
performance note structured as a variable rate note to a lender by an
affiliate of a mortgage guaranty insurer where the rate of interest to the
lender is based upon the underwriting experience of the mortgage guaranty
insurer on the mortgages originated by the lender would be considered to be
illegal under New York law. The Company is currently discussing with the New
York Department of Insurance the structure of its performance note product as
well as its captive reinsurance arrangements with certain of its customers.
The Company indicated to the New York Department of Insurance that it
disagrees with the statements in the letter. Management is unable to predict
at this time the results of these discussions.
RISK-TO-CAPITAL RATIO
Regulators specifically limit the amount of insurance risk that may be
written by PMI to a multiple of 25 times PMI's statutory capital (which
includes the contingency reserve). Other factors affecting PMI's risk-to-
capital ratio include: (i) regulatory review and oversight by the State of
Arizona, PMI's state of domicile for insurance regulatory purposes; (ii)
limitations under the Runoff Support Agreement with Allstate discussed below,
which prohibit PMI from paying any dividends if, after the payment of any such
dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; (iii)
TPG's credit agreements; and (iv) TPG's and PMI's credit or claims-paying
ability ratings which require that the risk-to-capital ratio not exceed 20 to
1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's
ability to write new business. The inability to write new business could
materially and adversely affect the Company's financial condition and results
of operations.
CHANGES IN COMPOSITION OF INSURANCE WRITTEN
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, 1997, 46.2% 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, 1997, 1.8% of PMI's risk in force consisted of 97s
which have even higher risk characteristics than 95s and greater uncertainty
as to pricing adequacy. PMI's NIW
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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. During the fourth quarter
of 1997, PMI began offering a pool insurance product to state housing finance
authorities and certain lenders. This product is similar in structure to the
pool insurance product previously offered by PMI during 1990--1993, but has
different risk characteristics, including limits on total exposure,
diversification and loan to value ratios. Management presently cannot predict
the impact this pool insurance product will have on PMI's market share. Pool
insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions and generally covers the loss on a
defaulted mortgage loan that exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan. Pool
insurance also generally covers the total loss on a defaulted mortgage loan
which did not require primary insurance, in each case up to a stated aggregate
loss limit. Although PMI charges higher premium rates for loans that have
higher risk characteristics, including ARMs, 95s, 97s and pool insurance
products, the premiums earned on such products, and the associated investment
income, may ultimately prove to be inadequate to compensate for future losses
from such products. Such losses could materially and adversely affect the
Company's financial condition and results of operations.
POTENTIAL INCREASE IN CLAIMS
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured 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
PMI establishes loss reserves based upon estimates of the claim rate and
average claim amounts, as well as the estimated costs, including legal and
other fees, of settling claims. Such reserves are based on estimates, which
are regularly reviewed and updated. There can be no assurance that PMI's
reserves will prove to be adequate to cover ultimate loss development on
incurred defaults. The Company's financial condition and results of operations
could be materially and adversely affected if PMI's reserve estimates are
insufficient to cover the actual related claims paid and expenses incurred.
REGIONAL CONCENTRATION
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, where PMI has 20.5% of
its risk in force concentrated and where the default rate on all PMI policies
in force is 3.73% compared with 2.38% nationwide as of December 31, 1997.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE
In December 1993, PMI entered into a Reinsurance Treaty with Forestview
whereby Forestview agreed to reinsure all liabilities (net of amounts
collected from third party reinsurers and indemnitors) in connection with
PMI's mortgage pool insurance business in exchange for premiums received. In
1994, Forestview also agreed that as soon as practicable after November 1,
1994, Forestview and PMI would seek regulatory approval for the Reinsurance
Treaty to be deemed to be an assumption agreement and that, upon receipt of
the requisite approvals, Forestview would assume such liabilities. The parties
are in the process of seeking regulatory approval to complete the assumption
of the mortgage pool insurance policies. Until Forestview has assumed directly
such mortgage pool insurance policies, PMI will remain primarily liable on the
unassumed policies. Forestview's previous claims-paying ability rating of "AA"
(Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P").
Management is uncertain at this time what impact the withdrawal of the claims-
paying ability
30
<PAGE>
rating will have on the parties' ability to timely consummate the assumption
transaction. Pursuant to this agreement, during 1997 PMI ceded $11.7 million
of pool premiums to Forestview and Forestview reimbursed PMI for claims on the
covered policies in the amount of $61.4 million. It is anticipated that
additional pool claims significantly in excess of pool premiums will be paid
in 1998 and beyond. As of December 31, 1997, the Company has an $89.6 million
reinsurance recoverable from Forestview. The failure of Forestview to meet its
contractual commitments would materially and adversely affect the Company's
financial condition and results of operations.
On October 28, 1994, TPG entered into a Runoff Support Agreement 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. Alternatively, Allstate may make
contributions directly to PMI or TPG. In the event that Allstate makes
payments or contributions under the Runoff Support Agreement (which
possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return. During 1997, no
payment obligation arose under the Runoff Support Agreement. See "R. Factors
That May Affect Future Results and Market Price of Stock."
ITEM 2. PROPERTIES
TPG leases its home office in San Francisco, California, which consists of
approximately 98,450 square feet of office space. The San Francisco lease
expires on December 31, 1999. In addition, TPG leases space for 32 PMI and MSC
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.
TPG believes its existing properties are well utilized and are suitable and
adequate for its present circumstances.
ITEM 3. LEGAL PROCEEDINGS
Various legal actions and regulatory reviews are currently pending that
involve the Company and specific aspects of its conduct of business. In the
opinion of management, the ultimate liability or resolution in one or more of
the foregoing actions is not expected to have a material 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 1997 to a vote of
stockholders through the solicitation of proxies or otherwise.
31
<PAGE>
EXECUTIVE OFFICERS OF REGISTRANT
Set forth below is certain information regarding TPG's executive officers as
of December 31, 1997, including age as of April 1, 1998, and business
experience for at least the past five years.
W. Roger Haughton, 50, has been President and Chief Executive Officer of PMI
Mortgage Insurance Co. ("PMI"), TPG's principal subsidiary, since January 1993
and was elected to the same positions with TPG in January 1995. Mr. Haughton
joined PMI in 1985 as Vice President of Underwriting, after 16 years with
Allstate Insurance Company ("Allstate"). In 1987, he was promoted to Vice
President/General Manager for PMI's Central Zone, responsible for all sales
and field office operations in that region. In 1989, he became Group Vice
President of Insurance Operations, Claims and Actuarial Services departments.
Mr. Haughton has been President of the Mortgage Insurance Companies of America
("MICA"), the industry trade association, since March 1997. He also has a long
history of active volunteerism with various affordable housing organizations,
including Habitat for Humanity, and serves on the board of Social Impact. Mr.
Haughton has been a Director of TPG since January 1995 and a Director of PMI
since 1990.
L. Stephen Smith, 48, has been Executive Vice President of Field Operations
of PMI since May 1994 and was elected to the same position 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.
John M. Lorenzen, Jr., 53, 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 position with TPG in January 1995. Prior thereto, he was PMI's
Senior Vice President from April 1989 to May 1994 and Vice President--Finance
from April 1985 to April 1989.
Claude J. Seaman, 51, has been Executive Vice President of Insurance
Operations and Assistant Secretary of PMI since May 1994, and was elected to
the same position 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.
Victor J. Bacigalupi, 54, has been Senior Vice President, General Counsel
and Secretary of TPG and PMI since November 1996. Prior to joining TPG, he was
a partner in the law firm of Bronson, Bronson & McKinnon LLP, San Francisco,
California since February 1992.
Thomas C. Brown, 49, has been Senior Vice President of National Accounts of
TPG and PMI since June 1997. Prior to joining TPG, he was president and chief
executive officer of Centerbank Mortgage Company, positions he held since
1989.
John H. Fulford, 48, has been Senior Vice President of National Sales of TPG
and PMI since August 1997. Prior to joining TPG, he was senior vice president
of marketing at Fannie Mae. He first joined Fannie Mae in 1983, serving as
senior assistant regional vice president of marketing and in 1985 became the
company's senior vice president for its western regional office, a position he
held for eleven years.
Daniel L. Roberts, 48, has been Senior Vice President and 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 partner with the accounting firm
of Deloitte & Touche from July 1985 to December 1990.
Bradley M. Shuster, 43, has been 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.
32
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
COMMON STOCK
TPG is listed on the New York Stock Exchange and the Pacific Exchange under
the trading symbol PMA. As of December 31, 1997 there were 32,461,247 shares
issued and outstanding. As of February 27, 1998 there were 32,419,800 shares
issued and outstanding held by approximately 31 stockholders of record and
approximately 10,500 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, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---------------------- --------------------
HIGH LOW CLOSE HIGH LOW CLOSE
---- --- ----- ---- --- -----
<S> <C> <C> <C> <C> <C> <C>
First quarter................. 56 7/8 50 50 1/8 51 3/4 41 1/2 43 5/8
Second quarter................ 63 47 3/4 62 3/8 46 1/4 40 42 1/2
Third Quarter................. 63 13/16 56 1/2 57 5/16 54 3/8 39 7/8 53 1/8
Fourth Quarter................ 74 56 1/2 72 5/16 60 52 1/8 55 3/8
</TABLE>
PREFERRED STOCK
TPG's Board of Directors is authorized to issue up to 5,000,000 shares of
preferred stock of TPG in classes or series and to fix the designations,
preferences, qualifications, limitations or restrictions of any class or
series with respect to the rate and nature of dividends, the price and terms
and conditions on which shares may be redeemed, the amount payable in the
event of voluntary or involuntary liquidation, the terms and conditions for
conversion or exchange into any other class or series of the stock, voting
rights and other terms. The Company may issue, without the approval of the
holders of common stock, preferred stock which has voting, dividend or
liquidation rights superior to the common stock and which may adversely affect
the rights of the holders of common stock. The Company has reserved for
issuance under the Shareholder Rights Plan described below up to 400,000
shares of preferred stock.
SHAREHOLDER RIGHTS PLAN
On January 13, 1998, the Company adopted a Preferred Share Purchase Rights
Plan ("Rights Plan"). Under the Rights Plan, all shareholders of record as of
January 26, 1998 received rights to purchase shares of a new series of
preferred stock on the basis of one right for each common stock held on that
date. However, rights issued under the Rights Plan will not be exercisable
initially. The rights will trade with the Company's common stock and no
certificates will be issued until certain triggering events occur. The Rights
Plan has a 10-year term from the record date, but the Company's Board of
Director's will review the merits of redeeming or continuing the Rights Plan
not less than once every three years. Rights issued under the plan will be
exercisable only if a person or group acquires 10% or more of the Company's
common stock or announces a tender offer for 10% or more of the common stock.
If a person or group acquires 10% or more of the Company's common stock, all
rightholders except the buyer will be entitled to acquire the Company's common
stock at a discount and/or under certain circumstances to purchase shares of
the acquiring company at a discount. The Rights Plan contains an exception
that would allow passive institution investors to acquire up to a 15%
ownership interest before the rights would become exercisable. The Rights Plan
also excludes Allstate from the definition of an acquiring person, pending
such time as Allstate distributes or otherwise transfers such ownership
interest.
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,
33
<PAGE>
regulatory restrictions by the Arizona Department of Insurance and TPG's
credit agreements and the Agreement with The Allstate Corporation and Allstate
Insurance Company. (See Part I."O. Regulation", "R. Factors That May Affect
Future Results and Market Price of Stock--Continuing Relationships with
Allstate and Affiliate" and Part II, Item 8, Financial Statement Note 12--
"Dividends and Shareholders' 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 first quarter of 1998.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated by reference from
portions of The PMI Group, Inc. 1997 Annual Report to Shareholders under the
heading "Five year Summary of Financial Data" filed as part of Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this Item is incorporated by reference from
portions of The PMI Group, Inc. 1997 Annual Report to Shareholders under the
heading "Management's Discussion and Analysis of Financial Condition and
Results of Operations" as part of Exhibit 13.1.
ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not Applicable
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference from
portions of The PMI Group, Inc. 1997 Annual Report to Shareholders as part of
Exhibit 13.1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
34
<PAGE>
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 1998 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 1998 Proxy Statement under the captions "Directors-Compensation and
Benefits" and "Executive Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
TPG's 1998 Proxy Statement under the caption "Security Ownership of Certain
Beneficial Owners and Management".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from
TPG's 1998 Proxy Statement under the captions "Transactions with Allstate" and
"Compensation Committee Interlocks and Insider Participation".
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements: The financial statements listed in the
accompanying Index to Consolidated Financial Statements and Financial
Statement Schedules are filed as part of this Form 10-K.
2. Financial Statement Schedules: The financial statement schedules
listed in the accompanying Index to Consolidated Financial Statements
and Financial Statement Schedules are filed as part of the Form 10-K.
All other schedules are omitted because of the absence of conditions
under which they are required or because the required information is
included in the consolidated financial statements or notes thereto.
3. Exhibits: The exhibits listed in the accompanying Index to Exhibits
are filed as part of this Form 10-K.
(b) Reports on Form 8-K: (i) On November 21, 1997, TPG filed a report on
Form 8-K to announce that its Board of Directors authorized a new stock
repurchase program to purchase up to $150 million of the Company's
outstanding common stock, (ii) On January 15, 1998, TPG filed a report
on Form 8-K to announce that its Board of Directors authorized the
adoption of a Shareholder Rights Plan.
35
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
[ITEM 14(A) 1 AND 2]
<TABLE>
<CAPTION>
PAGE
---------------------
FORM ANNUAL REPORT
10-K TO SHAREHOLDERS
----- ---------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
<S> <C> <C>
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995........................ N/A 26
Consolidated Balance Sheets as of December 31, 1997and
1996.................................................... N/A 27
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1997, 1996 and 1995............ N/A 28
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995........................ N/A 29
Notes to Consolidated Financial Statements............... N/A 30-47
Report of Independent Auditors........................... N/A 48
<CAPTION>
FINANCIAL STATEMENT SCHEDULES
-----------------------------
<S> <C> <C>
Report of Independent Auditors on Financial Statement
Schedules............................................... 38 N/A
Schedules as of and for the specified years in the three-
year period ended December 31, 1997:
Schedule I-Summary of investments other than in related
parties............................................... 39 N/A
Schedule II-Condensed financial information of
Registrant............................................ 40-43 N/A
Schedule III-Supplementary insurance information....... 44 N/A
Schedule IV-Reinsurance................................ 45 N/A
</TABLE>
36
<PAGE>
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 27th day of March, 1998.
The PMI Group, Inc.
/s/ W. Roger Haughton
By___________________________________
W. Roger Haughton
President, Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW ON MARCH 27, 1998 BY THE FOLLOWING PERSONS ON
BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.
SIGNATURE TITLE DATED
/s/ W. Roger Haughton President, Chief March 27, 1998
- ------------------------------------- Executive Officer,
W. ROGER HAUGHTON Director
/s/ John M. Lorenzen, Jr. Executive Vice March 27, 1998
- ------------------------------------- President and Chief
JOHN M. LORENZEN, JR. Financial Officer
(Principal Financial
Officer)
/s/ William A. Seymore Vice President, March 27, 1998
- ------------------------------------- Controller
WILLIAM A. SEYMORE (Controller and
Principal
Accounting Officer)
/s/ Edward M. Liddy Chairman and March 27, 1998
- ------------------------------------- Director
EDWARD M. LIDDY
/s/ James C. Castle Director March 27, 1998
- -------------------------------------
JAMES C. CASTLE
/s/ Donald C. Clark Director March 27, 1998
- -------------------------------------
DONALD C. CLARK
/s/ Wayne E. Hedien Director March 27, 1998
- -------------------------------------
WAYNE E. HEDIEN
/s/ John D. Roach Director March 27, 1998
- -------------------------------------
JOHN D. ROACH
/s/ Kenneth T. Rosen Director March 27, 1998
- -------------------------------------
KENNETH T. ROSEN
/s Richard L. Thomas Director March 27, 1998
- -------------------------------------
RICHARD L. THOMAS
/s/ Mary Lee Widener Director March 27, 1998
- -------------------------------------
MARY LEE WIDENER
37
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The PMI Group, Inc.:
We have audited the consolidated financial statements of The PMI Group, Inc.
and subsidiaries as of December 31, 1997 and 1996, and for each of the three
years in the period ended December 31, 1997, and have issued our report
thereon dated January 20, 1998; such consolidated financial statements and
report are included in your 1997 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 reponsibility
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, 1998
38
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENT IN RELATED PARTIES
DECEMBER 31, 1997
<TABLE>
<CAPTION>
AMOUNT AT WHICH
AMORTIZED MARKET SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
------------------ ---------- ---------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
FIXED MATURITIES:
Bonds:
United States government and government
agencies and authorities.............. $ 42,017 $ 43,250 $ 43,250
States, municipalities and political
subdivisions 1,044,964 1,116,316 1,116,316
All other corporate.................... 147,197 149,202 149,202
---------- ---------- ----------
TOTAL FIXED MATURITIES................ 1,234,178 $1,308,768 1,308,768
---------- ========== ----------
EQUITY SECURITIES:
Common stocks:
Banks, trust and insurance companies... 940 $ 1,724 1,724
Industrial, miscellaneous and all
other................................. 37,281 71,872 71,872
Non-redeemable preferred stocks 12,049 12,360 12,360
---------- ---------- ----------
TOTAL EQUITY SECURITIES............... 50,270 $ 85,956 85,956
---------- ========== ----------
SHORT-TERM INVESTMENTS................... 78,890 78,890
---------- ----------
TOTAL INVESTMENTS, OTHER THAN RELATED
PARTY................................ $1,363,338 $1,473,614
========== ==========
</TABLE>
39
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
PARENT COMPANY ONLY
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
ASSETS (DOLLARS IN THOUSANDS)
<S> <C> <C>
Investment portfolio, available for sale, at market
value:
Fixed income securities (cost--$96,316 and $56,157).. $ 97,605 $ 55,881
Short-term investments............................... 36,177 49,377
----------- -----------
Total investment portfolio......................... 133,782 105,258
Cash................................................... 437 83
Investment in subsidiaries, at equity in net assets.... 1,120,809 987,105
Other assets........................................... 12,317 2,741
----------- -----------
TOTAL ASSETS....................................... $ 1,267,345 $ 1,095,187
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Long-term debt....................................... $ 99,409 $ 99,342
Accounts payable--affiliates......................... 1,113 5,359
Other liabilities.................................... 3,544 3,624
----------- -----------
TOTAL LIABILITIES.................................. 104,066 108,325
----------- -----------
Commitments and contingent liabilities (Note A)........ -- --
JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURE
HELD SOLELY BY SUBSIDIARY TRUST....................... 102,099 --
SHAREHOLDERS' EQUITY:
Preferred stock -- $.01 par value; 5,000,000 shares
authorized.......................................... -- --
Common stock -- $.01 par value; 125,000,000 shares
authorized, 35,145,247 and 35,047,619 shares issued. 351 350
Additional paid-in capital........................... 262,448 258,059
Unrealized gains..................................... 71,936 50,709
Retained earnings.................................... 876,588 707,885
----------- -----------
1,211,323 1,017,003
Less treasury stock (2,684,000 and 537,800 shares at
cost)............................................... 150,143 30,141
----------- -----------
TOTAL SHAREHOLDERS' EQUITY......................... 1,061,180 986,862
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......... $ 1,267,345 $ 1,095,187
=========== ===========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
40
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
PARENT COMPANY ONLY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUE:
Equity in undistributed net income of
subsidiaries.................................... $101,488 $110,758 $124,642
Subsidiary dividends............................. 78,863 47,660 10,000
Investment income, net........................... 8,990 2,532 1,651
Capital gains (losses), net...................... (2,405) 113 --
-------- -------- --------
TOTAL REVENUE.................................. 186,936 161,063 136,293
-------- -------- --------
EXPENSES:
Operating expenses............................... 642 437 519
Interest expense................................. 14,618 907 --
-------- -------- --------
TOTAL EXPENSES................................. 15,260 1,344 519
-------- -------- --------
INCOME BEFORE TAX.................................. 171,676 159,719 135,774
INCOME TAX EXPENSE (BENEFIT)....................... (3,633) 1,801 543
-------- -------- --------
NET INCOME......................................... $175,309 $157,918 $135,231
======== ======== ========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
41
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................ $175,309 $157,918 $135,231
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization............................ 848 185 80
Equity in net income of subsidiaries.... (180,351) (158,418) (134,642)
Capital (gains) losses, net............. 2,405 (113) --
Increase (decrease) in payable to
affiliates............................. (4,246) 1,127 4,232
Other................................... (10,437) (551) (43)
-------- -------- --------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES................................. (16,472) 148 4,858
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Dividends from subsidiaries............... 78,863 26,300 10,000
Investment in subsidiaries................ (13,093) (14,683) --
Purchase of fixed income securities....... (92,350) (77,037) --
Investment collections of fixed income
securities............................... 5,000 20,848 --
Proceeds from sales of fixed income
securities............................... 46,667 -- --
Net (increase) decrease in short-term in-
vestments................................ 13,200 (19,147) (11,253)
-------- -------- --------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES................................. 38,287 (63,719) (1,253)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of junior subordinated
debentures............................... 102,093 -- --
Issuance of long-term debt................ -- 99,337 --
Dividends paid to shareholders............ (6,733) (7,002) (3,500)
Proceeds from exercise of stock options... 3,181 1,135 170
Purchase of The PMI Group, Inc. common
stock.................................... (120,002) (30,057) (84)
-------- -------- --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES................................. (21,461) 63,413 (3,414)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH ............ 354 (158) 191
CASH AT BEGINNING OF YEAR................... 83 241 50
-------- -------- --------
CASH AT END OF YEAR......................... $ 437 $ 83 $ 241
======== ======== ========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
42
<PAGE>
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 have been
prepared on the basis of generally accepted accounting principles. In these
financial statements, the Company's investment in its subsidiaries is stated
at cost plus equity in undistributed earnings of the subsidiaries. The
Company's share of net income of its subsidiaries is included in income using
the equity method. The accompanying Parent Company financial statements should
be read in conjunction with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements (including Notes 9, 10 and 11 related to
long-term obligations, commitments and contingent liabilities and the junior
subordinated debenture) appearing on pages 30 through 47 of The PMI Group,
Inc. 1997 Annual Report to Shareholders.
NOTE B
During 1997, 1996 and 1995, TPG received $78.9 million, $26.3 million and
$10.0 million, respectively, of ordinary and extraordinary cash dividends from
subsidiaries. In addition, during 1996 TPG received $21.4 million of non-cash
dividends from a subsidiary.
43
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1997:
MI(#).................. $37,864 $192,211 $ 94,150 $394,010 $81,879 $150,367 $62,778 $39,277 $ 372,114
Title.................. -- 10,176 -- 59,938 1,257 1,890 -- 53,085 59,938
------- -------- -------- -------- ------- -------- ------- ------- ---------
Total.................. $37,864 $202,387 $ 94,150 $453,948 $83,136 $152,257 $62,778 $92,362 $ 432,052
======= ======== ======== ======== ======= ======== ======= ======= =========
1996:
MI(#).................. $31,633 $190,425 $116,951 $359,527 $66,280 $150,642 $48,302 $29,688 $ 349,809
Title.................. -- 9,349 -- 53,211 1,162 1,767 -- 48,012 53,211
------- -------- -------- -------- ------- -------- ------- ------- ---------
Total.................. $31,633 $199,774 $116,951 $412,738 $67,442 $152,409 $48,302 $77,700 $ 403,020
======= ======== ======== ======== ======= ======== ======= ======= =========
1995:
MI(#).................. $22,986 $183,615 $140,322 $288,453 $61,022 $110,962 $52,881 $22,234 $ 273,718
Title.................. -- 8,472 -- 40,303 1,019 1,875 -- 36,547 40,303
------- -------- -------- -------- ------- -------- ------- ------- ---------
Total.................. $22,986 $192,087 $140,322 $328,756 $62,041 $112,837 $52,881 $58,781 $ 314,021
======= ======== ======== ======== ======= ======== ======= ======= =========
</TABLE>
- --------
# Represents mortgage insurance operations, including ancillary services and
parent company investment income.
44
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
PERCENTAGE
CEDED ASSUMED OF AMOUNT
PREMIUMS EARNED FOR THE GROSS OT OTHER FROM OTHER NET ASSUMED
YEAR ENDED DECEMBER 31, AMOUNT COMPANIES COMPANIES AMOUNT TO NET
----------------------- -------- --------- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1997:
Mortgage Guaranty............ $398,904 $ 6,068 $1,174 $394,010 0.3%
Title........................ 60,068 138 8 59,938 0.0%
-------- ------- ------ --------
TOTAL....................... $458,972 $ 6,206 $1,182 $453,948 0.3%
======== ======= ====== ======== ====
1996:
Mortgage Guaranty............ $372,439 $13,546 $ 634 $359,527 0.2%
Title........................ 53,392 181 -- 53,211 0.0%
-------- ------- ------ --------
TOTAL....................... $425,831 $13,727 $ 634 $412,738 0.2%
======== ======= ====== ======== ====
1995:
Mortgage Guaranty............ $312,020 $26,979 $3,412 $288,453 1.2%
Title........................ 40,439 136 -- 40,303 0.0%
-------- ------- ------ --------
TOTAL....................... $352,459 $27,115 $3,412 $328,756 1.0%
======== ======= ====== ======== ====
</TABLE>
45
<PAGE>
INDEX TO EXHIBITS
[ITEM 14(A)3]
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<C> <S>
3.1(b) Restated Certificate of Incorporation of the Registrant.
3.2(e) By-laws of the Registrant as amended November 15, 1995.
4.1(b) Specimen common stock Certificate.
4.2(h) 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 63/4% Notes due November
15, 2006.
4.3(i) The Junior Subordinated Indenture dated February 4, 1997 between The
PMI Group, Inc. and The Bank of New York, Inc.
4.4(i) Form of Right Certificate, relating to Rights Agreement dated as of
January 26, 1998.
10.1(b)* PMI Mortgage Insurance Co. Annual Incentive Plan.
10.2* The PMI Group, Inc. Equity Incentive Plan. (Amended & Restated).
10.3(g)* The PMI Group, Inc. Stock Plan for Non-Employee Directors. (Amended &
Restated).
10.4(a) Form of 1984 Master Policy of PMI Mortgage Insurance Co.
10.5(a) Form of 1994 Master Policy of PMI Mortgage Insurance Co.
10.6(a) CMG Shareholders Agreement dated September 8, 1994 between CUNA
Mutual Investment Corporation and PMI Mortgage Insurance Co.
10.7(b) Runoff Support Agreement dated October 28, 1994 between Allstate
Insurance Company, the Registrant and PMI Mortgage Insurance Co.
10.8(a) Mortgage Pool Guaranty Insurance Reinsurance Treaty effective
February 14, 1994 ceded by PMI Mortgage Insurance Co. to Forestview
Mortgage Insurance Co. (formerly PMI Insurance Co.).
10.9(a) First Amendment Agreement made as of October 27, 1994 between PMI
Mortgage Insurance Co. and Forestview Mortgage Insurance Co.
(formerly PMI Insurance Co.).
10.10(a) Mortgage Guaranty Insurance Reinsurance Treaty effective December 31,
1991 ceded by PMI Mortgage Insurance Co. to Forestview Mortgage
Insurance Co. (formerly PMI Insurance Co.).
10.11(a) Termination Agreement made as of October 27, 1994 between PMI
Mortgage Insurance Co. and Forestview Mortgage Insurance Co.
(formerly PMI Insurance Co.).
10.12(c) Form of Separation Agreement between the Registrant, PMI Mortgage
Insurance Co., The Allstate Corporation and Allstate Insurance
Company.
10.13(a) Agreement dated June 23, 1994 between PMI Mortgage Insurance Co. and
Allstate Insurance Company regarding cash/remittance processing.
10.14(b) Form of Services Agreement between the Registrant, PMI Mortgage
Insurance Co., and Forestview Mortgage Insurance Co.
10.15(d) Form of Research Center Services Agreement between PMI Mortgage
Insurance Co. and Allstate Insurance Company.
10.16(b) Form of Tax Sharing Agreement among the Registrant, the Registrant's
subsidiaries, The Allstate Corporation, Allstate Insurance Company
and Sears, Roebuck and Co.
10.17(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty effective
January 1, 1991 issued to PMI Mortgage Insurance Co. by Hannover
Ruckversicherungs-Aktiengesellschaft ("Hannover").
10.18(a) First Amendment to Mortgage Insurance Variable Quota Share
Reinsurance Treaty made as of January 1, 1992 between Hannover and
PMI Mortgage Insurance Co.
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<C> <S>
10.19 Form of Change of Control Employment Agreement.
10.20 Supplemental Employee Retirement Plan as amended.
10.21(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
10.22(a) Form of Indemnification Agreement between the Registrant and its
officers and directors.
10.23(a) Form of Human Resources Allocation Agreement among the Registrant,
PMI Mortgage Insurance Co., Sears, Roebuck and Co., The Allstate
Corporation and Allstate Insurance Company.
10.24(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January 1,
1994 issued to PMI Mortgage Insurance Co. by Hannover.
10.27(i)* The PMI Group Inc., Long Term Incentive Plan
10.29(i) The Guarantee Agreement, dated February 4, 1997 between The PMI
Group, Inc. (As Guarantor) and The Bank of New York (As Trustee).
10.30(i) 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.
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
1997 Annual Report to Shareholders.
21.1 Subsidiaries of the Registrant.
23.1 Independent Auditors' Consent.
27.1 Financial Data Schedule for the year ended December 31, 1997.
27.2 Restated Financial Data Schedule for the quarters ended March 31,
1997, June 30, 1997 and September 30, 1997 and the year ended
December 31, 1996.
27.3 Restated Financial Data Schedule for the quarters ended March 31,
1996, June 30, 1996 and September 30, 1996 and the year ended
December 31, 1995.
</TABLE>
- --------
(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 Amendment No. 3 to Form S-1, filed with the SEC on
April 5, 1995.
(e) Previously filed with Form 8-K, filed with the SEC on November 29, 1995.
(f) Previously filed with Form 10-K for the year ended December 31, 1995,
filed with the SEC on March 28, 1996.
(g) Previously filed with Form 10-Q, filed with the SEC on September 30, 1996.
(h) Previously filed with Form 8-K, filed with the SEC on November 25, 1996.
(i) Previously filed with Form 10-K, filed with the Sec on March 28, 1997.
(j) Previously filed with Form 8-A, filed with the Sec on February 2, 1998, as
Exhibit "B."
* Compensatory or benefit plan in which certain executive officers or
Directors of The PMI Group, Inc., or its subsidiaries are eligible to
participate.
47
<PAGE>
Exhibit 10.2
THE PMI GROUP, INC.
EQUITY INCENTIVE
PLAN
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
1. Purpose............................................................ 1
2. Definitions........................................................ 1
3. Scope of the Plan.................................................. 4
(a) Number of Shares Available For Delivery Under the Plan......... 4
(b) Effect of Expiration or Termination............................ 5
(c) Treasury Stock................................................. 5
(d) Committee Discretion to Cancel Options......................... 5
4. Administration..................................................... 5
(a) Committee Administration....................................... 5
(b) Board Reservation and Delegation............................... 5
(c) Committee Authority............................................ 6
(d) Committee Determinations Final................................. 7
5. Eligibility........................................................ 7
6. Conditions to Grants............................................... 7
(a) General Conditions............................................. 7
(b) Grant of Replacement Options................................... 7
(c) Grant of Options and Option Price.............................. 9
(d) Grant of Incentive Stock Options............................... 9
(e) Grant of Reload Options........................................11
(g) Grant of Unrestricted Stock....................................15
(h) Grant of Performance Shares....................................15
7. Non-transferability................................................16
8. Exercise...........................................................16
(a) Exercise of Options............................................16
(b) Special Rules for Section 16 Grantees..........................17
(c) Permissible Shares Issued......................................17
(d) Vesting Upon Change of Control.................................17
9. Loans and Guarantees...............................................17
10. Notification under Section 83(b)...................................18
11. Mandatory Withholding Taxes........................................18
12. Elective Share Withholding.........................................19
</TABLE>
-i-
<PAGE>
TABLE OF CONTENTS
(Continued)
<TABLE>
<CAPTION>
Page
<S>.................................................................<C>
13. Termination of Employment..................................... 19
(a) Restricted Stock........................................ 19
(b) Other Awards............................................ 20
(c) Maximum Extension....................................... 20
14. Equity Incentive Plans of Foreign Subsidiaries................ 20
15. Substituted Awards............................................ 20
16. Securities Law Matters........................................ 21
17. No Funding Required........................................... 21
18. No Employment Rights.......................................... 21
19. Rights as a Stockholder....................................... 21
20. Nature of Payments............................................ 22
21. Non-Uniform Determinations.................................... 22
22. Adjustments................................................... 22
23. Amendment of the Plan......................................... 22
24. Termination of the Plan....................................... 22
25. No Illegal Transactions....................................... 23
26. Controlling Law............................................... 23
27. Severability.................................................. 23
</TABLE>
-ii-
<PAGE>
The Plan. The PMI Group, Inc., having established The PMI Group, Inc.
--------
Equity Incentive Plan, hereby amends and restates the Plan, effective as of
February 14, 1996. The amended and restated Plan is subject to ratification by
an affirmative vote of the holders of a majority of the Stock who are present in
person or by proxy and entitled to vote at the 1996 Annual Meeting of
Stockholders.
1. PURPOSE. The primary purpose of the Plan is to provide a means by which
-------
key employees of the Company and its Subsidiaries can acquire and maintain stock
ownership, thereby strengthening their commitment to the success of the Company
and its Subsidiaries and their desire to remain employed by the Company and its
Subsidiaries. Another purpose of the Plan is to provide continuation of
benefits and opportunities provided to former participants in any of the Sears
Plans, or the Allstate Plan, which benefits and opportunities were lost,
terminated, forfeited, canceled (with or without the consent of the granter) or
reduced as a result of the Company's initial public offering ("IPO"), by
providing for the grant of substitute Awards hereunder. The Plan also is
intended to attract and retain key employees and to provide such employees with
additional incentive and reward opportunities designed to encourage them to
enhance the profitable growth of the Company and its Subsidiaries.
2. DEFINITIONS.
-----------
As used in the Plan, terms defined parenthetically immediately after
their use shall have the respective meanings provided by such definitions and
the terms set forth below shall have the following meanings (such meanings to be
equally applicable to both the singular and plural forms of the terms defined):
(a) "Allstate Option" means an option granted under the Allstate Plan.
(b) "Allstate Plan" means The Allstate Corporation Equity Incentive
Plan.
(c) "Award" means, individually or collectively, a grant under the
Plan of options, restricted Stock, unrestricted Stock or performance shares.
(d) "Award Agreement" means the written agreement by which an Award is
evidenced.
(e) "Board" means the board of directors of the Company.
(f) "Change of Control" means the earliest of the following to occur:
(i) ten (10) days following a public announcement that a person or group of
affiliated or associated persons (other than (a) the Company, (b) a majority
owned subsidiary of the Company, (c) any employee benefit plan of the Company or
of any majority owned subsidiary of the Company, (d) any entity holding shares
of Stock for or pursuant to the terms of any such plan, or (e) The Allstate
Corporation and its affiliates, and their respective successors ("Allstate"),
pending such time that Allstate distributes or transfers its current ownership
interest in the Stock (as contemplated by the Prospectus dated April 10, 1995
relating to the initial public offering of the Stock)) (an "Acquiring Person")
have acquired beneficial ownership of 10% or more of the outstanding Stock (or
15% in the case of a passive investor meeting the definition of a Qualified
<PAGE>
Institutional Investor as set forth in the Company's Preferred Share Rights Plan
dated January 26, 1998 (the "Rights Agreement"), or (ii) ten (10) business days
(or such later date as may be determined by action of the Board prior to such
time as any person or group of affiliated persons becomes an Acquiring Person)
following the commencement of, or announcement of an intention to make, a tender
or exchange offer the consummation of which would result in the beneficial
ownership by a person or group of 10% or more of the outstanding Stock.
Capitalized terms used in this Article 1(f), not otherwise defined, shall have
the meaning set forth in the Rights Agreement.
(g) "Committee" means the committee of the Board appointed pursuant to
Article 4.
(h) "Company" means The PMI Group, Inc., a Delaware corporation.
(i) "Disability" means, as relates to the exercise of an incentive
stock option after Termination of Employment, a permanent and total disability
within the meaning of Section 22(e)(3) of the Internal Revenue Code, and for all
other purposes, a mental or physical condition which, in the opinion of the
Committee, renders a Grantee unable or incompetent to carry out the job
responsibilities which such Grantee held or the duties to which such Grantee was
assigned at the time the disability was incurred, and which is expected to be
permanent or for an indefinite duration.
(j) "Effective Date" means the date described in the first paragraph
of the Plan.
(k) "Fair Market Value" of the Stock means, as of any applicable date
(other than the Effective Date) the mean between the high and low prices of the
Stock as reported on the New York Stock Exchange Composite Tape, or if there
were no sales on such date, on the next preceding date on which there was such a
reported sale, provided, however, that if the Stock is acquired and sold in a
simultaneous sale pursuant to the provisions of Article 8(a)(iv), Fair Market
Value means the price received upon such sale. Solely as of the effective date
of the IPO, Fair Market Value of the Stock means the price to the public
pursuant to the form of final prospectus used in connection with the IPO, as
indicated on the cover page of such prospectus or otherwise.
(l) "Fiscal Year" means the fiscal year of the Company.
(m) "Grant Date" means the date of grant of an Award determined in
accordance with Article 6.
(n) "Grantee" means an individual who has been granted an Award.
(o) "Internal Revenue Code" means the Internal Revenue Code of 1986,
as amended, and regulations and rulings thereunder. References to a particular
section of the Internal Revenue Code shall include references to successor
provisions.
(p) "IPO" means such term as defined in the first paragraph of the
Plan.
2
<PAGE>
(q) "Minimum Consideration" means the $.01 par value per share or such
larger amount determined pursuant to resolution of the Board to be capital
within the meaning of Section 154 of the Delaware General Corporation Law.
(r) "Net Operating Income Per Share" means as to any Fiscal Year, (i)
the Company's net income from operations, net of after-tax realized capital
gains and losses, divided by (ii) the weighted average number of shares of Stock
outstanding during the Fiscal Year, plus dilutive common equivalent shares
calculated in accordance with Accounting Principles Board Opinion No. 15. Net
Operating Income Per Share for a multi-Fiscal Year period means the average of
Net Operating Income Per Share calculated separately for each Fiscal Year of
such multi-Fiscal Year period.
(s) "1934 Act" means the Securities Exchange Act of 1934, as amended.
(t) "Option Price" means the per share purchase price of (i) Stock
subject to an option or (ii) restricted Stock subject to an option.
(u) "Parent" means Allstate Insurance Company.
(v) "Performance Goals" means the goal(s) (or combined goal(s))
determined by the Committee (in its discretion) to be applicable to a Grantee
with respect to an Award. As determined by the Committee, the Performance Goals
(if any) applicable to an Award may provide for a targeted level or levels of
achievement using one or more of the following measures: (i) Net Operating
Income per Share, (ii) Return on Equity, and (iii) Total Return. The
Performance Goals may differ from Grantee to Grantee and from Award to Award.
(w) "Plan" means The PMI Group, Inc. Equity Incentive Plan, as set
forth in this instrument and as hereafter amended from time to time.
(x) "PMI Group Grantee" means any individual who is employed on the
Effective Date by The PMI Group, Inc. or any of its Subsidiaries.
(y) "Reload Option" has the meaning specified in Article 6(e).
(z) "Retirement" means a Termination of Employment occurring on or
after an individual attains age 65, or a Termination of Employment approved by
the Company as an early retirement; provided that in the case of a Section 16
Grantee, such early retirement must be approved by the Committee.
(aa) "Return on Equity" means as to any Fiscal Year, the
Company's net income after taxes expressed as a percentage of average
stockholders' equity. For this purpose, average stockholders' equity shall
be calculated as the average of stockholders' equity on the first and last
days of the Fiscal Year, and excluding unrealized gains and losses.
(bb) "Sears" means Sears, Roebuck and Co., a New York
corporation.
3
<PAGE>
(cc) "Sears Option" means an option granted under a Sears Plan.
(dd) "Sears Plans" means the following plans of Sears: the 1994
Employees Stock Plan, the 1990 Employees Stock Plan, the 1986 Employees
Stock Plan, the 1982 Employees Stock Plan, the 1978 Employees Stock Plan
and the 1979 Incentive Compensation Plan.
(ee) "SEC" means the Securities and Exchange Commission.
(ff) "Section 16 Grantee" means a person subject to potential
liability with respect to equity securities of the Company under Section
16(b) of the 1934 Act.
(gg) "Stock" means common stock of the Company, par value $.01
per share.
(hh) "Subsidiary" means a corporation as defined in Section
424(f) of the Internal Revenue Code, with the Company being treated as the
employer corporation for purposes of this definition.
(ii) "10% Owner" means a person who owns stock (including stock
treated as owned under Section 424(d) of the Internal Revenue Code)
possessing more than 10% of the Voting Power of the Company.
(jj) "Termination of Employment" occurs the first day on which an
individual is for any reason no longer employed by the Company or any of
its Subsidiaries, or by the Parent or any of its subsidiaries, or with
respect to an individual who is an employee of a Subsidiary or a subsidiary
of the Parent, the first day on which the Company (or the Parent, as the
case may be) no longer owns voting securities possessing at least 50% of
the Voting Power of such Subsidiary (or subsidiary of the Parent, as the
case may be).
(kk) "Total Return" means as to any Fiscal Year or multi-Fiscal
Year period, the total return (change in share price plus reinvestment of
any dividends) of the Stock, as compared to the total return of an index or
indexes selected by the Committee. For this purpose, the Committee shall
choose from among (i) the Standard & Poor's 500 Composite Index, (ii) the
Standard & Poor's Financial Miscellaneous Index, (iii) the Russell 1000
Index, and (iv) the Russell 1000 Financial Services Index.
(ll) "Voting Power" means the combined voting power of the then-
outstanding voting securities entitled to vote generally in the election of
directors.
3. SCOPE OF THE PLAN.
-----------------
(a) Number of Shares Available For Delivery Under the Plan. A maximum
------------------------------------------------------
of 1,400,000 shares of Stock shall be authorized for issuance and delivery on
account of the exercise of Awards, including Awards of Replacement Options. No
more than an aggregate of 300,000 shares of the aforesaid 1,400,000 shares of
Stock may be granted under Article 6(f) and (g). No
4
<PAGE>
more than 150,000 shares of Stock may be granted as stock options to any
employee during the duration of the Plan. During any Fiscal Year, no Grantee
shall be granted more than 20,000 performance shares. Shares of Stock issuable
under the Plan may be either authorized but unissued shares of Stock or Treasury
Stock.
(b) Effect of Expiration or Termination. If and to the extent an Award
-----------------------------------
shall expire or terminate for any reason without having been exercised in full
(including, without limitation, a cancellation and regrant of an option pursuant
to Article 4(c)(vii)), or shall be forfeited, without, in either case, the
Grantee having enjoyed any of the benefits of stock ownership (other than voting
rights or dividends that are likewise forfeited), the shares of Stock (including
restricted Stock) associated with such Award shall become available for other
Awards. Except in the case of a Reload Option granted to a Section 16 Grantee,
the grant of a Reload Option shall not reduce the number of shares of Stock
available for other Awards.
(c) Treasury Stock. The Committee shall have the authority to cause
--------------
the Company to purchase from time to time shares of Stock to be held as treasury
shares and used for or in connection with Awards.
(d) Committee Discretion to Cancel Options. Except with respect to
--------------------------------------
options granted pursuant to Article 6(b), the Committee may, in its discretion,
elect at any time, should it determine it is in the best interest of the
Company's stockholders to cancel any options granted hereunder, to cancel all or
any of the options granted hereunder and pay the holders of any such options an
amount (payable in such proportion as the Committee may determine in cash or in
Stock (valued at the Fair Market Value of a share of Stock on the date of
cancellation of such option)) equal to the number of shares of Stock subject to
such canceled option, multiplied by the amount (if any) by which the Fair Market
Value of Stock on the date of cancellation of the option exceeds the Option
Price; provided that if the Committee should determine that not making payment
of such amount to the holders of such option upon the cancellation would be in
the best interests of stockholders of the Company (ignoring in such
determination the cost of such payment and considering only other matters), the
Committee may void options granted hereunder and declare that no payment shall
be made to the holders of such options.
4. ADMINISTRATION.
--------------
(a) Committee Administration. Subject to Article 4(b), the Plan shall
------------------------
be administered by the Committee, which shall consist of not less than two
persons appointed by the Board, who are directors of the Company and not
employees of the Parent, the Company or any of its Subsidiaries. Membership on
the Committee shall be subject to such limitations (including, if appropriate, a
change in the minimum number of members of the Committee) as the Board deems
appropriate to permit transactions pursuant to the Plan to be exempt from
potential liability under Section 16(b) of the 1934 Act and to comply with
Section 162 (m) of the Internal Revenue Code.
(b) Board Reservation and Delegation. The Board may, in its
--------------------------------
discretion, reserve to itself or delegate to another committee of the Board any
or all of the authority and responsibility of the Committee with respect to
Awards to Grantees who are not Section 16 Grantees at the time any such
delegated authority or responsibility is exercised. Such other
5
<PAGE>
committee may consist of one or more directors who may, but need not be,
officers or employees of the Company or of any of its Subsidiaries. To the
extent that the Board has reserved to itself or delegated the authority and
responsibility of the Committee to such other committee, all references to the
Committee in the Plan shall be to such other committee.
(c) Committee Authority. The Committee shall have full and final
-------------------
authority, in its sole and absolute discretion, but subject to the express
provisions of the Plan, as follows:
(i) to grant Awards,
(ii) to determine (A) when Awards may be granted, and (B) whether
or not specific Awards shall be identified with other specific Awards, and
if so, whether they shall be exercisable cumulatively with, or
alternatively to, such other specific Awards,
(iii) to interpret the Plan and to make all determinations
necessary or advisable for the administration of the Plan,
(iv) to prescribe, amend, and rescind rules and regulations
relating to the Plan, including, without limitation, rules with respect to
the exercisability and nonforfeitability of Awards upon the Termination of
Employment of a Grantee,
(v) to determine the terms and provisions of the Award
Agreements, which need not be identical and, with the consent of the
Grantee, to modify any such Award Agreement at any time,
(vi) to cancel options in accordance with the provision of
Section 3(d),
(vii) except as provided in Section 4(c)(vi) hereof, to cancel,
with the consent of the Grantee, outstanding Awards, and to grant new
Awards in substitution thereof,
(viii) to accelerate the exercisability of, and to accelerate or
waive any or all of the restrictions and conditions applicable to, any
Award,
(ix) to authorize foreign Subsidiaries to adopt plans as provided
in Article 14,
(x) to make such adjustments or modifications to Awards to
Grantees working outside the United States as are necessary and advisable
to fulfill the purposes of the Plan,
(xi) to authorize any action of or make any determination by the
Company as the Committee shall deem necessary or advisable for carrying out
the purposes of the Plan,
(xii) to make appropriate adjustments to, cancel or continue
Awards in accordance with Article 22, and
6
<PAGE>
(xiii) to impose such additional conditions, restrictions, and
limitations upon the grant, exercise or retention of Awards as the
Committee may, before or concurrently with the grant thereof, deem
appropriate, including, without limitation, requiring simultaneous exercise
of related identified Awards, and limiting the percentage of Awards which
may from time to time be exercised by a Grantee.
(d) Committee Determinations Final. The determination of the Committee
------------------------------
on all matters relating to the Plan or any Award Agreement shall be conclusive
and final. No member of the Committee shall be liable for any action or
determination made in good faith with respect to the Plan or any Award.
5. ELIGIBILITY. Awards may be granted to any employee of the Company or
-----------
any of its Subsidiaries. In selecting the individuals to whom Awards may be
granted, as well as in determining the number of shares of Stock subject to, and
the other terms and conditions applicable to, each Award, the Committee shall
take into consideration such factors as it deems relevant in promoting the
purposes of the Plan.
6. CONDITIONS TO GRANTS.
--------------------
(a) General Conditions.
------------------
(i) In accordance with its powers under the Plan, the Committee
may grant replacement options (including Reload Options) in accordance with
this Article 6 to preserve those opportunities and benefits of PMI Group
Grantees which were terminated, forfeited, canceled, or reduced in
connection with the IPO.
(ii) The Grant Date of an Award shall be the date on which the
Committee grants the Award or such later date as specified in advance by
the Committee.
(iii) The term of each Award (subject to Article 6(b), with
respect to replacement Awards and Articles 6(d) and 6(e) with respect to
incentive stock options and Reload Options, respectively) shall be a period
of not more than 12 years from the Grant Date, and shall be subject to
earlier termination as herein provided.
(iv) A Grantee may, if otherwise eligible, be granted additional
Awards in any combination.
(v) The Committee may grant Awards with terms and conditions
which differ among the Grantees thereof. To the extent not set forth in the
Plan, the terms and conditions of each Award shall be set forth in an Award
Agreement.
(b) Grant of Replacement Options. Subject to Article 3(a), the
----------------------------
Committee may grant options ("Replacement Options") under the Plan to each PMI
Group Grantee who holds unexercised Sears Options (whether or not
nonforfeitable) and unexercised Allstate Options (whether or not forfeitable) at
the Effective Date; provided that such PMI Group Grantee's right to exercise any
Sears Options and Allstate Options has been forfeited or canceled in connection
with the IPO. The Award Agreement with respect to such Replacement Options shall
provide that
7
<PAGE>
the Grantee may exercise a Replacement Option at the same time as he would have
been able to exercise the Sears Option or Allstate Option it replaces, subject
to Article 8(b), if applicable.
(i) Replacement of Sears Options.
----------------------------
(A) The Option Price for a Replacement Option shall be
determined by the following formula; provided that in no event shall
the Option Price be less than the Minimum Consideration:
Option Price = A x B
-----
C
Any fraction of a cent shall be rounded down to the next full cent.
(B) The number of shares of Stock for which the Replacement
Option is exercisable shall be determined in accordance with the
following formula:
Number of Shares = C x D
-----
B
Any fractional share shall be rounded up to the next full share.
(C) In the foregoing formulas,
"A" is the option exercise price for a Sears Option being
replaced,
"B" is the Fair Market Value of a share of Stock as of the
effective date of the IPO,
"C" is the Fair Market Value of a Sears common share as of the
effective date of the IPO, and
"D" is the number of Sears common shares for which the Sears
Option being replaced is exercisable.
(D) Each Replacement Option shall have the same terms and
conditions (other than the Option Price and the number of shares of
Stock, but including any provision for Reload Options) as, and not
give the Grantee any benefits he did not have, under the corresponding
Sears Option.
(ii) Replacement of Allstate Options.
-------------------------------
(A) The Option Price for a Replacement Option shall be
determined by the following formula; provided that in no
8
<PAGE>
event shall the Option Price be less than the Minimum Consideration:
Option Price = A x B
-----
C
Any fraction of a cent shall be rounded down to the next full cent.
(B) The number of shares of Stock for which the Replacement
Option is exercisable shall be determined in accordance with the
following formula:
Number of Shares = C x D
-----
B
Any fractional share shall be rounded up to the next full share.
(C) In the foregoing formulas,
"A" is the option exercise price for an Allstate Option being
replaced,
"B" is the Fair Market Value of a share of Stock as of the
effective date of the IPO,
"C" is the Fair Market Value of an Allstate common share as of
the effective date of the IPO, and
"D" is the number of Allstate common shares for which the
Allstate Option being replaced is exercisable.
(D) Each Replacement Option shall have the same terms and
conditions (other than the Option Price and the number of shares of
Stock, but including any provision for Reload Options) as, and not
give the Grantee any benefits he did not have, under the corresponding
Allstate Option.
(c) Grant of Options and Option Price. Other than for purposes of
---------------------------------
Replacement Options as set forth in Article 6(b) above, the Committee may, in
its discretion, grant options (which may be options to acquire unrestricted
Stock or restricted Stock) to any employee eligible under Article 5 to receive
Awards. No later than the Grant Date of any option, the Committee shall
determine the Option Price; provided that the Option Price shall, except as
provided in subsection (d) below and in Article 15, not be less than 100% of the
Fair Market Value of the Stock on the Grant Date.
(d) Grant of Incentive Stock Options. At the time of the grant of any
--------------------------------
option other than a Replacement Option, the Committee may designate that such
option shall be made subject to additional restrictions to permit it to qualify
as an "incentive stock option" under the
9
<PAGE>
requirements of Section 422 of the Internal Revenue Code. Any option designated
as an incentive stock option:
(i) shall have an Option Price of (A) not less than 100% of the
Fair Market Value of the Stock on the Grant Date or (B) in the case of a
10% Owner, not less than 110% of the Fair Market Value of the Stock on the
Grant Date;
(ii) shall have a term of not more than 10 years (five years, in
the case of a 10% Owner) from the Grant Date, and shall be subject to
earlier termination as provided herein or in the applicable Award
Agreement;
(iii) shall not have an aggregate Fair Market Value (determined
for each incentive stock option at its Grant Date) of Stock with respect to
which incentive stock options are exercisable for the first time by such
Grantee during any calendar year (under the Plan and any other employee
stock option plan of the Grantee's employer or any parent (including but
not limited to Allstate Insurance Company and Sears) or subsidiary thereof
("Other Plans")), determined in accordance with the provisions of Section
422 of the Internal Revenue Code, which exceeds $100,000 (the "$100,000
Limit");
(iv) shall, if the aggregate Fair Market Value of Stock
(determined on the Grant Date) with respect to all incentive stock options
previously granted under the Plan and any Other Plans ("Prior Grants") and
any incentive stock options under such grant (the "Current Grant") which
are exercisable for the first time during any calendar year would exceed
the $100,000 Limit, be exercisable as follows:
(A) the portion of the Current Grant exercisable for the
first time by the Grantee during any calendar year which would be,
when added to any portions of any Prior Grants exercisable for the
first time by the Grantee during such calendar year with respect to
stock which would have an aggregate Fair Market Value (determined as
of the respective Grant Date for such options) in excess of the
$100,000 Limit shall, notwithstanding the terms of the Current Grant,
be exercisable for the first time by the Grantee in the first
subsequent calendar year or years in which it could be exercisable for
the first time by the Grantee when added to all Prior Grants without
exceeding the $100,000 Limit; and
(B) if, viewed as of the date of the Current Grant, any
portion of a Current Grant could not be exercised under the provisions
of the immediately preceding sentence during any calendar year
commencing with the calendar year in which it is first exercisable
through and including the last calendar year in which it may by its
terms be exercised, such portion of the Current Grant shall not be an
incentive stock option, but shall be exercisable as a separate option
at such date or dates as are provided in the Current Grant;
10
<PAGE>
(v) shall be granted within 10 years from the earlier of the date
the Plan is adopted or the date the Plan is approved by the stockholders of
the Company; and
(vi) shall require the Grantee to notify the Committee of any
disposition of any Stock issued pursuant to the exercise of the incentive
stock option under the circumstances described in Section 421(b) of the
Internal Revenue Code (relating to certain disqualifying dispositions),
within 10 days of such disposition.
Notwithstanding the foregoing and Article 4(c)(v), the Committee may take any
action with respect to any option, including but not limited to an incentive
stock option, without the consent of the Grantee, in order to prevent such
option from being treated as an incentive stock option.
(e) Grant of Reload Options. The Committee may provide in an Award
-----------------------
Agreement, including an Award Agreement for the grant of a Replacement Option
when the Replaced Sears Option or Replaced Allstate Option included a reload
option for Sears shares or Allstate shares, respectively, as the case may be,
that a Grantee who exercises all or any portion of an option for shares of Stock
which have a Fair Market Value equal to not less than 100% of the Option Price
for such options ("Exercised Options") and who paid the Option Price with shares
of Stock shall be granted, subject to Article 3, an additional option ("Reload
Option") for a number of shares of stock equal to the sum ("Reload Number") of
the number of shares of Stock tendered to exercise the Exercised Options plus,
if so provided by the Committee, the number of shares of Stock, if any, retained
by the Company in connection with the exercise of the Exercised options to
satisfy any federal, state or local tax withholding requirements.
Reload Options shall be subject to the following terms and conditions:
(i) the Grant Date for each Reload Option shall be the date of
exercise of the Exercised Option to which it relates;
(ii) subject to Article 6(e)(iii) below, the Reload Option may be
exercised at any time during the unexpired term of the Exercised Option
(subject to earlier termination thereof as provided in the Plan and in the
applicable Award Agreement); and
(iii) the terms of the Reload Option shall be the same as the
terms of the Exercised Option to which it relates, except that (A) the
Option Price shall be the Fair Market Value of the Stock on the Grant Date
of the Reload Option and (B) no Reload Option may be exercised within one
year from the Grant Date thereof.
(f) Grant of Shares of Restricted Stock.
-----------------------------------
(i) The Committee may, in its discretion, grant shares of
restricted Stock to any employee eligible under Article 5 to receive
Awards.
(ii) Before the grant of any shares of restricted Stock, the
Committee shall determine, in its discretion:
11
<PAGE>
(A) whether the certificates for such shares shall be
delivered to the Grantee or held (together with a stock power executed
in blank by the Grantee) in escrow by the Secretary of the Company
until such shares become nonforfeitable or are forfeited,
(B) the per share purchase price of such shares, which may
be zero provided, however, that
(1) the per share purchase price of all such shares
(other than treasury shares) shall not be less than the Minimum
Consideration for each such share; and
(2) if such shares are to be granted to a Section 16
Grantee, the per share purchase price of any such shares shall
also be at least 50% of the Fair Market Value of the Stock on the
Grant Date unless such shares are granted for no monetary
consideration (in which case treasury shares are to be delivered)
or with a purchase price per share equal to the Minimum
Consideration for the Stock, and
(C) the restrictions applicable to such grant;
(iii) Payment of the purchase price (if greater than zero) for
shares of restricted Stock shall be made in full by the Grantee before the
delivery of such shares and, in any event, no later than 10 days after the
Grant Date for such shares. Such payment may, at the election of the
Grantee, be made in any one or any combination of the following:
(A) cash,
(B) Stock valued at its Fair Market Value on the date of
payment or, if the date of payment is not a business day, the next
succeeding business day, or
(C) with the approval of the Committee, shares of restricted
Stock, each valued at the Fair Market Value of a share of Stock on the
date of payment or, if the date of payment is not a business day, the
next succeeding business day
provided, however, that, in the case of payment in Stock or restricted
Stock,
(1) the use of Stock or restricted Stock in payment of
such purchase price by a Section 16 Grantee is subject to the
prior receipt by the Company of either a favorable opinion of
counsel for the Company or a "no action" letter from the staff of
the SEC with respect to the exemption of such use of stock from
potential liability under Section 16(b) of the 1934 Act or the
inapplicability of such Section;
12
<PAGE>
(2) in the discretion of the Committee and to the
extent permitted by law, payment may also be made in accordance
with Article 9; and
(3) if the purchase price for restricted Stock ("New
Restricted Stock") is paid with shares of restricted Stock ("Old
Restricted Stock"), the restrictions applicable to the New
Restricted Stock shall be the same as if the Grantee had paid for
the New Restricted Stock in cash unless, in the judgment of the
Committee, the Old Restricted Stock was subject to a greater risk
of forfeiture, in which case a number of shares of New Restricted
Stock equal to the number of shares of Old Restricted Stock
tendered in payment for New Restricted Stock may in the
discretion of the Committee be subject to the same restrictions
as the Old Restricted Stock, determined immediately before such
payment.
(iv) The Committee may, but need not, provide that all or any
portion of a Grantee's Award of restricted Stock shall be forfeited
(A) except as otherwise specified in the Award Agreement,
upon the Grantee's Termination of Employment within a specified time
period after the Grant Date, or
(B) if the Company or the Grantee does not achieve specified
performance goals within a specified time period after the Grant Date
and before the Grantee's Termination of Employment, or
(C) upon failure to satisfy such other restrictions as the
Committee may specify in the Award Agreement.
(v) If a share of restricted Stock is forfeited, then
(A) the Grantee shall be deemed to have resold such share of
restricted Stock to the Company at the lesser of (1) the purchase
price paid by the Grantee (such purchase price shall be deemed to be
zero dollars ($0) if no purchase price was paid) or (2) the Fair
Market Value of a share of Stock on the date of such forfeiture;
(B) the Company shall pay to the Grantee the amount
determined under clause (A) of this sentence as soon as is
administratively practical; and
(C) such share of restricted Stock shall cease to be
outstanding, and shall no longer confer on the Grantee thereof any
rights as a stockholder of the Company, from and after the date of the
Company's tender of the payment specified in clause (B) of
13
<PAGE>
this sentence, whether or not such tender is accepted by the Grantee.
(vi) Any share of restricted Stock shall bear an appropriate
legend specifying that such share is non-transferable and subject to the
restrictions set forth in the Plan. If any shares of restricted Stock
become nonforfeitable, the Company shall cause certificates for such shares
to be issued or reissued without such legend and delivered to the Grantee
or, at the request of the Grantee, shall cause such shares to be credited
to a brokerage account specified by the Grantee.
(vii) Notwithstanding any contrary provision of the Plan or of
any Award Agreement in respect of any restricted Stock, immediately upon
the occurrence of a Change of Control that occurs prior to a Grantee's
Termination of Employment, 100% of any outstanding restricted Stock shares
shall be 100% vested in the Grantee. Notwithstanding the preceding
provisions of this Article 6(f)(vii), 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.
(g) Grant of Unrestricted Stock. The Committee may, in its discretion,
---------------------------
grant shares of unrestricted Stock to any employee eligible under Article 5 to
receive Awards.
(h) Grant of Performance Shares.
---------------------------
(i) The Committee may, in its discretion, grant performance
shares to any employee eligible under Article 5 to receive Awards.
(ii) Each performance share shall have an initial value equal to
the Fair Market Value of a share of Stock on the date of grant.
(iii) The Committee shall set performance objectives in its
discretion which, depending on the extent to which they are met, will
determine the number of performance shares that will be paid out to the
Participants. The time period during which the performance objectives must
be met shall be called the "Performance Period".
(iv) The Committee may set performance objectives based upon the
achievement of Company-wide, divisional, or individual goals, applicable
Federal or state securities laws, or any other basis determined by the
Committee in its discretion. For purposes of qualifying grants of
performance shares as "performance-based compensation" under Section 162(m)
of the Internal Revenue Code, the Committee, in its discretion, may
determine that the performance objectives applicable to performance 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
14
<PAGE>
performance shares to qualify as "performance-based compensation" under
Section 162(m) of the Internal Revenue Code. In granting performance shares
which are intended to qualify under Code Section 162(m), the Committee
shall follow any procedures determined by it from time to time to be
necessary or appropriate to ensure qualification of the performance shares
under Internal Revenue Code Section 162(m) (e.g., in determining the
---
Performance Goals).
(v) After the applicable Performance Period has ended, the
Grantee shall be entitled to receive a payout of the number of performance
shares earned over the Performance Period, to be determined as a function
of the extent to which the corresponding performance objectives have been
achieved. Payment of earned 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 earned performance shares in the
form of cash, in shares of Stock (which have an aggregate Fair Market Value
equal to the value of the earned performance Shares at the close of the
applicable Performance Period) or in a combination thereof.
(vi) Notwithstanding any contrary provision of the Plan or of any
Award Agreement in respect of any performance share, immediately upon the
occurrence of a Change of Control that occurs prior to a Grantee's
Termination of Employment, 100% of any outstanding performance shares shall
be deemed to be earned and shall be immediately payable to the Grantee, or,
in cases where a Grantee has received a target award of performance shares,
100% of the target amount shall vest. Notwithstanding the preceding
provisions of this Article 6(h)(vi), if the Committee determines that the
acceleration of vesting of performance 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. NON-TRANSFERABILITY. Each Award (other than unrestricted Stock) granted
-------------------
hereunder shall by its terms not be assignable or transferable other than by
will or the laws of descent and distribution and may be exercised, during the
Grantee's lifetime, only by the Grantee. Each share of restricted Stock shall be
non-transferable until such share becomes nonforfeitable. Notwithstanding the
foregoing, the Grantee may, to the extent provided in the Plan and in a manner
specified by the Committee, (a) designate in writing a beneficiary to exercise
his options after the Grantee's death, and (b) transfer an option (other than an
incentive stock option) to a revocable, inter vivos trust as to which the
Grantee is both the settlor and the trustee, but in no event shall any such
transfer be effective unless the Company shall have received a favorable opinion
of counsel for the Company or the staff of the SEC shall have issued an
interpretive or "no action" letter to the effect that transfers made on a basis
substantially consistent with this Article would not violate the conditions for
the exemption provided by SEC Rule 16b-3.
15
<PAGE>
8. EXERCISE.
--------
(a) Exercise of Options. Subject to Articles 4, 6, 14 and 17, and such
-------------------
terms and conditions as the Committee may impose, each option shall be
exercisable in one or more installments commencing not earlier than the first
anniversary of the Grant Date of such option; provided, however, that in the
case of a Replacement Option, such option shall be exercisable commencing not
earlier than the first anniversary of the grant date of the Sears Option or
Allstate Option it replaces. Options shall not be exercisable for twelve months
following a hardship distribution that is subject to Treasury Regulation
(S)1.401(k)-1(d)(2)(iv)(B)(4), except to the extent permitted thereunder. Each
option shall be exercised by delivery to the Company of written notice of intent
to purchase a specific number of shares of Stock or restricted Stock subject to
the option. The Option Price of any shares of Stock or restricted Stock as to
which an option shall be exercised shall be paid in full at the time of the
exercise. Payment may, at the election of the Grantee, or if specified, as
provided in the Award Agreement, be made in any one or any combination of the
following forms:
(i) check in such form as may be satisfactory to the Committee,
(ii) Stock valued at its Fair Market Value on the date of
exercise or, if the date of exercise is not a business day, the next
succeeding business day; provided that for the exercise of a Replacement
Option, such Stock must have been held for at least six months, valued at
the Fair Market Value on the date of exercise,
(iii) Except with respect to the exercise of a Replacement Sears
Option, with the approval of the Committee, shares of restricted Stock,
each valued at the Fair Market Value of a share of Stock on the date of
exercise or, if the date of exercise is not a business day, the next
succeeding business day, or
(iv) Except with respect to the exercise of a Replacement Sears
option, through simultaneous sale through a broker of shares of
unrestricted Stock acquired on exercise, as permitted under Regulation T of
the Federal Reserve Board.
If restricted Stock ("Tendered Restricted Stock") is used to pay the
Option Price for Stock, then a number of shares of Stock acquired on exercise of
the option equal to the number of shares of Tendered Restricted Stock shall be
subject to the same restrictions as the Tendered Restricted Stock, determined as
of the date of exercise of the option. If the Option Price for restricted Stock
is paid with Tendered Restricted Stock, and if the Committee determines that the
restricted Stock acquired on exercise of the option is subject to restrictions
("Greater Restrictions") that cause it to have a greater risk of forfeiture than
the Tendered Restricted Stock, then notwithstanding the preceding sentence, all
the restricted Stock acquired on exercise of the option shall be subject to such
Greater Restrictions.
Shares of unrestricted Stock acquired by a Grantee on exercise of an
option shall be delivered to the Grantee or, at the request of the Grantee,
shall be credited directly to a brokerage account specified by the Grantee.
16
<PAGE>
(b) Special Rules for Section 16 Grantees. Subject to Articles 6 and
-------------------------------------
15, no option shall be exercisable by a Section 16 Grantee during the first six
months after its Grant Date, except as exempted from Section 16(b) of the 1934
Act under Rule 16a-2(d) under the 1934 Act. This limitation shall not apply if
the Grantee dies or incurs a Disability before the end of the six-month period.
(c) Permissible Shares Issued. No shares of Stock shall be issued
-------------------------
hereunder upon option exercise except shares of Stock available under Article
3(a). Each Grantee, by acceptance of an award, waives all rights to specific
performance or injunctive or other equitable relief and acknowledges that he has
an adequate remedy at law in the form of damages.
(d) Vesting Upon Change of Control. Notwithstanding any contrary
------------------------------
provision of the Plan or of any Award Agreement in respect of an option,
immediately upon the occurrence of a Change of Control that occurs prior to a
Grantee's Termination of Employment, the right to exercise each option then
outstanding shall accrue as to 100% of the shares of Stock then subject to such
option. Notwithstanding the preceding provisions of this Article 8(d), if the
Committee determines that the acceleration of vesting of options following a
Change of Control would cause a Change of Control transaction to be ineligible
for pooling of interests accounting under APB No. 16, which transaction (but for
such accelerated vesting) otherwise would have been eligible for such accounting
treatment, the Committee, in its sole discretion, may determine that no such
accelerated vesting shall occur.
9. LOANS AND GUARANTEES. The Committee may, in its discretion except with
--------------------
respect to the Replacement of a Sears Option:
(a) allow a Grantee to defer payment to the Company of all or any
portion of (i) the Option Price of an option, (ii) the purchase price of a share
of restricted Stock, or (iii) any taxes associated with a benefit hereunder
which is not a cash benefit at the time such benefit is so taxable, or
(b) cause the Company to guarantee a loan from a third party to the
Grantee, in an amount equal to all or any portion of such option Price, purchase
price, or any related taxes. Any such payment deferral or guarantee by the
Company pursuant to this Article 9 shall be, on a secured or unsecured basis,
for such periods, at such interest rates, and on such other terms and conditions
as the Committee may determine. Notwithstanding the foregoing, a Grantee shall
not be entitled to defer the payment of such Option Price, purchase price, or
any related taxes unless the Grantee (i) enters into a binding obligation to pay
the deferred amount and (ii) except with respect to treasury shares, pays upon
exercise of an option or grant of shares of restricted Stock, as the case may
be, an amount equal to or greater than the aggregate Minimum Consideration
therefor. If the Committee has permitted a payment deferral or caused the
Company to guarantee a loan pursuant to this Article 9, then the Committee may,
in its discretion, require the immediate payment of such deferred amount or the
immediate release of such guarantee upon the Grantee's Termination of Employment
or if the Grantee sells or otherwise transfers the Grantee's shares of Stock
purchased pursuant to such deferral or guarantee.
17
<PAGE>
10. NOTIFICATION UNDER SECTION 83(b). The Committee may, on the Grant Date
--------------------------------
or any later date, prohibit a Grantee from making the election described below.
If the Committee has not prohibited such Grantee from making such election, and
the Grantee shall, in connection with the exercise of any option, or the grant
of any share of restricted Stock, make the election permitted under Section
83(b) of the Internal Revenue Code (i.e., an election to include in such
Grantee's gross income in the year of transfer the amounts specified in Section
83(b) of the Internal Revenue Code), such Grantee shall notify the Company of
such election within 10 days of filing notice of the election with the Internal
Revenue Service, in addition to any filing and notification required pursuant to
regulations issued under the authority of Section 83(b) of the Internal Revenue
Code.
11. MANDATORY WITHHOLDING TAXES.
---------------------------
(a) Whenever under the Plan, cash or shares of Stock are to be
delivered upon exercise or payment of an Award or upon a share of restricted
Stock becoming nonforfeitable, or any other event with respect to rights and
benefits hereunder, the Company shall be entitled to require as a condition of
delivery (i) that the Grantee remit an amount sufficient to satisfy all federal,
state, and local withholding tax requirements related thereto, (ii) the
withholding of such sums from compensation otherwise due to the Grantee or from
any shares of Stock due to the Grantee under the Plan or (iii) any combination
of the foregoing.
(b) If any disqualifying disposition described in Article 6(c)(vi) is
made with respect to shares of Stock acquired under an incentive stock option
granted pursuant to the Plan or any election described in Article 10 is made,
then the person making such disqualifying disposition or election shall remit to
the Company an amount sufficient to satisfy all federal, state, and local
withholding taxes thereby incurred; provided that, in lieu of or in addition to
the foregoing, the Company shall have the right to withhold such sums from
compensation otherwise due to the Grantee or from any shares of Stock due to the
Grantee under the Plan.
12. ELECTIVE SHARE WITHHOLDING.
--------------------------
(a) Subject to the prior approval of the Committee and to Article
12(b), a Grantee may elect the withholding ("Share Withholding") by the Company
of a portion of the shares of Stock otherwise deliverable to such Grantee upon
the exercise or payment of an Award or upon a share of restricted Stock's
becoming nonforfeitable (each a "Taxable Event") having a Fair Market Value
equal to
(i) the minimum amount necessary to satisfy required federal,
state, or local withholding tax liability attributable to the Taxable
Event; or
(ii) with the Committee's prior approval, a greater amount, not
to exceed the estimated total amount of such Grantee's tax liability with
respect to the Taxable Event.
(b) Each Share Withholding election by a Grantee shall be subject to
the following restrictions:
18
<PAGE>
(i) any Grantee's election shall be subject to the Committee's
right to revoke its approval of Share Withholding by such Grantee at any
time before the Grantee's election if the Committee has reserved the right
to do so at the time of its approval;
(ii) if the Grantee is a Section 16 Grantee, such Grantee's
election shall be subject to the disapproval of the Committee at any time,
whether or not the Committee has reserved the right to do so;
(iii) the Grantee's election must be made before the date (the
"Tax Date") on which the amount of tax to be withheld is determined;
(iv) the Grantee's election shall be irrevocable;
(v) a Section 16 Grantee may not elect Share Withholding to the
extent that such Share Withholding is to occur within six months after the
grant of the related option (except if the Grantee dies or incurs a
Disability before the end of the six-month period); and
(vi) a Section 16 Grantee must elect Share Withholding during the
ten business day period beginning on the third business day after the
release of the Company's quarterly or annual summary statement of sales and
earnings.
13. TERMINATION OF EMPLOYMENT.
-------------------------
(a) Restricted Stock. Except as otherwise provided by the Committee on
----------------
or after the Grant Date, a Grantee's shares of restricted Stock that are
forfeitable shall be forfeited upon the Grantee's Termination of Employment.
(b) Other Awards. If a Grantee has a Termination of Employment, then,
------------
unless otherwise provided in the Grant Agreement, any unexercised option to the
extent exercisable on the date of the Grantee's Termination of Employment may be
exercised by the Grantee, in whole or in part, at any time within three months
following such Termination of Employment, except that
(i) if the Grantee's Termination of Employment is on account of
Disability, then any unexercised option (except a Replacement of a Sears
Option) to the extent exercisable at the date of such Termination of
Employment, may be exercised, in whole or in part, by the Grantee at any
time within two years after the date of such Termination of Employment; and
(ii) if the Grantee's Termination of Employment is on account of
Retirement, then any unexercised option to the extent exercisable at the
date of such Termination of Employment, may be exercised, in whole or in
part, by the Grantee at any time within (a) two years after the date of
such Termination of Employment, in the case of a Replacement Sears Option
or (b) five years after the date of such Termination of Employment in the
case of all other options.
19
<PAGE>
(iii) if the Grantee's Termination of Employment is caused by
the death of the Grantee or if the Grantee's death occurs during the period
following Termination of Employment during which the option would be
exercisable under the preceding clause of Article 13(b) or under Article
13(b)(i) or (ii), then any unexercised option to the extent exercisable on
the date of the Grantee's death, may be exercised, in whole or in part, at
any time within two years after the Grantee's death by the Grantee's
personal representative or by the person to whom the option is transferred
by will or the applicable laws of descent and distribution.
(c) Maximum Extension. Notwithstanding the foregoing, no Award shall
-----------------
be exercisable beyond the maximum term permitted under the original Award
Agreement unless with respect to any option except a Replacement Sears option,
the Committee explicitly extends such original term, in which case such term
shall not be extended beyond the maximum term permitted by the Plan.
14. EQUITY INCENTIVE PLANS OF FOREIGN SUBSIDIARIES. The Committee may
----------------------------------------------
authorize any foreign Subsidiary to adopt a plan for granting Awards ("Foreign
Equity Incentive Plan"). All awards granted under such Foreign Equity Incentive
Plans shall be treated as grants under the Plan. Such Foreign Equity Incentive
Plans shall have such terms and provisions as the Committee permits not
inconsistent with the provisions of the Plan and which may be more restrictive
than those contained in the Plan. Awards granted under such Foreign Equity
Incentive Plans shall be governed by the terms of the Plan except to the extent
that the provisions of the Foreign Equity Incentive Plans are more restrictive
than the terms of the Plan, in which case such terms of the Foreign Equity
Incentive Plans shall control.
15. SUBSTITUTED AWARDS. Except with respect to Replacement Options, the
------------------
Committee may grant substitute awards for any canceled Award granted under this
Plan or any plan of any entity acquired by the Company or any of its
Subsidiaries in accordance with this Article 15. If the Committee cancels any
Award (granted under this Plan, or any plan of any entity acquired by the
Company or any of its Subsidiaries), and a new Award is substituted therefor,
then the Committee may, in its discretion, determine the terms and conditions of
such new Award, and may provide that the Grant Date of the canceled Award shall
be the date used to determine the earliest date or dates for exercising the new
substituted Award under Article 8 hereof so that the Grantee may exercise the
substituted Award at the same time as if the Grantee had held the substituted
Award since the Grant Date of the canceled Award.
16. SECURITIES LAW MATTERS.
----------------------
(a) If the Committee deems necessary to comply with the Securities Act
of 1933, the Committee may require a written investment intent representation by
the Grantee and may require that a restrictive legend be affixed to certificates
for shares of Stock.
(b) If based upon the opinion of counsel for the Company, the
Committee determines that the exercise or nonforfeitability of, or delivery of
benefits pursuant to, any Award could violate any applicable provision of (i)
federal or state securities law or regulations or (ii) the listing requirements
of any national securities exchange on which are listed any of the Company's
20
<PAGE>
equity securities, then the Committee may postpone any such exercise,
nonforfeitability or delivery, as the case may be, but the Company shall use its
best efforts to cause such exercise, nonforfeitability or delivery to comply
with all such provisions at the earliest practicable date.
17. NO FUNDING REQUIRED. Benefits payable under the Plan to any person
-------------------
shall be paid directly by the Company. The Company shall not be required to
fund, or otherwise segregate assets to be used for payment of, benefits under
the Plan.
18. NO EMPLOYMENT RIGHTS. Neither the establishment of the Plan, nor the
--------------------
granting of any Award shall be construed to (a) give any Grantee the right to
remain employed by the Company or any of its Subsidiaries or to any benefits not
specifically provided by the Plan or (b) in any manner modify the right of the
Company or any of its Subsidiaries to modify, amend, or terminate any of its
employee benefit plans.
19. RIGHTS AS A STOCKHOLDER. A Grantee shall not, by reason of any Award
-----------------------
(other than restricted Stock) have any right as a stockholder of the Company
with respect to the shares of Stock which may be deliverable upon exercise or
payment of such Award until such shares have been delivered to him. Shares of
restricted Stock held by a Grantee or held in escrow by the Secretary of the
Company shall confer on the Grantee all rights of a stockholder of the Company,
except as otherwise provided in the Plan or the Award Agreement. The Committee,
in its discretion, at the time of grant of restricted Stock, may permit or
require the payment of cash dividends thereon to be deferred and, if the
Committee so determines, reinvested in additional restricted Stock to the extent
shares are available under Article 3, or otherwise reinvested in Stock. Stock
dividends, deferred cash dividends and dividends in the form of property other
than cash, issued with respect to restricted Stock shall, unless otherwise
provided in the Award Agreement, be treated as additional shares of restricted
Stock that are subject to the same restrictions and other terms as apply to the
shares with respect to which such dividends are issued. The Committee may, in
its discretion, provide for crediting and payment of interest on deferred cash
dividends.
20. NATURE OF PAYMENTS. Any and all grants, payments of cash, or
------------------
deliveries of shares of Stock hereunder shall constitute special incentive
payments to the Grantee and shall not be taken into account in computing the
amount of salary or compensation of the Grantee for the purposes of determining
any pension, retirement, death or other benefits under (a) any pension,
retirement, profit-sharing, bonus, life insurance or other employee benefit plan
of the Company or any of its Subsidiaries or (b) any agreement between the
Company or any Subsidiary, on the one hand, and the Grantee, on the other hand,
except as such plan or agreement shall otherwise expressly provide.
21. NON-UNIFORM DETERMINATIONS. Neither the Committee's nor the Board's
--------------------------
determinations under the Plan need be uniform and may be made by the Committee
or the Board selectively among persons who receive, or are eligible to receive,
Awards (whether or not such persons are similarly situated). Without limiting
the generality of the foregoing, the Committee shall be entitled, among other
things, to make non-uniform and selective determinations, to enter into non-
uniform and selective Award Agreements as to (a) the identity of the Grantees,
(b) the
21
<PAGE>
terms and provisions of Awards, and (c) the treatment, under Article 13, of
Terminations of Employment.
22. ADJUSTMENTS. Subject to Article 6, the Committee may make such
-----------
provision with respect to Awards, including without limitation, equitable
adjustment of
(a) the aggregate numbers of shares of Stock available under Articles
3(a) and 3(b),
(b) the number of shares of Stock or shares of restricted Stock
covered by an Award, and
(c) the Option Price, or
the termination or continuation of an Award as it may determine to be
appropriate and equitable to reflect a stock dividend, stock split, reverse
stock split, share combination, recapitalization, merger, consolidation,
acquisition of property or shares, separation, spin-off, reorganization, stock
rights offering, liquidation, or similar event, of or by the Company.
23. AMENDMENT OF THE PLAN. The Board may from time to time in its
---------------------
discretion amend or modify the Plan without the approval of the stockholders of
the Company, except as such stockholder approval may be required (a) to permit
transactions in Stock pursuant to the Plan to be exempt from potential liability
under Section 16(b) of the 1934 Act, (b) to permit the Company to deduct, in
computing its income tax liability pursuant to the provisions of the Internal
Revenue Code, compensation resulting from Awards, (c) to retain incentive stock
option treatment under Section 422 of the Internal Revenue Code, or (d) under
the listing requirements of any securities exchange on which are listed any of
the Company's equity securities.
24. TERMINATION OF THE PLAN. The Plan shall terminate on the tenth (10th)
-----------------------
anniversary of the Effective Date or at such earlier time as the Board may
determine. Any termination, whether in whole or in part, shall not affect (a)
any Award then outstanding under the Plan, or (b) the Company's ability to make
adjustments to or cancel or continue Awards in accordance with Article 22.
25. NO ILLEGAL TRANSACTIONS. The Plan and all Awards granted pursuant to
-----------------------
it are subject to all laws and regulations of any governmental authority which
may be applicable thereto; and notwithstanding any provision of the Plan or any
Award, Grantees shall not be entitled to exercise Awards or receive the benefits
thereof and the Company shall not be obligated to deliver any Stock or pay any
benefits to a Grantee if such exercise, delivery, receipt or payment of benefits
would constitute a violation by the Grantee or the Company of any provision of
any such law or regulation.
26. CONTROLLING LAW. The law of the State of Delaware except its law with
---------------
respect to choice of law, shall be controlling in all matters relating to or
arising out of the Plan or any Award.
22
<PAGE>
27. SEVERABILITY. If all or any part of the Plan is declared by any court
------------
or governmental authority to be unlawful or invalid, such unlawfulness or
invalidity shall not serve to invalidate any portion of the Plan not declared to
be unlawful or invalid. Any Article or part of an Article so declared to be
unlawful or invalid shall, if possible, be construed in a manner which will give
effect to the terms of such Article or part of an Article to the fullest extent
possible while remaining lawful and valid.
23
<PAGE>
Exhibit 10.19
CHANGE OF CONTROL
EMPLOYMENT AGREEMENT
--------------------
AGREEMENT by and between The PMI Group, Inc., a Delaware corporation
(the "Company"), and ________________ (the "Executive"), dated as of the ___ day
of ________, 199_.
The Board of Directors of the Company (the "Board"), has determined
that it is in the best interests of the Company and its shareholders to assure
that the Company will have the continued dedication of the Executive,
notwithstanding the possibility, threat or occurrence of a Change of Control (as
defined below) of the Company. The Board believes it is imperative to diminish
the inevitable distraction of the Executive by virtue of the personal
uncertainties and risks created by a pending or threatened Change of Control and
to encourage the Executive's full attention and dedication to the Company
currently and in the event of any threatened or pending Change of Control, and
to provide the Executive with compensation and benefits arrangements upon a
Change of Control which ensure that the compensation and benefits expectations
of the Executive will be satisfied and which are competitive with those of other
corporations. Therefore, in order to accomplish these objectives, the Board has
caused the Company to enter into this Agreement.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
1. Certain Definitions. (a) The "Effective Date" shall mean the
-------------------
first date during the Change of Control Period (as defined in Section 1(b)) on
which a Change of Control (as defined in Section 2) occurs. Anything in this
Agreement to the contrary notwithstanding, if a Change of Control occurs and
if the Executive's employment with the Company is terminated prior to the date
on which the Change of Control occurs, and if it is reasonably demonstrated by
the Executive that such termination of employment (i) was at the request of a
third party who has taken steps reasonably calculated to effect a Change of
Control or (ii) otherwise arose in connection with or anticipation of a Change
of Control, then for all purposes of this Agreement the "Effective Date" shall
mean the date immediately prior to the date of such termination of employment.
<PAGE>
(b) The "Change of Control Period" shall mean the period commencing
on the date hereof and ending on the third anniversary of the date hereof;
provided, however, that commencing on the date one year after the date hereof,
and on each annual anniversary of such date (such date and each annual
anniversary thereof shall be hereinafter referred to as the "Renewal Date"),
unless previously terminated, the Change of Control Period shall be
automatically extended so as to terminate three years from such Renewal Date,
unless at least 60 days prior to the Renewal Date the Company shall give
notice to the Executive that the Change of Control Period shall not be so
extended.
2. Change of Control. For the purpose of this Agreement, a "Change
-----------------
of Control" shall mean:
(a) The acquisition by any individual, entity or group (within the
meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of
1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership
(within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20%
or more of either (i) the then outstanding shares of common stock of the
Company (the "Outstanding Company Common Stock") or (ii) the combined voting
power of the then outstanding voting securities of the Company entitled to
vote generally in the election of directors (the "Outstanding Company Voting
Securities"); provided, however, that for purposes of this subsection (a), the
following shall not constitute a Change of Control: (i) any acquisition
directly from the Company, (ii) any acquisition by the Company, (iii) any
acquisition by any employee benefit plan (or related trust) sponsored or
maintained by the Company or any corporation controlled by the Company, (iv)
any beneficial ownership maintained by (but not additional acquisitions by),
The Allstate Corporation and its subsidiaries, and their respective successors
("Allstate"), pending such time that Allstate distributes or transfers its
current ownership interest in the Outstanding Company Common Stock and
Outstanding Company Voting Securities as contemplated by the Prospectus dated
April 10, 1995, relating to the initial public offering of the common stock of
the Company, or (v) any acquisition pursuant to a transaction which complies
with clauses (i), (ii) and (iii) of subsection (c) of this Section 1.
Notwithstanding the foregoing, in its sole discretion, the Board may increase
the 20% threshold set forth above in this subsection (a) prior to any
acquisition of 20% or more beneficial ownership of the Outstanding Company
-2-
<PAGE>
Common Stock or the Outstanding Company Voting Securities; provided, that (i)
such increased threshold shall apply only to the acquisition and maintenance
of beneficial ownership by any Person eligible to report such beneficial
ownership at the time of such acquisition on Schedule 13G under the Exchange
Act, and (ii) in the event that any Person initially eligible to so report on
Schedule 13G thereafter ceases to be eligible to so report on Schedule 13G,
the occurrence of the event causing such Person no longer to be eligible to so
report shall be deemed an acquisition by such Person of all of the Outstanding
Company Common Stock and Outstanding Company Voting Securities beneficially
owned by such Person immediately prior to such occurrence; or
(b) Individuals who, as of the date hereof, constitute the Board (the
"Incumbent Board") cease for any reason to constitute at least a majority of
the Board; provided, however, that any individual becoming a director
subsequent to the date hereof whose election, or nomination for election by
the Company's shareholders, was approved by a vote of at least a majority of
the directors then comprising the Incumbent Board shall be considered as
though such individual were a member of the Incumbent Board, but excluding,
for this purpose, any such individual whose initial assumption of office
occurs as a result of an actual or threatened election contest with respect to
the election or removal of directors or other actual or threatened
solicitation of proxies or consents by or on behalf of a Person other than the
Board; or
(c) Consummation by the Company of a reorganization, merger or
consolidation or sale or other disposition of all or substantially all of the
assets of the Company or the acquisition of assets of another entity (a
"Business Combination"), in each case, unless, following such Business
Combination, (i) all or substantially all of the individuals and entities who
were the beneficial owners, respectively, of the Outstanding Company Common
Stock and Outstanding Company Voting Securities immediately prior to such
Business Combination beneficially own, directly or indirectly, more than 60%
of, respectively, the then outstanding shares of common stock and the combined
voting power of the then outstanding voting securities entitled to vote
generally in the election of directors, as the case may be, of the corporation
resulting from such Business Combination (including, without limitation, a
corporation which as a result of such transaction owns the Company or all or
substantially all of the Company's assets either directly or through one or
more subsidiaries) in substantially the same proportions as their ownership,
-3-
<PAGE>
immediately prior to such Business Combination of the Outstanding Company
Common Stock and Outstanding Company Voting Securities, as the case may be,
(ii) no Person (excluding any employee benefit plan (or related trust) of the
Company or such corporation resulting from such Business Combination)
beneficially owns, directly or indirectly, 20% or more of, respectively, the
then outstanding shares of common stock of the corporation resulting from such
Business Combination or the combined voting power of the then outstanding
voting securities of such corporation except to the extent that such ownership
existed prior to the Business Combination and (iii) at least a majority of the
members of the board of directors of the corporation resulting from such
Business Combination were members of the Incumbent Board at the time of the
execution of the initial agreement, or of the action of the Board, providing
for such Business Combination; or
(d) Approval by the shareholders of the Company of a complete
liquidation or dissolution of the Company.
Notwithstanding the foregoing, a Change of Control shall not be deemed to
occur solely because any Person acquires beneficial ownership of 20% or more
of the Outstanding Company Voting Securities or Outstanding Company Common
Stock as a result of the acquisition of such securities or stock by the
Company, which acquisition reduces the number of the Outstanding Company
Voting Securities or Outstanding Company Common Stock; provided, that if after
such acquisition by the Company such Person (while such Person remains the
beneficial owner of 20% or more of the Outstanding Company Voting Securities
or Outstanding Company Common Stock) becomes the beneficial owner of
additional shares of such Outstanding Company Voting Securities or Outstanding
Company Common Stock (as the case may be), a Change of Control shall then
occur.
3. Employment Period. The Company hereby agrees to continue the
-----------------
Executive in its employ, and the Executive hereby agrees to remain in the
employ of the Company subject to the terms and conditions of this Agreement,
for the period commencing on the Effective Date and ending on the third
anniversary of such date (the "Employment Period").
-4-
<PAGE>
4. Terms of Employment. (a) Position and Duties. (i) During the
------------------- -------------------
Employment Period, (A) the Executive's position (including status, offices,
titles and reporting requirements), authority, duties and responsibilities
shall be at least commensurate in all material respects with the most
significant of those held, exercised and assigned to the Executive at any time
during the 90-day period immediately preceding the Effective Date and (B) the
Executive's services shall be performed at the location where the Executive
was employed immediately preceding the Effective Date or any office or
location less than 50 miles from such location.
(ii) During the Employment Period, and excluding any periods of
vacation and sick leave to which the Executive is entitled, the Executive
agrees to devote reasonable attention and time during normal business
hours to the business and affairs of the Company and, to the extent
necessary to discharge the responsibilities assigned to the Executive
hereunder, to use the Executive's reasonable best efforts to perform
faithfully and efficiently such responsibilities. During the Employment
Period it shall not be a violation of this Agreement for the Executive to
(A) serve on corporate, civic or charitable boards or committees, (B)
deliver lectures, fulfill speaking engagements or teach at educational
institutions and (C) manage personal investments, so long as such
activities do not significantly interfere with the performance of the
Executive's responsibilities as an employee of the Company in accordance
with this Agreement. It is expressly understood and agreed that to the
extent that any such activities have been conducted by the Executive
prior to the Effective Date, the continued conduct of such activities (or
the conduct of activities similar in nature and scope thereto) subsequent
to the Effective Date shall not thereafter be deemed to interfere with
the performance of the Executive's responsibilities to the Company.
(b) Compensation. (i) Base Salary. During the Employment Period,
------------ -----------
the Executive shall receive an annual base salary ("Annual Base Salary"),
which shall be paid at a monthly rate, at least equal to twelve times the
highest monthly base salary paid or payable, including any base salary which
has been earned but deferred, to the Executive by the Company and its
affiliated companies in respect of the twelve-month period immediately
preceding the month in which the Effective Date occurs. During the Employment
Period, the Annual Base Salary shall be reviewed no more than 12 months after
the last salary increase awarded to the
-5-
<PAGE>
Executive prior to the Effective Date and thereafter at least annually. Any
increase in Annual Base Salary shall not serve to limit or reduce any other
obligation to the Executive under this Agreement. Annual Base Salary shall not
be reduced after any such increase and the term Annual Base Salary as utilized
in this Agreement shall refer to Annual Base Salary as so increased. As used
in this Agreement, the term "affiliated companies" shall include any company
controlled by, controlling or under common control with the Company.
(ii) Annual Bonus. In addition to Annual Base Salary, the
------------
Executive shall be awarded, for each fiscal year ending during the
Employment Period, an annual bonus (the "Annual Bonus") in cash at least
equal to the Executive's target bonus under the Company's annual
incentive plans for the fiscal year in which the Effective Date occurs
or, if no target bonus has been set for such fiscal year, the Executive's
target bonus for the immediately preceding fiscal year (the "Target
Bonus"). Each such Annual Bonus shall be paid no later than the end of
the third month of the fiscal year next following the fiscal year for
which the Annual Bonus is awarded, unless the Executive shall elect to
defer the receipt of such Annual Bonus.
(iii) Incentive, Savings and Retirement Plans. During the
---------------------------------------
Employment Period, the Executive shall be entitled to participate in all
incentive, savings and retirement plans, practices, policies and programs
applicable generally to other peer executives of the Company and its
affiliated companies, but in no event shall such plans, practices,
policies and programs (other than equity-based incentives) provide the
Executive with incentive opportunities (measured with respect to both
regular and special incentive opportunities, to the extent, if any, that
such distinction is applicable), savings opportunities and retirement
benefit opportunities, in each case, less favorable, in the aggregate,
than the most favorable of those provided by the Company and its
affiliated companies for the Executive under such plans, practices,
policies and programs as in effect at any time during the 90-day period
immediately preceding the Effective Date or if more favorable to the
Executive, those provided generally at any time after the Effective Date
to other peer executives of the Company and its affiliated companies.
(iv) Welfare Benefit Plans. During the Employment Period, the
---------------------
Executive and/or the Executive's family, as the case may be, shall be
eligible for participation in and shall
-6-
<PAGE>
receive all benefits under welfare benefit plans, practices, policies and
programs provided by the Company and its affiliated companies (including,
without limitation, medical, prescription, dental, disability, salary
continuance, employee life, group life, accidental death and travel
accident insurance plans and programs) to the extent applicable generally
to other peer executives of the Company and its affiliated companies, but
in no event shall such plans, practices, policies and programs provide
the Executive with benefits which are less favorable, in the aggregate,
than the most favorable of such plans, practices, policies and programs
in effect for the Executive at any time during the 90-day period
immediately preceding the Effective Date or, if more favorable to the
Executive, those provided generally at any time after the Effective Date
to other peer executives of the Company and its affiliated companies.
(v) Expenses. During the Employment Period, the Executive shall
--------
be entitled to receive prompt reimbursement for all reasonable expenses
incurred by the Executive in accordance with the most favorable policies,
practices and procedures of the Company and its affiliated companies in
effect for the Executive at any time during the 90-day period immediately
preceding the Effective Date or, if more favorable to the Executive, as
in effect generally at any time thereafter with respect to other peer
executives of the Company and its affiliated companies.
(vi) Fringe Benefits. During the Employment Period, the
---------------
Executive shall be entitled to fringe benefits, including, without
limitation, tax and financial planning services, payment of club dues,
and, if applicable, use of an automobile and payment of related expenses,
in accordance with the most favorable plans, practices, programs and
policies of the Company and its affiliated companies in effect for the
Executive at any time during the 90-day period immediately preceding the
Effective Date or, if more favorable to the Executive, as in effect
generally at any time thereafter with respect to other peer executives of
the Company and its affiliated companies.
(vii) Office and Support Staff. During the Employment Period,
------------------------
the Executive shall be entitled to an office or offices of a size and
with furnishings and other appointments, and to exclusive personal
secretarial and other assistance, at least equal to the most favorable of
the foregoing provided to the Executive by the Company and its affiliated
companies at any time
-7-
<PAGE>
during the 90-day period immediately preceding the Effective Date or, if
more favorable to the Executive, as provided generally at any time
thereafter with respect to other peer executives of the Company and its
affiliated companies.
(viii) Vacation. During the Employment Period, the Executive
--------
shall be entitled to paid vacation in accordance with the most favorable
plans, policies, programs and practices of the Company and its affiliated
companies as in effect for the Executive at any time during the 90-day
period immediately preceding the Effective Date or, if more favorable to
the Executive, as in effect generally at any time thereafter with respect
to other peer executives of the Company and its affiliated companies.
5. Termination of Employment. (a) Death or Disability. The
------------------------- -------------------
Executive's employment shall terminate automatically upon the Executive's
death during the Employment Period. If the Company determines in good faith
that the Disability of the Executive has occurred during the Employment Period
(pursuant to the definition of Disability set forth below), it may give to the
Executive written notice in accordance with Section 12(b) of this Agreement of
its intention to terminate the Executive's employment. In such event, the
Executive's employment with the Company shall terminate effective on the 30th
day after receipt of such notice by the Executive (the "Disability Effective
Date"), provided that, within the 30 days after such receipt, the Executive
shall not have returned to full-time performance of the Executive's duties.
For purposes of this Agreement, "Disability" shall mean the absence of the
Executive from the Executive's duties with the Company on a full-time basis
for 180 consecutive business days as a result of incapacity due to mental or
physical illness which is determined to be total and permanent by a physician
selected by the Company or its insurers and acceptable to the Executive or the
Executive's legal representative.
(b) Cause. The Company may terminate the Executive's employment
-----
during the Employment Period for Cause. For purposes of this Agreement,
"Cause" shall mean:
(i) the willful and continued failure of the Executive to
perform substantially the Executive's duties with the Company or one of
its affiliates (other than any such failure resulting from incapacity due
to physical or mental illness), after a written de-
-8-
<PAGE>
mand for substantial performance is delivered to the Executive by the
Board or the Chief Executive Officer of the Company which specifically
identifies the manner in which the Board or Chief Executive Officer
believes that the Executive has not substantially performed the
Executive's duties, or
(ii) the willful engaging by the Executive in illegal conduct or
gross misconduct which is materially and demonstrably injurious to the
Company.
For purposes of this provision, no act or failure to act, on the part of the
Executive, shall be considered "willful" unless it is done, or omitted to be
done, by the Executive in bad faith or without reasonable belief that the
Executive's action or omission was in the best interests of the Company. Any
act, or failure to act, based upon authority given pursuant to a resolution duly
adopted by the Board or upon the instructions of the Chief Executive Officer or
a senior officer of the Company or based upon the advice of counsel for the
Company shall be conclusively presumed to be done, or omitted to be done, by the
Executive in good faith and in the best interests of the Company. The cessation
of employment of the Executive shall not be deemed to be for Cause unless and
until there shall have been delivered to the Executive a copy of a resolution
duly adopted by the affirmative vote of not less than three-quarters of the
entire membership of the Board at a meeting of the Board called and held for
such purpose (after reasonable notice is provided to the Executive and the
Executive is given an opportunity, together with counsel, to be heard before the
Board), finding that, in the good faith opinion of the Board, the Executive is
guilty of the conduct described in subparagraph (i) or (ii) above, and
specifying the particulars thereof in detail.
(c) Good Reason. The Executive's employment may be terminated by
-----------
the Executive for Good Reason. For purposes of this Agreement, "Good Reason"
shall mean:
(i) the assignment to the Executive of any duties inconsistent
in any substantial respect with the Executive's position (including status,
offices, titles and reporting requirements), authority, duties or
responsibilities as contemplated by Section 4(a) of this Agreement, or any
other action by the Company which results in a substantial diminution in
such position, authority, duties or responsibilities, excluding for this
purpose an
-9-
<PAGE>
isolated, insubstantial and inadvertent action not taken in bad faith and
which is remedied by the Company promptly after receipt of notice thereof
given by the Executive;
(ii) any failure by the Company to comply with any of the
provisions of Section 4(b) of this Agreement, other than an isolated,
insubstantial and inadvertent failure not occurring in bad faith and which
is remedied by the Company promptly after receipt of notice thereof given
by the Executive;
(iii) the Company's requiring the Executive to be based at any
office or location other than as provided in Section 4(a)(i)(B) hereof or
the Company's requiring the Executive to travel on Company business to a
substantially greater extent than required immediately prior to the
Effective Date;
(iv) any purported termination by the Company of the Executive's
employment otherwise than as expressly permitted by this Agreement; or
(v) any failure by the Company to comply with and satisfy
Section 11(c) of this Agreement.
For purposes of this Section 5(c), any good faith determination of "Good Reason"
made by the Executive shall be conclusive. Anything in this Agreement to the
contrary notwithstanding, a termination by the Executive for any reason during
the 30-day period immediately following the first anniversary of the Effective
Date shall be deemed to be a termination for Good Reason for all purposes of
this Agreement (a "30-day Window Termination").
(d) Notice of Termination. Any termination by the Company for
---------------------
Cause, or by the Executive for Good Reason, shall be communicated by Notice of
Termination to the other party hereto given in accordance with Section 12(b) of
this Agreement. For purposes of this Agreement, a "Notice of Termination" means
a written notice which (i) indicates the specific termination provision in this
Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable
detail the facts and circumstances claimed to provide a basis for termination of
the Executive's employment under the provision so indicated and (iii) if the
Date of Termination (as
-10-
<PAGE>
defined below) is other than the date of receipt of such notice, specifies the
termination date (which date shall be not more than thirty days after the giving
of such notice). The failure by the Executive or the Company to set forth in the
Notice of Termination any fact or circumstance which contributes to a showing of
Good Reason or Cause shall not waive any right of the Executive or the Company,
respectively, hereunder or preclude the Executive or the Company, respectively,
from asserting such fact or circumstance in enforcing the Executive's or the
Company's rights hereunder.
(e) Date of Termination. "Date of Termination" means (i) if the
-------------------
Executive's employment is terminated by the Company for Cause, or by the
Executive for Good Reason, the date of receipt of the Notice of Termination or
any later date specified therein, as the case may be, (ii) if the Executive's
employment is terminated by the Company other than for Cause or Disability, the
date on which the Company notifies the Executive of such termination and (iii)
if the Executive's employment is terminated by reason of death or Disability,
the date of death of the Executive or the Disability Effective Date, as the case
may be.
6. Obligations of the Company upon Termination. (a) Good Reason;
------------------------------------------- ------------
Other Than for Cause, Death or Disability. If, during the Employment Period,
- -----------------------------------------
the Company shall terminate the Executive's employment other than for Cause or
Disability or the Executive shall terminate employment for Good Reason:
(i) the Company shall pay to the Executive in a lump sum in
cash within 30 days after the Date of Termination the aggregate of the
following amounts:
A. the sum of (1) the Executive's Annual Base Salary
through the Date of Termination to the extent not theretofore paid, (2)
the product of (x) the greater of (i) the Target Bonus and (ii) the
Executive's target bonus under the Company's annual incentive plans for
the fiscal year in which the Date of Termination occurs or, if no
target bonus has been set for such fiscal year, the Executive's target
bonus for the immediately preceding fiscal year (the "Date of
Termination Target Bonus") and (y) a fraction, the numerator of which
is the number of days in the current fiscal year through the Date of
Termination, and the denominator of
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<PAGE>
which is 365 and (3) any compensation previously deferred by the
Executive (together with any accrued interest or earnings thereon) and
any accrued vacation pay, in each case to the extent not theretofore
paid (the sum of the amounts described in clauses (1), (2), and (3)
shall be hereinafter referred to as the "Accrued Obligations"); and
B. the amount equal to the product of (1) [THREE] and (2)
the sum of (x) the Executive's Annual Base Salary and (y) the greater
of (i) the Target Bonus and (ii) the Date of Termination Target Bonus;
and
C. an amount equal to the difference between (a) the
aggregate benefit under the Company's qualified defined benefit
retirement plan (currently entitled The PMI Group, Inc. Retirement
Plan) (the "Retirement Plan") and the Company's excess or supplemental
defined benefit retirement plan(s) in which the Executive participates
(currently entitled The PMI Group, Inc. Supplemental Employee
Retirement Plan) (the "SERP") which the Executive would have accrued
(whether or not vested) if the Executive's employment had continued for
[INSERT SEVERANCE MULTIPLE] years after the Date of Termination and (b)
the actual vested benefit, if any, of the Executive under the
Retirement Plan and the SERP, determined as of the Date of Termination
(with the foregoing amounts to be computed on an actuarial present
value basis, based on the assumption that the Executive's compensation
in each of the [INSERT SEVERANCE MULTIPLE] years following such
termination would have been that required by Section 4(b)(i) and
Section 4(b)(ii), and using actuarial assumptions no less favorable to
the Executive than the most favorable of those in effect for purposes
of computing benefit entitlements under the Retirement Plan and the
SERP at any time from the day before the Effective Date) through the
Date of Termination;
-12-
<PAGE>
(ii) for [INSERT SEVERANCE MULTIPLE] years after the Executive's
Date of Termination, or such longer period as may be provided by the terms
of the appropriate plan, program, practice or policy, the Company shall
continue benefits to the Executive and/or the Executive's family at least
equal to those which would have been provided to them in accordance with
the plans, programs, practices and policies described in Section 4(b)(iv)
of this Agreement if the Executive's employment had not been terminated or,
if more favorable to the Executive, as in effect generally at any time
thereafter with respect to other peer executives of the Company and its
affiliated companies and their families, provided, however, that if the
Executive becomes reemployed with another employer and is eligible to
receive medical or other welfare benefits under another employer-provided
plan, the medical and other welfare benefits described herein shall be
secondary to those provided under such other plan during such applicable
period of eligibility, and for purposes of determining eligibility (but not
the time of commencement of benefits) of the Executive for retiree benefits
pursuant to such plans, practices, programs and policies, the Executive
shall be considered to have remained employed until [INSERT SEVERANCE
MULTIPLE] years after the Date of Termination and to have retired on the
last day of such period;
(iii) the Company shall, at its sole expense as incurred,
provide the Executive with outplacement services the scope and provider of
which shall be selected by the Executive in the Executive's sole
discretion; and
(iv) to the extent not theretofore paid or provided, the Company
shall timely pay or provide to the Executive any other amounts or benefits
required to be paid or provided or which the Executive is eligible to
receive under any plan, program, policy or practice or contract or
agreement of the Company and its affiliated companies (such other amounts
and benefits shall be hereinafter referred to as the "Other Benefits").
Notwithstanding the foregoing, in the event the Executive terminates employment
for Good Reason as a result of a 30-day Window Termination, the number of full
and partial years for (A) the severance payment multiple, (B) credited age and
service under the SERP, (C) welfare benefit
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<PAGE>
continuation and (D) credited age and service for retiree benefits, under
Sections 6(a)(i)(B) and (C) and Section 6(a)(ii) above, shall each be reduced by
one-half year.
(b) Death. If the Executive's employment is terminated by reason of
-----
the Executive's death during the Employment Period, this Agreement shall
terminate without further obligations to the Executive's legal representatives
under this Agreement, other than for payment of Accrued Obligations and the
timely payment or provision of Other Benefits. Accrued Obligations shall be paid
to the Executive's estate or beneficiary, as applicable, in a lump sum in cash
within 30 days of the Date of Termination. With respect to the provision of
Other Benefits, the term Other Benefits as utilized in this Section 6(b) shall
include, without limitation, and the Executive's estate and/or beneficiaries
shall be entitled to receive, benefits at least equal to the most favorable
benefits provided by the Company and affiliated companies to the estates and
beneficiaries of peer executives of the Company and such affiliated companies
under such plans, programs, practices and policies relating to death benefits,
if any, as in effect with respect to other peer executives and their
beneficiaries at any time during the 90-day period immediately preceding the
Effective Date or, if more favorable to the Executive's estate and/or the
Executive's beneficiaries, as in effect on the date of the Executive's death
with respect to other peer executives of the Company and its affiliated
companies and their beneficiaries.
(c) Disability. If the Executive's employment is terminated by
----------
reason of the Executive's Disability during the Employment Period, this
Agreement shall terminate without further obligations to the Executive, other
than for payment of Accrued Obligations and the timely payment or provision of
Other Benefits. Accrued Obligations shall be paid to the Executive in a lump sum
in cash within 30 days of the Date of Termination. With respect to the provision
of Other Benefits, the term Other Benefits as utilized in this Section 6(c)
shall include, and the Executive shall be entitled after the Disability
Effective Date to receive, disability and other benefits at least equal to the
most favorable of those generally provided by the Company and its affiliated
companies to disabled executives and/or their families in accordance with such
plans, programs, practices and policies relating to disability, if any, as in
effect generally with respect to other peer executives and their families at any
time during the 90-day period immediately preceding the Effective Date or, if
more favorable to the Executive and/or the Executive's family,
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<PAGE>
as in effect at any time thereafter generally with respect to other peer
executives of the Company and its affiliated companies and their families.
(d) Cause; Other than for Good Reason. If the Executive's
---------------------------------
employment shall be terminated for Cause during the Employment Period, this
Agreement shall terminate without further obligations to the Executive other
than the obligation to pay to the Executive (x) the Annual Base Salary through
the Date of Termination, (y) the amount of any compensation previously deferred
by the Executive, and (z) Other Benefits, in each case to the extent theretofore
unpaid. If the Executive voluntarily terminates employment during the Employment
Period, excluding a termination for Good Reason, this Agreement shall terminate
without further obligations to the Executive, other than for Accrued Obligations
and the timely payment or provision of Other Benefits. In such case, all Accrued
Obligations shall be paid to the Executive in a lump sum in cash within 30 days
of the Date of Termination.
7. Non-exclusivity of Rights. Nothing in this Agreement shall
-------------------------
prevent or limit the Executive's continuing or future participation in any plan,
program, policy or practice provided by the Company or any of its affiliated
companies and for which the Executive may qualify, nor, subject to Section
12(f), shall anything herein limit or otherwise affect such rights as the
Executive may have under any contract or agreement with the Company or any of
its affiliated companies. Amounts which are vested benefits or which the
Executive is otherwise entitled to receive under any plan, policy, practice or
program of or any contract or agreement with the Company or any of its
affiliated companies at or subsequent to the Date of Termination shall be
payable in accordance with such plan, policy, practice or program or contract or
agreement except as explicitly modified by this Agreement.
8. Full Settlement; Legal Fees. The Company's obligation to make
---------------------------
the payments provided for in this Agreement and otherwise to perform its
obligations hereunder shall not be affected by any set-off, counterclaim,
recoupment, defense or other claim, right or action which the Company may have
against the Executive or others. In no event shall the Executive be obligated to
seek other employment or take any other action by way of mitigation of the
amounts payable to the Executive under any of the provisions of this Agreement
and except as specifically
-15-
<PAGE>
provided in Section 6(a)(ii), such amounts shall not be reduced
whether or not the Executive obtains other employment. The Company agrees to
pay as incurred, to the full extent permitted by law, all legal fees and
expenses which the Executive may reasonably incur as a result of any contest
(regardless of the outcome thereof) by the Company, the Executive or others of
the validity or enforceability of, or liability or entitlement under, any
provision of this Agreement or any guarantee of performance thereof (whether
such contest is between the Company and the Executive or between either of them
and any third party, and including as a result of any contest by the Executive
about the amount of any payment pursuant to this Agreement), plus in each case
interest on any delayed payment at the applicable Federal rate provided for in
Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the
"Code").
9. Certain Additional Payments by the Company.
------------------------------------------
(a) Anything in this Agreement to the contrary notwithstanding, in
the event it shall be determined that any payment, award, benefit or
distribution by the Company (or any of its affiliated entities) or by any entity
which effectuates a Change of Control (or any of its affiliated entities) to or
for the benefit of the Executive (whether pursuant to the terms of this
Agreement or otherwise, but determined without regard to any additional payments
required under this Section 9) (a "Payment") would be subject to the excise tax
imposed by Section 4999 of the Code or any corresponding provisions of state or
local tax laws, or any interest or penalties are incurred by the Executive with
respect to such excise tax (such excise tax, together with any such interest and
penalties, are hereinafter collectively referred to as the "Excise Tax"), then
the Executive shall be entitled to receive an additional payment (a "Gross-Up
Payment") in an amount such that after payment by the Executive of all taxes
(including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments. The payment of a Gross-Up Payment under this Section
9(a) shall not be conditioned upon the Executive's termination of employment.
Notwithstanding the foregoing provisions of this Section 9(a), if it shall be
determined that the Executive is entitled to a Gross-Up Payment, but that the
portion of the Payments that would be treated as "parachute payments" under
Section
-16-
<PAGE>
280G of the Code does not exceed 110% of the greatest amount (the "Safe Harbor
Amount") that could be paid to the Executive such that the receipt of Payments
would not give rise to any Excise Tax, then no Gross-Up Payment shall be made to
the Executive and the amounts payable under this Agreement shall be reduced so
that the Payments, in the aggregate, are reduced to the Safe Harbor Amount. The
reduction of the amounts payable hereunder, if applicable, shall be made by
first reducing the payments under Section 6(a)(i)(B), unless an alternative
method of reduction is elected by the Executive. For purposes of reducing the
Payments to the Safe Harbor Amount, only amounts payable under this Agreement
(and no other Payments) shall be reduced. If the reduction of the amounts
payable under this Agreement would not result in a reduction of the Payments to
the Safe Harbor Amount, no amounts payable under this Agreement shall be reduced
pursuant to this Section 9(a).
(b) Subject to the provisions of Section 9(c), all determinations
required to be made under this Section 9, including whether and when a Gross-Up
Payment is required and the amount of such Gross-Up Payment and the assumptions
to be utilized in arriving at such determination, shall be made by Deloitte &
Touche LLP or such other certified public accounting firm as may be designated
by the Executive (the "Accounting Firm"), which shall provide detailed
supporting calculations both to the Company and the Executive within 15 business
days of the receipt of notice from the Executive that there has been a Payment,
or such earlier time as is requested by the Company. In the event that the
Accounting Firm is serving as accountant or auditor for the individual, entity
or group effecting the Change of Control, the Executive shall appoint another
nationally recognized accounting firm to make the determinations required
hereunder (which accounting firm shall then be referred to as the Accounting
Firm hereunder). All fees and expenses of the Accounting Firm shall be borne
solely by the Company. Any Gross-Up Payment, as determined pursuant to this
Section 9, shall be paid by the Company to the Executive within five days of the
receipt of the Accounting Firm's determination. Any determination by the
Accounting Firm shall be binding upon the Company and the Executive. As a result
of the uncertainty in the application of Section 4999 of the Code at the time of
the initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that the Company exhausts its remedies
-17-
<PAGE>
pursuant to Section 9(c) and the Executive thereafter is required to make a
payment of any Excise Tax, the Accounting Firm shall determine the amount of the
Underpayment that has occurred and any such Underpayment shall be promptly paid
by the Company to or for the benefit of the Executive.
(c) The Executive shall notify the Company in writing of any claim
by the Internal Revenue Service that, if successful, would require the payment
by the Company of the Gross-Up Payment. Such notification shall be given as soon
as practicable but no later than ten business days after the Executive is
informed in writing of such claim and shall apprise the Company of the nature of
such claim and the date on which such claim is requested to be paid. The
Executive shall not pay such claim prior to the expiration of the 30-day period
following the date on which the Executive gives such notice to the Company (or
such shorter period ending on the date that any payment of taxes with respect to
such claim is due). If the Company notifies the Executive in writing prior to
the expiration of such period that it desires to contest such claim, the
Executive shall:
(i) give the Company any information reasonably requested by
the Company relating to such claim,
(ii) take such action in connection with contesting such claim
as the Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation with respect
to such claim by an attorney reasonably selected by the Company,
(iii) cooperate with the Company in good faith in order
effectively to contest such claim, and
(iv) permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Executive harmless, on an
after-tax basis, for any Excise Tax or income tax (including
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<PAGE>
interest and penalties with respect thereto) imposed as a result of such
representation and payment of costs and expenses. Without limitation on the
foregoing provisions of this Section 9(c), the Company shall control all
proceedings taken in connection with such contest and, at its sole option, may
pursue or forgo any and all administrative appeals, proceedings, hearings and
conferences with the taxing authority in respect of such claim and may, at its
sole option, either direct the Executive to pay the tax claimed and sue for a
refund or contest the claim in any permissible manner, and the Executive agrees
to prosecute such contest to a determination before any administrative tribunal,
in a court of initial jurisdiction and in one or more appellate courts, as the
Company shall determine; provided, however, that if the Company directs the
Executive to pay such claim and sue for a refund, the Company shall advance the
amount of such payment to the Executive, on an interest-free basis and shall
indemnify and hold the Executive harmless, on an after-tax basis, from any
Excise Tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income with
respect to such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for the taxable year of the
Executive with respect to which such contested amount is claimed to be due is
limited solely to such contested amount. Furthermore, the Company's control of
the contest shall be limited to issues with respect to which a Gross-Up Payment
would be payable hereunder and the Executive shall be entitled to settle or
contest, as the case may be, any other issue raised by the Internal Revenue
Service or any other taxing authority.
(d) If, after the receipt by the Executive of an amount advanced by
the Company pursuant to Section 9(c), the Executive becomes entitled to receive
any refund with respect to such claim, the Executive shall (subject to the
Company's complying with the requirements of Section 9(c)) promptly pay to the
Company the amount of such refund (together with any interest paid or credited
thereon after taxes applicable thereto). If, after the receipt by the Executive
of an amount advanced by the Company pursuant to Section 9(c), a determination
is made that the Executive shall not be entitled to any refund with respect to
such claim and the Company does not notify the Executive in writing of its
intent to contest such denial of refund prior to the expiration of 30 days after
such determination, then such advance shall be forgiven and shall not be
required
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<PAGE>
to be repaid and the amount of such advance shall offset, to the extent thereof,
the amount of Gross-Up Payment required to be paid.
10. Confidential Information. The Executive shall hold in a
------------------------
fiduciary capacity for the benefit of the Company all secret or confidential
information, knowledge or data relating to the Company or any of its affiliated
companies, and their respective businesses, which shall have been obtained by
the Executive during the Executive's employment by the Company or any of its
affiliated companies and which shall not be or become public knowledge (other
than by acts by the Executive or representatives of the Executive in violation
of this Agreement). After termination of the Executive's employment with the
Company, the Executive shall not, without the prior written consent of the
Company or as may otherwise be required by law or legal process, communicate or
divulge any such information, knowledge or data to anyone other than the Company
and those designated by it. In no event shall an asserted violation of the
provisions of this Section 10 constitute a basis for deferring or withholding
any amounts otherwise payable to the Executive under this Agreement.
11. Successors. (a) This Agreement is personal to the Executive
----------
and without the prior written consent of the Company shall not be assignable by
the Executive otherwise than by will or the laws of descent and distribution.
This Agreement shall inure to the benefit of and be enforceable by the
Executive's legal representatives.
(b) This Agreement shall inure to the benefit of and be binding upon
the Company and its successors and assigns.
(c) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to assume
expressly and agree to perform this Agreement in the same manner and to the same
extent that the Company would be required to perform it if no such succession
had taken place. As used in this Agreement, "Company" shall mean the Company as
hereinbefore defined and any successor to its business and/or assets as
aforesaid which assumes and agrees to perform this Agreement by operation of
law, or otherwise.
-20-
<PAGE>
12. Miscellaneous. (a) This Agreement shall be governed by and
-------------
construed in accordance with the laws of the State of California, without
reference to principles of conflict of laws. The captions of this Agreement are
not part of the provisions hereof and shall have no force or effect. This
Agreement may not be amended or modified otherwise than by a written agreement
executed by the parties hereto or their respective successors and legal
representatives.
(b) All notices and other communications hereunder shall be in
writing and shall be given by hand delivery to the other party or by registered
or certified mail, return receipt requested, postage prepaid, addressed as
follows:
If to the Executive:
If to the Company:
The PMI Group, Inc.
601 Montgomery Street
San Francisco, California 94111
Attention: General Counsel
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
(c) The invalidity or unenforceability of any provision of this
Agreement shall not affect the validity or enforceability of any other provision
of this Agreement.
(d) The Company may withhold from any amounts payable under this
Agreement such Federal, state, local or foreign taxes as shall be required to be
withheld pursuant to any applicable law or regulation.
(e) The Executive's or the Company's failure to insist upon strict
compliance with any provision hereof or any other provision of this Agreement or
the failure to assert any right the Executive or the Company may have hereunder,
including, without limitation, the right of the Executive to terminate
employment for Good Reason pursuant to Section 5(c)(i)-(v) of this
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<PAGE>
Agreement, shall not be deemed to be a waiver of such provision or right or any
other provision or right of this Agreement.
(f) The Executive and the Company acknowledge that, except as may
otherwise be provided under any other written agreement between the Executive
and the Company, the employment of the Executive by the Company is "at will"
and, prior to the Effective Date, the Executive's employment may be terminated
by either the Executive or the Company at any time prior to the Effective Date,
in which case the Executive shall have no further rights under this Agreement.
From and after the Effective Date this Agreement shall supersede any other
agreement between the parties with respect to the subject matter hereof,
including, without limitation, the right of the Executive to participate in any
severance plan of the Company or otherwise receive severance benefits from the
Company.
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<PAGE>
IN WITNESS WHEREOF, the Executive has hereunto set the Executive's
hand and, pursuant to the authorization from its Board of Directors, the Company
has caused this Agreement to be executed in its name on its behalf, all as of
the day and year first above written.
---------------------------------------
[Executive]
THE PMI GROUP, INC.
By:
------------------------------------
Donald C. Clark
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<PAGE>
EXHIBIT 10.20
THE PMI GROUP, INC.
SUPPLEMENTAL EMPLOYEE RETIREMENT PLAN
EFFECTIVE APRIL 1, 1995
<PAGE>
ARTICLE I
Definitions
-----------
1.01 "Committee" means the Committee under the PMI Retirement Plan.
---------
1.02 "Company" means The PMI Group, Inc.
-------
1.03 "Early Retirement Age" means Early Retirement Age as defined under the
--------------------
Retirement Plan.
1.04 "Early Retirement Benefit" means the Early Retirement Benefit as defined
------------------------
under the Retirement Plan.
1.05 "Employer" means The PMI Group, Inc. as defined under the Retirement Plan.
--------
1.06 "Participant" means any employee who: (a) is eligible for benefits under
-----------
the Retirement Plan, (b) retires on or after January 1, 1989, and (c)
meets the eligibility requirements of Section 3.01 of this Plan.
1.07 "Plan" means this plan, The PMI Group, Inc. Supplemental Employee
----
Retirement Plan as set forth in the instrument and as heretofore or
hereafter amended from time to time.
1.08 "Retirement Plan Benefits" is defined in Section 4.03 of this Plan.
------------------------
1.09 "Retirement Plan" means The PMI Group, Inc. Retirement Plan.
---------------
1.10 "Retired Participant" means a Participant who retired in accordance with
-------------------
the provisions of the Retirement Plan as heretofore or hereafter amended.
1.11 "Spouse" means Spouse as defined in the Retirement Plan.
------
<PAGE>
ARTICLE II
Introduction
------------
2.01 Purpose. The purpose of this Plan is: (1) to restore to employees of the
-------
Company the benefits they lose under the Retirement Plan as a result of the
compensation limit in section 401(a)(17) of the Internal Revenue Code of
1986, as amended, or any successor provision ("section 401(a)(17)"), (2) to
restore to employees the benefits they lose as a result of Section 415 of
the Internal Revenue Code of 1986, as amended, or any successor provision
("Section 415"), (3) to provide the "Beef-up" benefit for eligible
employees as described in Section 3.02(b), and (4) to make up lost early
retirement payments for individuals who failed to reach their 20th
anniversary with Allstate as described in Section 3.02(c). The Plan is an
unfunded deferred compensation program for a select group of management and
highly compensated employees. Thus, the Plan is subject to Part 1 of Title
I of ERISA, but is exempt from Parts 2, 3 and 4 thereof.
2.02 Administration. The Plan will be administered by the Committee. The
--------------
Committee has all discretionary authority to issue such rules as it deems
appropriate and to interpret the provisions of the Plan and make factual
determinations, including the power to determine the rights or eligibility
of employees or participants and any other persons, and the amounts of
their benefits under the Plan, and to remedy ambiguities, inconsistencies,
or omissions. Any decision by the Committee shall be final, binding, and
conclusive on all participants and all other persons.
ARTICLE III
Eligibility and Amount of Benefits
----------------------------------
3.01 Eligibility. Each Participant is eligible to receive a benefit under this
-----------
Plan if he or she is vested in benefits under the Retirement Plan and if:
(a) such vested benefits have been reduced because of the application of
section 401(A)(17) or 415; or
(b) he or she is eligible for the "Beef-up" as described in the Allstate
Retirement Plan Document in effect on April 1, 1995;
or
(c) he or she less than 20 years of service with Allstate on April 1,
1995 and retires from the Company with at least 20 years of total
service with the Company and Allstate combined and has reached his or
her 55th birthday but has not reached his or her normal retirement
date as defined by the Allstate Retirement Plan.
<PAGE>
3.02 Amount of Benefit. The amount of benefit paid from the Plan will be equal
-----------------
to: (a) plus (b) plus (c) minus (d) below:
(a) The benefit which would have been payable to the Participant under
the term of the Retirement Plan, but for the restrictions of section
401(a)(17) and section 415.
(b) For Participants who retire from the Retirement Plan before December
31, 1999 and who are at least age 55 but less than age 60, the
Company will enhance their benefit as described in (i) and (ii)
below:
(i) The Participant's Final Average Earnings (FAE) will be calculated
as if he or she had continued to work until the earlier of
December 31, 1999 or age 60 at their current pensionable
earnings. If the FAE is greater when calculated in this manner,
it will be used in place of the FAE calculated in the normal
manner at termination.
(ii) For Participants who were hired at Allstate before 1978, his or
her benefit will be first decreased by (A) below and then
increased by (B) below:
(A) 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 Allstate
pre-1978 benefit.
(B) 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
Allstate post-1988 benefit.
(c) For Participants who retire from the Retirement Plan with at least 55
years of age and 20 years of combined service with The Company and
Allstate and who did not have 20 years of service with Allstate on
April 1, 1995, The Company will provide a temporary annuity equal to:
(i) as reduced in (ii) payable for the period described in (iii)
below:
(i) The monthly life annuity payable from the Allstate Retirement Plan
starting at the Participant's Normal Retirement Date as described
by the Allstate Retirement Plan. This is the accrued Allstate
benefit at the The Company spin-off date as communicated by
Allstate.
(ii) 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 as described by the
Allstate Retirement Plan.
<PAGE>
(iii) The monthly life annuity will be paid starting on the first day
of the month following retirement until the earlier of the
Participant's death or the date 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 3.02(c)(ii) above 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 3.02(c)(ii) above will be further reduced one
percent.
(d) The amount of benefit payable from the Retirement Plan.
3.03 Preretirement Surviving Spouse Benefit. Preretirement Surviving Spouse
--------------------------------------
Benefits will be payable under this Plan on behalf of a Participant if such
Participant's surviving Spouse is eligible for benefits payable from the
Retirement Plan. The benefit payable will be determined in a manner
consistent with similar benefits under the Retirement Plan.
3.04 Death Benefits After Retirement. Benefits will be payable from this Plan
-------------------------------
to a beneficiary or contingent annuitant designated by a Retired
Participant only if such beneficiary or contingent annuitant will also
receive benefits from the Retirement Plan after such Participant's death.
The amount of the benefit payable will be determined in a manner consistent
with similar benefits under the Retirement Plan.
ARTICLE IV
Payment of Benefits
-------------------
4.01 Forms and Timing of Benefit Payments. All benefits except those described
------------------------------------
in 3.02(c) above will be paid as a single lump sum based on the life
annuity at the time the Participant terminates or retires. The Retirement
Plan factors for calculating lump sums in effect at the time of termination
or retirement will be used to calculate the lump sum.
4.02 Plan Termination. No further benefits may be earned under this Plan with
----------------
respect to the Retirement Plan after the termination of such Retirement
Plan.
4.03 Retirement Plan Benefits. The term "Retirement Plan Benefits" generally
------------------------
means the benefits actually payable to a Participant, Spouse, beneficiary,
or contingent annuitant under the Retirement Plan. However, this Plan is
only intended to remedy pension reductions caused by the operation of
---
sections 401(a)(17) and 415 and not reductions caused for any other reason.
---
In those instances where pension benefits are reduced for some other
reason, the
<PAGE>
term "Retirement Plan Benefits" shall be deemed to mean the benefits that
would have been actually payable but for such other reason.
Examples of such other reasons include, but are not limited to, the
following:
(a) A reduction in pension benefits as a result of a distress termination
(as described in ERISA (S)4041(c) or any comparable successor
provision of law) of the Retirement Plan. In such a case, the
Retirement Plan Benefits will be deemed to refer to the payments that
would have been made from the Retirement Plan had it terminated on a
fully funded basis as a standard termination (as described in ERISA
(S)4041(b) or any comparable successor provision of law).
(b) A reduction of accrued benefits as permitted under section 412(c)(8)
of the Internal Revenue Code of 1986, as amended, or any comparable
successor provision of law.
(c) A reduction of pension benefits as a result of payment of all or a
portion of a Participant's benefits to a third party on behalf of or
with respect to a Participant.
4.04 Facility of Payment. Any amount payable under the Plan to a person under
-------------------
legal disability or who, in the judgment of the Committee, is unable to
properly manage his financial affairs, may be paid to such person's legal
representative, or may be applied for the benefit of such person in any
manner selected by the Committee.
4.05 Review of Benefit Determinations. The Committee will provide notice in
--------------------------------
writing to any Participant or Beneficiary whose claim for benefits under
the Plan is denied and the Committee shall afford such Participant or
Beneficiary a review of its decision if so requested.
4.06 Payment and Funding of Benefits. Amounts payable under the Plan to or on
-------------------------------
account of a Participant shall be paid directly by the Employers, and shall
be provided solely from the general assets of the Employers. Benefits
under the Plan are not funded, the Employers' obligation to pay such
benefits is merely an unsecured contractual obligation, and a Participant
or Beneficiary shall be treated as a general creditor of the Employers with
respect to any benefits payable under the Plan. Nothing contained in this
Plan shall be deemed to create a trust of any kind for the benefit of the
Participant or any beneficiary, or create any fiduciary relationship
between the Company and the Participant or any beneficiary with respect to
any assets of the Company.
<PAGE>
ARTICLE V
Miscellaneous
-------------
5.01 Action by Company. Any action required or permitted to be taken by the
-----------------
Company under the Plan shall be by resolution of its Board of Directors, by
resolution of a duly authorized committee of its Board of Directors, or by
a person or persons authorized by resolution of its Board of Directors or
such committee.
5.02 Amendment and Plan Termination. The Company may, in its sole discretion,
------------------------------
terminate, suspend, or amend this Plan at any time or from time to time, in
whole or in part, but no amendment, suspension, or termination of the Plan
shall, without the consent of a Participant, reduce the accrued benefit of
the Participant or any Spouse; provided, however, that this Section 5.02
shall not prevent reductions on account of the Participant's (or Spouse's)
benefit ceasing to be affected (or becoming affected to a lesser degree) by
the limitations of section 401(a)(17) and section 415.
5.03 No Effect on Employment. Nothing in the Plan shall interfere with or limit
-----------------------
in any way the right of the Company or the Employer directly employing the
Participant to terminate any Participant's employment at any time, with or
without cause. Employment with the Company and its affiliates is on an at-
will basis only.
5.04 Assignment of Benefits. A Participant, Retired Participant, surviving
----------------------
Spouse, or beneficiary may not, either voluntarily or involuntarily,
assign, anticipate, alienate, commute, pledge, or encumber any benefits to
which he or she is or may become entitled under the Plan, nor may the same
be subject to attachment or garnishment by any creditor's claim or to legal
process.
5.05 Construction. The Committee shall have full discretionary authority to
------------
determine eligibility and to construe and interpret the terms of the Plan,
including the power to remedy possible ambiguities, inconsistencies, or
omissions.
5.06 Governing Law; Severability. The Plan shall be construed, administered and
---------------------------
governed in all respects in accordance with the laws of the State of
California (but without giving effect to any choice or conflict of law,
provision or rule which would cause the application of the laws of any
jurisdiction other than the State of California), and, to the extent
applicable, ERISA and the Code. If any provision of the Plan shall be held
invalid or unenforceable by a court of competent jurisdiction, the
remaining provisions hereof shall continue to be fully effective.
5.07 Number. The singular, where appearing in this Plan, will be deemed to
------
include the plural, unless the context clearly indicates the contrary.
<PAGE>
5.08 Participation of Affiliates. One or more affiliates of the
---------------------------
Company may become participating employers by adopting the Plan. By
adopting the Plan, an affiliate is deemed to agree to all of its terms,
including (but not limited to) the provisions granting exclusive
authority to the Company to amend the Plan and the provisions granting
exclusive authority to the Committee to administer and interpret the Plan.
Any affiliate may terminate its participation in the Plan at any time
subject, in each case, to the approval of the Company. 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.
5.09 Indemnification. The Company shall, and hereby does, indemnify and hold
---------------
harmless the members of the Committee, from and against any and all losses,
claims, damages or liabilities (including attorneys' fees and amounts paid,
with the approval of the Company's Board of Directors, 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.
EXECUTION
IN WITNESS WHEREOF, The PMI Group, Inc., by it duly authorized officer, has
executed the Plan on the date indicated below.
THE PMI Group, INC.
By: /s/ Margaret M. Heater
-----------------------------
Title: VP Human Resources
--------------------------
Dated: 10-01-1996
------
<PAGE>
AMENDMENT NO. 1 TO
THE PMI GROUP, INC.
SUPPLEMENTAL EMPOYEE RETIREMENT PLAN
THE PMI GROUP, INC., having adopted The PMI Group, Inc. Supplemental
Employee Retirement Plan (the "Plan") effective as of April 1, 1995, hereby
amends the Plan, effective as of January 1, 1998, as follows:
1. Article I is amended to add the following to the end thereof:
I.12 "Trust" shall mean a trust established pursuant to
-------
Section 4.07 of the Plan for the purposes of holding assets for the
payment of the Employer's general creditors, includingthe Employer's
Participants. Such Trust shall be intended to be a grantor trust, of
which the Employer is the grantor, within the meaning of subpart E,
part I, subchapter J, chapter 1, subtitle A of the Code. In addition,
the Trust, if established, shall be irrevocable and shall conform to
the provisions of Revenue Procedure 92-64.
2. The last sentence of Section 4.06 of Article IV is hereby
amended in its entirety to read as follows:
Except as provided in Section 4.07, nothing in this Plan shall
be deemed to create a trust of any kind for the benefit of the
Participant or any benficiary, or create any fiduciary relationship
between the Company and the Participant or any beneficiary with
respect to any assets of the Company.
3. Article IV is hereby amended by adding the following to the end
thereof:
4.07 Contributions to Trust Upon a Change of Control. Upon
------------------------------------------------
a Change of Control (as defined in the Company's Preferred Share
Purchase Rights Plan) and by the fifteenth business day following the
end of each calendar month of each Plan year thereafter, the Employer
shall irrevocably deposit cash (or its equivalent) to a Trust for the
investment of benefits payable under the Plan to or on account of each
Participant. However, any contributions made to the Trust in respect of
each Participant shall remain subject to the claims of the general
creditors of the Employers. Nothing contained in this Section 4.07 shall
give any Participant or beneficiary any interest in or claim against any
specific assets of the Company.
<PAGE>
EXHIBIT 11.1
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
(In thousands, except for per share data)
Basic net income per common share:
<S> <C> <C> <C>
Net income ............................................ $175,309 $157,918 $135,231
Average common shares outstanding ..................... 33,386 34,952 35,003
-------- -------- --------
Basic net income per common share ........... $ 5.25 $ 4.52 $ 3.86
======== ======== ========
Diluted net income per common share:
Net income ............................................ $175,309 $157,918 $135,231
-------- -------- --------
Average common shares outstanding ..................... 33,386 34,952 35,003
Net shares to be issued upon exercise of dilutive
stock options after applying treasury stock method 124 88 119
-------- -------- --------
Average shares outstanding ............................ 33,510 35,040 35,122
-------- -------- --------
Diluted net income per common share ......... $ 5.23 $ 4.51 $ 3.85
======== ======== ========
</TABLE>
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF PROFIT TO FIXED CHARGES
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- --------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Income from continuing operations before
income taxes ................................. $ 242,867 $ 222,106 $ 180,541 $138,551 $ 112,973
========= ========= ========= ======== =========
Fixed Charges:
Rentals-- at computed interest* .............. $ 2,549 $ 2,459 $ 2,046 $ 1,584 $ 1,558
Interest expense ............................. 6,766 907 -- -- --
Distributions on redeemable capital securities 7,617 -- -- -- --
--------- --------- --------- -------- ---------
Total fixed charges ...................... $ 16,932 $ 3,366 $ 2,046 $ 1,584 $ 1,558
========= ========= ========= ======== =========
Profit before taxes plus fixed charges ............. $ 259,799 $ 225,472 $ 182,587 $140,135 $ 114,531
========= ========= ========= ======== =========
Ratio of adjusted profit to fixed charges .......... 15.3x 67.0x 89.2x 88.5x 73.5x
========= ========= ========= ======== =========
</TABLE>
* Those portions of rent expense that are representative of interest cost
<PAGE>
EXHIBIT 13.1
THE PMI GROUP, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996, 1995, 1994 AND 1993
<PAGE>
FIVE YEAR SUMMARY OF FINANCIAL DATA
(Dollars in thousands, except per share data or otherwise noted)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SUMMARY OF CONSOLIDATED OPERATIONS:
Net premiums written $ 432,052 $ 403,020 $ 314,021 $ 277,747 $ 291,089
========== ========== ========== ========== ==========
Premiums earned $ 453,948 $ 412,738 $ 328,756 $ 296,345 $ 268,554
Investment income, less
investment expense 83,136 67,442 62,041 56,774 45,733
Realized capital gains, net 19,584 14,296 11,934 3,064 1,229
Other income 7,979 6,948 2,309 3,802 -
---------- ---------- ---------- ---------- ----------
Total revenues 564,647 501,424 405,040 359,985 315,516
Total losses and expenses 321,780 279,318 224,499 221,434 202,543
---------- ---------- ---------- ---------- ----------
Income from continuing
operations before taxes 242,867 222,106 180,541 138,551 112,973
Income tax expense 67,558 64,188 45,310 32,419 24,305
---------- ---------- ---------- ---------- ----------
Income from continuing operations 175,309 157,918 135,231 106,132 88,668
Loss from discontinued operations - - - - 28,863
---------- ---------- ---------- ---------- ----------
Net income $ 175,309 $ 157,918 $ 135,231 $ 106,132 $ 59,805
========== ========== ========== ========== ==========
MORTGAGE INSURANCE OPERATING RATIOS:
Loss ratio 38.2% 41.9% 38.5% 40.5% 41.4%
Expense ratio 22.7% 18.4% 24.9% 30.1% 28.2%
---------- ---------- ---------- ---------- ----------
Combined ratio 60.9% 60.3% 63.4% 70.6% 69.6%
========== ========== ========== ========== ==========
CONSOLIDATED BALANCE SHEET DATA:
Total assets $1,686,603 $1,509,919 $1,304,440 $1,097,421 $ 985,129
Reserve for losses and loss
adjustment expenses $ 202,387 $ 199,774 $ 192,087 $ 173,885 $ 135,471
Long-term obligations $ 99,409 $ 99,342 - - -
Preferred capital securities
of subsidiary trust $ 99,006 - - - -
Shareholders' equity $1,061,180 $ 986,862 $ 870,503 $ 687,178 $ 575,300
PER SHARE DATA:
Income from continuing operations:
Basic $ 5.25 $ 4.52 $ 3.86 $ 3.03 $ 2.53
Diluted $ 5.23 $ 4.51 $ 3.85 $ 3.03 $ 2.53
Shareholders' equity $ 32.69 $ 28.60 $ 24.87 $ 19.63 $ 16.44
Cash dividends declared $ 0.20 $ 0.20 $ 0.15 - -
PMI OPERATING AND STATUTORY DATA:
Number of policies in force 698,831 700,084 657,800 612,806 543,924
Default rate 2.38% 2.19% 1.98% 1.88% 1.81%
Persistency 80.8% 83.3% 86.4% 83.6% 70.0%
Direct primary insurance
in force (in millions) $ 77,787 $ 77,312 $ 71,430 $ 65,982 $ 56,991
Direct primary risk in force
(in millions) $ 18,092 $ 17,336 $ 15,130 $ 13,243 $ 11,267
Statutory capital $1,114,342 $ 988,475 $ 824,156 $ 659,402 $ 494,621
Risk-to-capital ratio 14.6:1 15.9:1 15.8:1 17.7:1 20.8:1
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
1997 VERSUS 1996
Consolidated net income in 1997 was $175.3 million, an 11.0% increase over net
income of $157.9 million in 1996. The increase was attributable to increases
primarily in premiums earned of 10.0%, secondarily in investment income of
23.3%, and also to an increase in realized capital gains of 37.0%, partially
offset primarily by an increase in underwriting and other expenses of 23.1%, and
secondarily by an increase of $13.5 million in interest related costs. Premiums
earned increased primarily from the growth in mortgage insurance renewal
premiums, partially offset by the effect of the termination and commutation of a
reinsurance treaty with Centre Reinsurance Company of New York and Centre
Reinsurance International Company ("Centre Re Termination") recorded in the
fourth quarter of 1996. The 1996 results of operations, including premiums
earned, losses and loss adjustment expenses and underwriting expenses, were
impacted by the Centre Re Termination as discussed below. Diluted earnings per
share were $5.23 in 1997 compared with $4.51 in 1996, a 16.0% increase. The
increase in earnings per share was affected by the repurchase of 2.1 million
shares of common stock in 1997. Excluding capital gains, earnings per share
were $4.85 in 1997 compared with $4.24 in 1996, a 14.4% increase. Revenues in
1997 were $564.6 million, a 12.6% increase over revenues of $501.4 million in
1996.
MORTGAGE INSURANCE OPERATIONS
PMI Mortgage Insurance Co.'s ("PMI") new insurance written ("NIW") totaled $15.3
billion in 1997 compared with $17.9 billion in 1996, a 14.5% decrease. The
decrease in NIW resulted from the number of new mortgage insurance policies
issued decreasing by 16.6%, to 119,200 policies in 1997 from 142,900 policies in
1996, partially offset by an increase in the average loan size to $128,400 from
$125,100.
The primary factor contributing to the decrease in new policies issued was a
decline in market share. PMI's market share of NIW decreased to 12.7% in 1997
from 14.1% in 1996. On a combined basis with CMG Mortgage Insurance Company
("CMG"), market share was 13.8% in 1997 compared with 14.7% in 1996. CMG is a
45%-owned affiliate of PMI and is accounted for on the equity method in the
Company's consolidated financial statements. The decline in market share was
primarily due to the availability of a pool insurance product not offered by PMI
for the majority of 1997 and secondarily to increases in product and
underwriting competition in the California market. During the fourth quarter of
1997, as part of the Company's value-added strategy, PMI began to offer a pool
insurance product to state housing finance authorities and a select group of
quality lenders with well-diversified loan pools. No significant pool policies
were issued in 1997. During the second half of 1997, PMI's market share
increased to 12.9% from 12.4% in the first half of 1997. However, PMI
experienced a drop in market share of NIW from the third quarter of 1997 to the
fourth quarter of 1997, from 13.3% to 12.4%. The decrease in market share in the
fourth quarter is primarily due to the impact of the issuance of pool insurance
commitments by competitors earlier in the year.
The secondary factor contributing to the decrease in new policies issued was the
decline in the total volume of insured loans in the private mortgage insurance
industry in 1997 compared with 1996. The private mortgage insurance industry
experienced a decline in total NIW of 4.8% to $120.9 billion in 1997 from $127.0
billion in 1996. Management believes that this decline in 1997 was due to a
larger refinance market that included borrowers who either did not require
mortgage insurance or chose alternative products available in the market.
PMI's cancellations of insurance in force were $14.8 billion in 1997 compared to
$12.0 billion in 1996. This increase is primarily due to an increase in
refinancing activity throughout the industry brought on by lower interest rates.
In addition, management believes that, in response to proposed mortgage
insurance cancellation legislation, servicers are now reviewing their loan
portfolios and requesting cancellations on loans with current loan-to-value
ratios of 80% or less.
PMI's persistency rate (percentage of insurance remaining in force from one year
prior) decreased 2.5 percentage points during 1997, and stands at 80.8% as of
December 31, 1997 compared with 83.3% as of December 31, 1996. This decrease is
due primarily to the cancellations discussed above. Insurance in force grew at
a rate of 0.6% and 8.3% during 1997 and 1996, respectively, to a total of $77.8
billion at December 31, 1997 compared with $77.3 billion at December 31, 1996.
The year-over-year decline in the growth rate of insurance in force is due
primarily to lower NIW and higher policy cancellations in 1997 compared with
1996. However, the growth rate of risk in force was 4.4% in 1997, and is
greater than the growth rate in insurance in force because terminating policies
are being replaced by new policies with higher coverage percentages and,
<PAGE>
accordingly, higher premium rates. The lower growth rate in insurance in force
will have an adverse impact on the rate of growth, if any, of PMI's future
renewal premiums.
Mortgage insurance net premiums written were $372.1 million in 1997 compared
with $349.8 million in 1996, an increase of 6.4%. The increase is attributable
primarily to higher average premium rates and higher average loan sizes, and
also to the growth of risk in force from one year prior, offset primarily by the
effect of the Centre Re Termination in 1996 and also to a decrease in new
premiums written. Excluding the impact of the additional profit commission
realized on the Centre Re Termination, net premiums written increased by 15.6%.
New premiums written decreased by 38.9% to $13.2 million in 1997 from $21.6 in
1996 while renewal premiums increased by 9.6% to $378.4 million in 1997 from
$345.1 million in 1996. The decrease in new premiums written during 1997
resulted primarily from the decrease in NIW from the 1996 level. Renewal
premiums increased primarily from a shift in the composition of policies in
force to loans with higher premium rates and secondarily to the growth of risk
in force. Mortgages with original loan-to-value ratios greater than 90% and
equal to or less than 95% ("95s") with 30% insurance coverage increased to 28.8%
of risk in force as of December 31, 1997 from 21.9% as of December 31, 1996.
Similarly, mortgages with original loan-to-value ratios greater than 85% and
equal to or less than 90% ("90s") with 25% insurance coverage increased to 23.6%
of risk in force in 1997 compared with 19.6% in 1996.
Mortgage insurance premiums earned were $394.0 million in 1997 compared with
$359.5 million in 1996, an increase of 9.6%. This increase is due primarily to
higher premium rates and higher average loan sizes and secondarily to the growth
in risk in force from one year prior, offset primarily by the effect of the
Centre Re Termination in 1996 and also to the decrease in NIW from the 1996
level. Excluding the impact of the Centre Re Termination, net premiums earned
increased by 15.5%.
Mortgage insurance losses and loss adjustment expenses decreased slightly to
$150.4 million in 1997 from $150.6 million in 1996. This decrease was due
primarily to the effect of the Centre Re Termination in 1996. Excluding the
impact of the Centre Re Termination, mortgage insurance losses and loss
adjustment expenses would have increased by 10.6% due to an increase in the
number of loans in default caused by the growth and maturation of insurance in
force. Primary direct claims paid by PMI increased slightly in 1997 to
approximately $147 million compared with approximately $143 million in 1996.
The average claim size decreased, however, to $26,400 in 1997 from $27,600 in
1996, due primarily to a smaller percentage of claims originating from the
California book of business, and also to increased loss mitigation activity.
PMI's default rate increased to 2.38% at December 31, 1997 from 2.19% at
December 31, 1996. This increase was due primarily to the policy cancellations
discussed above, and secondarily to normal delinquency development in states
where PMI has expanded its market presence, and also to the maturation of PMI's
1993 and 1994 books of business. Management expects the total default rate to
continue to increase in 1998. See Cautionary Statement.
The default rates on PMI's California policies decreased to 3.73% (representing
3,987 loans in default) at December 31, 1997, from 3.81% (representing 4,261
loans in default) at December 31, 1996. Policies written in California
accounted for approximately 64% and 73% of the total dollar amount of claims
paid in 1997 and 1996, respectively. Although management expects that California
should continue to account for the majority of total claims paid, management
anticipates that with continued improvement in the California economy, increased
benefits of loss mitigation and improved default reinstatement rates, California
claims paid as a percentage of total claims paid should continue to decline. See
Cautionary Statement.
Mortgage insurance underwriting and other expenses increased 31.1% to $84.4
million in 1997 from $64.4 million in 1996. This increase was primarily
attributable to the effect of the Centre Re Termination and ceding commissions
in 1996, and secondarily to an increase in contract underwriting expenses.
Excluding the impact of the 1996 Centre Re transactions, 1997 expenses increased
by 11.9% over 1996. Contract underwriting processed loans represented 21.6% of
PMI's NIW in 1997 compared with 13.0% in 1996. Contract underwriting is
generally more expensive for the Company on a per-application basis than
underwriting a loan in-house, and is becoming an increasingly popular method
among mortgage lenders for processing loan applications. Management anticipates
that contract underwriting will continue to process loans that will generate a
significant percentage of PMI's NIW. See Cautionary Statement.
The mortgage insurance loss ratio decreased to 38.2% in 1997 from 41.9% in 1996.
This decrease was due primarily to the growth in net premiums earned, and also
to the decrease in losses and loss adjustment expenses discussed above. The
expense ratio increased to 22.7% in 1997 from 18.4% in 1996, due primarily to
the Centre Re transactions, resulting in a combined ratio of 60.9% in 1997, 0.6
percentage points higher than the 1996 ratio of 60.3%. Excluding the 1996
Centre Re transactions, the 1996 expense ratio was 23.4% and the 1996 loss ratio
was 39.9%, resulting in a combined ratio of 63.3%.
<PAGE>
Interest expense of $6.8 million was incurred in 1997 related to the long-term
debt issued by the Company in November 1996. The Company incurred an additional
$7.6 million of expenses related to distributions on the redeemable preferred
capital securities issued by the Company in February 1997.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 12.6% to $59.9 million in 1997
compared with $53.2 million in 1996. This improvement was due to increasing
current market share combined with successful ongoing expansion efforts into new
states. Underwriting and other expenses increased 10.6% to $53.1 million in 1997
compared with $48.0 million in 1996. This increase is directly attributable to
the increase in fees and commissions payable to third parties based on premiums
earned. The title insurance combined ratio decreased to 91.8% in 1997 from
93.5% in 1996. The title insurance industry expense ratios are higher than
those experienced in the mortgage insurance industry primarily because the
commission rates paid to title agencies and attorneys are higher than those paid
to mortgage insurance sales agents.
OTHER
The Company's net investment income in 1997 was $83.1 million compared with
$67.4 million in 1996, an increase of 23.3%. The increase was primarily
attributable to the growth in the average amount of invested assets, which
resulted primarily from the $198.3 million of combined proceeds from the
November 1996 debt offering and the February 1997 redeemable preferred capital
securities offering, secondarily to positive cash flows generated by operating
activities, and also to the collection of $53.6 million in connection with the
Centre Re Termination, partially offset by $120 million of common stock
repurchases in 1997. The average investment yield (pretax) decreased to 6.0% in
1997 from 6.1% in 1996 due to declining interest rates in 1997. Realized
capital gains (net of losses) increased over 1996, up 37.1% to $19.6 million in
1997 from $14.3 million in 1996. This was due primarily to the sale of
approximately $50.0 million of equity securities in the first quarter of 1997.
Other income, primarily revenues generated by PMI Mortgage Services Co. ("MSC"),
increased to $8.0 million in 1997 from $6.9 million in 1996. Other expenses,
primarily expenses incurred by MSC, increased to $17.6 million in 1997 from
$13.6 million in 1996. These increases are primarily due to expanded ancillary
services, primarily contract underwriting. Management expects the demand for
contract underwriting to increase for the foreseeable future. See Cautionary
Statement.
The Company's effective tax rate decreased to 27.8% in 1997 compared to 28.9% in
1996. The benefits of tax-preference investment income and other permanent
differences reduced the effective rates below the statutory rate of 35% during
both periods. The decrease in the effective tax rate is due to an increase in
tax-exempt income and to a decrease in the state income tax provision during
1997.
1996 VERSUS 1995
Consolidated net income in 1996 was $157.9 million, a 16.8% increase over net
income of $135.2 million in 1995. The increase was attributable to increases
primarily in premiums earned and secondarily in investment income (including
capital gains) of 25.5% and 10.5%, respectively, partially offset by increases
primarily in losses and loss adjustment expenses and secondarily in underwriting
and other expenses (including interest expense) of 35.1% and 13.7%,
respectively. Premiums earned increased primarily from the ongoing mortgage
insurance operations, secondarily from the Centre Re Termination, and also from
the title insurance operations. Earnings per share were $4.51 in 1996 compared
with $3.85 in 1995, a 17.1% increase. Excluding capital gains, earnings per
share were $4.24 in 1996 compared with $3.63 in 1995, a 16.8% increase.
Revenues in 1996 were $501.4 million, a 23.8% increase over revenues of $405.0
million in 1995.
MORTGAGE INSURANCE OPERATIONS
PMI's NIW totaled $17.9 billion in 1996 compared with $14.5 billion in 1995, a
23.4% increase. The increase in NIW resulted primarily from the number of new
mortgage insurance policies issued increasing by 19.5%, to 142,900 policies in
1996 from 119,600 policies in 1995, and secondarily from an increase in the
average loan size to $125,100 from $120,900. NIW net of quota share reinsurance
increased by 39.3% to $17.0 billion in 1996 from $12.2 billion in 1995. This
increase was affected by three factors: the first is the increase in gross NIW;
the second, effective for new policies written in 1996, PMI reduced its
percentage of quota share cessions from approximately 15% in 1995 to 5% in 1996;
and third, the Centre Re Termination. The impact of the Centre Re Termination is
described below.
One of the factors contributing to the increase in new policies issued was
growth in market share in 1996 compared with 1995. PMI's market share of NIW
increased to 14.1% during 1996 from 13.2% in 1995. On a combined basis with
CMG, market share increased to 14.7% in 1996 compared with 13.5% in 1995. A
second factor was the growth in the total number
<PAGE>
of loan originations in the mortgage insurance industry in 1996 compared with
1995, which was caused by increases in the purchase market and refinancing
activity primarily in the first half of 1996. Refinancing as a percentage of
PMI's NIW increased by 5.4 percentage points, to 16.9% in 1996 from 11.5% in
1995. Consistent with the industry, PMI experienced a significantly higher level
of refinance business in the first half of 1996 as compared with the second half
of 1996.
PMI's persistency rate decreased 3.1 percentage points during 1996, and stands
at 83.3% as of December 31, 1996 compared with 86.4% as of December 31, 1995.
The persistency rate leveled off in the second quarter of 1996 and experienced
slight but consistent improvements in the third and fourth quarters. This trend
is consistent with PMI's refinancing activity during 1996. Insurance in force
grew at a rate of 8.3% during 1996 to a total of $77.3 billion at December 31,
1996 compared with $71.4 billion at December 31, 1995. The higher level of NIW
in 1996 compared with 1995, coupled with the slight rebound in persistency
during the second half of 1996, slightly improved the 1996 growth rate of
insurance in force to 8.3% over the 1995 rate of 8.2%.
Mortgage insurance net premiums written were $349.8 million in 1996 compared
with $273.7 million 1995, an increase of 27.8%. The increase is attributable
primarily to the increase in NIW over the 1995 level, secondarily to the Centre
Re Termination, and also to higher average premiums resulting from the
increasing shift to deep coverage loans, higher average loan sizes and the
growth of insurance in force. New premiums written decreased by 15.6% to $21.6
million in 1996 from $25.6 million in 1995, while renewal premiums increased by
22.3% to $345.1 million in 1996 from $282.1 million in 1995. The decrease in
new premiums written during 1996 resulted primarily from the continuing shift to
the monthly premium product from an annual premium product. The monthly premium
plan as a percent of NIW represented 95.1% of NIW in 1996 compared with 85.2% in
1995, and 96.6% in the fourth quarter of 1996 compared with 91.0% in the
corresponding period of 1995.
The increase in average premiums was caused by a continuing shift to 95s with
increased insurance coverage, partially offset by a decrease in the use of
adjustable rate mortgages (ARMs). 95s with 30% coverage increased to 41.8% of
NIW in 1996 compared with 34.7% in 1995. Similarly, 90s with 25% coverage
increased to 41.7% in 1996 compared with 32.9% in 1995. ARMs decreased to 13.4%
of NIW in 1996 compared with 21.3% in 1995.
Refunded premiums increased by 24.0% in 1996 to $15.5 million from $12.5 million
in 1995. This was due primarily to the increase in policy cancellations related
to the growth in mortgage refinancing volume during the first half of 1996.
Mortgage insurance ceded premiums were $1.3 million in 1996 compared with $21.5
million in 1995, while PMI's ceded premiums written as a percentage of net new,
renewal and refunded premiums decreased to 0.2% in 1996 compared with 9.2% in
1995. The reduction of ceding percentages in 1996 was due primarily to the
Centre Re Termination and secondarily to a larger portion of premiums remaining
with the Company through the use of Residential Guaranty Co. ("RGC"), a
subsidiary of The PMI Group, Inc. ("TPG"), as a reinsurer.
Mortgage insurance premiums earned increased 24.6% to $359.5 million in 1996
from $288.5 million in 1995. This increase is due primarily to the increase in
NIW over the 1995 level, secondarily to the Centre Re Termination, and also to
the growth in insurance in force in 1996 over 1995, the impact of higher premium
rates resulting from the shift to increased insurance coverage products and
higher average loan sizes.
Mortgage insurance losses and loss adjustment expenses increased to $150.6
million in 1996 from $111.0 million in 1995, an increase of 35.7%. This increase
was due primarily to the growth and maturation of insurance in force,
secondarily to the Centre Re Termination, and also to increased claim amounts
associated with the higher coverage percentages, higher loan sizes and an
increase in the default rate.
Direct primary claims paid by PMI in 1996 were approximately $143 million
compared with approximately $101 million in 1995. During 1996, PMI experienced
an acceleration in its claim payment process. This acceleration was a result of
Fannie Mae's and Freddie Mac's loss mitigation efforts to make earlier
determinations regarding delinquent loans and to accelerate the loan foreclosure
and claim process. Policies written in California accounted for approximately
73% and 67% of the total dollar amount of claims paid in 1996 and 1995,
respectively.
In addition to claim increases, PMI's default rate increased to 2.19% at
December 31, 1996 from the December 31, 1995 rate of 1.98%. This increase was
primarily caused by a growth in the inventory level of notices of delinquency
due primarily to the maturation of PMI's 1992 and 1993 books of business.
Default rates on PMI's California policies decreased to 3.81% at December 31,
1996, from 4.08% at December 31, 1995.
Mortgage insurance underwriting and other expenses decreased to $64.4 million in
1996 from $68.0 million in 1995, or 5.3%. This decrease, in contrast to the
growth rate in NIW, is primarily the result of management's focus on controlling
expenses and the expense ratio, and secondarily to the Centre Re Termination.
<PAGE>
The mortgage insurance loss ratio increased to 41.9% in 1996 compared with 38.5%
in 1995 due to the increase in losses and loss adjustment expenses discussed
above. The expense ratio improved over 1995, dropping to 18.4% in 1996 from
24.9% in 1995, resulting in a combined ratio of 60.3% in 1996, 3.1 percentage
points better than the 1995 ratio of 63.4%.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 32.0% to $53.2 million in 1996
compared with $40.3 million in 1995. This improvement was due to expansion
efforts of the title business, as well as the overall improvement in the volume
of residential mortgage originations. Underwriting and other expenses increased
31.5% to $48.0 million in 1996 compared to $36.5 million in 1995. This increase
is directly attributable to the increase in premiums earned. The title
insurance combined ratio decreased to 93.5% in 1996 from 95.4% in 1995.
OTHER
The Company's net investment income in 1996 was $67.4 million compared with
$62.0 million in 1995, an increase of 8.7%. The increase was primarily
attributable to the growth in the average amount of invested assets, which
resulted from cash flows generated by operating activities, partially offset by
a decrease in the average investment yield (pretax) to 6.1% in 1996 from 6.5% in
1995. Realized capital gains (net of losses) increased over 1995, up 20.2% to
$14.3 million in 1996 from $11.9 million in 1995.
Other income, primarily revenues generated by MSC, increased to $6.9 million in
1996 from $2.3 million in 1995. This growth is primarily due to increased
mortgage services operations resulting from higher refinancing activity and
expansion of MSC's contract underwriting services.
The Company's effective tax rate was 28.9% in 1996 compared to 25.1% in 1995.
The benefits of tax-preference investment income and other permanent differences
reduced the effective rates below the statutory rate of 35% during both periods.
The increase in the effective rate in 1996 over 1995 was due to a greater
portion of operating income generated from insurance operations rather than tax-
free bond income and a shift in the mix of the investment portfolio to a greater
portion of taxable fixed-income bonds.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary, as discussed below. There are no
material liquidity requirements for the remaining subsidiaries of the Company.
TPG's principal sources of funds are dividends from PMI and American Pioneer
Title Insurance Company, cash and investment income thereon and funds that may
be raised from time to time in the capital markets. There are various
restrictions on PMI's ability to pay dividends to TPG, which are discussed in
Note 12 of Notes to Consolidated Financial Statements. PMI has paid regular and
extraordinary dividends to TPG totaling $76.4 million during 1997. TPG has two
bank credit lines available totaling $50.0 million. There were no borrowings
under the credit lines during 1997. In February 1997, TPG, through a trust,
privately issued $100 million 8.309% redeemable preferred capital securities
(see Note 11 of Notes to Consolidated Financial Statements).
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. During
1997, the Company completed a $150 million stock buy-back program that had been
authorized by the TPG Board of Directors in 1996. In November 1997, an
additional $150 million stock buy-back program was authorized by the TPG Board
of Directors and commenced in 1998.
As of December 31, 1997, TPG had available funds of approximately $134 million.
This amount increased from the December 31, 1996 balance of $104 million due to
the unused portion of the proceeds from the February 1997 $100.0 million
redeemable preferred capital securities issue and $76.4 million in dividends
from PMI, less common stock repurchases of $120.0 million in 1997.
The principal sources of funds for PMI are premiums received on new and renewal
business, reimbursement of losses from reinsurers and amounts earned from the
investment of this cash flow. The reimbursement of losses from reinsurers
includes $61.4 million from Forestview Mortgage Insurance Company ("Forestview")
in 1997. Forestview is an affiliate of the Company's largest shareholder, The
Allstate Corporation. The principal uses of funds by PMI are the payment of
claims and related expenses, reinsurance premiums to affiliated companies, other
operating expenses and dividends to TPG.
<PAGE>
The majority of claims paid 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, 1992 through December 31, 1995
represents 55.2% of PMI's insurance in force at December 31, 1997, with the 1993
book of business representing 18.6%. Direct primary claims paid by PMI were
approximately $147 million and $143 million in 1997 and 1996, respectively.
In the mortgage guaranty insurance industry, liquidity refers to the ability of
an enterprise to generate adequate amounts of cash from its normal operations,
including premiums received and investment income, in order to meet its
financial commitments, which are principally obligations under the insurance
policies it has written. Liquidity requirements are significantly influenced by
the level and severity of claims. 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
Investors Service, Inc., 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 and are not applicable to the Company's
common stock or outstanding debt.
PMI generates substantial cash flows from operations as a result of premiums
being received in advance of the payment of claims. Cash flows generated from
PMI's operating activities totaled $180.1 million and $96.7 million in 1997 and
1996, respectively. This increase is due primarily to the collection of $53.6
million as a result of the Centre Re Termination.
Consolidated shareholders' equity increased from $986.9 million at December 31,
1996, to $1,061.2 million at December 31, 1997, an increase of $74.3 million, or
7.5%. The change in shareholders' equity consisted of increases of $175.3
million from net income, $4.4 million from stock option activity, and an
increase of $21.2 million in net unrealized gains on investments available for
sale (net of tax), offset by common stock repurchases of $120.0 million, and
dividends declared of $6.6 million.
PMI's risk-to-capital ratio at December 31, 1997 was 14.6:1, compared to 15.9:1
at December 31, 1996.
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, 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 in the "Shareholder Letter" include the following: Management
believes that with the (i) expansion of underwriting offices, (ii) improvement
in California's economy and real estate market, and (iii) overall national
economic indicators, the Company is in a position for continued growth and
improved loss results. Such forward-looking statements in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
include the following: (i) management expects the total default rate to continue
to increase in 1998; (ii) although management expects that California should
continue to account for the majority of total claims paid, management
anticipates that with continued improvement in the California economy, increased
benefits of loss mitigation and improved default reinstatement rates, California
claims paid as a percentage of total claims paid should continue to decline;
(iii) Management anticipates that contract underwriting will continue to process
loans that will generate a significant percentage of PMI's NIW; (iv) Management
expects the demand for contract underwriting to increase for the foreseeable
future; and (v) Management presently believes that the current statutes will not
have a material impact on the Company's financial condition or results of
operations. 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 factors set forth below and in the Company's periodic filings
with the Securities and Exchange Commission.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
GENERAL CONDITIONS
Several factors such as economic recessions, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, legislation
impacting borrowers' rights, or combinations of such factors might affect the
mortgage insurance industry and demand for housing in general and could
materially and adversely affect the Company's financial condition and results of
operations. Such economic events
<PAGE>
could materially and adversely impact the demand for mortgage insurance, cause
claims on policies issued by PMI to increase, and/or cause a similar adverse
increase in PMI's loss experience.
Other factors that may influence the amount of NIW by PMI include: mortgage
insurance industry volumes of new business; the impact of competitive
underwriting criteria and product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of risk-
sharing structured transactions; changes in the performance of the financial
markets; general economic conditions that affect the demand for or acceptance of
the Company's products; changes in government housing policy; changes in
government regulations or interpretations regarding the Real Estate Settlement
Procedures Act ("RESPA"); changes in the statutory charters, regulations, powers
and coverage requirements of government sponsored enterprises ("GSEs"), banks
and savings institutions; and customer consolidation.
MARKET SHARE AND COMPETITION
The Company's financial condition and results of operations could be materially
and adversely affected by a decline in its market share, or a decline in market
share of the private mortgage insurance industry as a whole. Numerous factors
bear on the relative position of the private mortgage insurance industry versus
government and quasi-governmental competition as well as the competition of
lending institutions that choose to remain uninsured, self-insure through
affiliates, or offer residential mortgage products that do not require mortgage
insurance. The impact of competitive underwriting criteria and product
offerings, including mortgage pool insurance, has a direct impact on the
Company's market share. Further, several of the Company's competitors have
greater direct or indirect capital reserves that provide them with potentially
greater flexibility than the Company in addressing competitive issues.
PMI competes directly with federal and state governmental and quasi-governmental
agencies, principally the FHA and, to a lesser degree, the VA. PMI and other
private mortgage insurers are also affected by Fannie Mae and Freddie Mac. These
GSEs are permitted by statute to purchase conventional high-LTV mortgages from
lenders who obtain mortgage insurance on those loans. Further, the Office of the
Comptroller of the Currency has granted permission to certain national banks to
form reinsurance companies as wholly-owned operating subsidiaries for the
purpose of reinsuring mortgage insurance written on loans originated or
purchased by such banks. In addition, the Federal Reserve Board and the Office
of Thrift Supervision are in the process of considering whether similar
activities are permitted for bank holding companies and savings institutions,
respectively. The reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors of
the Company in the future. Mortgage lenders, other than banks, thrifts or their
affiliates, are forming reinsurance affiliates that are typically regulated
solely by the insurance authority of their state of domicile. Management
believes that such reinsurance affiliates will increase competition in the
mortgage insurance industry and may materially and adversely impact PMI's market
share.
Certain lenders originate a first mortgage lien with an 80 percent LTV ratio, a
10 percent second mortgage lien, and 10 percent of the purchase price from
borrower's funds ("80/10/10"). This 80/10/10 product competes with mortgage
insurance as an alternative for lenders selling loans in the secondary mortgage
market. If the 80/10/10 product becomes a widely accepted alternative to
mortgage insurance, it could have a material and adverse impact on the Company's
financial condition and results of operations.
During 1997, the maximum single-family principal balance loan limit eligible for
purchase by Fannie Mae and Freddie Mac was increased from $214,600 to $227,150
effective in 1998. Any increase in the loan principal balance eligible for
purchase by these GSEs could potentially expand the mortgage insurance market.
Another proposal would allow Fannie Mae and Freddie Mac greater flexibility in
utilizing substitutes for private mortgage insurance. Fannie Mae and Freddie
Mac also have the discretion to reduce the amount of private mortgage insurance
they require on loans. The adoption by the GSE's of private mortgage insurance
substitutes or reduction in the amount of private mortgage insurance coverage
could materially and adversely affect the Company's financial condition and
results of operations.
Legislation and regulatory changes affecting the FHA and certain commercial
banks that forego insurance have affected demand for private mortgage insurance.
PMI and other private mortgage insurers compete directly with federal and state
governmental and quasi-governmental agencies, principally the FHA and, to a
lesser degree, the VA. These agencies sponsor government-backed mortgage
insurance programs which accounted for 45.6%, 44.8%, and 38.5% for 1997, 1996
and 1995, respectively, of all loans insured or guaranteed. The maximum
individual loan amount that the FHA can insure is currently $170,362 and the
maximum individual loan amount that the VA can insure is $203,150. The Clinton
administration and Congress are considering increasing the single-family loan
limit which FHA could purchase to $227,150. The Company believes that any
increase in the FHA loan limit, or other expansion of eligibility for the FHA
and VA would likely have an adverse affect on the competitive position of PMI
and consequently could materially and adversely affect the Company's financial
condition and results of operations.
<PAGE>
INSURANCE IN FORCE
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration of 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. There can be no assurance that policies for
insurance coverage originated in a particular year or for a particular customer
will not be canceled at a later time or that the Company will be able to
regain such insurance coverage at a later time. As a result, the Company's
financial condition and results of operation could be materially and adversely
affected by greater than anticipated policy cancellations or lower than
projected persistency resulting in declines in insurance in force.
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies, generally experience an increase in the prepayment rate of insurance
in force, resulting from policy cancellations of older books of business.
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. Any significant decrease in PMI's insurance in force could
materially and adversely affect the Company's financial condition and results of
operations.
Insurance in force as of December 31, 1997 was $77.8 billion compared with $77.3
billion as of December 31, 1996. The annualized growth rate of insurance in
force was 0.6% and 8.3% as of December 31, 1997 and 1996, respectively. The
period over period decrease in the growth rate is primarily due to lower NIW and
higher policy cancellations. The lower growth rate in insurance in force will
have an adverse impact on PMI's future renewal premiums.
FANNIE MAE, FREDDIE MAC AND FHA; STATE AND FEDERAL MORTGAGE CANCELLATION
LEGISLATION
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. 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.
Although PMI cannot generally cancel its mortgage insurance policies once
issued, PMI must cancel mortgage insurance for a mortgage loan upon the request
of the insured. Fannie Mae and Freddie Mac have guidelines which give borrowers
the right to request cancellation of mortgage insurance when specified
conditions are met. In addition, federal legislation and legislation in
approximately a dozen states has been introduced that also addresses this issue.
Proposals concerning borrower notification of their cancellation rights,
cancellation criteria, or the point at which mortgage insurance premiums may no
longer be charged to borrowers, are still being formulated and their enactment
remains uncertain. Statutes giving borrowers cancellation rights and/or
preventing premiums from being charged to borrowers presently exist in five
states, including California. Management presently believes that the existing
statutes will not have a material impact on the Company's financial condition or
results of operations. Management believes it is too early to ascertain the
impact of the enactment of any additional mortgage cancellation proposals.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS
The Company 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. Contract underwriting services have
become increasingly important to mortgage lenders as they seek to reduce costs.
Accordingly, contract underwriting generates a significant percentage of PMI's
NIW. Management anticipates that contract underwriting will continue to process
loans that will generate a significant percentage of PMI's NIW. Due to the
increasing demand of contract underwriting services, the limited number of
underwriting personnel available, and heavy price competition among mortgage
insurance companies, PMI's inability to recruit and maintain a sufficient number
of qualified underwriters could materially and adversely affect its market share
and materially and adversely affect the Company's financial condition and
results of operations.
TPG and PMI, from time to time, introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially and adversely affected if PMI or the Company experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
YEAR 2000 ISSUES
<PAGE>
The Company is heavily dependent upon complex computer systems for all phases of
its operations, including customer service, servicing the insurance portfolio,
risk analysis, underwriting, and loss reserves. Since many of the Company's
older computer software programs recognize only the last two digits of the year
in any date (e.g., "97" for 1997), some software may fail to operate properly in
1999 or 2000 if the software is not reprogrammed or replaced (the "Year 2000
Issue"). The Company believes that many of its suppliers and customers may have
Year 2000 Issues that could adversely affect the Company; however, it is
uncertain what impact, if any, such Year 2000 Issues would have on the Company.
The Company has commenced a plan intended to mitigate and/or prevent the adverse
interanl effects of Year 2000 Issues and estimates the cost of this work at
approximately $3 million. The Company presently believes that it will be able
to resolve its internal Year 2000 Issues in a timely manner and that the cost
of addressing such matters will not have a material effect on the Company's
current financial condition, liquidity or results of operations. Management
believes its failure or its customers or suppliers failure to resolve the Year
2000 Issues in a timely manner could materially and adversely affect the
Company's financial condition and results of operations.
NEW YORK DEPARTMENT OF INSURANCE
TPG offers a captive reinsurance structure and in the past, offered a risk-
sharing product (a performance note) that was designed to encourage quality
originations and loss mitigation by its customers. To date, neither product
represents a significant portion of the Company's revenues. In March 1997, the
New York Department of Insurance stated in a letter addressed to all private
mortgage insurers that both captive reinsurance structures and the use of a
performance note structured as a variable rate note to a lender by an affiliate
of a mortgage guaranty insurer where the rate of interest to the lender is based
upon the underwriting experience of the mortgage guaranty insurer on the
mortgages originated by the lender would be considered to be illegal under New
York law. The Company is currently discussing with the New York Department of
Insurance the structure of its performance note product as well as its captive
reinsurance arrangements with certain of its customers. The Company indicated
to the New York Department of Insurance that it disagrees with the statements in
the letter. Management is unable to predict at this time the results of these
discussions.
RISK-TO-CAPITAL RATIO
Regulators specifically limit the amount of insurance risk that may be written
by PMI to a multiple of 25 times PMI's statutory capital (which includes the
contingency reserve). Other factors affecting PMI's risk-to-capital ratio
include: (i) regulatory review and oversight by the State of Arizona, PMI's
state of domicile for insurance regulatory purposes; (ii) limitations under the
Runoff Support Agreement with Allstate, which prohibit PMI from paying any
dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or exceed 23 to 1; (iii) TPG's credit agreements; and (iv)
TPG's and PMI's credit or claims-paying ability ratings which require that the
risk-to-capital ratio not exceed 20 to 1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's ability
to write new business. The inability to write new business could materially and
adversely affect the Company's financial condition and results of operations.
CHANGES IN COMPOSITION OF INSURANCE WRITTEN
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, 1997, 46.2% 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, 1997, 1.8% of PMI's risk in force consisted of 97s which have even
higher risk characteristics than 95s and greater uncertainty as to pricing
adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which,
although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole. During the
fourth quarter of 1997, PMI began offering a pool insurance product to state
housing finance authorities and certain lenders. This product is similar in
structure to the pool insurance product previously offered by PMI during 1990 -
1993, but has different risk characteristics, including limits on total
exposure, diversification and loan to value ratios. Management presently cannot
predict the impact this pool insurance product will have on PMI's market share.
Pool insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions and generally covers the loss on a
defaulted mortgage loan that exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan. Pool
insurance also generally covers the total loss on a defaulted mortgage loan
which did not require primary insurance, in each case up to a stated aggregate
loss limit. Although PMI charges higher premium rates for loans that have
higher risk characteristics, including ARMs, 95s, 97s and pool insurance
products, the premiums earned on such products, and the associated investment
income, may ultimately prove to be
<PAGE>
inadequate to compensate for future losses from such products. Such losses
could materially and adversely affect the Company's financial condition and
results of operations.
POTENTIAL INCREASE IN CLAIMS
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured 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
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, as well as the estimated costs, including legal and other fees,
of settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
REGIONAL CONCENTRATION
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, where PMI has 20.5% of its
risk in force concentrated and where the default rate on all PMI policies in
force is 3.73% compared with 2.38% nationwide as of December 31, 1997.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE
In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage
Insurance Company ("Forestview") whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed that as soon as
practicable after November 1, 1994, Forestview and PMI would seek regulatory
approval for the Reinsurance Treaty to be deemed to be an assumption agreement
and that, upon receipt of the requisite approvals, Forestview would assume such
liabilities. The parties are in the process of seeking regulatory approval to
complete the assumption of the mortgage pool insurance policies. Until
Forestview has assumed directly such mortgage pool insurance policies, PMI will
remain primarily liable on the unassumed policies. Forestview's previous
claims-paying ability rating of "AA" (Excellent) was withdrawn by Standard and
Poor's Rating Services ("S&P"). Management is uncertain at this time what
impact the withdrawal of the claims-paying ability rating will have on the
parties' ability to timely consummate the assumption transaction. Pursuant to
this agreement, during 1997 PMI ceded $11.7 million of pool premiums to
Forestview and Forestview reimbursed PMI for claims on the covered policies in
the amount of $61.4 million. It is anticipated that additional pool claims
significantly in excess of pool premiums will be paid in 1998 and beyond. As of
December 31, 1997, the Company has an $89.6 million reinsurance recoverable from
Forestview. The failure of Forestview to meet its contractual commitments would
materially and adversely affect the Company's financial condition and results of
operations.
On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff
Support Agreement") with Allstate Insurance Company ("Allstate") to replace
various capital support commitments that Allstate had previously provided to
PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI
prior to October 28, 1994, if PMI's financial condition deteriorates below
specified levels, or if a third party brings a claim thereunder. Alternatively,
Allstate may make contributions directly to PMI or TPG. In the event that
Allstate makes payments or contributions under the Runoff Support Agreement
(which possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return. During 1997, no
payment obligation arose under the Runoff Support Agreement.
<PAGE>
CONSOLIDATED STATEMENTS OF
OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(In thousands, except per share amounts) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES Premiums earned $ 453,948 $ 412,738 $ 328,756
Investment income, less investment expense 83,136 67,442 62,041
Realized capital gains 19,584 14,296 11,934
Other income 7,979 6,948 2,309
-----------------------------------------
TOTAL REVENUES 564,647 501,424 405,040
-----------------------------------------
LOSSES AND Losses and loss adjustment expenses 152,257 152,409 112,837
EXPENSES Underwriting and other operating expenses 155,140 126,002 111,662
Interest expense 6,766 907 --
Distributions on preferred capital securities 7,617 -- --
-----------------------------------------
TOTAL LOSSES AND EXPENSES 321,780 279,318 224,499
-----------------------------------------
INCOME BEFORE INCOME TAXES 242,867 222,106 180,541
INCOME TAX EXPENSE 67,558 64,188 45,310
-----------------------------------------
NET INCOME $ 175,309 $ 157,918 $ 135,231
=========================================
PER SHARE BASIC NET INCOME PER COMMON SHARE $ 5.25 $ 4.52 $ 3.86
=========================================
DILUTED NET INCOME PER COMMON SHARE $ 5.23 $ 4.51 $ 3.85
=========================================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CONSOLIDATED
BALANCE SHEETS
<TABLE>
<CAPTION>
As of December 31,
(Dollars in thousands) 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS Investments:
Available for sale, at market:
Fixed income securities (amortized
cost $1,234,178 and $1,042,570) $1,308,768 $1,085,514
Equity securities:
Common (cost $38,221 and $77,775) 73,596 112,583
Preferred (cost $12,049 and $305) 12,360 388
Common stock of affiliate, at underlying book value 16,987 11,385
Short-term investments 78,890 81,876
-------------------------
Total investments 1,490,601 1,291,746
Cash 11,101 6,592
Accrued investment income 20,794 19,439
Reinsurance recoverable and prepaid premiums 31,676 83,379
Premiums receivable 19,756 14,647
Receivable from affiliates 8,605 10,525
Receivable from Allstate 16,822 16,822
Deferred policy acquisition costs 37,864 31,633
Property and equipment, net 31,393 22,519
Other assets 17,991 12,617
-------------------------
TOTAL ASSETS $1,686,603 $1,509,919
=========================
LIABILITIES Reserve for losses and loss adjustment expenses $ 202,387 $ 199,774
Unearned premiums 94,150 116,951
Long-term debt 99,409 99,342
Reinsurance balances payable 11,828 13,295
Deferred income taxes 76,395 50,786
Other liabilities and accrued expenses 42,248 42,909
-------------------------
TOTAL LIABILITIES 526,417 523,057
-------------------------
Commitments and contingent liabilities (Note 10) - -
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED
CAPITAL SECURITIES OF SUBSIDIARY TRUST HOLDING
SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURE OF THE COMPANY 99,006 -
SHAREHOLDERS' Preferred stock - $.01 par value; 5,000,000 shares authorized - -
EQUITY Common stock - $.01 par value; 125,000,000 shares authorized
35,145,247 and 35,047,619 issued 351 350
Additional paid-in capital 262,448 258,059
Unrealized net gains on investments 71,936 50,709
Retained earnings 876,588 707,885
-------------------------
1,211,323 1,017,003
Less treasury stock (2,684,000 and 537,800 shares at cost) 150,143 30,141
-------------------------
TOTAL SHAREHOLDERS' EQUITY 1,061,180 986,862
-------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,686,603 $1,509,919
=========================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Year Ended December 31,
(In thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
COMMON Balance, beginning of year $ 350 $ 350 $ 350
STOCK Stock grants and exercise of stock options 1 - -
-------------------------------------------
Balance, end of year 351 350 350
-------------------------------------------
ADDITIONAL Balance, beginning of year 258,059 256,507 $256,163
PAID-IN Stock grants and exercise of stock options 4,389 1,552 344
CAPITAL -------------------------------------------
Balance, end of year 262,448 258,059 256,507
-------------------------------------------
UNREALIZED Balance, beginning of year 50,709 56,761 3,676
NET GAINS ON Change in unrealized net gains on investments 21,227 (6,052) 53,085
INVESTMENTS -------------------------------------------
Balance, end of year 71,936 50,709 56,761
-------------------------------------------
RETAINED Balance, beginning of year 707,885 556,969 426,989
EARNINGS Net income 175,309 157,918 135,231
Dividends declared (6,606) (7,002) (5,251)
-------------------------------------------
Balance, end of year 876,588 707,885 556,969
-------------------------------------------
TREASURY Balance, beginning of year (30,141) (84) -
STOCK Purchases of The PMI Group, Inc. common stock (120,002) (30,057) (84)
-------------------------------------------
Balance, end of year (150,143) (30,141) (84)
-------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $1,061,180 $986,862 $870,503
============================================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF
CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
(In thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CASH Net income $175,309 $157,918 $135,231
FLOWS Reconciliation of net income to net cash provided by
FROM operating activities:
OPERATING Realized capital gains, net (19,584) (14,296) (11,934)
ACTIVITIES Equity in (earnings) loss of affiliate (1,455) (192) 605
Depreciation and amortization 4,679 3,283 5,155
Changes in:
Reserve for losses and loss adjustment expenses 2,613 7,687 18,202
Unearned premiums (22,801) (23,371) (16,699)
Deferred policy acquisition costs (6,231) (8,647) 2,616
Accrued investment income (1,355) (1,072) (1,265)
Reinsurance balances payable (1,467) (5,446) 6,126
Reinsurance recoverable and prepaid premiums 51,703 (5,372) (17,328)
Premiums receivable (5,109) (14,647) -
Income taxes 14,179 1,915 12,549
Receivable from affiliates 1,920 (2,946) 12,330
Receivable from Allstate - (2,089) (47,111)
Other (5,863) 9,081 1,554
--------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 186,538 101,806 100,031
--------------------------------------------
CASH Proceeds from sales of equity securities 82,008 97,104 56,163
FLOWS Investment collections of fixed income securities 13,590 32,595 67,697
FROM Proceeds from sales of fixed income securities 367,865 211,945 -
INVESTING Purchases of fixed income securities (573,627) (415,162) (168,641)
ACTIVITIES Purchases of equity securities (33,010) (77,634) (56,078)
Net decrease in short-term investments 2,986 434 4,700
Investment in affiliate (3,600) (1,350) (1,848)
Purchase of property and equipment (13,687) (10,213) (6,368)
--------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (157,475) (162,281) (104,375)
--------------------------------------------
CASH Issuance of redeemable preferred capital securities 99,000 - -
FLOWS Issuance of long-term debt - 99,337 -
FROM Proceeds from exercise of stock options 3,181 1,135 170
FINANCING Dividends paid to shareholders (6,733) (7,002) (3,500)
ACTIVITIES Purchases of The PMI Group, Inc. common stock (120,002) (30,057) (84)
--------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES (24,554) 63,413 (3,414)
--------------------------------------------
NET INCREASE (DECREASE) IN CASH 4,509 2,938 (7,758)
CASH AT BEGINNING OF YEAR 6,592 3,654 11,412
--------------------------------------------
CASH AT END OF YEAR $ 11,101 $ 6,592 $ 3,654
============================================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995 THROUGH 1997
NOTE 1. BASIS OF PRESENTATION
BASIS OF PRESENTATION - The accompanying consolidated financial statements
include the accounts of The PMI Group, Inc. ("TPG"), its wholly owned
subsidiaries, PMI Mortgage Insurance Co. ("PMI"), Residential Guaranty Co.
("RGC"), American Pioneer Title Insurance Company ("APTIC"), PMI Mortgage
Guaranty Co. ("PMG") and PMI Capital I, and PMI's wholly owned subsidiaries PMI
Mortgage Services Co. ("MSC") and PMI Securities Co., collectively referred to
as the "Company." All material intercompany transactions and balances have been
eliminated in consolidation.
FORMATION OF COMPANY - TPG was incorporated in December 1993. After obtaining
the required regulatory approvals, on November 28, 1994, Allstate Insurance
Company ("Allstate") contributed all of the outstanding common stock of PMI to
TPG. Allstate had previously been the direct owner of all of the common stock
of PMI. Allstate is a wholly owned subsidiary of The Allstate Corporation
("Allstate Corp.").
On April 18, 1995, Allstate, which had been the sole shareholder of the Company,
sold 24.5 million shares of the Company's common stock, representing 70% of the
outstanding shares of common stock, for approximately $784.0 million (net of
related underwriting discount) in an underwritten public offering registered
under the Securities Act of 1933. Concurrent with the stock offering, Allstate
Corp. sold a new issue of 6.76% exchangeable notes due in April 1998. The notes
are mandatorily exchangeable at maturity into approximately 8.6 million shares
of the Company's common stock owned by Allstate after completion of the public
offering (subject to Allstate Corp.'s right to deliver cash in lieu of such
shares). Such exchange will be computed based on the average market value of
the Company's common stock in the 20 trading-day period preceding the exchange
date. As a result, Allstate Corp. will continue to own, directly or indirectly,
10.5 million shares of the Company's common stock until the notes are exchanged,
at which time Allstate's ownership could be reduced to approximately 1.9 million
shares. In connection with the public offering of the Company's common stock,
the Company increased the number of shares of common stock outstanding to 35
million through a stock split effected as a stock dividend on February 27, 1995.
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. In addition, the Company writes title insurance
through APTIC. Primary 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 13). 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 separate component of shareholders' equity.
In September 1994, PMI acquired 45% of the common stock of CMG Mortgage
Insurance Company ("CMG") from CUNA Mutual Investment Corporation ("CMIC").
CMIC continues to own the remaining 55% of the common stock of CMG. Such
affiliated investment is reported in accordance with the equity method of
accounting.
<PAGE>
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 for equipment and 40 years for real property.
Accumulated depreciation on property and equipment was $33.1 million and $28.0
million at December 31, 1997 and 1996, respectively.
INSURANCE ACCOUNTING - Primary 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 a monthly, annual or single
payment basis. Upon renewal by the insured, the Company is not able to re-
underwrite or re-price its policies. Premiums written on a single premium and
an annual premium basis are initially deferred as unearned premiums and earned
over the policy term. Premiums written on policies covering more than one year
(single premium plans) are amortized over the policy life in relation to the
expiration of risk. Premiums written on annual payment policies are earned on a
monthly pro rata basis. Premiums written on monthly payment policies are earned
in the period which they are due, and any unpaid portion is recorded in premiums
receivable. Title insurance premiums are recognized as revenue on the effective
date of the title insurance policy. Fee income of the non-insurance
subsidiaries is earned as the services are provided.
Certain costs of acquiring insurance business, including compensation, premium
taxes and other underwriting expenses, are deferred, to the extent recoverable,
and amortized to expense as the related premiums are earned. Policy acquisition
costs amortized to expense in the years ended December 31, 1997, 1996 and 1995
were $62.8 million, $48.3 million and $52.9 million, respectively.
The reserve for losses and loss adjustment expenses is the estimated cost of
settling claims related to notices of default on insured loans that have been
reported to the Company as well as loan defaults that have occurred but have not
been reported. Estimates are based on an evaluation of claim rates, claim
amounts, and salvage recoverable. Reserves for title insurance claims are based
on estimates of the amounts required to settle such claims, including expenses
for defending claims for which notice has been received and an amount estimated
for claims not yet reported.
Management believes that the reserve for losses and loss adjustment expenses at
December 31, 1997 is appropriately established in the aggregate and is adequate
to cover the ultimate net cost of reported and unreported claims arising from
losses which had occurred by that date. The establishment of appropriate
reserves is an inherently uncertain process. Such reserves are necessarily
based on estimates and the ultimate net cost may vary from such estimates.
These estimates are regularly reviewed and updated using the most current
information available. Any resulting adjustments, which may be material, are
reflected in current operations.
INCOME PER COMMON SHARE - In February 1997, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.
128, Earnings per Share. SFAS No. 128 requires a dual presentation of basic and
diluted earnings per share ("EPS") on the face of all income statements issued
after December 15, 1997. Basic 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 33,385,828,
34,951,764 and 35,003,000 for 1997, 1996 and 1995, respectively. The weighted
average common shares outstanding for computing diluted EPS includes only stock
options issued by the Company that have a dilutive impact and are outstanding
for the period, and had the potential effect of increasing common shares to
33,510,261, 35,039,976 and 35,122,427 for 1997, 1996 and 1995, respectively.
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 6.
CONCENTRATION OF RISK - A substantial portion of PMI's business is generated
within the state of California. For the year ended December 31, 1997, 14.9% of
new insurance written was in California. In addition, California's book of
business represented 20.5% of total risk in force at December 31, 1997.
<PAGE>
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 12).
NEW ACCOUNTING PRONOUNCEMENTS - In June 1997, the FASB issued SFAS No. 130,
Reporting Comprehensive Income, and SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 130 requires that an
enterprise report, by major component and as a single total, the change in its
net assets during the period from non-owner sources. SFAS No. 131 establishes
annual and interim reporting standards for an enterprise's operating segments
and related disclosures about its products, services, geographic areas and major
customers. Adoption of these statements will not impact the Company's financial
condition, results of operations or cash flows, and any effect will be limited
to the form and content of its disclosures. Both statements are effective for
the fiscal years beginning after December 15, 1997, with earlier application
permitted. The Company is not electing early adoption and, accordingly, the
impact of SFAS Nos. 130 and 131 are not reflected in the 1997 financial
statements.
RECLASSIFICATION - Certain prior year amounts have been reclassified to conform
to current year presentation.
NOTE 3. INVESTMENTS
MARKET VALUES - The amortized cost and estimated market values for fixed
income securities are shown below:
<TABLE>
<CAPTION>
Gross Unrealized
Amortized ------------------------ Market
(In thousands) Cost Gains (Losses) Value
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At December 31, 1997
U.S. government and agencies $ 42,017 $ 1,233 $ -- $ 43,250
Municipals 1,044,964 71,369 (17) 1,116,316
Corporate bonds 147,197 2,269 (264) 149,202
- --------------------------------------------------------------------------------------------------
Total $1,234,178 $ 74,871 $ (281) $1,308,768
==================================================================================================
At December 31, 1996
U.S. government and agencies $ 89,131 $ 588 $(1,129) $ 88,590
Municipals 831,213 44,806 (1,018) 875,001
Corporate bonds 121,990 424 (749) 121,665
Redeemable preferred stock 236 22 -- 258
- --------------------------------------------------------------------------------------------------
Total $1,042,570 $ 45,840 $(2,896) $1,085,514
==================================================================================================
</TABLE>
SCHEDULED MATURITIES - The scheduled maturities for fixed income securities
are as follows at December 31, 1997:
<TABLE>
<CAPTION>
Amortized Market
(In thousands) Cost Value
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 7,941 $ 8,014
Due after one year through five years 80,991 82,554
Due after five years through ten years 175,746 183,685
Due after ten years 918,748 983,418
Other 50,752 51,097
--------------------------
Total $1,234,178 $1,308,768
==========================
</TABLE>
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, 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.
<PAGE>
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Illinois 13.4% 14.2%
Washington 13.3 10.4
Texas 13.0 17.3
New York 7.7 3.7
California 6.9 9.4
Massachusetts 6.0 5.3
Indiana 5.4 10.0
Pennsylvania 5.3 3.9
</TABLE>
At December 31, 1997, fixed income securities with a market value of $11.7
million were on deposit with regulatory authorities as required by law.
UNREALIZED NET GAINS ON INVESTMENTS - Unrealized net gains on investments
included in shareholders' equity at December 31, 1997, are as follows:
<TABLE>
<CAPTION>
Gross Unrealized Net
Market ----------------------- Unrealized
(In thousands) Cost Value Gains (Losses) Gains
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed income securities $1,234,178 $1,308,768 $ 74,871 $(281) $74,590
Common stocks 38,221 73,596 35,528 (153) 35,375
Preferred stocks 12,049 12,360 311 -- 311
Investment in affiliate 16,589 16,987 398 -- 398
--------------------------------------------------------------------------
Total $1,301,037 $1,411,711 $111,108 $(434) 110,674
================================================================
Less deferred income taxes 38,738
----------
Total $ 71,936
==========
</TABLE>
The difference between cost and market value of the investment in affiliate
reflects net unrealized gains on the affiliate's investment portfolio. The
stated market value does not necessarily represent the fair value of the
affiliate's common stock held by the Company.
The change in net unrealized gains, net of deferred income taxes, for fixed
income securities and equity securities are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income securities $20,572 $(11,777) $42,065
Equity securities 517 5,895 10,729
Investment in affiliate 138 (170) 291
----------------------------------------
Total $21,227 $ (6,052) $53,085
========================================
</TABLE>
INVESTMENT INCOME - Investment income by investment type is as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income securities $74,641 $63,715 $56,259
Equity securities 1,476 2,136 2,625
Common stock of affiliate 1,455 192 (605)
Short-term 6,332 2,119 5,030
----------------------------------------
Investment income, before
expenses 83,904 68,162 63,309
Less investment expense 768 720 1,268
----------------------------------------
Investment income, less
investment expense $83,136 $67,442 $62,041
========================================
</TABLE>
<PAGE>
REALIZED CAPITAL GAINS AND LOSSES - Net realized capital gains (losses) on
investments are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income securities $ (777) $ 2,072 $ 1,381
Equity securities 20,188 12,024 10,555
Short-term 173 200 (2)
----------------------------------------
Realized capital gains -- net,
before taxes 19,584 14,296 11,934
Less income taxes 6,854 5,004 4,177
----------------------------------------
Realized capital gains, net
of taxes $12,730 $ 9,292 $ 7,757
========================================
</TABLE>
Gross realized capital gains and losses on investments are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Gross realized capital gains $26,167 $19,842 $13,306
Gross realized capital losses (6,583) (5,546) (1,372)
----------------------------------------
Net realized capital gains $19,584 $14,296 $11,934
========================================
</TABLE>
<PAGE>
NOTE 4. LOSS RESERVES
The following table is a reconciliation of the beginning and ending reserve for
losses and loss adjustment expenses for each of the last three years:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1 $199,774 $192,087 $173,885
Less reinsurance recoverable 5,287 17,899 17,569
----------------------------------------
Net balance, January 1 194,487 174,188 156,316
----------------------------------------
Losses and loss adjustment expenses
(principally in respect of defaults
occurring in)
Current year 158,147 161,740 133,536
Prior years (5,890) (9,331) (20,699)
----------------------------------------
Total losses and loss
adjustment expenses 152,257 152,409 112,837
----------------------------------------
Losses and loss adjustment expense
payments (principally in respect
of defaults occurring in)
Current year 27,700 23,353 16,180
Prior years 122,724 108,757 78,785
----------------------------------------
Total payments 150,424 132,110 94,965
----------------------------------------
Net balance, December 31 196,320 194,487 174,188
Plus reinsurance recoverable 6,067 5,287 17,899
----------------------------------------
Balance, December 31 $202,387 $199,774 $192,087
========================================
</TABLE>
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 $5.9 million, $9.3 million and
$20.7 million in 1997, 1996 and 1995, respectively, due primarily to lower than
expected losses in California. Such re-estimates were based on management's
analysis of various economic trends (including the real estate market and
unemployment rates) and their effect on recent claim rate and claim severity
experience.
NOTE 5. REINSURANCE
PMI cedes reinsurance to reduce net risk in force to meet regulatory risk-to-
capital requirements and to comply with the regulatory maximum policy coverage
percentage limitation of 25%. Certain of the Company's reinsurance arrangements
remain in effect and have adjustable features, including experience account
refunds, which depend on the loss experience of the underlying business. While
such estimates are based on the Company's actuarial analysis of the applicable
business, the amounts the Company will ultimately recover could differ
materially from amounts recorded in reinsurance recoverable. Reinsurance ceding
arrangements do not discharge the Company from its obligations as the primary
insurer.
Effective December 31, 1996 PMI terminated and commuted its reinsurance
agreement with Centre Reinsurance Company of New York and Centre Reinsurance
International Company. This commutation did not have a significant impact on
the Company's results of operations. Effective December 31, 1997 PMI terminated
its reinsurance agreement with Capital Mortgage Reinsurance Company of New York.
This termination did not have an impact on the Company's financial condition or
results of operations. This agreement will be in run-off through December 31,
2006 on policies existing prior to January 1, 1998. As a result of these
reinsurance treaty terminations, the Company will no longer cede reinsurance to
third party reinsurers on policies written after December 31, 1997.
In December 1993, the Company decided to cease writing new business in its
mortgage pool insurance business segment (except for honoring certain
commitments in existence prior to the discontinuation of this business).
Concurrently, the Company entered into a reinsurance agreement with Forestview
Mortgage Insurance Co. ("Forestview"), a wholly owned subsidiary of Allstate, to
cede all future mortgage pool net premiums and net losses from PMI to
Forestview. As a result of this ceding agreement, the pool business had no
significant impact on the Company's results of operations for the years ended
December 31, 1997, 1996 and 1995. The Board of Directors of Allstate has
resolved that Allstate will make capital
<PAGE>
contributions to Forestview as necessary to maintain Forestview's risk-to-
capital ratio below 20.0 to 1. In accordance with accounting for discontinued
operations, pool insurance assets (unpaid losses recoverable and paid claims
receivable from reinsurers) and liabilities (loss reserves and premiums payable)
have been netted in the accompanying consolidated balance sheets, resulting in a
net receivable from non-affiliated reinsurers of $4.1 million and $5.2 million
included in other assets at December 31, 1997 and 1996, respectively. Gross pool
reinsurance recoverables and receivables from Forestview and other reinsurers
are as follows at December 31:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- ---------------------------------------------------------
<S> <C> <C>
Forestview $ 89,580 $ 140,670
Other reinsurers 23,565 39,322
-------------------------
Total $ 113,145 $ 179,992
=========================
</TABLE>
Reinsurance recoverable on paid primary losses from non-affiliated reinsurers
was $6.1 million and $5.3 million at December 31, 1997 and 1996, respectively.
Prepaid primary reinsurance premiums from non-affiliated reinsurers were $3.0
million and $3.8 million at December 31, 1997 and 1996, 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:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums written
Direct $435,971 $404,528 $335,632
Assumed 1,383 (901) 3,010
Ceded (5,302) (607) (24,621)
----------------------------------------
Premiums written,
net of reinsurance $432,052 $403,020 $314,021
========================================
Premiums earned
Direct $458,972 $425,831 $352,459
Assumed 1,182 634 3,412
Ceded (6,206) (13,727) (27,115)
----------------------------------------
Premiums earned
net of reinsurance $453,948 $412,738 $328,756
========================================
Losses and loss adjustment expenses
Direct $157,012 $157,203 $128,607
Assumed 219 (267) 499
Ceded (4,974) (4,527) (16,269)
----------------------------------------
Losses and loss adjustment
expenses, net of reinsurance $152,257 $152,409 $112,837
========================================
</TABLE>
In the first quarter of 1996 a quota share reinsurance assumption agreement with
Triad Guaranty Insurance Corporation was terminated.
<PAGE>
NOTE 6. INCOME TAXES
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Current $ 3,859 $ 9,056 $10,513
Deferred 63,699 55,132 34,797
-----------------------------------
Total income tax expense $ 67,558 $ 64,188 $45,310
===================================
</TABLE>
A reconciliation of the statutory federal income tax rate to the effective tax
rate reported on income from operations before taxes is as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal income tax rate 35.0% 35.0% 35.0%
Tax-exempt income (7.5) (7.1) (9.5)
State income tax (net) 0.2 0.9 0.4
Other 0.1 0.1 (0.8)
-----------------------------------
Effective income tax rate 27.8% 28.9% 25.1%
===================================
</TABLE>
On April 10, 1995 the Company and its subsidiaries separated from Allstate (see
Note 1). Effective April 11, 1995 the Company and its subsidiaries file a
consolidated income tax return. Prior to that date, the Company was part of the
consolidated return of Sears, Roebuck and Co. ("Sears"), the former parent
company of Allstate Corp. The Company's share of consolidated federal income
tax liability prior to April 11, 1995 was determined under a tax sharing
agreement as part of the Sears tax group. Under the tax sharing agreement, the
Company has continuing rights and obligations to Allstate and Sears for the tax
effect of any changes in taxable income relating to the periods during which the
Company was part of the Sears tax group. At December 31, 1997 the Company had
income taxes receivable of $16.8 million 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 13). 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 reserves. The Company purchased tax and loss bonds
of $50.7 million, $50.4 million and $21.2 million in 1997, 1996 and 1995,
respectively.
The Company paid income taxes of $8.4 million, $8.2 million and $28.4 million in
1997, 1996 and 1995, respectively. Included in these amounts are federal income
tax payments to Allstate under the tax sharing agreement of $0.7 million and
$21.2 million in 1996 and 1995, respectively.
<PAGE>
The components of the deferred income tax assets and liabilities at December 31
are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- -------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Discount on loss reserves $ 3,743 $ 3,722
Unearned premium reserves 6,591 8,187
Alternative minimum tax credit carryforward 23,687 10,453
Pension costs 3,037 2,586
Other assets 2,197 2,266
-------------------------
Total deferred assets 39,255 27,214
-------------------------
Deferred tax liabilities:
Statutory contingency reserves (56,730) (36,435)
Policy acquisition costs (13,253) (11,072)
Unrealized net gains on investments (38,738) (27,311)
Software development costs (5,550) (2,700)
Other liabilities (1,379) (482)
-------------------------
Total deferred tax liabilities (115,650) (78,000)
-------------------------
Net deferred tax liability $ (76,395) $(50,786)
=========================
</TABLE>
7. 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.
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
(In thousands) Value Fair Value Value Fair Value
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
6.75% Long-term debt $99,409 $100,983 $99,342 $99,984
8.309% Redeemable preferred
capital securities 99,006 107,875 -- --
</TABLE>
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.
8. BENEFIT PLANS
Pension 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
(the "Plan"), a noncontributory defined benefit plan. Also, employees earning
in excess of $150,000 per year participate in The PMI Group, Inc. Supplemental
Employee Retirement Plan ("SERP"), a noncontributory defined benefit plan.
Prior to April 18, 1995 the Company participated in the Allstate retirement plan
("Allstate Plan"), which was a noncontributory defined benefit plan. Benefits
under all three plans are based upon the employee's length of service, average
annual compensation and estimated social security retirement benefits. Pension
expense of $0.6 million for the year ended December 31, 1995 was allocated to
the Company from the Allstate Plan based upon compensation. Information about
the components of net periodic pension expense and the Allstate Plan's funded
status is not available on a separate company basis.
The components of the net periodic cost of the Company's defined benefit pension
plans for the years ended December 31, 1997 and 1996 and the period April 18,
1995, through December 31, 1995, are as follows:
<PAGE>
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $3,424 $3,282 $2,003
Interest on projected benefit
obligation 759 484 175
Actual return on plan assets (265) (219) (4)
Net amortization and deferral (125) 78 10
----------------------------------------
Net periodic pension cost $3,793 $3,625 $2,184
========================================
</TABLE>
The following lists the funded status of the pension plan as of December 31,
1997 and 1996:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- ---------------------------------------------------------------
<S> <C> <C>
Actuarial present value of
benefit obligations
Vested $ 4,220 $ 3,399
Non-vested 1,384 1,370
------------------------
Accumulated benefit obligation $ 5,604 $ 4,769
========================
Projected benefit obligation $11,381 $ 6,658
Net assets available for benefits (5,204) (2,896)
------------------------
Projected benefit obligation in
excess of plan assets 6,177 3,762
Unrecognized net gain (loss) (505) 581
------------------------
Net pension liability $ 5,672 $ 4,343
========================
</TABLE>
The Company has accrued the $5.7 million pension obligation as of December 31,
1997. The discount rates used in determining the actuarial present value of the
projected benefit obligation and the pension expense were 7.25% and 7.50% for
1997 and 1996, respectively. The expected long-term rate of return on plan
assets was 8.5% for 1997 and 1996. The assumed rate of compensation increase
was 5.5% for 1997 and 1996. Plan assets consist of fixed income and equity
securities.
POST-RETIREMENT BENEFITS OTHER THAN PENSION - The Company provides certain
health care and life insurance benefits for retired employees ("OPEB Plan").
Generally, qualified employees may become eligible for these benefits if they
retire in accordance with the Company's established retirement policy and are
continuously insured under the Company's group plans or other approved plans for
10 or more years prior to retirement. The Company shares the cost of the
retiree medical benefits with retirees based on years of service with the
Company's share being subject to a 5% limit on annual medical cost inflation
after retirement. The Company has the right to modify or terminate these plans.
The components of the net periodic post-retirement benefit cost of the Company's
OPEB Plan for the years ended December 31, 1997 and 1996 and the period April
18, 1995, through December 31, 1995, are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 387 $ 438 $ 226
Interest on projected benefit
obligation 209 235 124
----------------------------------------
Net periodic post-retirement
benefit cost $ 596 $ 673 $ 350
========================================
</TABLE>
<PAGE>
The following lists the funded status of the OPEB Plan as of December 31, 1997
and 1996:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
- ------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of
benefit obligations:
Active employees eligible to retire $ 300 $ 216
Active employees ineligible to retire 2,812 2,566
------------------------
Accumulated post-retirement benefit
obligation 3,112 2,782
Unrecognized prior service cost (284) (304)
Unrecognized gains 781 535
-------------------------
Accrued post-retirement benefit
obligation $3,609 $3,013
=========================
</TABLE>
The discount rates for the beginning of the period were 7.5% and 7.0% for 1997
and 1996, respectively. The discount rates used at the end of the period were
7.25% and 7.5% in 1997 and 1996, respectively. The assumed health care trend
rate used in measuring the accumulated post-retirement benefit obligation as of
December 31, 1997 is 9.0% grading down to 5.0% over six years. The effect of a
one percentage point increase in the health care trend rate assumption would
result in an increase of approximately 23% in the accumulated post-retirement
benefit obligation from $3.1 million to $3.8 million as of December 31, 1997.
SAVINGS AND PROFIT SHARING PLAN - As of April 18, 1995, employees of the company
were eligible to participate in The PMI Group, Inc. Savings and Profit Sharing
Plan ("PMI Plan") covering both salaried and hourly employees. Eligible
employees who participate in the PMI Plan receive, within certain limits,
matching Company contributions. Costs relating to the PMI Plan amounted to $1.2
million, $1.1 million and $0.8 million for 1997, 1996 and 1995, respectively.
9. 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 (the "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 1997, and no interest payments were made in 1996.
LINES OF CREDIT - The Company has two line of credit agreements (the "Lines"),
each in the amount of $25.0 million. The Lines have final maturities of January
2001 and December 2000 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 and no interest payments were made
during 1997. Interest payments of $0.1 million were made in the year ended
December 31, 1996.
10. 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, 1997, are as follows:
<TABLE>
<CAPTION>
(In thousands) Amount
- ------------------------------------------------
<S> <C>
Year ending December 31:
1998 $ 7,933
1999 6,723
2000 3,937
2001 1,482
2002 432
--------
Total $20,507
========
</TABLE>
Total rent expense for all leases was $7.6 million, $7.4 million and $6.2
million in 1997, 1996 and 1995, respectively.
LEGAL PROCEEDINGS - Various legal actions and regulatory reviews are currently
pending that involve the Company. In the opinion of management, the ultimate
liability in one or more of these actions is not expected to have a material
effect on the financial condition or results of operations of the Company.
<PAGE>
11. 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 (the "Issuer Trust"). The
sole asset of the Issuer Trust consists of $103.1 million principal amount of a
junior subordinated debenture (the "Debenture") issued by TPG to the Issuer
Trust. The Debenture bears interest at the rate of 8.309% per annum and matures
on February 1, 2027. The amounts due to the Issuer Trust under the Debenture
and the related income statement amounts have been eliminated in the Company's
consolidated financial statements. Distributions on the Capital Securities
occur on February 1 and August 1 of each year. The obligations of TPG under the
Debenture and a related guarantee and expense agreement constitute a full and
unconditional guarantee by TPG of the Issuer Trust's obligations under the
Capital Securities. The Capital Securities are subject to mandatory redemption
under certain circumstances. Distribution payments of $4.2 million were made in
1997.
12. DIVIDENDS AND SHAREHOLDERS' EQUITY
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 will receive 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 Directors will review the merits of redeeming or continuing
the Rights Plan not less than once every three years. Rights issued under the
plan will be exercisable only if a person or group acquires 10% or more of the
Company's common stock or announces a tender offer for 10% or more of the common
stock. If a person or group acquires 10% or more of the Company's common stock,
all rightholders except the buyer will be entitled to acquire the Company's
common stock at a discount and/or under certain circumstances to purchase shares
of the acquiring company at a discount. The Rights Plan contains an exception
that would allow passive institutional investors to acquire up to a 15%
ownership interest before the rights would become exercisable. The Rights Plan
also excludes Allstate from the definition of an acquiring person, pending such
time as Allstate distributes or otherwise transfers such ownership interest.
DIVIDENDS - The ability of the Company to pay dividends is dependent on business
conditions, income, cash requirements of the Company, receipt of dividends from
PMI, restrictions contained in the Company's credit agreements and other
relevant factors. PMI's ability to pay dividends to TPG is limited under
Arizona law. The payment of dividends by PMI without the prior approval of the
Arizona state insurance department is limited to formula amounts based on net
income, net investment income, and capital and surplus, including unassigned
surplus, determined in accordance with statutory accounting practices, as well
as the timing and amount of dividends paid in the preceding twelve months.
Limitations on PMI's risk-to-capital ratio also effectively limit PMI's ability
to pay dividends because the payment of dividends reduces statutory capital.
Various state regulatory authorities impose a limitation that the risk-to-
capital ratio may not exceed 25 to 1. In addition, under a support agreement
with Allstate, PMI is prohibited from paying any dividend that would cause its
risk-to-capital ratio to equal or exceed 23 to 1 (see Note 15). PMI's dividend
restrictions have not had, and are not expected to have, an 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, 1997, without prior regulatory approval is $27.5 million. PMI paid
ordinary and, after obtaining regulatory approval, extraordinary dividends to
TPG totaling $76.4 million and $46.4 million in the years ended December 31,
1997 and 1996, respectively. APTIC paid ordinary dividends to TPG totaling $2.5
million and $1.3 million in the years ended December 31, 1997 and 1996,
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 that
has voting, dividend or liquidation rights superior to the common stock and that
may adversely affect the rights of holders of common stock.
<PAGE>
Pursuant to the Runoff Support Agreement (see Note 15), 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.
Common Stock - During 1997, 1996 and 1995, the Company issued 97,628, 36,125 and
11,494, respectively, shares of common stock through stock option exercises and
stock grants. During 1997, 1996 and 1995, the Company repurchased 2,146,200,
535,800 and 2,000, respecitively, shares of common stock through the stock
buy-back program.
EQUITY INCENTIVE PLAN AND DIRECTORS PLAN - During 1996, the Company amended and
restated The PMI Group, Inc. Equity Incentive Plan (the "Equity Incentive Plan")
and The PMI Group, Inc. Stock Plan for Non-Employee Directors (the "Directors
Plan"). Pursuant to such plans, an aggregate of 1,500,000 shares of common
stock was reserved for issuance to Directors, officers and employees of TPG and
its subsidiaries. The Equity Incentive Plan provides for awards of both non-
qualified stock options and incentive stock options, stock appreciation rights,
restricted stock subject to forfeiture and restrictions on transfer, and
performance awards entitling the recipient to receive cash or common stock in
the future following the attainment of performance goals determined by the Board
of Directors. Generally, options are granted with an exercise price equal to the
market value on the date of grant, expire ten years from the date of grant and
have a three year vesting period. The Directors Plan provides that each
Director who is not an employee of the Company or its subsidiaries will receive
an annual grant of up to 300 shares of common stock and will receive stock
options for 1,500 shares annually, after an initial option of up to 3,000
shares. The shares will be granted on June 1 of each year or as soon as
administratively practicable after each anniversary of the Director's
commencement of service.
The following is a summary of activity in the Equity Incentive Plan and the
Directors Plan during 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------------------------------
Weighted Weighted
Shares Average Shares Average
Under Option Exercise Price Under Option Exercise Price
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Options outstanding at
beginning of year 538,604 $ 36.40 487,181 $ 33.96
Options granted 206,310 54.61 105,100 45.73
Options exercised (92,653) 34.33 (33,526) 33.85
Options forfeited (35,873) 43.19 (20,151) 33.95
--------------------------------------------------------------
Outstanding at end of year 616,388 $ 42.30 538,604 $ 36.40
==============================================================
Exercisable at year end 230,331 $ 35.28 147,031 $ 33.55
Reserved for future grants 743,439 916,376
- --------------------------------------------------------------------------------------------
Note: The weighted average remaining contractual life of shares under option was 8.0 years
(for an exercise price between $32.14 and $67.97) in 1997 and 8.3 years ($32.14 and $56.37)
in 1996.
============================================================================================
</TABLE>
As discussed in Note 2, the Company accounts for stock-based compensation under
APB No. 25 and its related interpretations. SFAS No. 123, Accounting for Stock-
Based Compensation, requires the disclosure of pro-forma net income and earnings
per share had the Company adopted the fair value method as of the beginning of
fiscal year 1995. The fair value of stock-based awards to employees is
calculated through the use of option pricing models, even though such models
were developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which differ significantly from the
Company's stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise, which
greatly affect the calculated values. The Company's calculations were made using
the Black-Scholes option pricing model with the following weighted average
assumptions: dividend yield range of 0.29% to 0.37% for the 1997 options and
0.35% to 0.44% for the 1996 options; expected volatility range of 20.61% to
21.90% for the 1997 options and 21.08% to 23.12% for the 1996 options; risk-free
interest rates of 6.06%, 6.43%, 6.36%, 6.18% and 5.86% for the 1997 options and
5.40%, 5.83%, 6.51%, 6.53% and 6.54% for the 1996 options; and an expected life
of four years following vesting. Forfeitures are recognized as they occur.
If the computed fair values of the 1997, 1996 and 1995 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:
<PAGE>
<TABLE>
<CAPTION>
(In thousands, except per share amounts) 1997 1996 1995
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income: As reported $175,309 $157,918 $135,231
Pro-forma $173,598 $156,709 $134,272
Basic earnings per share: As reported $ 5.25 $ 4.52 $ 3.86
Pro-forma $ 5.20 $ 4.48 $ 3.84
Diluted earnings per share: As reported $ 5.23 $ 4.51 $ 3.85
Pro-forma $ 5.18 $ 4.47 $ 3.82
</TABLE>
13. STATUTORY ACCOUNTING
The Company's insurance subsidiaries prepare statutory financial statements in
accordance with the accounting practices prescribed or permitted by their
respective state's Department of Insurance, which is a comprehensive basis of
accounting other than GAAP. The principles used in determining statutory
financial amounts differ from GAAP primarily for the following reasons:
Under statutory accounting practices, mortgage guaranty insurance companies are
required to establish each year a contingency reserve equal to 50% of premiums
earned in such year. Such amount must be maintained in the contingency reserve
for 10 years after which time it is released to unassigned surplus. Prior to
10 years, the contingency reserve may be reduced with regulatory approval to
the extent that losses in any calendar year exceed 35% of earned premiums for
such year. Under GAAP, the contingency reserve is not required.
Under statutory accounting practices, insurance policy acquisition costs are
charged against operations in the year incurred. Under GAAP, these costs are
deferred and amortized as the related premiums are earned.
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, and
purchases of tax and loss bonds are recorded as payments of income taxes.
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 are valued at
amortized cost. Under GAAP, those investments that 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 value, with the unrealized gain or loss
recognized, net of tax, as an increase or decrease to shareholders' equity.
The statutory net income, statutory surplus and contingency reserve liability of
PMI as of and for the years ended December 31 are as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory net income $227,148 $202,584 $172,470
------------------------------------
Statutory surplus $274,864 $313,635 $293,282
------------------------------------
Contingency reserve liability $839,478 $674,841 $530,874
------------------------------------
</TABLE>
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.
14. BUSINESS SEGMENTS
The Company's two business segments are mortgage insurance ("MI"), including
ancillary services, and title insurance ("Title"). Following is segment
information as of and for the years ended December 31, 1997, 1996 and 1995:
<PAGE>
<TABLE>
<CAPTION>
1997 | 1996 | 1995 |
--------------------------------|-------------------------------------|---------------------------------|
(In thousands) MI Title Total | MI Title Total | MI Title Total |
- ---------------------------------------------------------|-------------------------------------|----------------------------------
<S> <C> <C> <C> | <C> <C> <C> | <C> <C> <C> |
Revenues $ 503,422 $61,225 $ 564,647 | $ 447,051 $54,373 $ 501,424 | $ 363,718 $41,322 $ 405,040 |
Income before | | |
income taxes 236,617 6,250 242,867 | 217,511 4,595 222,106 | 177,641 2,900 180,541 |
Net income 171,277 4,032 175,309 | 154,914 3,004 157,918 | 133,196 2,035 135,231 |
Depreciation expense 4,045 768 4,813 | 4,467 801 5,268 | 5,151 875 6,026 |
Capital expenditures 13,563 124 13,687 | 9,710 503 10,213 | 5,833 535 6,368 |
Assets 1,649,553 37,050 1,686,603 | 1,476,511 33,408 1,509,919 | 1,274,386 30,054 1,304,440 |
</TABLE>
15. CAPITAL SUPPORT AGREEMENTS
PMI's claims-paying ability 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.
The Runoff Support Agreement contains certain covenants, including covenants
that: (i) PMI will write no new business after its risk-to-capital ratio equals
or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any
such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and
(iii) on the date that any of the following events occur: (A) PMI's risk-to-
capital ratio exceeds 24.5 to 1, (B) Allstate shall have paid any claims
relating to PMI policies directly to a policyholder or by paying an amount equal
to such claims to PMI (or to TPG for contribution to PMI) pursuant to the Runoff
Support Agreement, or (C) any regulatory order is issued restricting or
prohibiting PMI from making full or timely payments under policies, PMI will
transfer substantially all of its assets in excess of $50.0 million to a trust
account established for the payment of claims.
On June 6, 1996, a CMG Capital Support Agreement was executed by PMI and CMIC
whereby both parties agreed to contribute funds, subject to certain limitations,
so as to maintain CMG's risk-to-capital ratio at or below 18.0 to 1. At
December 31, 1997 CMG's risk-to-capital ratio was 17.3 to 1.
16. QUARTERLY RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
1997 1996 1997 1996 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $147,546 $115,906 $132,909 $119,056 $141,204 $127,450 $142,988 $139,012
--------------------------------------------------------------------------------------
Net income $ 49,172 $ 36,990 $ 42,279 $ 41,220 $ 41,913 $ 41,280 $ 41,945 $ 38,428
--------------------------------------------------------------------------------------
Basic EPS $ 1.44 $ 1.06 $ 1.26 $ 1.18 $ 1.26 $ 1.18 $ 1.29 $ 1.10
--------------------------------------------------------------------------------------
Diluted EPS $ 1.43 $ 1.05 $ 1.25 $ 1.17 $ 1.26 $ 1.18 $ 1.28 $ 1.10
--------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<S> <C>
R e p o r t o f R E P O R T O F
M a n a g e m e n t I N D E P E N D E N T
A U D I T O R S
To the Shareholders of The PMI To the Board Of Directors and
Group, Inc. Shareholders of The PMI Group,
Inc.
The consolidated financial
statements of The PMI Group, We have audited the
Inc. and subsidiaries have accompanying consolidated
been prepared by management balance sheets of The PMI
and have been audited by the Group, Inc. and subsidiaries
Company's independent (the "Company") as of December
auditors, Deloitte & Touche 31, 1997 and 1996, and the
LLP, whose report appears on related consolidated statements
this page. Management is of operations, shareholders'
responsible for the equity and cash flows for each
consolidated financial of the three years in the
statements, which have been period ended December 31, 1997.
prepared in conformity with These consolidated financial
generally accepted accounting statements are the
principles and include amounts responsibility of the Company's
based on management's management. Our responsibility
judgments. is to express an opinion on
these consolidated financial
Management is also responsible statements based on our audits.
for maintaining internal
control systems designed to We conducted our audits in
provide reasonable assurance, accordance with generally
at appropriate cost, that accepted auditing standards.
assets are safeguarded and Those standards require that we
that transactions are executed plan and perform the audit to
and recorded in accordance obtain reasonable assurance
with established policies and about whether the consolidated
procedures. The Company's financial statements are free
systems are under continuing of material misstatement. An
review and are supported by, audit includes examining, on a
among other things, business test basis, evidence supporting
conduct and other written the amounts and disclosures in
guidelines, an internal audit the consolidated financial
function and the selection and statements. An audit also
training of qualified includes assessing the
personnel. accounting principles used and
significant estimates made by
The Board of Directors, through management, as well as
its Audit Committee, oversees evaluating the overall
management's financial financial statement
reporting responsibilities. presentation. We believe that
The Audit Committee meets our audits provide a reasonable
regularly with the independent basis for our opinion.
auditors, representatives of
management and the internal In our opinion, such
auditors to discuss and make consolidated financial
inquiries into their statements present fairly, in
activities. Both the all material respects, the
independent auditors and the financial position of The PMI
internal auditors have free Group, Inc. and subsidiaries as
access to the Audit Committee, of December 31, 1997 and 1996,
with and without management and the results of their
representatives in attendance. operations and their cash flows
for each of the three years in
the period ended December 31,
1997, in conformity with
/s/ W. Roger Haughton generally accepted accounting
- -------------------------------- principles.
President and Chief Executive
Officer
/s/ Deloitte & Touche LLP
--------------------------------
/s/ John M. Lorenzen, Jr. San Francisco, California
- -------------------------------- January 20, 1998
Executive Vice President and
Chief Financial Officer
January 20, 1998
</TABLE>
<PAGE>
EXHIBIT 21.1
------------
THE PMI GROUP, INC. - SUBSIDIARIES
<TABLE>
<CAPTION>
Name Under Which
Subsidiary Does Jurisdiction of
Subsidiary Name Business (If Different) Incorporation
- --------------------------------- ---------------------------------------- ------------------------------
<S> <C> <C>
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
</TABLE>
<PAGE>
EXHIBIT 23.1
------------
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No. 33-
92636, No. 33-99378 and No. 333-47473 of The PMI Group, Inc. (the "Company")
on Form S-8, Registration Statements No. 333-15543 and No 333-48035 of the
Company on Form S-3 and Registration Statement No. 333-29777 of the Company on
Form S-4 of our reports dated January 20, 1998 appearing in and incorporated by
reference in this Annual Report on Form 10-K of the Company for the year ended
December 31, 1997.
/s/ Deloitte & Touche LLP
San Francisco, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 1,308,768
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 102,943
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,490,601
<CASH> 11,101
<RECOVER-REINSURE> 31,676
<DEFERRED-ACQUISITION> 37,864
<TOTAL-ASSETS> 1,686,603
<POLICY-LOSSES> 202,387
<UNEARNED-PREMIUMS> 94,150
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 99,409
0
0
<COMMON> 351
<OTHER-SE> 1,060,829
<TOTAL-LIABILITY-AND-EQUITY> 1,686,603
453,948
<INVESTMENT-INCOME> 83,136
<INVESTMENT-GAINS> 19,584
<OTHER-INCOME> 7,979
<BENEFITS> 152,257
<UNDERWRITING-AMORTIZATION> 62,778
<UNDERWRITING-OTHER> 92,362
<INCOME-PRETAX> 242,867
<INCOME-TAX> 67,558
<INCOME-CONTINUING> 175,309
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 175,309
<EPS-PRIMARY> 5.25
<EPS-DILUTED> 5.23
<RESERVE-OPEN> 194,487
<PROVISION-CURRENT> 158,147
<PROVISION-PRIOR> (5,890)
<PAYMENTS-CURRENT> 27,700
<PAYMENTS-PRIOR> 122,724
<RESERVE-CLOSE> 196,320
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 9-MOS 6-MOS 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997 JAN-01-1996
<PERIOD-END> SEP-30-1997 JUN-30-1997 MAR-31-1997 DEC-31-1996
<DEBT-HELD-FOR-SALE> 1,282,433 1,224,661 1,201,654 1,085,514
<DEBT-CARRYING-VALUE> 0 0 0 0
<DEBT-MARKET-VALUE> 0 0 0 0
<EQUITIES> 97,940 89,263 72,675 124,356
<MORTGAGE> 0 0 0 0
<REAL-ESTATE> 0 0 0 0
<TOTAL-INVEST> 1,454,573 1,443,628 1,413,187 1,291,746
<CASH> 7,737 4,990 6,517 6,592
<RECOVER-REINSURE> 28,305 23,439 22,031 83,379
<DEFERRED-ACQUISITION> 35,794 33,789 32,757 31,633
<TOTAL-ASSETS> 1,648,841 1,615,069 1,580,337 1,509,919
<POLICY-LOSSES> 199,798 198,289 201,196 199,774
<UNEARNED-PREMIUMS> 97,594 99,690 104,294 116,951
<POLICY-OTHER> 0 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0 0
<NOTES-PAYABLE> 99,547 99,418 99,359 99,342
0 0 0 0
0 0 0 0
<COMMON> 351 351 351 350
<OTHER-SE> 1,028,054 1,014,311 979,636 986,512
<TOTAL-LIABILITY-AND-EQUITY> 1,648,841 1,615,069 1,580,337 1,509,919
335,541 217,997 108,091 412,738
<INVESTMENT-INCOME> 62,181 40,671 19,995 67,442
<INVESTMENT-GAINS> 19,106 18,814 18,268 14,296
<OTHER-INCOME> 4,831 2,897 1,192 6,948
<BENEFITS> 113,262 73,750 39,515 152,409
<UNDERWRITING-AMORTIZATION> 0 0 0 48,302
<UNDERWRITING-OTHER> 111,893 70,298 34,415 77,700
<INCOME-PRETAX> 185,894 129,492 70,543 222,106
<INCOME-TAX> 52,530 38,041 21,371 64,188
<INCOME-CONTINUING> 133,364 91,451 49,172 157,918
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 133,364 91,451 49,172 157,918
<EPS-PRIMARY> 3.96 2.70 1.44 4.52
<EPS-DILUTED> 3.95 2.69 1.43 4.51
<RESERVE-OPEN> 0 0 0 174,188
<PROVISION-CURRENT> 0 0 0 161,740
<PROVISION-PRIOR> 0 0 0 (9,331)
<PAYMENTS-CURRENT> 0 0 0 23,353
<PAYMENTS-PRIOR> 0 0 0 108,757
<RESERVE-CLOSE> 0 0 0 194,487
<CUMULATIVE-DEFICIENCY> 0 0 0 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 9-MOS 6-MOS 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1995
<PERIOD-END> SEP-30-1996 JUN-30-1996 MAR-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 1,023,977 1,000,820 998,938 928,773
<DEBT-CARRYING-VALUE> 0 0 0 0
<DEBT-MARKET-VALUE> 0 0 0 0
<EQUITIES> 121,739 116,908 117,804 121,889
<MORTGAGE> 0 0 0 0
<REAL-ESTATE> 0 0 0 0
<TOTAL-INVEST> 1,168,337 1,131,364 1,135,364 1,132,972
<CASH> 3,596 3,853 1,904 3,654
<RECOVER-REINSURE> 94,094 82,528 78,766 78,007
<DEFERRED-ACQUISITION> 26,452 22,939 21,466 22,986
<TOTAL-ASSETS> 1,389,146 1,331,542 1,314,775 1,304,440
<POLICY-LOSSES> 199,497 195,091 197,277 192,087
<UNEARNED-PREMIUMS> 117,675 117,287 123,753 140,322
<POLICY-OTHER> 0 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0 0
<NOTES-PAYABLE> 0 0 0 0
0 0 0 0
0 0 0 0
<COMMON> 350 350 350 350
<OTHER-SE> 965,361 923,188 888,554 870,153
<TOTAL-LIABILITY-AND-EQUITY> 1,389,146 1,331,542 1,314,775 1,304,440
293,237 188,284 93,023 328,756
<INVESTMENT-INCOME> 49,937 33,488 15,761 62,041
<INVESTMENT-GAINS> 14,174 9,984 6,223 11,934
<OTHER-INCOME> 5,064 3,206 899 2,309
<BENEFITS> 100,273 63,503 33,825 112,837
<UNDERWRITING-AMORTIZATION> 0 0 0 52,881
<UNDERWRITING-OTHER> 94,097 61,889 30,539 58,781
<INCOME-PRETAX> 168,042 109,570 51,542 180,541
<INCOME-TAX> 48,552 31,360 14,552 45,310
<INCOME-CONTINUING> 119,490 78,210 36,990 135,231
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 119,490 78,210 36,990 135,231
<EPS-PRIMARY> 3.41 2.23 1.06 3.86
<EPS-DILUTED> 3.40 2.23 1.05 3.85
<RESERVE-OPEN> 0 0 0 156,316
<PROVISION-CURRENT> 0 0 0 133,536
<PROVISION-PRIOR> 0 0 0 (20,699)
<PAYMENTS-CURRENT> 0 0 0 16,180
<PAYMENTS-PRIOR> 0 0 0 78,785
<RESERVE-CLOSE> 0 0 0 174,188
<CUMULATIVE-DEFICIENCY> 0 0 0 0
</TABLE>
