MTG

Business Context and Reporting Period

Company: MGIC Investment Corporation (MGIC)
Reporting Period: Fiscal year ended December 31, 2005
Business Overview: MGIC is the leading provider of private mortgage insurance (PMI) in the United States, operating primarily through its subsidiary Mortgage Guaranty Insurance Corporation. The company insures residential first mortgage loans, enabling home purchases with less than 20% down payments. It also provides contract underwriting services and holds significant interests in joint ventures focused on credit-sensitive mortgage assets (C-BASS) and delinquent consumer assets (Sherman Financial Group).

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Increase: Net income increased 13.3% to $626.9 million, driven primarily by a significant decrease in losses incurred and higher income from joint ventures.
• Losses Improvement: Net losses incurred dropped 21% to $553.5 million. This was due to favorable prior year loss development ($126 million reduction) and lower estimates for current year defaults converting to claims.
• Premium Decline: Net premiums written and earned declined due to a reduction in the average insurance in force, resulting from high cancellation rates (refinancing) and lower new insurance written in the flow channel.
• Joint Venture Growth: Income from joint ventures (C-BASS and Sherman) rose to $147.3 million, up from $120.8 million in 2004, contributing significantly to the bottom line.
• Stock Repurchases: The company repurchased 8.7 million shares of common stock in 2005 at a cost of $533.8 million.

Guidance, Outlook, and Risks

• Outlook: Management expects New Insurance Written (NIW) in 2006 to be slightly below 2005 levels. Net premiums written and earned are anticipated to decline in 2006 due to lower average insurance in force. However, losses incurred are expected to exceed 2005 levels in 2006.
• Key Risks:
  • Credit Risk: Deterioration in the domestic economy or housing markets could increase defaults. Approximately 8.5% of primary risk in force is in areas affected by Hurricanes Katrina, Rita, and Wilma.
  • Competition: Alternatives to PMI, such as "piggyback" loans (80-10-10 structures), continue to grow, reducing demand for traditional flow insurance.
  • Regulatory/Litigation: Ongoing scrutiny of captive mortgage reinsurance arrangements by state insurance departments (NY, MN, CO, NC) and potential future litigation under RESPA or FCRA.
  • Interest Rates: Declining interest rates increase refinancing activity, leading to higher policy cancellations and reduced persistency.
• Unusual Items: The company entered into two excess of loss reinsurance agreements in 2005 to cede approximately $85.5 million of risk in force to special purpose reinsurance companies to reduce exposure to specific geographic and risk categories.

Investor Verification Checklist

• Loss Reserve Adequacy: Verify the assumptions used for claim rates and severity, particularly regarding the $126 million favorable prior year development and the impact of hurricane-related defaults.
• Persistency Trends: Monitor the persistency rate (61.3% at year-end 2005) and its sensitivity to interest rate movements, as this directly impacts future premium revenue.
• Joint Venture Exposure: Review the financial health and leverage of C-BASS and Sherman, which contributed significantly to net income but carry distinct credit and liquidity risks.
• Regulatory Status: Track the outcome of state insurance department reviews regarding captive reinsurance arrangements and any potential impact on business practices.
• Debt Maturity: Note the $200 million Senior Notes due in March 2007 and the $300 million Senior Notes due in November 2015.