form10q.htm


FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2013
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______  to ______
Commission file number 1-10816
 
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)

WISCONSIN
 
39-1486475
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
250 E. KILBOURN AVENUE
 
53202
MILWAUKEE, WISCONSIN
 
(Zip Code)
(Address of principal executive offices)
   

(414) 347-6480
(Registrant's telephone number, including area code)

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  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
YES  x
NO  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o
Smaller reporting company  o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
YES  o
NO  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

CLASS OF STOCK
PAR VALUE
DATE
NUMBER OF SHARES
Common stock
$1.00
04/30/13
337,758,169
 


 
 

 
 
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2013 and December 31, 2012
(Unaudited)

   
March 31,
   
December 31,
 
   
2013
   
2012
 
ASSETS
 
(In thousands)
 
Investment portfolio (notes 7 and 8):
           
Securities, available-for-sale, at fair value:
           
Fixed maturities (amortized cost, 2013 - $4,506,873; 2012 - $4,185,937)
  $ 4,537,762     $ 4,227,339  
Equity securities
    2,928       2,936  
Total investment portfolio
    4,540,690       4,230,275  
                 
Cash and cash equivalents
    1,635,810       1,027,625  
Accrued investment income
    31,290       27,243  
Reinsurance recoverable on loss reserves (note 4)
    96,179       104,848  
Reinsurance recoverable on paid losses
    13,283       15,605  
Premium receivable
    72,641       67,828  
Home office and equipment, net
    26,863       27,190  
Deferred insurance policy acquisition costs
    12,208       11,245  
Other assets
    79,534       62,465  
Total assets
  $ 6,508,498     $ 5,574,324  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Liabilities:
               
Loss reserves (note 12)
  $ 3,848,348     $ 4,056,843  
Premium deficiency reserve (note 13)
    72,131       73,781  
Unearned premiums
    140,213       138,840  
Senior notes (note 3)
    99,929       99,910  
Convertible senior notes (note 3)
    845,000       345,000  
Convertible junior debentures (note 3)
    389,522       379,609  
Other liabilities
    335,673       283,401  
Total liabilities
    5,730,816       5,377,384  
                 
Contingencies (note 5)
               
                 
Shareholders' equity (note 14):
               
Common stock (one dollar par value, shares authorized 680,000; shares issued 2013 - 340,047; 2012 - 205,047; shares outstanding 2013 - 337,758; 2012 - 202,032)
    340,047       205,047  
Paid-in capital
    1,657,567       1,135,296  
Treasury stock (shares at cost 2013 - 2,289; 2012 - 3,015)
    (64,435 )     (104,959 )
Accumulated other comprehensive loss, net of tax (note 9)
    (57,801 )     (48,163 )
Retained deficit
    (1,097,696 )     (990,281 )
Total shareholders' equity
    777,682       196,940  
Total liabilities and shareholders' equity
  $ 6,508,498     $ 5,574,324  

See accompanying notes to consolidated financial statements.
 
 
2

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2013 and 2012
(Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Revenues:
 
(In thousands, except per share data)
 
Premiums written:
           
Direct
  $ 254,547     $ 263,795  
Assumed
    551       641  
Ceded
    (6,598 )     (9,450 )
Net premiums written
    248,500       254,986  
(Increase) decrease in unearned premiums, net
    (1,441 )     7,419  
Net premiums earned
    247,059       262,405  
Investment income, net of expenses
    18,328       37,408  
Realized investment gains, net
    1,259       77,561  
Total other-than-temporary impairment losses
    -       -  
Portion of losses recognized in other comprehensive income, before taxes
    -       -  
Net impairment losses recognized in earnings
    -       -  
Other revenue
    2,539       2,309  
Total revenues
    269,185       379,683  
                 
Losses and expenses:
               
Losses incurred, net (note 12)
    266,208       337,088  
Change in premium deficiency reserve (note 13)
    (1,650 )     (14,183 )
Amortization of deferred policy acquisition costs
    1,697       1,670  
Other underwriting and operating expenses, net
    48,315       48,673  
Interest expense
    26,406       24,627  
Total losses and expenses
    340,976       397,875  
Loss before tax
    (71,791 )     (18,192 )
Provision for income taxes (note 11)
    1,139       1,363  
                 
Net loss
  $ (72,930 )   $ (19,555 )
                 
Loss per share (note 6):
               
Basic
  $ (0.31 )   $ (0.10 )
Diluted
  $ (0.31 )   $ (0.10 )
                 
Weighted average common shares outstanding - diluted (note 6)
    232,348       201,528  

See accompanying notes to consolidated financial statements.
 
 
3

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended  March 31, 2013 and 2012
(Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
             
Net Loss
  $ (72,930 )   $ (19,555 )
                 
Other comprehensive income (loss), net of tax (note 9):
               
                 
Change in unrealized investment gains and losses
    (9,954 )     (45,918 )
                 
Foreign currency translation adjustment
    316       1,083  
                 
Other comprehensive loss, net of tax
    (9,638 )     (44,835 )
                 
Total comprehensive loss
  $ (82,568 )   $ (64,390 )

See accompanying notes to consolidated financial statements.
 
 
4

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED  STATEMENTS OF SHAREHOLDERS' EQUITY
Year Ended December 31, 2012 and Three Months Ended March 31, 2013
(Unaudited)

                     
Accumulated
       
                     
other
   
Retained
 
   
Common
   
Paid-in
   
Treasury
   
comprehensive
   
earnings
 
   
stock
   
capital
   
stock
   
income (loss)
   
(deficit)
 
   
(In thousands)
 
                               
Balance, December 31, 2011
  $ 205,047     $ 1,135,821     $ (162,542 )   $ 30,124     $ (11,635 )
                                         
Net loss
                                    (927,079 )
Change in unrealized investment gains and losses, net
    -       -       -       (78,659 )     -  
Reissuance of treasury stock, net
    -       (8,749 )     57,583       -       (51,567 )
Equity compensation
    -       8,224       -       -       -  
Defined benefit plan adjustments, net
    -       -       -       (1,221 )     -  
Unrealized foreign currency translation adjustment
    -       -       -       1,593       -  
                                         
Balance, December 31, 2012
  $ 205,047     $ 1,135,296     $ (104,959 )   $ (48,163 )   $ (990,281 )
                                         
Net loss
                                    (72,930 )
Change in unrealized investment gains and losses, net (notes 7 and 8)
    -       -       -       (9,954 )     -  
Common stock issuance (note 14)
    135,000       528,542       -       -       -  
Reissuance of treasury stock, net
    -       (7,892 )     40,524       -       (34,485 )
Equity compensation
    -       1,621       -       -       -  
Unrealized foreign currency translation adjustment
    -       -       -       316       -  
                                         
Balance, March 31, 2013
  $ 340,047     $ 1,657,567     $ (64,435 )   $ (57,801 )   $ (1,097,696 )

See accompanying notes to consolidated financial statements.
 
 
5

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2013 and 2012
(Unaudited)

   
Three Months Ended
 
   
March 31,
 
             
   
2013
   
2012
 
   
(In thousands)
 
Cash flows from operating activities:
           
Net loss
  $ (72,930 )   $ (19,555 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and other amortization
    22,858       24,696  
Deferred tax (benefit) provision
    (8 )     72  
Realized investment gains, excluding impairment losses
    (1,259 )     (77,561 )
Other
    6,335       (2,609 )
Change in certain assets and liabilities:
               
Accrued investment income
    (4,047 )     3,652  
Reinsurance recoverable on loss reserves
    8,669       12,318  
Reinsurance recoverable on paid losses
    2,322       2,401  
Premiums receivable
    (4,813 )     3,339  
Deferred insurance policy acquisition costs
    (963 )     (1,196 )
Loss reserves
    (208,495 )     (348,342 )
Premium deficiency reserve
    (1,650 )     (14,183 )
Unearned premiums
    1,373       (7,491 )
Income taxes payable (current)
    899       844  
Net cash used in operating activities
    (251,709 )     (423,615 )
                 
Cash flows from investing activities:
               
Purchase of fixed maturities
    (975,555 )     (1,833,039 )
Purchase of equity securities
    (18 )     (21 )
Proceeds from sale of fixed maturities
    361,119       1,519,761  
Proceeds from maturity of fixed maturities
    282,701       617,036  
Net increase in payable for securities
    43,435       26,685  
Net cash (used in) provided by investing activities
    (288,318 )     330,422  
                 
Cash flows from financing activities:
               
Net proceeds from convertible senior notes
    484,670       -  
Common stock shares issued
    663,542       -  
Net cash provided by financing activities
    1,148,212       -  
                 
Net increase (decrease) in cash and cash equivalents
    608,185       (93,193 )
Cash and cash equivalents at beginning of period
    1,027,625       995,799  
Cash and cash equivalents at end of period
  $ 1,635,810     $ 902,606  

See accompanying notes to consolidated financial statements.
 
 
6

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2013
(Unaudited)

Note 1 - Basis of Presentation

MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation ("MGIC"), MGIC Indemnity Corporation (“MIC”) and several other subsidiaries, is principally engaged in the mortgage insurance business.  We provide mortgage insurance to lenders throughout the United States and to government sponsored entities (“GSEs”) to protect against loss from defaults on low down payment residential mortgage loans.

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012 included in our Annual Report on Form 10-K. As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our financial position and results of operations for the periods indicated. The results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2013.

Capital

The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the risk in force (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “Capital Requirements.” While they vary among jurisdictions, the most common Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk-to-capital ratio will increase if the percentage decrease in capital exceeds the percentage decrease in insured risk. Therefore, as capital decreases, the same dollar decrease in capital will cause a greater percentage decrease in capital and a greater increase in the risk-to-capital ratio. Wisconsin does not regulate capital by using a risk-to-capital measure but instead requires a minimum policyholder position (“MPP”). The “policyholder position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums.
 
During part of 2012 and 2013, MGIC’s risk-to-capital ratio exceeded 25 to 1. In March 2013, our holding company issued additional equity and convertible debt securities and transferred $800 million to increase MGIC’s capital. As a result, at March 31, 2013, MGIC’s risk-to-capital ratio was 20.4 to 1, below the maximum allowed by the jurisdictions with Capital Requirements, and its policyholder position was $168 million above the required MPP of $1.2 billion. At March 31, 2013, the risk-to-capital ratio of our combined insurance operations (which includes reinsurance affiliates) was 23.1 to 1. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC to continue to utilize reinsurance arrangements with its subsidiaries or subsidiaries of our holding company, additional capital contributions to the reinsurance affiliates could be needed. These reinsurance arrangements permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements.

 
7

 

At this time, we expect MGIC to continue to comply with the current Capital Requirements, although factors that could negatively affect such compliance are discussed throughout the financial statement footnotes. The remainder of the discussion in this footnote addresses circumstances that would be significant if we were not in such compliance.

The Office of the Commissioner of Insurance of the State of Wisconsin (“OCI”) has waived MGIC’s compliance with Wisconsin’s Capital Requirements until December 31, 2013 (the “OCI Waiver”). The OCI, in its sole discretion, may modify, terminate or extend the OCI Waiver. If the OCI modifies or terminates its waiver, or if it fails to renew its waiver upon expiration, and if MGIC does not comply with the Capital Requirements at that time, MGIC could be prevented from writing new business in all jurisdictions. We cannot assure you that MGIC will comply with the Capital Requirements in the future. If MGIC were prevented from writing new business in all jurisdictions, our insurance operations in MGIC would be in run-off (meaning no new loans would be insured but loans previously insured would continue to be covered, with premiums continuing to be received and losses continuing to be paid on those loans) until MGIC either met the Capital Requirements or obtained a necessary waiver to allow it to once again write new business.
 
MGIC applied for waivers in the other jurisdictions with Capital Requirements and received waivers from some of them. Insurance departments, in their sole discretion, may modify, terminate or extend their waivers of Capital Requirements. If an insurance department other than the OCI modifies or terminates its waiver, or if it fails to grant a waiver or renew its waiver after expiration, and if MGIC does not comply with the Capital Requirements at that time, MGIC could be prevented from writing new business in that particular jurisdiction. New insurance written in the jurisdictions that have Capital Requirements represented approximately 50% of our new insurance written in 2012 and the first quarter of 2013. Depending on the level of losses that MGIC experiences in the future, it is possible that regulatory action by one or more jurisdictions, including those that do not have specific Capital Requirements, may prevent MGIC from continuing to write new insurance in that jurisdiction. The National Association of Insurance Commissioners (“NAIC”) is reviewing the minimum capital and surplus requirements for mortgage insurers, although it has not established a date by which it must make proposals to change such requirements. Depending on the scope of proposals made by the NAIC, MGIC may be prevented from writing new business in the jurisdictions adopting such proposals. The GSEs are also developing mortgage insurer capital standards that would replace the use of external credit ratings. Revised capital standards are expected to be released in 2013, however the timing of their implementation is unknown.
 
A possible future failure by MGIC to meet the Capital Requirements will not necessarily mean that MGIC lacks sufficient resources to pay claims on its insurance liabilities. While we believe MGIC has sufficient claims paying resources to meet its claim obligations on its insurance in force on a timely basis, we cannot assure you that events that may lead MGIC to fail to meet Capital Requirements would not also result in it not having sufficient claims paying resources. Furthermore, our estimates of MGIC’s claims paying resources and claim obligations are based on various assumptions. These assumptions include the timing of the receipt of claims on loans in our delinquency inventory and future claims that we anticipate will ultimately be received, our anticipated rescission activity, premiums, housing values and unemployment rates. These assumptions are subject to inherent uncertainty and require judgment by management. Current conditions in the domestic economy make the assumptions about when anticipated claims will be received, housing values, and unemployment rates highly volatile in the sense that there is a wide range of reasonably possible outcomes. Our anticipated rescission activity is also subject to inherent uncertainty due to the difficulty of predicting the amount of claims that will be rescinded and the outcome of any legal proceedings or settlement discussions related to rescissions. Factors that could negatively affect MGIC’s claims paying resources are discussed throughout the financial statement footnotes.
 
 
8

 
 
We have in place a longstanding plan to write new business in MIC, a direct subsidiary of MGIC, if MGIC is unable to do so. During 2012, MIC began writing new business on the same policy terms as MGIC in the jurisdictions where MGIC did not have active waivers of the Capital Requirements. Because MGIC again meets the Capital Requirements, MGIC will again be writing new business in all jurisdictions and MIC will suspend writing new business. As of March 31, 2013, MIC had statutory capital of $450 million and risk in force of approximately $800 million. MIC is licensed to write business in all jurisdictions and, subject to the conditions and restrictions discussed below, has received the necessary approvals from the GSEs and the OCI to write business in all of the jurisdictions where MGIC may become unable to do so because those jurisdictions have not waived their Capital Requirements for MGIC.
 
Under an agreement in place with Fannie Mae, as amended November 30, 2012, MIC will be eligible to write mortgage insurance through December 31, 2013, in those jurisdictions (other than Wisconsin) in which MGIC cannot write new insurance due to MGIC’s failure to meet Capital Requirements and to obtain a waiver of them. MIC is also approved to write mortgage insurance for 60 days in jurisdictions that do not have Capital Requirements if a jurisdiction notifies MGIC that, due to its financial condition, it may no longer write new business. The agreement with Fannie Mae contains certain conditions and restrictions to its continued effectiveness including the continued effectiveness of the OCI Order.
 
Under a letter from Freddie Mac that was amended and restated as of November 30, 2012, Freddie Mac approved MIC to write business only in those jurisdictions (other than Wisconsin) where either (a) MGIC is unable to write business because it does not meet the Capital Requirements and does not obtain waivers of them, or (b) MGIC receives notice that it may not write business because of that jurisdiction’s view of MGIC’s financial condition. This approval of MIC, which may be withdrawn at any time, expires December 31, 2013, or earlier if a financial examination by the OCI determines that there is a reasonable probability that MGIC will be unable to honor claim obligations at any time in the five years after the examination, or if MGIC fails to honor claim payments. The approval from Freddie Mac, contains certain conditions and restrictions to its continued effectiveness, including requirements that MIC not exceed a risk-to-capital ratio of 18:1 (at March 31, 2013, MIC’s risk-to-capital ratio was 1.8 to 1); MGIC and MIC comply with all terms and conditions of the OCI Waiver; the OCI Waiver remain effective; and MIC provide MGIC access to the capital of MIC in an amount necessary for MGIC to maintain sufficient liquidity to satisfy its obligations under insurance policies issued by MGIC.
 
On November 29, 2012, the OCI issued an order, effective until December 31, 2013, establishing a procedure for MIC to pay a dividend to MGIC if either of the following two events occurs: (1) an OCI examination determines that there is a reasonable probability that MGIC will be unable to honor its policy obligations at any time during the five years after the examination, or (2) MGIC fails to honor its policy obligations that it in good faith believes are valid. If one of these events occurs, the OCI is to conduct a review (to be completed within 60 days after the triggering event) to determine the maximum single dividend MIC could prudently pay to MGIC for the benefit of MGIC’s policyholders, taking account of the interests of MIC’s policyholders and the general public and certain standards for dividends imposed by Wisconsin law. Upon the completion of the review, the OCI will authorize, and MIC will pay, such a dividend within 30 days.
 
 
9

 
 
We cannot assure you that the GSEs will approve or continue to approve MIC to write new business in all jurisdictions in which MGIC may become unable to do so, or that they will extend their approvals upon expiration. If one GSE does not approve MIC in all jurisdictions in which MGIC becomes unable to write new business, MIC may be able to write insurance on loans that will be sold to the other GSE or retained by private investors. However, because lenders may not know which GSE will purchase their loans until mortgage insurance has been procured, lenders may be unwilling to procure mortgage insurance from MIC. Furthermore, if we are unable to write business in all jurisdictions utilizing a combination of MGIC and MIC, lenders may be unwilling to procure insurance from us anywhere. In addition, a lender’s assessment of the financial strength of our insurance operations may affect its willingness to procure insurance from us.

Statement of Statutory Accounting Principles No. 101 (“SSAP No. 101”) became effective January 1, 2012 and prescribed new standards for determining the amount of deferred tax assets that can be recognized as admitted assets for determining statutory capital. Under a permitted practice effective September 30, 2012 and until further notice, the OCI has approved MGIC to report its net deferred tax asset as an admitted asset in an amount not to exceed 10% of surplus as regards policyholders, notwithstanding any contrary provisions of SSAP No. 101. Deferred tax assets of $136 million and $63 million were included in MGIC’s statutory capital at March 31, 2013 and December 31, 2012, respectively.

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2012 amounts to conform to 2013 presentation.

Subsequent events

We have considered subsequent events through the date of this filing.

Note 2 - New Accounting Guidance

In June 2011, as amended in December 2011, new guidance was issued requiring entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. Our disclosures reflected the requirements of this new guidance beginning with the first quarter of 2012. Other provisions of this guidance regarding reclassifications out of other comprehensive income were finalized in February 2013. Our disclosures reflect the requirements of this additional guidance beginning with the first quarter of 2013.

 
10

 

Note 3 – Debt

Senior Notes

At March 31, 2013 and December 31, 2012 we had outstanding $100.1 million of 5.375% Senior Notes due in November 2015. Covenants in the Senior Notes include the requirement that there be no liens on the stock of the designated subsidiaries unless the Senior Notes are equally and ratably secured; that there be no disposition of the stock of designated subsidiaries unless all of the stock is disposed of for consideration equal to the fair market value of the stock; and that we and the designated subsidiaries preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the Senior Notes. A designated subsidiary is any of our consolidated subsidiaries which has shareholders’ equity of at least 15% of our consolidated shareholders’ equity. We were in compliance with all covenants at March 31, 2013.

If we fail to meet any of the covenants of the Senior Notes; there is a failure to pay when due at maturity, or a default results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; or we fail to make a payment of principal on the Senior Notes when due or a payment of interest on the Senior Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the Senior Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of our Senior Notes would have the right to accelerate the maturity of those notes.  In addition, the trustee of the Senior Notes could, independent of any action by holders of Senior Notes, accelerate the maturity of the Senior Notes. The amounts we owe under the Senior Notes would also be accelerated upon certain bankruptcy or insolvency-related events involving our holding company, including certain events involving the appointment of a custodian, receiver, liquidator, assignee, trustee or other similar official (collectively, an “Insolvency Official”) of our holding company or any substantial part of its property or the consent of our holding company to such an appointment. The description above is not intended to be complete in all respects. Moreover, the description is qualified in its entirety by the terms of the notes, which are contained in the Indenture, dated as of October 15, 2000, between us and U.S. Bank, National Association, as trustee, and in an Officer's Certificate dated as of October 4, 2005, which specifies the interest rate, maturity date and other terms of the Senior Notes.

There were no interest payments on the Senior Notes for the three months ended March 31, 2013 or 2012.

5% Convertible Senior Notes – due May 2017

At March 31, 2013 and December 31, 2012 we had outstanding $345 million principal amount of 5% Convertible Senior Notes due in May 2017. Interest on the 5% Notes is payable semi-annually in arrears on May 1 and November 1 of each year. The 5% Notes will mature on May 1, 2017. Covenants in the 5% Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the 5% Notes.

 
11

 

If an “events of default” under the 5% Notes occurs, including if: we fail to meet any of the covenants of the 5% Notes and such failure continues for 60 days after we receive notice from holders of 25% or more of the 5% Notes; there is a failure to pay when due at maturity or otherwise, or a default under any of our other debt results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; a final judgment for the payment of $40 million or more (excluding any amounts covered by insurance) is rendered against us or any of our subsidiaries which judgment is not discharged or stayed within certain time limits; or we fail to make a payment of principal on the 5% Notes when due or a payment of interest on the 5% Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the 5% Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of the 5% Notes would have the right to accelerate the maturity of those notes. In addition, the trustee of the 5% Notes could, independent of any action by holders, accelerate the maturity of the 5% Notes if an “event of default” occurs. The amounts we owe under the 5% Notes would also be accelerated upon certain bankruptcy or insolvency-related events involving our holding company or a Significant Subsidiary, including the failure to have dismissed or stayed a petition seeking relief under bankruptcy or insolvency laws or the consent of our holding company or a Significant Subsidiary to the appointment of an Insolvency Official for all or substantially all of their respective property. “Significant Subsidiary” is defined in Regulation S-X under the Securities Act of 1933 and is measured as of the most recently completed fiscal year. As of December 31, 2012, MGIC and MGIC Reinsurance Corporation of Wisconsin were our Significant Subsidiaries.

The 5% Notes are convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents an initial conversion price of approximately $13.44 per share. These 5% Notes will be equal in right of payment to our other senior debt, discussed above, and will be senior in right of payment to our existing Convertible Junior Debentures, discussed below. Debt issuance costs are being amortized to interest expense over the contractual life of the 5% Notes. The provisions of the 5% Notes are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the notes, which are contained in the Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as trustee, and the Indenture dated as of October 15, 2000, between us and the trustee.

There were no interest payments on the 5% Notes for the three months ended March 31, 2013 or 2012.

2% Convertible Senior Notes – due April 2020

In March 2013 we completed the sale of $500 million principal amount of 2% Convertible Senior Notes due in 2020. We received net proceeds of approximately $484.7 million after deducting underwriting discount and estimated offering expenses. See Note 14 - “Shareholders’ Equity” for information regarding the use of such proceeds. Interest on the 2% Notes will be payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2013. The 2% Notes will mature on April 1, 2020. Subject to certain limitations the 2% Notes are convertible at the holder's option at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount. This represents an initial conversion price of approximately $6.95 per share. Before January 1, 2020, conversions may only occur under certain circumstances, including upon redemption of the 2% Notes. On or after January 1, 2020, holders may convert their notes at any time. These 2% Notes will be equal in right of payment to our other senior debt and will be senior in right of payment to our existing Convertible Junior Debentures. Debt issuance costs will be amortized to interest expense over the contractual life of the 2% Notes. Prior to April 10, 2017, the notes will not be redeemable. On any business day on or after April 10, 2017 we may redeem for cash all or part of the notes, at our option, at a redemption price equal to 100% of the principal amount of the notes being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the notes for at least 20 of the 30 trading days preceding notice of the redemption.
 
 
12

 
 
Covenants in the 2% Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the 2% Notes.

If an “events of default” under the 2% Notes occurs, including if: we fail to meet any of the covenants of the 2% Notes and such failure continues for 60 days after we receive notice from holders of 25% or more of the 2% Notes; there is a failure to pay when due at maturity or otherwise, or a default under any of our other debt results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; a final judgment for the payment of $40 million or more (excluding any amounts covered by insurance) is rendered against us or any of our subsidiaries which judgment is not discharged or stayed within certain time limits; or we fail to make a payment of principal on the 2% Notes when due or a payment of interest on the 2% Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the 2% Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of the 2% Notes would have the right to accelerate the maturity of those notes. In addition, the trustee of the 2% Notes could, independent of any action by holders, accelerate the maturity of the 2% Notes if an “event of default” occurs. The amounts we owe under the 2% Notes would also be accelerated upon certain bankruptcy or insolvency-related events involving our holding company or a Significant Subsidiary, including the failure to have dismissed or stayed a petition seeking relief under bankruptcy or insolvency laws or the consent of our holding company or a Significant Subsidiary to the appointment of an Insolvency Official for all or substantially all of their respective property.

The provisions of the 2% Notes are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the notes, which are contained in the Second Supplemental Indenture, dated March 12, 2013, between us and U.S. Bank National Association, as trustee, and the Indenture dated as of October 15, 2000, between us and the trustee.

Convertible Junior Subordinated Debentures

At March 31, 2013 and December 31, 2012 we had outstanding $389.5 million principal amount of 9% Convertible Junior Subordinated Debentures due in 2063 (the “debentures”). The debentures have an effective interest rate of 19% that reflects our non-convertible debt borrowing rate at the time of issuance. At December 31, 2012 the amortized value of the principal amount of the debentures is reflected as a liability on our consolidated balance sheet of $379.6 million, with the unamortized discount reflected in equity. As of March 31, 2013 the full principal amount of the debentures is reflected as a liability on our consolidated balance sheet. The debentures rank junior to all of our existing and future senior indebtedness.

 
13

 

Violations of the covenants under the Indenture governing the debentures, including covenants to provide certain documents to the trustee, are not events of default under the Indenture and would not allow the acceleration of amounts that we owe under the debentures. Similarly, events of default under, or acceleration of, any of our other obligations, including those described above, would not allow the acceleration of amounts that we owe under the debentures. However, if we fail to pay principal or interest when due under the debentures, then the holders of 25% or more of the debentures would have the right to accelerate the maturity of them. In addition, the trustee of the debentures could, independent of any action by holders, accelerate the maturity of the debentures. The amounts we owe under the Convertible Junior Subordinated Debentures would also be accelerated upon certain bankruptcy or insolvency-related events involving our holding company, including the appointment of a custodian of it or any substantial part of its properties.

Interest on the debentures is payable semi-annually in arrears on April 1 and October 1 of each year. As long as no event of default with respect to the debentures has occurred and is continuing, we may defer interest, under an optional deferral provision, for one or more consecutive interest periods up to ten years without giving rise to an event of default. Deferred interest will accrue additional interest at the rate then applicable to the debentures. During an optional deferral period we may not pay or declare dividends on our common stock.

Interest on the debentures that would have been payable on the scheduled interest payment date of October 1, 2012 had been deferred. During the deferral period the deferred interest continued to accrue and compound semi-annually at an annual rate of 9%.

On April 1, 2013 we paid the deferred interest payment, including the compound interest. The interest payment, totaling approximately $18.3 million, was made from the net proceeds of our March 2013 common stock offering. We also paid the regular April 1, 2013 interest payment due on the debentures of approximately $17.5 million. We continue to have the right to defer interest that is payable on subsequent scheduled interest payment dates. Any deferral of such interest would be on terms equivalent to those described above.

When interest on the debentures is deferred, we are required, not later than a specified time, to use reasonable commercial efforts to begin selling qualifying securities to persons who are not our affiliates. The specified time is one business day after we pay interest on the debentures that was not deferred, or if earlier, the fifth anniversary of the scheduled interest payment date on which the deferral started. Qualifying securities are common stock, certain warrants and certain non-cumulative perpetual preferred stock. The requirement to use such efforts to sell such securities is called the Alternative Payment Mechanism.

The net proceeds of Alternative Payment Mechanism sales are to be applied to the payment of deferred interest, including the compound portion. We cannot pay deferred interest other than from the net proceeds of Alternative Payment Mechanism sales, except at the final maturity of the debentures or at the tenth anniversary of the start of the interest deferral. The Alternative Payment Mechanism does not require us to sell common stock or warrants before the fifth anniversary of the interest payment date on which that deferral started if the net proceeds (counting any net proceeds of those securities previously sold under the Alternative Payment Mechanism) would exceed the 2% cap. The 2% cap is 2% of the average closing price of our common stock times the number of our outstanding shares of common stock. The average price is determined over a specified period ending before the issuance of the common stock or warrants being sold, and the number of outstanding shares is determined as of the date of our most recent publicly released financial statements.

We are not required to issue under the Alternative Payment Mechanism a total of more than 10 million shares of common stock, including shares underlying qualifying warrants. In addition, we may not issue under the Alternative Payment Mechanism qualifying preferred stock if the total net proceeds of all issuances would exceed 25% of the aggregate principal amount of the debentures.

 
14

 

The Alternative Payment Mechanism does not apply during any period between scheduled interest payment dates if there is a “market disruption event” that occurs over a specified portion of such period. Market disruption events include any material adverse change in domestic or international economic or financial conditions.

The provisions of the debentures are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the debentures, which are contained in the Indenture, dated as of March 28, 2008, between us and U.S. Bank National Association, as trustee.

We may redeem the debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the debentures being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the debentures for at least 20 of the 30 trading days preceding notice of the redemption.

The debentures are currently convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.0741 common shares per $1,000 principal amount of debentures at any time prior to the maturity date. This represents an initial conversion price of approximately $13.50 per share. If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for any deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In lieu of issuing shares of common stock upon conversion of the debentures, we may, at our option, make a cash payment to converting holders for all or some of the shares of our common stock otherwise issuable upon conversion.

There were no interest payments on the debentures for the three months ended March 31, 2013 or 2012.

All debt

The par value and fair value of our debt at March 31, 2013 and December 31, 2012 appears in the table below.

 
15

 

   
Par Value
   
Total Fair
Value
   
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
   
(In thousands)
 
March 31, 2013
                             
Liabilities:
                             
Senior Notes
  $ 100,118     $ 98,266     $ 98,266     $ -     $ -  
Convertible Senior Notes due 2017
    345,000       341,550       341,550       -       -  
Convertible Senior Notes due 2020
    500,000       511,565       511,565       -       -  
Convertible Junior Subordinated Debentures
    389,522       390,009       -       390,009       -  
Total Debt
  $ 1,334,640     $ 1,341,390     $ 951,381     $ 390,009     $ -  
                                         
December 31, 2012
                                       
Liabilities:
                                       
Senior Notes
  $ 100,118     $ 79,594     $ 79,594     $ -     $ -  
Convertible Senior Notes due 2017
    345,000       242,880       242,880       -       -  
Convertible Junior Subordinated Debentures
    389,522       173,096       -       173,096       -  
Total Debt
  $ 834,640     $ 495,570     $ 322,474     $ 173,096     $ -  

The fair value of our Senior Notes and Convertible Senior Notes was determined using publicly available trade information and are considered Level 1 securities as described in Note 8 – “Fair Value Measurements.” The fair value of our debentures was determined using available pricing for these debentures or similar instruments and are considered Level 2 securities as described in Note 8 – “Fair Value Measurements.”

The Senior Notes, Convertible Senior Notes and Convertible Junior Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. At March 31, 2013, we had approximately $671 million in cash and investments at our holding company. The net unrealized gains on our holding company investment portfolio were approximately $1.3 million at March 31, 2013. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 2.0 years at March 31, 2013.

 
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Note 4 – Reinsurance
 
MGIC has obtained both captive and non-captive reinsurance in the past. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance.
 
Since June 2005, various state and federal regulators have conducted investigations or requested information regarding captive mortgage reinsurance arrangement in which we participated. In January 2012, we received correspondence from the Consumer  Financial Protection Bureau (“CFPB”) indicating that it was investigating captive reinsurance arrangements in the mortgage insurance industry. The correspondence requested, among other things, certain information regarding captive mortgage reinsurance transactions in which we participated. In June 2012, we received a Civil Investigative Demand (“CID”) from the CFPB requiring additional information and documentation regarding captive mortgage reinsurance.
 
In April 2013, the U.S. District Court approved a settlement between MGIC and the CFPB that resolves a previously-disclosed, nearly five-year-old federal investigation of MGIC’s participation in captive reinsurance arrangements in the mortgage insurance industry. The settlement concludes the investigation with respect to MGIC without the CFPB making any findings of wrongdoing. Three other mortgage insurers agreed to similar settlements. As part of the settlements, MGIC and the three other mortgage insurers agreed that they would not enter into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years. In accordance with this settlement, all of our active captive arrangements have been placed into run-off.

Captive agreements were written on an annual book of business and the captives are required to maintain a separate trust account to support the combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trust, and the trust account is made up of capital deposits by the lender captive, premium deposits by MGIC, and investment income earned.  These amounts are held in the trust account and are available to pay reinsured losses. The reinsurance recoverable on loss reserves related to captive agreements was approximately $96 million at March 31, 2013 which was supported by $289 million of trust assets, while at December 31, 2012 the reinsurance recoverable on loss reserves related to captives was $104 million which was supported by $303 million of trust assets. As of March 31, 2013 and December 31, 2012 there was an additional $25 million of trust assets in captive agreements where there was no related reinsurance recoverable on loss reserves. Trust fund assets of $3 million and $0.4 million were transferred to us as a result of captive terminations during the first three months of 2013 and 2012, respectively.

The CFPB's investigation involved captive reinsurance. In April 2013, we entered into a quota share reinsurance agreement with a group of unaffiliated reinsurers. These reinsurers are not captive reinsurers. The reinsurance agreement applies to new insurance written between April 1, 2013 and December 31, 2015 (with limited exclusions) and covers incurred losses, with renewal premium through December 31, 2018. Early termination is possible under specified scenarios. The structure of the reinsurance agreement is a 30% quota share, with a 20% ceding commission as well as a profit commission.

Note 5 – Litigation and Contingencies

Consumers continue to bring lawsuits against home mortgage lenders and settlement service providers. Mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in December 2004, following denial of class certification in June 2004. Since December 2006, class action litigation has been brought against a number of large lenders alleging that their captive mortgage reinsurance arrangements violated RESPA. Beginning in December 2011, MGIC, together with various mortgage lenders and other mortgage insurers, have been named as defendants in twelve lawsuits, alleged to be class actions, filed in various U.S. District Courts. Four of those cases have previously been dismissed. The complaints in all eight of the remaining cases allege various causes of action related to the captive mortgage reinsurance arrangements of the mortgage lenders, including that the defendants violated RESPA by paying excessive premiums to the lenders’ captive reinsurer in relation to the risk assumed by that captive. MGIC denies any wrongdoing and intends to vigorously defend itself against the allegations in the lawsuits. There can be no assurance that we will not be subject to further litigation under RESPA (or FCRA) or that the outcome of any such litigation, including the lawsuits mentioned above, would not have a material adverse effect on us.

 
17

 

See Note 4 - “Reinsurance” for a discussion of MGIC’s recent settlement with the CFPB.  In connection with the settlement, MGIC paid a civil penalty of $2.65 million.

We remain subject to various state investigations or information requests regarding captive mortgage reinsurance arrangements, including (1) a request received by MGIC in June 2005 from the New York Department of Financial Services for information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation; and (2) requests received from the Minnesota Department of Commerce beginning in February 2006 regarding captive mortgage reinsurance and certain other matters in response to which MGIC has provided information on several occasions, including as recently as May 2011. Other insurance departments or other officials, including attorneys general, may also seek information about or investigate captive mortgage reinsurance.
 
Various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring actions seeking various forms of relief, including civil penalties and injunctions against violations of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our practices are in conformity with applicable laws and regulations, it is not possible to predict the eventual scope, duration or outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.
 
We are subject to comprehensive, detailed regulation by state insurance departments. These regulations are principally designed for the protection of our insured policyholders, rather than for the benefit of investors. Although their scope varies, state insurance laws generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business. Given the recent significant losses incurred by many insurers in the mortgage and financial guaranty industries, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. State insurance regulatory authorities could take actions, including changes in capital requirements or termination of waivers of capital requirements, that could have a material adverse effect on us. In January 2013, the CFPB issued rules to implement laws requiring mortgage lenders to make ability-to-pay determinations prior to extending credit. We are uncertain whether the CFPB will issue any other rules or regulations that affect our business apart from any action it may take as a result of its investigation of captive mortgage reinsurance. Such rules and regulations could have a material adverse effect on us.

 
18

 

We understand several law firms have, among other things, issued press releases to the effect that they are investigating us, including whether the fiduciaries of our 401(k) plan breached their fiduciary duties regarding the plan’s investment in or holding of our common stock or whether we breached other legal or fiduciary obligations to our shareholders. We intend to defend vigorously any proceedings that may result from these investigations. With limited exceptions, our bylaws provide that our officers and 401(k) plan fiduciaries are entitled to indemnification from us for claims against them.
 
Since December 2009, we have been involved in legal proceedings with Countrywide Home Loans (“CHL”) and its affiliate, Bank of America, N.A., as successor to Countrywide Home Loans Servicing LP (“BANA”) and collectively with CHL, “Countrywide”) in which Countrywide alleged that MGIC denied valid mortgage insurance claims. (In our SEC reports, we refer to rescissions of insurance and denials of claims collectively as “rescissions” and variations of that term.) In addition to the claim amounts it alleged MGIC had improperly denied, Countrywide contended it was entitled to other damages of almost $700 million as well as exemplary damages. We sought a determination in those proceedings that we were entitled to rescind coverage on the applicable loans. From January 1, 2008 through March 31, 2013, rescissions of coverage on Countrywide-related loans mitigated our paid losses on the order of $445 million. This amount is the amount we estimate we would have paid had the coverage not been rescinded. In addition, in connection with mediation we were holding with Countrywide, we voluntarily suspended rescissions related to loans that we believed could be covered by a settlement. As of March 31, 2013, coverage on approximately 2,300 loans, representing total potential claim payments of approximately $170 million, that we had determined was rescindable, was affected by our decision to suspend such rescissions.

In April 2013, MGIC entered into separate settlement agreements with CHL and BANA, pursuant to which the parties will settle the Countrywide litigation as it relates to MGIC’s rescission practices.

The agreement with BANA covers loans which had been sold to the GSEs by CHL, including loans subsequently repurchased by BANA, as well as other CHL-originated loans currently owned by BANA or one of its affiliates.  Implementation of the BANA Agreement is subject to consent and approval by both GSEs. The agreement with CHL covers loans which were purchased by non-GSE investors, including securitization trusts (the “other investors”). The CHL Agreement will not be implemented until the implementation of the BANA Agreement and then will be implemented only as and to the extent that it is approved by or on behalf of the other investors. While there can be no assurance that the Agreements will be implemented, we have determined that their implementation is probable.

Under the Agreements, the parties are seeking to stay their pending arbitration proceedings. Upon implementation of the BANA Agreement, the pending arbitration proceedings concerning the loans covered by the BANA Agreement will be dismissed, and the parties will provide mutual releases. Upon obtaining a specified number of consents by or on behalf of the other investors and also upon the conclusion of the period in the CHL Agreement for obtaining consents by or on behalf of the other investors, all legal proceedings will be dismissed and the parties will provide mutual releases, in each case limited as to the loans held by the other investors that consent to the CHL Agreement.

We are also discussing a settlement of a dispute with another customer and have also determined that it is probable we will reach a settlement with this customer. As of March 31, 2013, coverage on approximately 300 loans, representing total potential claim payments of approximately $20 million, was affected by our decision to suspend rescissions for that customer.

 
19

 

We recorded the estimated impact of the two probable settlements referred to above in our financial statements for the quarter ending December 31, 2012. The aggregate impact to loss reserves for the probable settlement agreements was an increase of approximately $100 million. This impact was somewhat offset by impacts to our return premium accrual and premium deficiency reserve. There was no additional charge in the first quarter of 2013 as a result of executing these agreements, as the financial impact was in line with our original estimations. If we are not able to implement the Agreements, we intend to defend MGIC against any related legal proceedings, vigorously.
 
The flow policies at issue with Countrywide are in the same form as the flow policies that we use with all of our customers, and the bulk policies at issue vary from one another, but are generally similar to those used in the majority of our Wall Street bulk transactions. The settlement with Countrywide may encourage other customers to pursue remedies against us. From January 1, 2008 through March 31, 2013, we estimate that total rescissions mitigated our incurred losses by approximately $2.9 billion, which included approximately $2.9 billion of mitigation on paid losses, excluding $0.6 billion that would have been applied to a deductible. At March 31, 2013, we estimate that our total loss reserves were benefited from anticipated rescissions by approximately $0.2 billion.
 
Before paying a claim, we review the loan and servicing files to determine the appropriateness of the claim amount. All of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy, including the requirement to mitigate our loss by performing reasonable loss mitigation efforts or, for example, diligently pursuing a foreclosure or bankruptcy relief in a timely manner. We call such reduction of claims submitted to us “curtailments.” In 2012 and the first quarter of 2013, curtailments reduced our average claim paid by approximately 4.1% and 4.7%, respectively. In addition, the claims submitted to us sometimes include costs and expenses not covered by our insurance policies, such as mortgage insurance premiums, hazard insurance premiums for periods after the claim date and losses resulting from property damage that has not been repaired. These other adjustments reduced claim amounts by less than the amount of curtailments.
 
After we pay a claim, servicers and insureds sometimes object to our curtailments and other adjustments. We review these objections if they are sent to us within 90 days after the claim was paid. Historically, we have not had material disputes regarding our curtailments or other adjustments.

The Agreements referred to above do not resolve assertions by Countrywide that MGIC has improperly curtailed numerous insurance coverage claims. Countrywide has asserted that the amount of disputed curtailments approximates $40 million. MGIC and Countrywide have agreed to mediate this matter and to enter into arbitration if the mediation does not resolve the matter. We do not believe a loss is probable regarding this curtailment dispute and have not accrued any reserves that would reflect an adverse outcome to this dispute. We intend to defend vigorously our position regarding the correctness of these curtailments under our insurance policy. Although we have not had other material objections to our curtailment and adjustment practices, there can be no assurances that we will not face additional challenges to such practices.

A non-insurance subsidiary of our holding company is a shareholder of the corporation that operates the Mortgage Electronic Registration System (“MERS”).  Our subsidiary, as a shareholder of MERS, has been named as a defendant (along with MERS and its other shareholders) in eight lawsuits asserting various causes of action arising from allegedly improper recording and foreclosure activities by MERS. Two of those lawsuits remain pending and the other six lawsuits have been dismissed without any further opportunity to appeal.  The damages sought in the remaining cases are substantial. We deny any wrongdoing and intend to defend ourselves against the allegations in the lawsuits, vigorously.
 
 
20

 
 
In addition to the matters described above, we are involved in other legal proceedings in the ordinary course of business. In our opinion, based on the facts known at this time, the ultimate resolution of these ordinary course legal proceedings will not have a material adverse effect on our financial position or results of operations.

Through a non-insurance subsidiary, we utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of the contract underwriting activities, that subsidiary is responsible for the quality of the underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. That subsidiary may be required to provide certain remedies to its customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such future obligations. These obligations have been primarily funded by contributions from our holding company and, in part, from the operations of the subsidiary. A generally positive economic environment for residential real estate that continued until approximately 2007 may have mitigated the effect of some of these costs in previous years. Historically, a material portion of our new insurance written through the flow channel has involved loans for which that subsidiary provided contract underwriting services, including new insurance written between 2006 and 2008. Claims for remedies may be made a number of years after the underwriting work was performed. We believe the rescission of mortgage insurance coverage on loans for which the subsidiary provided contract underwriting services may make a claim for a contract underwriting remedy more likely to occur. Beginning in the second half of 2009, our subsidiary experienced an increase in claims for contract underwriting remedies, which continued throughout 2012. The related contract underwriting remedy expense was approximately $27 million, $23 million and $19 million for the years ended December 31, 2012, 2011 and 2010. The underwriting remedy expense for each of the first three months of 2013 and 2012 was not significant.

See Note 11 – “Income Taxes” for a description of federal income tax contingencies.

Note 6 – Earnings (Loss) per Share

Our basic EPS is based on the weighted average number of common shares outstanding, which excludes participating securities of 1.2 million and 1.1 million for the three months ended March 31, 2013 and 2012, respectively, because they were anti-dilutive due to our reported net loss. Typically, diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include certain stock awards, stock options and the dilutive effect of our convertible debt. In accordance with accounting guidance, if we report a net loss from continuing operations then our diluted EPS is computed in the same manner as the basic EPS. In addition if any common stock equivalents are anti-dilutive they are excluded from the calculation. The following includes a reconciliation of the weighted average number of shares; however for the three months ended March 31, 2013 and 2012 common stock equivalents of 77.3 million and 56.0 million, respectively, were not included because they were anti-dilutive.

 
21

 

 
Three Months Ended
 
   
March 31,
 
             
   
2013
   
2012
 
 
(In thousands, except per share data)
 
             
Basic earnings per share:
           
Weighted average common shares outstanding
    232,348       201,528  
Net loss
  $ (72,930 )   $ (19,555 )
Basic loss per share
  $ (0.31 )   $ (0.10 )
                 
Diluted earnings per share:
               
Weighted-average shares - Basic
    232,348       201,528  
Common stock equivalents
    -       -  
                 
Weighted-average shares - Diluted
    232,348       201,528  
                 
Net loss
  $ (72,930 )   $ (19,555 )
Diluted loss per share
  $ (0.31 )   $ (0.10 )

Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at March 31, 2013 and December 31, 2012 are shown below.
 
 
22

 
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
March 31, 2013
 
Cost
   
Gains
   
Losses (1)
   
Value
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 882,336     $ 2,967     $ (568 )   $ 884,735  
Obligations of U.S. states and political subdivisions
    783,756       16,069       (383 )     799,442  
Corporate debt securities
    1,693,146       13,683       (3,649 )     1,703,180  
Asset-backed securities
    329,493       1,315       (69 )     330,739  
Residential mortgage-backed securities
    432,977       923       (5,940 )     427,960  
Commercial mortgage-backed securities
    232,936       407       (1,680 )     231,663  
Collateralized loan obligations
    19,897       4       -       19,901  
Debt securities issued by foreign sovereign governments
    132,332       8,231       (421 )     140,142  
Total debt securities
    4,506,873       43,599       (12,710 )     4,537,762  
Equity securities
    2,815       115       (2 )     2,928  
                                 
Total investment portfolio
  $ 4,509,688     $ 43,714     $ (12,712 )   $ 4,540,690  

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2012
 
Cost
   
Gains
   
Losses (1)
   
Value
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 863,282     $ 3,040     $ (71 )   $ 866,251  
Obligations of U.S. states and political subdivisions
    795,935       16,965       (506 )     812,394  
Corporate debt securities
    1,469,844       13,813       (2,716 )     1,480,941  
Asset-backed securities
    322,802       1,657       (23 )     324,436  
Residential mortgage-backed securities
    451,352       871       (1,314 )     450,909  
Commercial mortgage-backed securities
    150,232       524       (414 )     150,342  
Debt securities issued by foreign sovereign governments
    132,490       9,784       (208 )     142,066  
Total debt securities
    4,185,937       46,654       (5,252 )     4,227,339  
Equity securities
    2,797       139       -       2,936  
                                 
Total investment portfolio
  $ 4,188,734     $ 46,793     $ (5,252 )   $ 4,230,275  

(1) At March 31, 2013 and December 31, 2012, there were no other-than-temporary impairment losses recorded in other comprehensive income.

Our foreign investments primarily consist of the investment portfolio supporting our Australian domiciled subsidiary. This portfolio is comprised of Australian government and semi government securities, representing 87% of the market value of our foreign investments with the remaining 11% invested in corporate securities and 2% in cash equivalents. Ninety-two percent of the Australian portfolio is rated AAA, by one or more of Moody’s, Standard & Poor’s and Fitch Ratings, and the remaining 8% is rated AA.

 
23

 

The amortized cost and fair values of debt securities at March 31, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Because most asset-backed and mortgage-backed securities and collateralized loan obligations provide for periodic payments throughout their lives, they are listed below in separate categories.

   
Amortized
   
Fair
 
March 31, 2013
 
Cost
   
Value
 
   
(In thousands)
 
             
Due in one year or less
  $ 959,410     $ 961,273  
Due after one year through five years
    1,558,703       1,581,603  
Due after five years through ten years
    600,924       608,277  
Due after ten years
    372,533       376,346  
                 
    $ 3,491,570     $ 3,527,499  
                 
Asset-backed securities
    329,493       330,739  
Residential mortgage-backed securities
    432,977       427,960  
Commercial mortgage-backed securities
    232,936       231,663  
Collateralized loan obligations
    19,897       19,901  
                 
Total at March 31, 2013
  $ 4,506,873     $ 4,537,762  

At March 31, 2013 and December 31, 2012, the investment portfolio had gross unrealized losses of $12.7 million and $5.3 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:

 
24

 

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2013
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 107,846     $ 568     $ -     $ -     $ 107,846     $ 568  
Obligations of U.S. states and political subdivisions
    102,228       383       56       -       102,284       383  
Corporate debt securities
    547,075       3,646       3,321       3       550,396       3,649  
Asset-backed securities
    81,463       69       -       -       81,463       69  
Residential mortgage-backed securities
    307,541       5,586       18,132       354       325,673       5,940  
Commercial mortgage-backed securities
    139,102       1,680       -       -       139,102       1,680  
Debt securities issued by foreign sovereign governments
    22,711       421       -       -       22,711       421  
Equity securities
    135       2       -       -       135       2  
Total investment portfolio
  $ 1,308,101     $ 12,355     $ 21,509     $ 357     $ 1,329,610     $ 12,712  
                                                 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2012
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 24,094     $ 71     $ -     $ -     $ 24,094     $ 71  
Obligations of U.S. states and political subdivisions
    156,111       505       1,006       1       157,117       506  
Corporate debt securities
    280,765       2,714       3,353       2       284,118       2,716  
Asset-backed securities
    29,675       23       -       -       29,675       23  
Residential mortgage-backed securities
    315,000       982       19,939       332       334,939       1,314  
Commercial mortgage-backed securities
    72,689       414       -       -       72,689       414  
Debt securities issued by foreign sovereign governments
    14,695       208       -       -       14,695       208  
Total investment portfolio
  $ 893,029     $ 4,917     $ 24,298     $ 335     $ 917,327     $ 5,252  

The unrealized losses in all categories of our investments at March 31, 2013 and December 31, 2012 were primarily caused by the difference in interest rates at March 31, 2013 and December 31, 2012, respectively, compared to interest rates at the time of purchase.

Under the current guidance a debt security impairment is deemed other than temporary if we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery or we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During each of the first three months of 2013 and 2012 there were no other-than-temporary impairments (“OTTI”) recognized.

 
25

 

The net realized investment gains (losses) and OTTI on the investment portfolio are as follows:
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
 
(In thousands)
 
Net realized investment gains (losses) and OTTI on investments:
           
Fixed maturities
  $ 1,257     $ 75,339  
Equity securities
    2       382  
Other
    -       1,840  
                 
    $ 1,259     $ 77,561  

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
 
(In thousands)
 
Net realized investment gains (losses) and OTTI on investments:
           
Gains on sales
  $ 1,934     $ 80,035  
Losses on sales
    (675       (2,474 )
Impairment losses
    -       -  
                 
    $ 1,259     $ 77,561  

Note 8 – Fair Value Measurements

In accordance with fair value guidance, we applied the following fair value hierarchy in order to measure fair value for assets and liabilities:

Level 1 – Quoted prices for identical instruments in active markets that we can access. Financial assets utilizing Level 1 inputs primarily include certain U.S. Treasury securities and obligations of U.S. government corporations and agencies and Australian government and semi government securities.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and inputs, other than quoted prices, that are observable in the marketplace for the financial instrument. The observable inputs are used in valuation models to calculate the fair value of the financial instruments. Financial assets utilizing Level 2 inputs primarily include certain municipal and corporate bonds.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. Level 3 inputs reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets utilizing Level 3 inputs include certain state and auction rate (backed by student loans) securities. Non-financial assets which utilize Level 3 inputs include real estate acquired through claim settlement.
 
 
26

 
 
To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model.  Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. This model combines all inputs to arrive at a value assigned to each security.  In addition, on a quarterly basis, we perform quality controls over values received from the pricing sources which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. We have not made any adjustments to the prices obtained from the independent pricing sources.

Assets classified as Level 3 are as follows:

·
Securities available-for-sale classified in Level 3 are not readily marketable and are valued using internally developed models based on the present value of expected cash flows. Our Level 3 securities, at December 31, 2012, primarily consisted of auction rate securities for which observable inputs or value drivers were unavailable. Due to limited market information, we utilized a discounted cash flow (“DCF”) model to derive an estimate of fair value of these assets at December 31, 2012.  The DCF model for estimating the fair value of the auction rate securities as of December 31, 2012 was based on the following key assumptions:

 
o
Nominal credit risk as substantially all of the underlying collateral of these securities is ultimately guaranteed by the United States Department of Education;
 
o
Time to liquidity  through December 31, 2013;
 
o
Continued receipt of contractual interest; and
 
o
Discount rates ranging from 16.87% to 18.35%, which include a spread for liquidity risk.

During the first three months of 2013 we sold our remaining auction rate securities.  At March 31, 2013, the majority of the $3 million balance of Level 3 securities is state premium tax credit investments.  The state premium tax credit investments have an average maturity of under 5 years, credit ratings of AA+ or higher, and their balance reflects their remaining scheduled payments discounted at an average annual rate of 7.5%.

·
Real estate acquired through claim settlement is fair valued at the lower of our acquisition cost or a percentage of appraised value. The percentage applied to appraised value is based upon our historical sales experience adjusted for current trends.

Fair value measurements for assets measured at fair value included the following as of March 31, 2013 and December 31, 2012:
 
 
27

 
 
   
Fair Value
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
   
(In thousands)
 
March 31, 2013
                       
                         
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 884,735     $ 884,735     $ -     $ -  
Obligations of U.S. states and political subdivisions
    799,442       -       796,485       2,957  
Corporate debt securities
    1,703,180       -       1,703,180       -  
Asset-backed securities
    330,739       -       330,739       -  
Residential mortgage-backed securities
    427,960       -       427,960       -  
Commercial mortgage-backed securities
    231,663       -       231,663       -  
Collateralized loan obligations
    19,901       -       19,901       -  
Debt securities issued by foreign sovereign governments
    140,142       140,142       -       -  
Total debt securities
    4,537,762       1,024,877       3,509,928       2,957  
Equity securities
    2,928       2,607       -       321  
Total investments
  $ 4,540,690     $ 1,027,484     $ 3,509,928     $ 3,278  
Real estate acquired (1)
  $ 7,524     $ -     $ -     $ 7,524  
                                 
December 31, 2012
                               
                                 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 866,251     $ 866,251     $ -     $ -  
Obligations of U.S. states and political subdivisions
    812,394       -       809,264       3,130  
Corporate debt securities
    1,480,941       -       1,463,827       17,114  
Asset-backed securities
    324,436       -       324,436       -  
Residential mortgage-backed securities
    450,909       -       450,909       -  
Commercial mortgage-backed securities
    150,342       -       150,342       -  
Debt securities issued by foreign sovereign governments
    142,066       142,066       -       -  
Total debt securities
    4,227,339       1,008,317       3,198,778       20,244  
Equity securities
    2,936       2,615       -       321  
Total investments
  $ 4,230,275     $ 1,010,932     $ 3,198,778     $ 20,565  
Real estate acquired (1)
  $ 3,463     $ -     $ -     $ 3,463  

(1)
Real estate acquired through claim settlement, which is held for sale, is reported in Other Assets on the consolidated balance sheet.

 
28

 

There were no transfers of securities between Level 1 and Level 2 during the first three months of 2013 or 2012.

For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three months ended March 31, 2013 and 2012 is as follows:
 
   
Obligations of U.S.
States and Political
Subdivisions
   
Corporate Debt
Securities
   
Equity
Securities
   
Total
Investments
   
Real Estate
Acquired
 
   
(In thousands)
 
Balance at December 31, 2012
  $ 3,130     $ 17,114     $ 321     $ 20,565     $ 3,463  
Total realized/unrealized gains (losses):
                                 
Included in earnings and reported as realized investment gains (losses), net
    -       (225 )     -       (225 )     -  
Included in earnings and reported as losses incurred, net
    -       -       -       -       (1,302 )
Purchases
    30       -       -       30       8,014  
Sales
    (203 )     (16,889 )     -       (17,092 )     (2,651 )
Transfers into Level 3
    -       -       -       -       -  
Transfers out of Level 3
    -       -       -       -       -  
Balance at March 31, 2013
  $ 2,957     $ -     $ 321     $ 3,278     $ 7,524  
                                         
Amount of total losses included in earnings for the three months ended March 31, 2013 attributable to the change in unrealized losses on assets still held at March 31, 2013
  $ -     $ -     $ -     $ -     $ -  
 
 
29

 
 
   
Obligations of U.S.
States and Political
Subdivisions
   
Corporate Debt
Securities
   
Equity
Securities
   
Total
Investments
   
Real Estate
Acquired
 
   
(In thousands)
 
Balance at December 31, 2011
  $ 114,226     $ 60,228     $ 321     $ 174,775     $ 1,621  
Total realized/unrealized gains (losses):
                                 
Included in earnings and reported as realized investment gains (losses), net
    (1,950 )     (381 )     -       (2,331 )     -  
Included in earnings and reported as losses incurred, net
    -       -       -       -       (316 )
Included in other comprehensive income
    1,869       277       -       2,146       -  
Purchases
    27       -       -       27       2,082  
Sales
    (18,656 )     (9,006 )     -       (27,662 )     (1,047 )
Transfers into Level 3
    -       -       -       -       -  
Transfers out of Level 3
    -       -       -       -       -  
Balance at March 31, 2012
  $ 95,516     $ 51,118     $ 321     $ 146,955     $ 2,340  
                                         
Amount of total losses included in earnings for the three months ended March 31, 2012 attributable to the change in unrealized losses on assets still held at March 31, 2012
  $ -     $ -     $ -     $ -     $ -  

Additional fair value disclosures related to our investment portfolio are included in Note 7 – “Investments.” Fair value disclosures related to our debt are included in Note 3 – “Debt.”

Note 9 – Other Comprehensive Income

Our other comprehensive income for the three months ended March 31, 2013 and 2012 was as follows:
 
 
Three Months Ended
 
   
March 31, 2013
 
               
Valuation
       
   
Before tax
   
Tax effect
   
allowance
   
Net of tax
 
 
(In thousands)
 
                         
Other comprehensive income (loss):
                       
Change in unrealized gains and losses on investments
  $ (10,539 )   $ 3,592     $ (3,007 )   $ (9,954 )
Unrealized foreign currency translation adjustment
    486       (170 )     -       316  
                                 
Other comprehensive income (loss)
  $ (10,053 )   $ 3,422     $ (3,007 )   $ (9,638 )

 
30

 
 
 
Three Months Ended
 
   
March 31, 2012
 
               
Valuation
       
   
Before tax
   
Tax effect
   
allowance
   
Net of tax
 
 
(In thousands)
 
                         
Other comprehensive income (loss):
                       
Change in unrealized gains and losses on investments
  $ (46,926 )   $ 16,256     $ (15,248 )   $ (45,918 )
Unrealized foreign currency translation adjustment
    1,667       (584 )     -       1,083  
                                 
Other comprehensive income (loss)
  $ (45,259 )   $ 15,672     $ (15,248 )   $ (44,835 )

See Note 11 – “Income Taxes” for a discussion of the valuation allowance.

Total accumulated other comprehensive income and changes in accumulated other comprehensive income, including amounts reclassified from other comprehensive income, are included in the table below.

   
Three Months Ended
 
   
March 31, 2013
 
   
Unrealized gains and
                     
   
losses on available-
     
Defined benefit
   
Foreign currency
       
   
for-sale securities
     
plans
   
translation
   
Total
 
   
(In thousands)
 
                           
Balance at December 31, 2012, before tax
  $ 41,541       $ (71,804 )   $ 32,747     $ 2,484  
                                   
Other comprehensive income (loss) before reclassifications
    (8,467 )       -       486       (7,981 )
Amounts reclassified from accumulated other comprehensive income (loss)
    2,072   (1)     -       -       2,072  
Net current period other comprehensive income (loss)
    (10,539 )       -       486       (10,053 )
                                   
Balance at March 31, 2013, before tax
    31,002         (71,804 )     33,233       (7,569 )
                                   
Tax effect (2)
    (66,054 )       26,940       (11,118 )     (50,232 )
                                   
Balance at March 31, 2013, net of tax
  $ (35,052 )     $ (44,864 )   $ 22,115     $ (57,801 )

(1) During the three months ended March 31, 2013, unrealized gains and losses of $2.1 million were reclassified to the Consolidated Statement of Operations and included in Realized investment gains.
(2)Tax effect does not approximate 35% due to amounts of tax benefits not provided in various periods due to our tax valuation allowance.

 
31

 

Note 10 - Benefit Plans

The following table provides the components of net periodic benefit cost for the pension, supplemental executive retirement and other postretirement benefit plans:

   
Three Months Ended March 31,
 
    Pension and Supplemental    
Other Postretirement
 
    Executive Retirement Plans    
Benefits
 
   
2013
   
2012
   
2013
   
2012
 
   
(In thousands)
 
                         
Service cost
  $ 2,717     $ 2,390     $ 194     $ 309  
Interest cost
    3,799       4,106       154       292  
Expected return on plan assets
    (5,038 )     (4,516 )     (920 )     (790 )
Recognized net actuarial loss
    1,516       1,478       -       210  
Amortization of prior service cost
    125       161       (1,663 )     (1,554 )
                                 
Net periodic benefit cost
  $ 3,119     $ 3,619     $ (2,235 )   $ (1,533 )

We currently intend to make a $10 million contribution to the pension plan during 2013.

Under Statement of Statutory Accounting Principles (“SSAP”) No. 92 and No. 102, which became effective January 1, 2013, the measurement of pension and other postretirement benefit liabilities will begin to include non-vested employees. This measurement, referred to as the projected benefit obligation, is the measurement currently used under GAAP. The new SSAPs did not have a material impact on our statutory benefit obligations or statutory surplus.

Note 11 – Income Taxes

We review the need to establish a deferred tax asset valuation allowance on a quarterly basis. We analyze several factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the expected occurrence of future income or loss and available tax planning alternatives. Based on our analysis and the level of cumulative operating losses, we have reduced our benefit from income tax through the recognition of a valuation allowance.

The effect of the change in valuation allowance on the benefit from income taxes was as follows:

 
32

 
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
             
Benefit from income taxes
  $ (21,590 )   $ (6,062 )
Change in valuation allowance
    22,729       7,425  
                 
Provision for income taxes
  $ 1,139     $ 1,363  

The increase in the valuation allowance that was included in other comprehensive income for the three months ended March 31, 2013 and 2012 was $3.0 million and $15.2 million, respectively.  The total valuation allowance as of March 31, 2013 and December 31, 2012 was $991.7 million and $966.0 million, respectively.
 
We have approximately $2.6 billion of net operating loss carryforwards on a regular tax basis and $1.7 billion of net operating loss carryforwards for computing the alternative minimum tax as of March 31, 2013. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.
 
The Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued assessments for unpaid taxes, interest and penalties related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). This portfolio has been managed and maintained during years prior to, during and subsequent to the examination period. The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. The IRS assessment related to the REMIC issue is $190.7 million in taxes and penalties. There would also be applicable interest which, when computed on the amount of the assessment, is substantial. Depending on the outcome of this matter, additional state income taxes along with any applicable interest may become due when a final resolution is reached and could also be substantial.

We appealed these assessments within the IRS and, in 2007, we made a payment of $65.2 million to the United States Department of the Treasury related to this assessment. In August 2010, we reached a tentative settlement agreement with the IRS which was not finalized. We currently expect to receive a statutory notice of deficiency (commonly referred to as a “90-day letter”) for the disputed amounts in the second quarter of 2013. We would then be required to litigate the validity of the assessments in order to avoid payment to the IRS of the entire amount assessed. Any such litigation could be lengthy and costly in terms of legal fees and related expenses. We continue to believe that our previously recorded tax provisions and liabilities are appropriate. However, we would need to make appropriate adjustments, which could be material, to our tax provision and liabilities if our view of the probability of success in this matter changes, and the ultimate resolution of this matter could have a material negative impact on our effective tax rate, results of operations, cash flows and statutory capital. In this regard, see Note 1 – “Nature of Business - Capital.”

 In March 2012, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax returns for the years 2008 and 2009. In January 2013, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax return for the year 2010. The adjustments that are proposed by the IRS are temporary in nature and will have no material effect on the financial statements.

 
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Note 12 – Loss Reserves

We establish reserves to recognize the estimated liability for losses and loss adjustment expenses (“LAE”) related to defaults on insured mortgage loans. Loss reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity.

Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment, and the current and future strength of local housing markets. Current conditions in the housing and mortgage industries make these assumptions more volatile than they would otherwise be. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a further deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a further drop in housing values that could result in, among other things, greater losses on loans that have pool insurance, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance and mitigation from rescissions being materially less than assumed. Changes to our estimates could result in a material impact to our results of operations and capital position, even in a stable economic environment.

The following table provides a reconciliation of beginning and ending loss reserves for the three months ended March 31, 2013 and 2012:
 
 
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Three Months Ended
 
   
March 31,
 
   
2013
   
2012