Edgar Filing: MGIC INVESTMENT CORP

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, 2014

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	04/30/14	338,515,868

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2014 and December 31, 2013

(Unaudited)

	March 31,			December 31,
	2014			2013
ASSETS	(In thousands)
Investment portfolio (notes 7 and 8):
Securities, available-for-sale, at fair value:
Fixed maturities (amortized cost, 2014 - $4,803,526; 2013 - $4,948,543)	$	4,758,526		$	4,863,925
Equity securities		2,955			2,894
Total investment portfolio		4,761,481			4,866,819
Cash and cash equivalents		296,887			332,692
Restricted cash and cash equivalents (note 1)		17,444			17,440
Accrued investment income		31,811			31,660
Prepaid reinsurance premiums (note 4)		38,071			36,243
Reinsurance recoverable on loss reserves (note 4)		57,618			64,085
Reinsurance recoverable on paid losses (note 4)		9,031			10,425
Premium receivable		54,339			62,301
Home office and equipment, net		28,650			26,185
Deferred insurance policy acquisition costs		10,154			9,721
Other assets		159,509			143,819
Total assets	$	5,464,995		$	5,601,390

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves (note 12)	$	2,834,559		$	3,061,401
Premium deficiency reserve (note 13)		43,288			48,461
Unearned premiums		160,097			154,479
Senior notes (note 3)		61,883			82,773
Convertible senior notes (note 3)		845,000			845,000
Convertible junior debentures (note 3)		389,522			389,522
Other liabilities		289,931			275,216
Total liabilities		4,624,280			4,856,852

Contingencies (note 5)

Shareholders' equity (note 14):
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2014 and 2013 - 340,047; shares outstanding 2014 - 338,516; 2013 - 337,758)		340,047			340,047
Paid-in capital		1,657,360			1,661,269
Treasury stock (shares at cost 2014 - 1,531; 2013 - 2,289)		(33,905	)		(64,435	)
Accumulated other comprehensive loss, net of tax (note 9)		(78,361	)		(117,726	)
Retained deficit		(1,044,426	)		(1,074,617	)
Total shareholders' equity		840,715			744,538
Total liabilities and shareholders' equity	$	5,464,995		$	5,601,390

See accompanying notes to consolidated financial statements.

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

(Unaudited)

	Three Months Ended
	March 31,
	2014			2013
Revenues:	(In thousands, except per share data)
Premiums written:
Direct	$	244,189		$	254,547
Assumed		451			551
Ceded (note 4)		(26,620	)		(6,598	)
Net premiums written		218,020			248,500
Increase in unearned premiums, net		(3,759	)		(1,441	)
Net premiums earned		214,261			247,059
Investment income, net of expenses		20,156			18,328
Realized investment (losses) gains, net		(231	)		1,259
Total other-than-temporary impairment losses		-			-
Portion of losses recognized in other comprehensive income, before taxes		-			-
Net impairment losses recognized in earnings		-			-
Other revenue		896			2,539
Total revenues		235,082			269,185

Losses and expenses:
Losses incurred, net (note 12)		122,608			266,208
Change in premium deficiency reserve (note 13)		(5,173	)		(1,650	)
Amortization of deferred policy acquisition costs		1,419			1,697
Other underwriting and operating expenses, net		37,981			48,315
Interest expense (note 3)		17,539			26,406
Total losses and expenses		174,374			340,976
Income (loss) before tax		60,708			(71,791	)
Provision for income taxes (note 11)		726			1,139

Net income (loss)	$	59,982		$	(72,930	)

Income (loss) per share (note 6):
Basic	$	0.18		$	(0.31	)
Diluted	$	0.15		$	(0.31	)

Weighted average common shares outstanding - basic (note 6)		338,213			232,348

Weighted average common shares outstanding - diluted (note 6)		413,180			232,348

See accompanying notes to consolidated financial statements.

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three Months Ended March 31, 2014 and 2013

(Unaudited)

	Three Months Ended
	March 31,
	2014			2013
	(In thousands)

Net income (loss)	$	59,982		$	(72,930	)

Other comprehensive income (loss), net of tax (note 9):

Change in unrealized investment gains and losses (note 7)		39,598			(9,954	)

Benefit plan adjustments		(1,486	)		-

Foreign currency translation adjustment		1,253			316

Other comprehensive income (loss), net of tax		39,365			(9,638	)

Comprehensive income (loss)	$	99,347		$	(82,568	)

See accompanying notes to consolidated financial statements.

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Year Ended December 31, 2013 and Three Months Ended March 31, 2014

(Unaudited)

									Accumulated
									other
	Common		Paid-in			Treasury			comprehensive			Accumulated
	stock		capital			stock			income (loss)			deficit
	(In thousands)

Balance, December 31, 2012	$	205,047	$	1,135,296		$	(104,959	)	$	(48,163	)	$	(990,281	)

Net loss													(49,848	)
Change in unrealized investment gains and losses, net		-		-			-			(123,591	)		-
Common stock issuance (note 14)		135,000		528,335			-			-			-
Reissuance of treasury stock, net		-		(7,892	)		40,524			-			(34,488	)
Equity compensation		-		5,530			-			-			-
Benefit plan adjustments		-		-			-			68,038			-
Unrealized foreign currency translation adjustment		-		-			-			(14,010	)		-

Balance, December 31, 2013	$	340,047	$	1,661,269		$	(64,435	)	$	(117,726	)	$	(1,074,617	)

Net income													59,982
Change in unrealized investment gains and losses, net (note 7)		-		-			-			39,598			-
Reissuance of treasury stock, net		-		(5,712	)		30,530			-			(29,791	)
Equity compensation		-		1,803			-			-			-
Benefit plan adjustments		-		-			-			(1,486	)		-
Unrealized foreign currency translation adjustment		-		-			-			1,253			-

Balance, March 31, 2014	$	340,047	$	1,657,360		$	(33,905	)	$	(78,361	)	$	(1,044,426	)

See accompanying notes to consolidated financial statements.

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended March 31, 2014 and 2013

(Unaudited)

	Three Months Ended
	March 31,

	2014			2013
	(In thousands)
Cash flows from operating activities:
Net income (loss)	$	59,982		$	(72,930	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and other amortization		14,765			22,858
Deferred tax benefit		(86	)		(8	)
Realized investment losses (gains), excluding impairment losses		231			(1,259	)
Loss on repurchases of senior notes		837			-
Other		(22,218	)		6,256
Change in certain assets and liabilities:
Accrued investment income		(151	)		(4,047	)
Prepaid reinsurance premium		(1,828	)		79
Reinsurance recoverable on loss reserves		6,467			8,669
Reinsurance recoverable on paid losses		1,394			2,322
Premium receivable		7,962			(4,813	)
Deferred insurance policy acquisition costs		(433	)		(963	)
Loss reserves		(226,842	)		(208,495	)
Premium deficiency reserve		(5,173	)		(1,650	)
Unearned premiums		5,618			1,373
Income taxes payable (current)		548			899
Net cash used in operating activities		(158,927	)		(251,709	)

Cash flows from investing activities:
Purchase of fixed maturities		(582,261	)		(975,555	)
Purchase of equity securities		(19	)		(18	)
Proceeds from sale of fixed maturities		419,293			361,119
Proceeds from maturity of fixed maturities		295,188			282,701
Net increase in payable for securities		12,692			43,435
Net change in restricted cash		(4	)		-
Net cash provided by (used in) investing activities		144,889			(288,318	)

Cash flows from financing activities:
Net proceeds from convertible senior notes		-			484,670
Common stock shares issued		-			663,542
Repurchases of long-term debt		(21,767	)		-
Net cash (used in) provided by financing activities		(21,767	)		1,148,212

Net (decrease) increase in cash and cash equivalents		(35,805	)		608,185
Cash and cash equivalents at beginning of period		332,692			1,027,625
Cash and cash equivalents at end of period	$	296,887		$	1,635,810

See accompanying notes to consolidated financial statements.

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(Unaudited)

Note 1 – Nature of Business and 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, 2013 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, 2014.

Capital - GSEs

Since 2008, substantially all of our insurance written has been for loans sold to Fannie Mae and Freddie Mac (the “GSEs”), each of which has mortgage insurer eligibility requirements to maintain the highest level of eligibility. The existing eligibility requirements include a minimum financial strength rating of Aa3/AA-. Because MGIC does not meet such financial strength rating requirements (its financial strength rating from Moody’s is Ba3 (with a stable outlook) and from Standard & Poor’s is BB (with a positive outlook)), MGIC is currently operating with each GSE as an eligible insurer under a remediation plan. We believe that the GSEs view remediation plans as a continuing process of interaction with a mortgage insurer and MGIC will continue to operate under a remediation plan for the foreseeable future. The GSEs may include new eligibility requirements as part of our current remediation plan. There can be no assurance that MGIC will be able to continue to operate as an eligible mortgage insurer under a remediation plan.

The GSEs previously advised us that, at the direction of their conservator, the Federal Housing Finance Agency (“FHFA”), they will be revising the eligibility requirements for all mortgage insurers. We expect the revised eligibility standards to include new counterparty financial requirements (the “GSE Counterparty Financial Requirements”). Prior to publicly releasing the draft of the revised eligibility requirements, the FHFA is allowing state insurance regulators a period of time in which to review them on a confidential basis. After considering any changes suggested by the state insurance regulators, the FHFA is expected to release the draft eligibility requirements for public input, which could occur as early as the second quarter of 2014. We have not been informed of the content of the new eligibility requirements, their timeframes for effectiveness, or the length of the public input period.

We have various alternatives available to improve our existing risk-to-capital position, including contributing additional funds that are on hand today from our holding company to MGIC, entering into additional external reinsurance transactions, seeking approval to write business in MIC and raising additional capital, which could be contributed to MGIC. While there can be no assurance that MGIC would meet the GSE Counterparty Financial Requirements by their effective date, we believe we could implement one or more of these alternatives so that we would continue to be an eligible mortgage insurer after the GSE Counterparty Financial Requirements are fully effective. If MGIC (or MIC, under certain circumstances) ceases to be eligible to insure loans purchased by one or both of the GSEs, it would significantly reduce the volume of our new business writings.

See additional disclosure regarding statutory capital in Note 15 – “Statutory Capital.”

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2013 amounts to conform to 2014 presentation.

Restricted cash and cash equivalents

During the second quarter of 2013, approximately $60.3 million was placed in escrow in connection with the two agreements we entered into to resolve our dispute 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”) regarding rescissions. In the fourth quarter of 2013, approximately $42.9 million was released from escrow in connection with the BANA agreement. At March 31, 2014 and December 31, 2013, approximately $17.4 million remains in escrow in connection with the CHL agreement. See additional discussion of these settlement agreements in Note 5 – “Litigation and Contingencies.”

Subsequent events

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

Note 2 - New Accounting Guidance

In July 2013, the FASB issued an update to the accounting standard regarding income taxes. This update provides guidance concerning the balance sheet presentation of an unrecognized tax benefit when a net operating loss carryforward or a tax credit carryforward (the “Carryforwards”) is available. This accounting standard requires an entity to net its liability related to unrecognized tax benefits against the related deferred tax assets for the Carryforwards. A gross presentation will be required when the Carryforwards are not available under the tax law of the applicable jurisdiction or when the Carryforwards would not be used by the entity to settle any additional income taxes resulting from disallowance of the uncertain tax position. This update is effective for fiscal years and interim periods within such years beginning after December 15, 2013. We are currently in compliance with this new guidance. It did not have a significant impact on our consolidated financial statements and disclosures.

Note 3 – Debt

5.375% Senior Notes – due November 2015

At March 31, 2014 and December 31, 2013 we had outstanding $62.0 million and $82.9 million, respectively, of 5.375% Senior Notes due in November 2015. In February 2014, we repurchased $20.9 million in par value of these notes at a cost slightly above par. Interest on these notes is payable semi-annually in arrears on May 1 and November 1 of each year. The description of these Senior Notes, included in our Annual Report on Form 10-K for the year ended December 31, 2013, 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 scheduled interest payments on the Senior Notes for the three months ended March 31, 2014 and 2013, respectively. In the first quarter of 2014, we paid $0.3 million in interest related to our repurchase discussed above.

5% Convertible Senior Notes – due May 2017

At March 31, 2014 and December 31, 2013 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 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 of these 5% Notes, included in our Annual Report on Form 10-K for the year ended December 31, 2013, 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 scheduled interest payments on the 5% Notes for the three months ended March 31, 2014 or 2013.

2% Convertible Senior Notes – due April 2020

At March 31, 2014 and December 31, 2013, we had outstanding $500 million principal amount of 2% Convertible Senior Notes due in 2020 which we issued in March 2013. We received net proceeds of approximately $484.6 million after deducting underwriting discount and offering expenses. Interest on the 2% Notes is payable semi-annually in arrears on April 1 and October 1 of each year. The 2% Notes will mature on April 1, 2020, unless earlier repurchased by us or converted. Prior to January 1, 2020, the 2% Convertible Senior Notes are convertible only upon satisfaction of one or more conditions. One such condition is that during any calendar quarter commencing after March 31, 2014, the last reported sale price of our common stock for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter be greater than or equal to 130% of the applicable conversion price on each applicable trading day. The notes are convertible 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. 130% of such conversion price is $9.03. On or after January 1, 2020, holders may convert their notes irrespective of satisfaction of the conditions. 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 are being 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.

The provisions of the 2% Notes are complex. The description of these 2% Notes, included in our Annual Report on Form 10-K for the year ended December 31, 2013, 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.

There were no scheduled interest payments on the 2% Notes for the three months ended March 31, 2014 or 2013.

9% Convertible Junior Subordinated Debentures – due April 2063

At March 31, 2014 and December 31, 2013 we had outstanding $389.5 million principal amount of 9% Convertible Junior Subordinated Debentures due in 2063 (the “debentures”). The debentures rank junior to all of our existing and future senior indebtedness.

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, and we remain current on all interest payments due. 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.

The provisions of the debentures are complex. The description of these debentures, included in our Annual Report on Form 10-K for the year ended December 31, 2013, 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 scheduled interest payments on the debentures for the three months ended March 31, 2014 or 2013.

All debt

The par value and fair value of our debt at March 31, 2014 and December 31, 2013 appears in the table below.

	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, 2014
Liabilities:
Senior Notes	$	61,953	$	64,121	$	64,121	$	-	$	-
Convertible Senior Notes due 2017		345,000		397,599		397,599		-		-
Convertible Senior Notes due 2020		500,000		703,815		703,815		-		-
Convertible Junior Subordinated Debentures		389,522		464,018		-		464,018		-
Total Debt	$	1,296,475	$	1,629,553	$	1,165,535	$	464,018	$	-

December 31, 2013
Liabilities:
Senior Notes	$	82,883	$	85,991	$	85,991	$	-	$	-
Convertible Senior Notes due 2017		345,000		388,988		388,988		-		-
Convertible Senior Notes due 2020		500,000		685,625		685,625		-		-
Convertible Junior Subordinated Debentures		389,522		439,186		-		439,186		-
Total Debt	$	1,317,405	$	1,599,790	$	1,160,604	$	439,186	$	-

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, 2014, we had approximately $542 million in cash and investments at our holding company. The net unrealized losses on our holding company investment portfolio were approximately $7.1 million at March 31, 2014. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 3.4 years at March 31, 2014.

Note 4 – Reinsurance

In April 2013, we entered into a quota share reinsurance agreement with a group of unaffiliated reinsurers that are not captive reinsurers. These reinsurers primarily have a rating of A or better by Moody’s Investors Service, Standard & Poor’s Rating Services or both. This reinsurance agreement applies to new insurance written between April 1, 2013 and December 31, 2015 (with certain exclusions) and covers incurred losses, with renewal premium through December 31, 2018, at which time the agreement terminates. Early termination of the agreement prior to December 31, 2018 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. In December 2013, we entered into an Addendum to the quota share reinsurance agreement that applies to certain insurance written before April 1, 2013 that has never been delinquent. The structure of the quota share reinsurance agreement remained the same, with the exception that the business written before April 1, 2013 is a 40% quota share. Under the Addendum, policies for which premium was received but unearned as of December 31, 2013 were ceded.

As of March 31, 2014, we have accrued a profit commission receivable of $24.6 million, which is included in "Other assets" on our consolidated balance sheet. This receivable could increase materially through the term of the agreement, but the ultimate amount of the commission will depend on the ultimate level of premiums earned and losses incurred under the agreement. Any profit commission would be paid to us upon termination of the reinsurance agreement.

The reinsurers are required to maintain trust funds or letters of credit to support recoverable balances for reinsurance, such as loss reserves, paid losses, prepaid reinsurance premiums and profit commissions. As such forms of collateral are in place, we have not established an allowance against these balances.

In the past, MGIC had also obtained captive reinsurance. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance. As part of our settlement with the Consumer Financial Protection Bureau (“CFPB”) discussed in Note 5 – “Litigation and Contingencies”, 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 $55 million at March 31, 2014 which was supported by $217 million of trust assets, while at December 31, 2013, the reinsurance recoverable on loss reserves related to captives was $64 million which was supported by $226 million of trust assets. At March 31, 2014 and December 31, 2013 there was an additional $23 million of trust assets in captive agreements where there was no related reinsurance recoverable on loss reserves. See Note 5 – “Litigation and Contingencies” for a discussion of requests or subpoenas for information regarding captive mortgage reinsurance arrangements.

A summary of the effect of our reinsurance agreements on our results for the three months ended March 31, 2014 and 2013 appears below.

	Three Months Ended
	March 31,
	2014		2013
	(In thousands)

Ceded premiums written, net of profit commission	$	26,620	$	6,598

Ceded premiums earned, net of profit commission		24,562		6,407

Ceded losses incurred		6,384		10,913

Ceding commissions		9,133		537

Note 5 – Litigation and Contingencies

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 2013 and the first quarter of 2014, curtailments reduced our average claim paid by approximately 5.8% and 5.9%, respectively. In addition, the claims submitted to us sometimes include costs and expenses not covered by our insurance policies, such as 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.

When reviewing the loan file associated with a claim, we may determine that we have the right to rescind coverage on the loan. Prior to 2008, rescissions of coverage on loans were not a material portion of our claims resolved during a year. However, beginning in 2008, our rescissions of coverage on loans have materially mitigated our paid losses. In 2009 through 2011, rescissions mitigated our paid losses in the aggregate by approximately $3.0 billion; and in 2012, 2013 and the first quarter of 2014, rescissions mitigated our paid losses by approximately $0.3 billion, $135 million and $26 million, respectively (in each case, the figure includes amounts that would have either resulted in a claim payment or been charged to a deductible under a bulk or pool policy, and may have been charged to a captive reinsurer). In recent quarters, approximately 5% of claims received in a quarter have been resolved by rescissions, down from the peak of approximately 28% in the first half of 2009.

We estimate rescissions mitigated our incurred losses by approximately $2.5 billion in 2009 and $0.2 billion in 2010. These figures include the benefit of claims not paid in the period as well as the impact of changes in our estimated expected rescission activity on our loss reserves in the period. In 2012, we estimate that our rescission benefit in loss reserves was reduced by $0.2 billion due to probable rescission settlement agreements. We estimate that other rescissions had no significant impact on our losses incurred in 2011 through the first quarter of 2014. At March 31, 2014, we estimate that our total loss reserves were benefited from anticipated rescissions by approximately $70 million. Our loss reserving methodology incorporates our estimates of future rescissions and reversals of rescissions. Historically, reversals of rescissions have been immaterial. A variance between ultimate actual rescission and reversal rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

If the insured disputes our right to rescind coverage, we generally engage in discussions in an attempt to settle the dispute. As part of those discussions, we may voluntarily suspend rescissions we believe may be part of a settlement. In 2011, Freddie Mac advised its servicers that they must obtain its prior approval for rescission settlements, Fannie Mae advised its servicers that they are prohibited from entering into such settlements and Fannie Mae notified us that we must obtain its prior approval to enter into certain settlements. Since those announcements, the GSEs have consented to our settlement agreements with two customers, one of which is Countrywide, as discussed below, and have rejected other settlement agreements. We have reached and implemented settlement agreements that do not require GSE approval, but they have not been material in the aggregate.

If we are unable to reach a settlement, the outcome of the dispute ultimately would be determined by legal proceedings. Under our policies, legal proceedings disputing our right to rescind coverage may be brought up to three years after the lender has obtained title to the property (typically through a foreclosure) or the property was sold in a sale that we approved, whichever is applicable, although in a few jurisdictions there is a longer time to bring such an action. As of March 31, 2014, the period in which a dispute may be brought has not ended for approximately 26% of our post-2008 rescissions that are not subject to a settlement agreement.

Until a liability associated with a settlement agreement or litigation becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes even though discussions and legal proceedings have been initiated and are ongoing. Under ASC 450-20, an estimated loss from such discussions and proceedings is accrued for only if we determine that the loss is probable and can be reasonably estimated.

Since December 2009, we have been involved in legal proceedings with Countrywide Home Loans, Inc. (“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 insurance rescissions 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.

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 (as amended, the “Agreements”). The Agreement with BANA covers loans purchased by the GSEs. That Agreement was implemented beginning in November 2013 and we resolved all related suspended rescissions in November and December 2013 by paying the associated claim or processing the rescission. The pending arbitration proceedings concerning the loans covered by that agreement have been dismissed, the mutual releases between the parties regarding such loans have become effective and the litigation between the parties regarding such loans is to be dismissed.

The Agreement with CHL covers loans that were purchased by non-GSE investors, including securitization trusts (the “other investors”). That Agreement will be implemented only as and to the extent that it is consented to by or on behalf of the other investors, and any such implementation is expected to occur later in 2014. While there can be no assurance that the Agreement with CHL will be implemented, we have determined that its implementation is probable.

We recorded the estimated impact of the Agreements and another probable settlement in our financial statements for the quarter ending December 31, 2012. We have also recorded the estimated impact of other probable settlements, which in the aggregate have not been material. The estimated impact that we recorded is our best estimate of our loss from these matters. We estimate that the maximum exposure above the best estimate provision we recorded is $484 million, of which about 50% is from rescission practices subject to the Agreement with CHL. If we are not able to implement the Agreement with CHL or the other settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.

The flow policies at issue with Countrywide are in the same form as the flow policies that we used with all of our customers during the period covered by the Agreements, 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.

We are involved in discussions and legal and consensual proceedings with customers with respect to our claims paying practices that are collectively material in amount. These include a previously disclosed curtailment dispute with Countrywide that is in a mediation process. Although it is reasonably possible that, when these discussions or proceedings are completed, we will not prevail in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. We estimate the maximum exposure associated with these discussions and proceedings to be approximately $266 million, although we believe we will ultimately resolve these matters for significantly less than this amount.

The estimates of our maximum exposure referred to above do not include interest or consequential or exemplary damages.

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, has been named as a defendant in twelve lawsuits, alleged to be class actions, filed in various U.S. District Courts. Seven of those cases have previously been dismissed without any further opportunity to appeal. The complaints in all of the cases allege various causes of action related to the captive mortgage reinsurance arrangements of the mortgage lenders, including that the lenders’ captive reinsurers received excessive premiums in relation to the risk assumed by those captives thereby violating RESPA. 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.

In 2013, the U.S. District Court for the Southern District of Florida approved a settlement with the CFPB that resolved a federal investigation of MGIC’s participation in captive reinsurance arrangements in the mortgage insurance industry. The settlement concluded the investigation with respect to MGIC without the CFPB or the court making any findings of wrongdoing. As part of the settlement, MGIC agreed that it 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. MGIC had voluntarily suspended most of its captive arrangements in 2008 in response to market conditions and GSE requests. In connection with the settlement, MGIC paid a civil penalty of $2.65 million and the court issued an injunction prohibiting MGIC from violating any provisions of RESPA.

We received requests from the Minnesota Department of Commerce (the “MN Department”) 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. In August 2013, MGIC and several competitors received a draft Consent Order from the MN Department containing proposed conditions to resolve its investigation, including unspecified penalties. We are engaged in discussions with the MN Department regarding the draft Consent Order. We also received a request 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. Other insurance departments or other officials, including attorneys general, may also seek information about, investigate, or seek remedies regarding captive mortgage reinsurance.

Various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring actions seeking various forms of relief in connection with 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 early 2013, the CFPB issued rules to implement laws requiring mortgage lenders to make ability-to-repay determinations prior to extending credit. We are uncertain whether the CFPB will issue any other rules or regulations that affect our business. Such rules and regulations could have a material adverse effect on us.

In December 2013, the U.S. Treasury Department’s Federal Insurance Office released a report that calls for federal standards and oversight for mortgage insurers to be developed and implemented. It is uncertain what form the standards and oversight will take and when they will become effective.

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.

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. Seven of these lawsuits have been dismissed without any further opportunity to appeal. The remaining lawsuit had also been dismissed by the U.S. District Court, however, the plaintiff in that lawsuit filed a motion for reconsideration by the U.S. District Court and to certify a related question of law to the Supreme Court of the State in which the U.S. District Court is located. In April 2014, that motion for reconsideration was denied, however, the plaintiff may appeal. The damages sought in this remaining case are substantial. We deny any wrongdoing and intend to defend ourselves vigorously against the allegations in the lawsuits.

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. Claims for remedies may be made a number of years after the underwriting work was performed. Beginning in the second half of 2009, our subsidiary experienced an increase in claims for contract underwriting remedies, which continued throughout 2012. The underwriting remedy expense for 2013 and the first quarter of 2014 was approximately $5 million and $2 million, respectively, but may increase in the future.

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 for the three months ended March 31, 2013 because they were anti-dilutive due to our reported net loss. Participating securities of 0.1 million were included in our weighted average number of common shares outstanding for the three months ended March 31, 2014. Typically, diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include certain stock awards 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, 2014 and 2013 common stock equivalents of 54.5 million and 77.3 million, respectively, were not included because they were anti-dilutive.

	Three Months Ended
	March 31,
	2014		2013
	(In thousands, except per share data)

Basic earnings per share:

Net income (loss)	$	59,982	$	(72,930	)

Weighted average common shares outstanding		338,213		232,348
Basic income (loss) per share	$	0.18	$	(0.31	)

Diluted earnings per share:

Net income (loss)	$	59,982	$	(72,930	)

Effect of dilutive securities:
2% Convertible Senior Notes		3,049		-

Net income (loss) plus assumed conversions	$	63,031	$	(72,930	)

Weighted-average shares - Basic		338,213		232,348
Common stock equivalents		74,967		-

Weighted-average shares - Diluted		413,180		232,348
Diluted income (loss) per share	$	0.15	$	(0.31	)

Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at March 31, 2014 and December 31, 2013 are shown below.

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
March 31, 2014	Cost		Gains		Losses (1)			Value
	(In thousands)
U.S. Treasury securities and obligations of U.S.government corporations and agencies	$	550,477	$	1,649	$	(17,078	)	$	535,048
Obligations of U.S. states and political subdivisions		906,385		8,232		(8,490	)		906,127
Corporate debt securities		2,192,333		9,038		(16,621	)		2,184,750
Asset-backed securities		392,435		1,317		(241	)		393,511
Residential mortgage-backed securities		373,314		141		(19,930	)		353,525
Commercial mortgage-backed securities		286,323		569		(4,331	)		282,561
Collateralized loan obligations		61,337		-		(903	)		60,434
Debt securities issued by foreign sovereign governments		40,922		1,885		(237	)		42,570
Total debt securities		4,803,526		22,831		(67,831	)		4,758,526
Equity securities		2,928		38		(11	)		2,955

Total investment portfolio	$	4,806,454	$	22,869	$	(67,842	)	$	4,761,481

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2013	Cost		Gains		Losses (1)			Value
	(In thousands)

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	663,642	$	1,469	$	(25,521	)	$	639,590
Obligations of U.S. states and political subdivisions		932,922		5,865		(17,420	)		921,367
Corporate debt securities		2,190,095		6,313		(24,993	)		2,171,415
Asset-backed securities		399,839		1,100		(453	)		400,486
Residential mortgage-backed securities		383,368		146		(24,977	)		358,537
Commercial mortgage-backed securities		277,920		131		(6,668	)		271,383
Collateralized loan obligations		61,337		-		(1,042	)		60,295
Debt securities issued by foreign sovereign governments		39,420		1,722		(290	)		40,852
Total debt securities		4,948,543		16,746		(101,364	)		4,863,925
Equity securities		2,908		9		(23	)		2,894

Total investment portfolio	$	4,951,451	$	16,755	$	(101,387	)	$	4,866,819

(1) At March 31, 2014 and December 31, 2013, 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 85% of the market value of our foreign investments with the remaining 11% invested in corporate securities and 4% in cash equivalents. Seventy-eight percent of the Australian portfolio is rated AAA, by one or more of Moody’s, Standard & Poor’s and Fitch Ratings, and the remaining 22% is rated AA.

The amortized cost and fair values of debt securities at March 31, 2014, 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, 2014	Cost		Value
	(In thousands)

Due in one year or less	$	609,374	$	610,697
Due after one year through five years		1,842,541		1,847,304
Due after five years through ten years		779,379		765,534
Due after ten years		458,823		444,960

	$	3,690,117	$	3,668,495

Asset-backed securities		392,435		393,511
Residential mortgage-backed securities		373,314		353,525
Commercial mortgage-backed securities		286,323		282,561
Collateralized loan obligations		61,337		60,434

Total at March 31, 2014	$	4,803,526	$	4,758,526

At March 31, 2014 and December 31, 2013, the investment portfolio had gross unrealized losses of $67.8 million and $101.4 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:

	Less Than 12 Months				12 Months or Greater				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2014	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	424,490	$	15,477	$	18,043	$	1,601	$	442,533	$	17,078
Obligations of U.S. states and political subdivisions		377,446		8,445		2,692		45		380,138		8,490
Corporate debt securities		1,072,046		13,570		67,839		3,051		1,139,885		16,621
Asset-backed securities		88,241		185		7,087		56		95,328		241
Residential mortgage-backed securities		90,098		2,765		262,298		17,165		352,396		19,930
Commercial mortgage-backed securities		177,235		4,191		15,256		140		192,491		4,331
Collateralized loan obligations		60,434		903		-		-		60,434		903
Debt securities issued by foreign sovereign governments		9,357		237		-		-		9,357		237
Equity securities		299		6		88		5		387		11
Total investment portfolio	$	2,299,646	$	45,779	$	373,303	$	22,063	$	2,672,949	$	67,842

	Less Than 12 Months				12 Months or Greater				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2013	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	465,975	$	24,980	$	4,103	$	541	$	470,078	$	25,521
Obligations of U.S. states and political subdivisions		503,967		17,370		4,226		50		508,193		17,420
Corporate debt securities		1,238,211		20,371		81,593		4,622		1,319,804		24,993
Asset-backed securities		126,991		387		7,114		66		134,105		453
Residential mortgage-backed securities		91,534		3,886		265,827		21,091		357,361		24,977
Commercial mortgage-backed securities		192,440		6,239		43,095		429		235,535		6,668
Collateralized loan obligations		60,295		1,042		-		-		60,295		1,042
Debt securities issued by foreign sovereign governments		7,203		290		-		-		7,203		290
Equity securities		1,012		18		75		5		1,087		23
Total investment portfolio	$	2,687,628	$	74,583	$	406,033	$	26,804	$	3,093,661	$	101,387

The unrealized losses in all categories of our investments at March 31, 2014 and December 31, 2013 were primarily caused by the difference in interest rates at each respective period, 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 three months ended March 31, 2014 and 2013 there were no other-than-temporary impairments (“OTTI”) recognized.

The net realized investment gains (losses) and OTTI on the investment portfolio are as follows:

		Three Months Ended
		March 31,
		2014			2013
	(In thousands)
Net realized investment gains (losses) and OTTI on investments:
Fixed maturities		$	(234	)	$	1,257
Equity securities			3			2

		$	(231	)	$	1,259

		Three Months Ended
		March 31,
		2014			2013
	(In thousands)
Net realized investment gains (losses) and OTTI on investments:
Gains on sales		$	805		$	1,934
Losses on sales			(1,036	)		(675	)

		$	(231	)	$	1,259

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 tax credit investments. Non-financial assets which utilize Level 3 inputs include real estate acquired through claim settlement.

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.

Our financial assets that are classified as Level 3 securities are primarily state premium tax credit investments. The state premium tax credit investments have an average maturity of under 5 years, credit ratings of AA+, and their balance reflects their remaining scheduled payments discounted at an average annual rate of 7.3%.

Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement that 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, 2014 and December 31, 2013:

	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, 2014

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	535,048	$	535,048	$	-	$	-
Obligations of U.S. states and political subdivisions		906,127		-		903,749		2,378
Corporate debt securities		2,184,750		-		2,184,750		-
Asset-backed securities		393,511		-		393,511		-
Residential mortgage-backed securities		353,525		-		353,525		-
Commercial mortgage-backed securities		282,561		-		282,561		-
Collateralized loan obligations		60,434		-		60,434		-
Debt securities issued by foreign sovereign governments		42,570		42,570		-		-
Total debt securities		4,758,526		577,618		4,178,530		2,378
Equity securities		2,955		2,634		-		321
Total investments	$	4,761,481	$	580,252	$	4,178,530	$	2,699
Real estate acquired (1)	$	11,137	$	-	$	-	$	11,137

	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)

December 31, 2013

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	639,590	$	639,590	$	-	$	-
Obligations of U.S. states and political subdivisions		921,367		-		918,944		2,423
Corporate debt securities		2,171,415		-		2,171,415		-
Asset-backed securities		400,486		-		400,486		-
Residential mortgage-backed securities		358,537		-		358,537		-
Commercial mortgage-backed securities		271,383		-		271,383		-
Collateralized loan obligations		60,295				60,295
Debt securities issued by foreign sovereign governments		40,852		40,852		-		-
Total debt securities		4,863,925		680,442		4,181,060		2,423
Equity securities		2,894		2,573		-		321
Total investments	$	4,866,819	$	683,015	$	4,181,060	$	2,744
Real estate acquired (1)	$	13,280	$	-	$	-	$	13,280

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

There were no transfers of securities between Level 1 and Level 2 during the first three months of 2014 or 2013.

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, 2014 and 2013 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, 2013	$	2,423		$	-	$	321	$	2,744		$	13,280
Total realized/unrealized gains (losses):
Included in earnings and reported as losses incurred, net		-			-		-		-			(1,160	)
Purchases		30			-		-		30			8,010
Sales		(75	)		-		-		(75	)		(8,993	)
Transfers into Level 3		-			-		-		-			-
Transfers out of Level 3		-			-		-		-			-
Balance at March 31, 2014	$	2,378		$	-	$	321	$	2,699		$	11,137

Amount of total losses included in earnings for the three months ended March 31, 2014 attributable to the change in unrealized losses on assets still held at March 31, 2014	$	-		$	-	$	-	$	-		$	-

	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	$	-		$	-		$	-	$	-		$	-

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, 2014 and 2013 was as follows:

	Three Months Ended
	March 31, 2014
								Valuation
		Before tax			Tax effect			allowance			Net of tax
	(In thousands)

Other comprehensive income (loss):
Change in unrealized gains and losses on investments		$	39,661		$	(13,871	)	$	13,808		$	39,598
Benefit plan adjustments			(1,486	)		520			(520	)		(1,486	)
Unrealized foreign currency translation adjustment			1,931			(678	)		-			1,253

Other comprehensive income (loss)		$	40,106		$	(14,029	)	$	13,288		$	39,365

	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	)

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, 2014
	Unrealized gains and
	losses on available-			Defined benefit			Foreign currency
	for-sale securities			plans			translation			Total
	(In thousands)

Balance at December 31, 2013, before tax	$	(84,634	)	$	(3,766	)	$	11,184		$	(77,216	)

Other comprehensive income (loss) before reclassifications		36,672			-			1,931			38,603
Amounts reclassified from accumulated other comprehensive income (loss)		(2,989	)(1)		1,486	(2)		-			(1,503	)
Net current period other comprehensive income (loss)		39,661			(1,486	)		1,931			40,106

Balance at March 31, 2014, before tax	$	(44,973	)	$	(5,252	)	$	13,115		$	(37,110	)

Tax effect (3)		(64,119	)		26,940			(4,072	)		(41,251	)

Balance at March 31, 2014, net of tax	$	(109,092	)	$	21,688		$	9,043		$	(78,361	)

	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 (3)		(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, 2014 and 2013, net unrealized (losses) gains of ($3.0) million and $2.1 million, respectively, were reclassified to the Consolidated Statement of Operations and included in Realized investment gains (losses)

(2)	During the three months ended March 31, 2014, other comprehensive income related to benefit plans of $1.5 million was reclassified to the Consolidated Statement of Operations and included in Underwriting and other expenses, net.

(3)	Tax effect does not approximate 35% due to amounts of tax benefits not provided in various periods due to our tax valuation allowance.

Total accumulated other comprehensive income at December 31, 2013 is included in the table below.

		Unrealized gains and
		losses on available-			Defined benefit			Foreign currency
		for-sale securities			plans			translation			Total
	(In thousands)


Balance at December 31, 2013, before tax			(84,634	)		(3,766	)		11,184			(77,216	)

Tax effect (1)			(64,056	)		26,940			(3,394	)		(40,510	)

Balance at December 31, 2013, net of tax		$	(148,690	)	$	23,174		$	7,790		$	(117,726	)

(1) Tax effect does not approximate 35% due to amounts of tax benefits not provided in various periods due to our tax valuation allowance.

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
			2014			2013			2014			2013
	(In thousands)

Service cost		$	2,080		$	2,717		$	177		$	194
Interest cost			4,009			3,799			183			154
Expected return on plan assets			(5,258	)		(5,038	)		(1,161	)		(920	)
Recognized net actuarial loss			291			1,516			(73	)		-
Amortization of prior service cost			(42	)		125			(1,662	)		(1,663	)

Net periodic benefit cost		$	1,080		$	3,119		$	(2,536	)	$	(2,235	)

We currently do not intend to make any contributions to the plans during 2014.

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 existence and current level of taxable operating income, 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 continue to reduce our benefit from income tax through the recognition of a valuation allowance.

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

	Three Months Ended
	March 31,
	2014			2013
	(In thousands)

Provision for (benefit from) income tax	$	23,120		$	(21,590	)
Change in valuation allowance		(22,394	)		22,729

Provision for income taxes	$	726		$	1,139

The change in the valuation allowance that was included in other comprehensive income for the three months ended March 31, 2014 and 2013 was a decrease of $13.3 million and an increase of $3.0 million, respectively. The total valuation allowance as of March 31, 2014 and December 31, 2013 was $968.6 million and $1,004.2 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, 2014. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.

Tax Contingencies

The Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed 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”). 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 proposed assessments for taxes and penalties related to these matters are $197.5 million and at March 31, 2014 there would also be interest of approximately $157.9 million. In addition, depending on the outcome of this matter, additional state income taxes and state interest may become due when a final resolution is reached. As of March 31, 2014, those state taxes and interest would approximate $46.3 million. In addition, there could also be state tax penalties.

Our total amount of unrecognized tax benefits as of March 31, 2014 is $105.6 million, which represents the tax benefits generated by the REMIC portfolio included in our tax returns that we have not taken benefit for in our financial statements, including any related interest. 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.”

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. The IRS is pursuing this matter in full and we currently expect to be in litigation on this matter in 2014. Any such litigation could be lengthy and costly in terms of legal fees and related expenses.

The IRS is currently conducting an examination of our federal income tax returns for the years 2011 and 2012, which is scheduled to be completed in 2014.

The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue, that would affect our effective tax rate is $93.0 million, after taking into account the effect of NOL carrybacks. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. As of March 31, 2014 and December 31, 2013, we had accrued $26.3 million and $26.1 million, respectively, for the payment of interest.

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 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 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. 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, 2014 and 2013:

	Three Months Ended
	March 31,
	2014			2013
	(In thousands)

Reserve at beginning of period	$	3,061,401		$	4,056,843
Less reinsurance recoverable		64,085			104,848
Net reserve at beginning of period		2,997,316			3,951,995

Losses incurred:
Losses and LAE incurred in respect of default notices related to:
Current year		155,982			268,793
Prior years (1)		(33,374	)		(2,585	)
Subtotal		122,608			266,208

Losses paid:
Losses and LAE paid in respect of default notices related to:
Current year		314			246
Prior years		342,669			468,933
Reinsurance terminations (2)		-			(3,145	)
Subtotal		342,983			466,034

Net reserve at end of period (3)		2,776,941			3,752,169
Plus reinsurance recoverables		57,618			96,179

Reserve at end of period	$	2,834,559		$	3,848,348

(1)	A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves and a positive number for prior year losses incurred indicates a deficiency of prior year loss reserves.

(2)

In a termination, the reinsurance agreement is cancelled, with no future premium ceded and funds for any incurred but unpaid losses transferred to us. The transferred funds result in an increase in our investment portfolio (including cash and cash equivalents) and a decrease in net losses paid (reduction to losses incurred). In addition, there is an offsetting decrease in the reinsurance recoverable (increase in losses incurred), and thus there is no net impact to losses incurred.

(3)	At March 31, 2014 and 2013, the estimated reduction in loss reserves related to rescissions approximated $70 million and $0.2 billion, respectively.

The “Losses incurred” section of the table above shows losses incurred on default notices received in the current year and in prior years. The amount of losses incurred relating to default notices received in the current year represents the estimated amount to be ultimately paid on such default notices. The amount of losses incurred relating to default notices received in prior years represents the actual claim rate and severity associated with those defaults notices resolved in the current year differing from the estimated liability at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory from the end of the prior year. This re-estimation of the estimated claim rate and estimated severity is the result of our review of current trends in the default inventory, such as percentages of defaults that have resulted in a claim, the amount of the claims, changes in the relative level of defaults by geography and changes in average loan exposure.

Losses incurred on default notices received in the current year decreased in the first three months of 2014 compared to the same period in 2013, primarily due to a decrease in the number of new default notices received, net of cures, as well as a decrease in the estimated claim rate on new and previously received delinquencies.

The prior year development of the reserves in the first three months of 2014 and 2013 is reflected in the table below.

	Three months ended March 31,
	2014			2013
	(In millions)
Prior year loss development (1):

Decrease in estimated claim rate on primary defaults	$	(30	)	$	(15	)
Increase in estimated severity on primary defaults		5			20
Change in estimates related to pool reserves, LAE reserves and reinsurance		(8	)		(8	)
Total prior year loss development	$	(33	)	$	(3	)

(1) A negative number for prior year loss development indicates a redundancy of prior year loss reserves, and a positive number indicates a deficiency of prior year loss reserves.

The prior year loss development was based on the resolution of approximately 25% and 23% for the three months ended March 31, 2014 and 2013, respectively of the prior year default inventory, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory from the end of the prior year and estimated incurred but not reported items from the end of the prior year. In the first three months of 2014 and 2013, we recognized favorable development on our estimated claim rate as we experienced a better cure rate on previously received delinquencies.

The “Losses paid” section of the table above shows the breakdown between claims paid on default notices received in the current year, claims paid on default notices received in prior years and the decrease in losses paid related to terminated reinsurance agreements as noted in footnote (2) of that table. Until a few years ago, it took, on average, approximately twelve months for a default that is not cured to develop into a paid claim. Over the past several years, the average time it takes to receive a claim associated with a default has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. It is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims.

The liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at March 31, 2014 and December 31, 2013 and approximated $126 million and $131 million, respectively. Separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.

A rollforward of our primary default inventory for the three months ended March 31, 2014 and 2013 appears in the table below. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and by transfers of servicing between loan servicers.

	Three Months Ended
	March 31,
	2014		2013

Default inventory at beginning of period		103,328		139,845
New Notices		23,346		27,864
Cures