Edgar Filing: MGIC INVESTMENT CORP

CLASS OF STOCK

NUMBER OF SHARES

Common stock

April 29, 2016

10-Q

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, 2016
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.

Forward Looking and Other Statements

All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are “forward looking statements.” Forward looking statements consist of statements that relate to matters other than historical fact. In most cases, forward looking statements may be identified by words such as “believe,” “anticipate” or “expect,” or words of similar import. The risk factors referred to in “Forward Looking Statements and Risk Factors – Location of Risk Factors” in Management’s Discussion and Analysis of Financial Condition and Results of Operations below, may cause our actual results to differ materially from the results contemplated by forward looking statements that we may make. We are not undertaking any obligation to update any forward looking statements or other statements we may make in this document even though these statements may be affected by events or circumstances occurring after the forward looking statements or other statements were made. Therefore no reader of this document should rely on these statements being current as of any time other than the time at which this document was filed with the Securities and Exchange Commission.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2016



TABLE OF CONTENTS
		Page
PART I — FINANCIAL INFORMATION
Item 1	Consolidated Financial Statements:
	Consolidated Balance Sheets (Unaudited) - March 31, 2016 and December 31, 2015	4
	Consolidated Statements of Operations (Unaudited) - Three Months Ended March 31, 2016 and 2015	5
	Consolidated Statements of Comprehensive Income (Unaudited) - Three Months Ended March 31, 2016 and 2015	6
	Consolidated Statements of Shareholders’ Equity (Unaudited) - Three Months Ended March 31, 2016 and 2015	7
	Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended March 31, 2016 and 2015	8
	Notes to Consolidated Financial Statements (Unaudited)	9

Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	31

Item 3	Quantitative and Qualitative Disclosures about Market Risk	53

Item 4	Controls and Procedures	53

PART II — OTHER INFORMATION
Item 1	Legal Proceedings	54

Item 1A	Risk Factors	54

Item 6	Exhibits	55

SIGNATURES		56
INDEX TO EXHIBITS		57

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)



(In thousands)	March 31, 2016			December 31, 2015
ASSETS
Investment Portfolio (notes 7 and 8):
Securities, available-for-sale, at fair value:
Fixed maturities (amortized cost, 2016 - $4,506,178; 2015 - $4,684,148)	$	4,557,914		$	4,657,561
Equity securities	6,289			5,645
Total investment portfolio	4,564,203			4,663,206
Cash and cash equivalents	249,898			181,120
Accrued investment income	39,019			40,224
Reinsurance recoverable on loss reserves (note 4)	41,119			44,487
Reinsurance recoverable on paid losses	3,855			3,319
Premiums receivable	47,185			48,469
Home office and equipment, net	31,047			30,095
Deferred insurance policy acquisition costs	15,946			15,241
Deferred income taxes, net (note 11)	702,400			762,080
Other assets	78,731			80,102
Total assets	$	5,773,403		$	5,868,343

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Loss reserves (note 12)	$	1,753,389		$	1,893,402
Unearned premiums	289,879			279,973
Federal Home Loan Bank advance (note 3)	155,000			—
Convertible senior notes (note 3)	685,624			822,301
Convertible junior subordinated debentures (note 3)	256,872			389,522
Other liabilities	289,240			247,005
Total liabilities	3,430,004			3,632,203
Contingencies (note 5)
Shareholders’ equity (note 13):
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2016 - 341,076; 2015 - 340,097; shares outstanding 2016 - 340,636; 2015 - 339,657)	341,076			340,097
Paid-in capital	1,657,783			1,670,238
Treasury stock at cost (shares - 440)	(3,362		)	(3,362		)
Accumulated other comprehensive loss, net of tax (note 9)	(11,336		)	(60,880		)
Retained earnings	359,238			290,047
Total shareholders’ equity	2,343,399			2,236,140
Total liabilities and shareholders’ equity	$	5,773,403		$	5,868,343

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



	Three Months Ended March 31,
(In thousands, except per share data)	2016			2015
Revenues:
Premiums written:
Direct	$	265,291		$	265,412
Assumed	208			338
Ceded (note 4)	(34,218		)	(31,294		)
Net premiums written	231,281			234,456
Increase in unearned premiums, net	(9,940		)	(17,168		)
Net premiums earned	221,341			217,288
Investment income, net of expenses	27,809			24,120
Net realized investment gains (losses):
Total other-than-temporary impairment losses	—			—
Portion of losses recognized in comprehensive income, before taxes	—			—
Net impairment losses recognized in earnings	—			—
Other realized investment gains	3,056			26,327
Net realized investment gains	3,056			26,327
Other revenue	6,373			2,480
Total revenues	258,579			270,215

Losses and expenses:
Losses incurred, net (note 12)	85,012			81,785
Change in premium deficiency reserve	—			(6,418		)
Amortization of deferred policy acquisition costs	1,961			1,757
Other underwriting and operating expenses, net	39,777			39,268
Interest expense	14,701			17,362
Loss on debt extinguishment (note 3)	13,440			—
Total losses and expenses	154,891			133,754

Income before tax	103,688			136,461
Provision for income taxes (note 11)	34,497			3,385

Net income	$	69,191		$	133,076

Income per share (note 6)
Basic	$	0.20		$	0.39
Diluted	$	0.17		$	0.32

Weighted average common shares outstanding - basic (note 6)	340,144			339,107
Weighted average common shares outstanding - diluted (note 6)	431,365			468,121

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)



	Three Months Ended March 31,
(In thousands)	2016			2015
Net income	$	69,191		$	133,076
Other comprehensive income (loss), net of tax (note 9):
Change in unrealized investment gains and losses (note 7)	50,827			19,563
Benefit plan adjustments	(308		)	(700		)
Foreign currency translation adjustment	(975		)	(2,014		)
Other comprehensive income (loss), net of tax	49,544			16,849
Comprehensive income	$	118,735		$	149,925

See accompanying notes to consolidated financial statements

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)



	Three Months Ended March 31,
(In thousands)	2016			2015
Common stock
Balance, beginning of period	$	340,097		$	340,047
Net common stock issued under share-based compensation plans	979			32
Balance, end of period	341,076			340,079

Paid-in capital
Balance, beginning of period	1,670,238			1,663,592
Net common stock issued under share-based compensation plans	(5,949		)	38
Reissuance of treasury stock, net	—			(7,251		)
Tax benefit from share-based compensation	115			2,568
Equity compensation	3,129			3,264
Reacquisition of convertible junior subordinated debentures-equity component	(9,750		)	—
Balance, end of period	1,657,783			1,662,211

Treasury stock
Balance, beginning of period	(3,362		)	(32,937		)
Reissuance of treasury stock, net	—			29,575
Balance, end of period	(3,362		)	(3,362		)

Accumulated other comprehensive income (loss)
Balance, beginning of period	(60,880		)	(81,341		)
Other comprehensive income	49,544			16,849
Balance, end of period	(11,336		)	(64,492		)

Retained earnings (deficit)
Balance, beginning of period	290,047			(852,458		)
Net income	69,191			133,076
Reissuance of treasury stock, net	—			(29,494		)
Balance, end of period	359,238			(748,876		)

Total shareholders’ equity	$	2,343,399		$	1,185,560

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three Months Ended March 31,
(In thousands)	2016			2015
Cash flows from operating activities:
Net income	$	69,191		$	133,076
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization	14,109			11,311
Deferred tax expense (benefit)	33,270			(11		)
Realized investment gains, net	(3,056		)	(26,327		)
Excess tax benefits related to share-based compensation	(115		)	(2,568		)
Payment of original issue discount-convertible junior subordinated debentures	(41,540		)	—
Change in certain assets and liabilities:
Accrued investment income	1,205			(1,596		)
Prepaid insurance premium	34			(2,496		)
Reinsurance recoverable on loss reserves	3,368			2,426
Reinsurance recoverable on paid losses	(536		)	458
Premium receivable	1,284			(1,812		)
Deferred insurance policy acquisition costs	(705		)	(1,011		)
Profit commission receivable	760			(23,474		)
Loss reserves	(140,013		)	(152,183		)
Premium deficiency reserve	—			(6,418		)
Unearned premiums	9,906			19,639
Return premium accrual	(4,850		)	3,300
Income taxes payable - current	289			287
Other	869			14,691
Net cash used in operating activities	(56,530		)	(32,708		)

Cash flows from investing activities:
Purchases of investments:
Fixed maturities	(288,273		)	(940,867		)
Equity securities	(3,109		)	(18		)
Proceeds from sales of fixed maturities	315,927			795,968
Proceeds from maturity of fixed maturities	139,863			192,463
Proceeds from sale of equity securities	2,525			—
Net increase in payable for securities	44,289			699
Net decrease in restricted cash	—			17,212
Additions to property and equipment	(1,916		)	(576		)
Net cash provided by investing activities	209,306			64,881

Cash flows from financing activities:
Proceeds from issuance of long-term debt	155,000			—
Purchase of convertible senior notes	(138,253		)	—
Purchase of convertible junior subordinated debentures-liability component	(91,110		)	—
Purchase of convertible junior subordinated debentures-equity component	(9,750		)	—
Excess tax benefits related to share-based compensation	115			2,568
Net cash (used in) provided by financing activities	(83,998		)	2,568

Net increase in cash and cash equivalents	68,778			34,741
Cash and cash equivalents at beginning of period	181,120			197,882
Cash and cash equivalents at end of period	$	249,898		$	232,623

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

Note 1 – Nature of Business and Basis of Presentation

MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation (“MGIC”) is principally engaged in the mortgage insurance business. We provide mortgage insurance to lenders throughout the United States and to government sponsored entities 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, 2015 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 consolidated financial position and consolidated results of operations for the periods indicated. The consolidated results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2016.

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2015 amounts to conform to 2016 presentation. See Note 2 - “New Accounting Pronouncements” for a discussion of our adoption of accounting guidance related to the presentation of debt issuance costs in the first quarter of 2016, with retrospective application to prior periods.

Subsequent events

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

Note 2 – New Accounting Pronouncements

Adopted Accounting Standards

Presentation of Debt Issuance Costs

In April 2015, the Financial Accounting Standards Board (“FASB”) issued updated guidance related to the presentation of debt issuance costs. The new standard requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge, consistent with the treatment of debt discounts. The updated guidance was effective for reporting periods beginning after December 15, 2015. The adoption of this guidance as of March 31, 2016 has been applied retrospectively to prior periods. See Note 3 - “Debt” for the reclassification made to our consolidated balance sheet as of December 31, 2015. The adoption of this guidance had no impact on our statements of operations or retained earnings.

Accounting for Share-Based Compensation When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period

In June 2014, the FASB issued updated guidance to resolve diversity in practice concerning employee shared-based compensation that contains performance targets that could be achieved after the requisite service period. No explicit guidance on how to account for these types of performance share-based compensation awards existed prior to this update. The updated guidance requires that a performance target that affects vesting and that can be achieved after the requisite service period be treated as a performance condition. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which service has been rendered. If the performance target becomes probable of being achieved before the end of the service period, the remaining unrecognized compensation cost for which requisite service has not yet been rendered is recognized prospectively over the remaining service period. The total amount of compensation cost recognized during and after the service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The updated guidance was effective for reporting periods after December 15, 2015. The adoption of this guidance as of March 31, 2016, with application to awards granted during the first quarter of 2016, is not expected to have a material impact on our consolidated financial statements.

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Prospective Accounting Standards

Improvements to Employee Share-Based Compensation Accounting

In March 2016, the FASB issued updated guidance that simplifies several aspects of the accounting for employee share-based compensation including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of related amounts within the statement of cash flows. The updated guidance requires that, prospectively, all tax effects related to share-based compensation be made through the statement of operations at the time of settlement as opposed to excess tax benefits being recognized in paid-in capital under the current guidance. The updated guidance also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based compensation are to be reported as operating activities on the statement of cash flows, a change from the existing requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, for tax withholding purposes, entities will be allowed to withhold an amount of shares up to the employee’s maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. The change in withholding requirements will be applied on a modified retrospective approach. The updated guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements.

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued updated guidance to address the recognition, measurement, presentation, and disclosure of certain financial instruments. The updated guidance requires equity investments, except those accounted for under the equity method of accounting, that have a readily determinable fair value to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have readily determinable fair values may be remeasured at fair value either upon the occurrence of an observable price change or upon identification of an impairment. A qualitative assessment for impairment is required for equity investments without readily determinable fair values. The updated guidance also eliminates the requirement to disclose the method and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost on the balance sheet. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods and will require recognition of a cumulative effect adjustment at adoption. We do not currently expect the adoption

of this guidance to impact our consolidated financial position or liquidity.

Disclosures about Short-Duration Contracts

In May 2015, the FASB issued updated guidance requiring expanded disclosures for insurance entities that issue short-duration contracts. The expanded disclosures are designed to provide additional insight into an insurance entity’s ability to underwrite and anticipate costs associated with claims. The disclosures include information about incurred and paid claims development, on a net of reinsurance basis, for the number of years claims incurred typically remain outstanding, not to exceed ten years. Each period presented in the disclosure about claims development that precedes the current reporting periods is considered supplementary information. The expanded disclosures also include more transparent information about significant changes in methodologies and assumptions used to estimate claims, and the timing, frequency, and severity of claims. The disclosures required by this update are effective for annual periods beginning after December 31, 2015, and interim periods within annual periods beginning after December 31, 2016, and is to be applied retrospectively. We are evaluating the applicability and impact, if any, of the new disclosure requirements.

Note 3 – Debt

2016 debt transactions

During the first quarter of 2016, market conditions allowed us to complete a series of transactions that repositioned the maturity profile of our debt and lowered our interest expense. These transactions, including the amounts and accounting impacts, are discussed below.

5% Convertible Senior Notes

During the first quarter of 2016, we purchased $138.3 million in par value of our 5% Convertible Senior Notes (the “5% Notes”) due in 2017 at a purchase price of $143.4 million, plus accrued interest using funds held at our holding company. The excess of the purchase price over par value is reflected as a loss on debt extinguishment and outstanding debt issuance costs on the purchased debt were recognized as interest expense on our consolidated statement of operations for the three months ended March 31, 2016. The purchases of the 5% Notes reduced our potentially dilutive shares by approximately 10.3 million shares.

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9% Convertible Junior Subordinated Debentures

In February 2016, MGIC purchased $132.7 million of par value of our 9% Convertible Junior Subordinated Debentures (the “9% Debentures”) due in 2063 at a purchase price of $150.7 million, plus accrued interest. The 9% Debentures include a conversion feature that allows us, at our option, to make a cash payment to converting holders in lieu of issuing shares of common stock upon conversion of the 9% Debentures. The accounting standards applicable to extinguishment of debt with a cash conversion feature require the consideration paid to be allocated between the extinguishment of the liability component and reacquisition of the equity component. The purchase of the 9% Debentures resulted in an $8.3 million loss on debt extinguishment on the consolidated statement of operations for the three months ended March 31, 2016, which represents the difference between the fair value and the carrying value of the liability component on the purchase date. In addition, our shareholders’ equity was separately reduced by $9.8 million related to the reacquisition of the equity component. For GAAP accounting purposes, the 9% Debentures owned by MGIC are considered retired and are eliminated in our consolidated financial statements and the underlying common stock equivalents, approximately 9.8 million shares, are not included in the computation of diluted shares.

Federal Home Loan Bank Advance

In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the Federal Home Loan Bank (“FHLB”) (the “Advance”) to provide funds used to purchase the 9% Debentures. Interest on the Advance is payable monthly at an annual rate, fixed for the term of the Advance, of 1.91%. The principal of the Advance matures on February 10, 2023. MGIC may prepay the Advance at any time. Such prepayment would be below par if interest rates have risen after the Advance was originated, or above par if interest rates have declined. The Advance is secured by eligible collateral whose market value must be maintained at 102% of the principal balance of the Advance. MGIC provided eligible collateral from its investment portfolio.

Accounting standard update

As of March 31, 2016 we adopted the accounting update related to the presentation of debt issuance costs in the financial statements. The change in accounting guidance has been applied retrospectively to prior periods. As a result, a reclassification of approximately $11.2 million of debt issuance costs was made on our December 31, 2015 balance sheet, resulting in a reduction to other assets and a reduction to long-term debt; there was no impact on our consolidated statement of operations or retained earnings.

The impact of the reclassification of debt issuance costs on our outstanding debt obligations as of December 31, 2015 is as follows.



	December 31, 2015
(In millions)	As previously reported		Adjustment			As Adjusted
Convertible Senior Notes, interest at 5% per annum, due May 2017	$	333.5	$	(2.0	)	$	331.5
Convertible Senior Notes, interest at 2% per annum, due April 2020	500.0		(9.2		)	490.8
Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063	389.5		—			389.5
Total long-term debt	$	1,223.0	$	(11.2	)	$	1,211.8

The carrying amount of our debt obligations as of March 31, 2016 and December 31, 2015 (as adjusted) was as follows.



(In millions)	March 31, 2016		December 31, 2015
FHLB Advance, interest at 1.91% per annum, due February 2023	$	155.0	$	—
Convertible Senior Notes, interest at 5% per annum, due May 2017 ⁽¹⁾	194.3		331.5
Convertible Senior Notes, interest at 2% per annum, due April 2020 ^{(2) (3)}	491.3		490.8
Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063 ⁽⁴⁾	256.9		389.5
Total long-term debt	$	1,097.5	$	1,211.8


⁽¹⁾	Convertible at any time prior to maturity at the holder’s option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount, representing an initial conversion price of approximately $13.44 per share.

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⁽²⁾

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 2% Notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount, representing 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.

⁽³⁾

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 rate 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 each of at least 20 of the 30 consecutive trading days preceding notice of the redemption.

⁽⁴⁾

Convertible at any time prior to maturity at the holder’s option, at an initial conversion rate, which is subject to adjustment, of 74.0741 shares per $1,000 principal amount, representing 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.

The Convertible Senior Notes and Convertible Junior Subordinated Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. As of March 31, 2016, we had approximately $265 million in cash and investments at our holding company. The net unrealized gains on our holding company investment portfolio were approximately $0.1 million as of March 31, 2016. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 2.4 years at March 31, 2016.

Interest payments on our debt obligations appear below.



	Three Months Ended March 31,
(In millions)	2016		2015
FHLB Advance, interest at 1.91% per annum, due February 2023	$	0.2	$	—
Convertible Senior Notes, interest at 5% per annum, due May 2017	1.8		—
Convertible Senior Notes, interest at 2% per annum, due April 2020	—		—
Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063	4.3		—
Total interest payments	$	6.3	$	—

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Note 4 – Reinsurance

The effect of all reinsurance agreements on premiums earned and losses incurred is as follows:



	Three Months Ended March 31,
(In thousands)	2016			2015
Premiums earned:
Direct	$	255,387		$	245,748
Assumed	208			338
Ceded	(34,254		)	(28,798		)
Net premiums earned	$	221,341		$	217,288

Losses incurred:
Direct	$	92,432		$	88,036
Assumed	101			568
Ceded	(7,521		)	(6,819		)
Net losses incurred	$	85,012		$	81,785

Quota share reinsurance

Effective July 1, 2015, we entered into a quota share reinsurance agreement (“2015 QSR Transaction”) and commuted our prior 2013 quota share reinsurance agreement (“2013 QSR Transaction”). The group of unaffiliated reinsurers are the same under our 2015 QSR Transaction as our prior 2013 QSR Transaction and each has an insurer financial strength rating of A- or better by Standard and Poor’s Rating Services, A.M. Best or both. The 2015 QSR Transaction provides coverage on policies that were in the 2013 QSR Transaction; additional qualifying in force policies as of the agreement effective date which either had no history of defaults, or where a single default had been cured for twelve or more months at the agreement effective date; and all qualifying new insurance written through December 31, 2016. The agreement cedes losses incurred and premiums on or after the effective date through December 31, 2024, at which time the agreement expires.

The 2015 QSR Transaction increased the amount of our insurance in force covered by reinsurance and will result in an increase in the amount of premiums and losses ceded. A higher level of losses ceded will reduce our profit commission and in turn will reduce our premium yield. Early termination of the agreement can be elected by us effective December 31, 2018 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the private mortgage insurer eligibility requirements (“PMIERs”) of Fannie Mae and Freddie Mac (collectively, the “GSEs”) for the risk ceded in any required calculation period. The structure of the 2015 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2015 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.

A summary of our quota share reinsurance agreements, excluding captive agreements, for the three months ended March 31, 2016 and 2015 appears as follows.



	Three Months Ended March 31,
(In thousands)	2016		2015
2013 QSR Transaction
Ceded premiums written, net of profit commission	n/a		$	27,136
Ceded premiums earned, net of profit commission	n/a		24,613
Ceded losses incurred	n/a		4,873
Ceding commissions ⁽²⁾	n/a		10,122
Profit commission	n/a		23,474

2015 QSR Transaction (Effective July 1, 2015)
Ceded premiums written, net of profit commission ⁽¹⁾	$	31,666	n/a
Ceded premiums earned, net of profit commission ⁽¹⁾	31,666		n/a
Ceded losses incurred	8,513		n/a
Ceding commissions ⁽²⁾	11,576		n/a
Profit commission	26,215		n/a


⁽¹⁾	Effective July 1, 2015 premiums are ceded on an earned and received basis as defined in our 2015 QSR Transaction.


⁽²⁾	Ceding commissions are reported within Other underwriting and operating expenses, net on the consolidated statements of operations.

Under the terms of the 2015 QSR Transaction, reinsurance premiums, ceding commission and profit commission are settled net on a quarterly basis. The reinsurance premium due after deducting the related ceding commission and profit commission is reported within “Other liabilities” on the consolidated balance sheets.

The reinsurance recoverable on loss reserves related to our 2015 QSR Transaction was $18 million as of March 31, 2016 and $11 million as of December 31, 2015. The reinsurance recoverable balance is secured by funds on deposit from the reinsurers which are based on the funding requirements of PMIERs that address ceded risk.

Captive reinsurance

In the past, MGIC 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”) in 2013 and with the Minnesota Department of Commerce (the “MN Department”) in 2015, discussed in Note 5 – “Litigation and Contingencies,” MGIC has agreed to not enter

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into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years subsequent to the respective settlements. In accordance with the CFPB settlement, all of our active captive arrangements were placed into run-off. In addition, the GSEs will not approve any future reinsurance or risk sharing transaction with a mortgage enterprise or an affiliate of a mortgage enterprise.

Captive agreements were generally written on an annual book of business and each captive reinsurer is required to maintain a separate trust account to support its combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trusts, and the trust accounts are made up of capital deposits by the captive reinsurers, premium deposits by MGIC, and investment income earned. The reinsurance recoverable on loss reserves related to captive agreements was $23 million as of March 31, 2016 which was supported by $123 million of trust assets, while as of December 31, 2015, the reinsurance recoverable on loss reserves related to captive agreements was $34 million, which was supported by $137 million of trust assets.

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. We call such reduction of claims “curtailments.” In 2015 and the first quarter of 2016, curtailments reduced our average claim paid by approximately 6.7% and 5.1%, respectively. After we pay a claim, servicers and insureds sometimes object to our curtailments and other adjustments.

When reviewing the loan file associated with a claim, we may determine that we have the right to rescind coverage on the loan. (In our SEC reports, we refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term.) 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. Our loss reserving methodology incorporates our estimates of future rescissions, curtailments, and reversals of rescissions and curtailments. A variance between ultimate actual rescission, curtailment 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 curtail claims or rescind coverage, we generally engage in discussions in an attempt to settle the dispute. If we are unable to reach a settlement, the outcome of a dispute ultimately would be determined by legal proceedings.

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 may 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. The estimated impact that we have recorded is our best estimate of our loss from these matters. If we are not able to implement settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.

In addition to the probable settlements for which we have recorded a loss, we are involved in other discussions and/or proceedings with insureds with respect to our claims paying practices. Although it is reasonably possible that when these matters are resolved 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 matters where a loss is reasonably possible to be approximately $193 million, although we believe we will ultimately resolve these matters for significantly less than this amount.

This estimate includes the maximum exposure for losses that we have determined are probable in excess of the provision we have recorded for such losses. The estimates of our maximum exposure referred to above do not include interest or consequential or exemplary damages.

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 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in 2004, following denial of class certification. Beginning in 2011, MGIC, together with various mortgage lenders and other mortgage insurers, was named as a defendant in twelve lawsuits, alleged to be class actions, filed in various U.S. District Courts. The complaints in all of the cases alleged 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. As of 2015, MGIC had been dismissed from all twelve cases. 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 would not have a material adverse effect on us.

In 2013, we entered into a settlement with the CFPB that resolved a federal investigation of MGIC’s participation in captive reinsurance arrangements without the CFPB or a 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

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and the court issued an injunction prohibiting MGIC from violating any provisions of RESPA.

In 2015, MGIC executed a Consent Order with the MN Department that resolved that department’s investigation of captive reinsurance matters without making any findings of wrongdoing. The Consent Order provided, among other things, that MGIC is prohibited from entering into any new captive reinsurance agreement or reinsuring any new loans under any existing captive reinsurance agreement for a period of ten years.

Various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring other actions seeking various forms of relief in connection with alleged 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.

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 2015 was approximately $1 million, but may increase in the future.

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.

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

Note 6 – Earnings per Share

Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common equivalent shares outstanding during the reporting period. We calculate diluted EPS using the treasury stock method for unvested restricted stock, and the if-converted method for convertible debt instruments. For unvested restricted stock, assumed proceeds under the treasury stock method would include unamortized compensation expense and windfall tax benefits or shortfalls. The determination of potentially issuable shares from our convertible debt instruments does not consider satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the beginning of the period, if dilutive. In addition, interest expense, net of tax, related to dilutive convertible debt instruments is added back to earnings in calculating diluted EPS.

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The following table reconciles the numerators and denominators used to calculate basic and diluted EPS and also indicates the number of antidilutive securities.



	Three months ended March 31,
(In thousands, except per share data)	2016		2015
Basic earnings per share:
Net income	$	69,191	$	133,076
Weighted average common shares outstanding	340,144		339,107
Basic income per share	$	0.20	$	0.39

Diluted earnings per share:
Net income	$	69,191	$	133,076
Interest expense, net of tax ⁽¹⁾:
2% Convertible Senior Notes due 2020	1,982		3,049
5% Convertible Senior Notes due 2017	2,678		4,692
9% Convertible Junior Subordinated Debentures due 2063	—		8,765
Diluted income available to common shareholders	$	73,851	$	149,582

Weighted average shares - basic	340,144		339,107
Effect of dilutive securities:
Unvested restricted stock units	1,679		2,569
2% Convertible Senior Notes due 2020	71,917		71,917
5% Convertible Senior Notes due 2017	17,625		25,674
9% Convertible Junior Subordinated Debentures due 2063	—		28,854
Weighted average shares - diluted	431,365		468,121
Diluted income per share	$	0.17	$	0.32

Antidilutive securities (in millions)	23.3		—


⁽¹⁾	Due to the valuation allowance recorded against deferred tax assets, the three months ended March 31, 2015 were not tax effected. The three months ended March 31, 2016 have been tax effected at a rate of 35%.

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Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at March 31, 2016 and December 31, 2015 are shown below.



March 31, 2016
(In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses ⁽¹⁾			Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	147,189	$	2,474	$	(1,135	)	$	148,528
Obligations of U.S. states and political subdivisions	1,854,959		60,677		(2,506		)	1,913,130
Corporate debt securities	1,856,376		16,315		(18,484		)	1,854,207
Asset-backed securities	110,241		176		(89		)	110,328
Residential mortgage-backed securities	255,344		452		(5,155		)	250,641
Commercial mortgage-backed securities	220,719		1,678		(1,701		)	220,696
Collateralized loan obligations	61,350		25		(991		)	60,384
Total debt securities	4,506,178		81,797		(30,061		)	4,557,914
Equity securities	6,209		87		(7		)	6,289
Total investment portfolio	$	4,512,387	$	81,884	$	(30,068	)	$	4,564,203



December 31, 2015
(In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses ⁽¹⁾			Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	160,393	$	2,133	$	(1,942	)	$	160,584
Obligations of U.S. states and political subdivisions	1,766,407		33,410		(7,290		)	1,792,527
Corporate debt securities	2,046,697		2,836		(44,770		)	2,004,763
Asset-backed securities	116,764		56		(203		)	116,617
Residential mortgage-backed securities	265,879		161		(8,392		)	257,648
Commercial mortgage-backed securities	237,304		162		(3,975		)	233,491
Collateralized loan obligations	61,345		3		(1,148		)	60,200
Debt securities issued by foreign sovereign governments	29,359		2,474		(102		)	31,731
Total debt securities	4,684,148		41,235		(67,822		)	4,657,561
Equity securities	5,625		38		(18		)	5,645
Total investment portfolio	$	4,689,773	$	41,273	$	(67,840	)	$	4,663,206


⁽¹⁾	At March 31, 2016 and December 31, 2015, there were no other-than-temporary impairment losses recorded in other comprehensive income.

During the first quarter of 2016, we substantially liquidated our Australian entities and repatriated most assets, including proceeds from the monetization of our Australian investment portfolio. As of March 31, 2016 we held no investments in foreign sovereign governments.

As discussed in Note 3 - “Debt” we are required to maintain collateral of at least 102% of the outstanding principal balance of the Advance. As of March 31, 2016 we pledged eligible collateral with a total fair value of $164.6 million.

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The amortized cost and fair values of debt securities at March 31, 2016, 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.



March 31, 2016
(In thousands)	Amortized Cost		Fair Value
Due in one year or less	$	310,484	$	311,202
Due after one year through five years	1,265,465		1,278,045
Due after five years through ten years	1,120,853		1,122,243
Due after ten years	1,161,722		1,204,375
	$	3,858,524	$	3,915,865

Asset-backed securities	110,241		110,328
Residential mortgage-backed securities	255,344		250,641
Commercial mortgage-backed securities	220,719		220,696
Collateralized loan obligations	61,350		60,384
Total as of March 31, 2016	$	4,506,178	$	4,557,914

At March 31, 2016 and December 31, 2015, the investment portfolio had gross unrealized losses of $30.1 million and $67.8 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:



March 31, 2016	Less Than 12 Months					12 Months or Greater					Total
(In thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	26,586	$	(1,094	)	$	2,998	$	(41	)	$	29,584	$	(1,135	)
Obligations of U.S. states and political subdivisions	105,443		(763		)	60,616		(1,743		)	166,059		(2,506		)
Corporate debt securities	350,566		(7,932		)	348,277		(10,552		)	698,843		(18,484		)
Asset-backed securities	29,107		(42		)	11,019		(47		)	40,126		(89		)
Residential mortgage-backed securities	14,548		(103		)	204,585		(5,052		)	219,133		(5,155		)
Commercial mortgage-backed securities	60,778		(925		)	56,126		(776		)	116,904		(1,701		)
Collateralized loan obligations	—		—			51,907		(991		)	51,907		(991		)
Equity securities	91		—			209		(7		)	300		(7		)
Total	$	587,119	$	(10,859	)	$	735,737	$	(19,209	)	$	1,322,856	$	(30,068	)

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December 31, 2015	Less Than 12 Months					12 Months or Greater					Total
(In thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	60,548	$	(1,467	)	$	1,923	$	(475	)	$	62,471	$	(1,942	)
Obligations of U.S. states and political subdivisions	417,615		(6,404		)	37,014		(886		)	454,629		(7,290		)
Corporate debt securities	1,470,628		(38,519		)	114,982		(6,251		)	1,585,610		(44,770		)
Asset-backed securities	86,604		(173		)	5,546		(30		)	92,150		(203		)
Residential mortgage-backed securities	35,064		(312		)	209,882		(8,080		)	244,946		(8,392		)
Commercial mortgage-backed securities	134,488		(2,361		)	69,927		(1,614		)	204,415		(3,975		)
Collateralized loan obligations	—		—			51,750		(1,148		)	51,750		(1,148		)
Debt securities issued by foreign sovereign governments	4,463		(102		)	—		—			4,463		(102		)
Equity securities	355		(8		)	171		(10		)	526		(18		)
Total	$	2,209,765	$	(49,346	)	$	491,195	$	(18,494	)	$	2,700,960	$	(67,840	)

The unrealized losses in all categories of our investments at March 31, 2016 and December 31, 2015 were primarily caused by the difference in interest rates at each respective period, compared to interest rates at the time of purchase. There were 316 and 303 securities in an unrealized loss position at March 31, 2016 and December 31, 2015, respectively.

During each of the three months ended March 31, 2016 and 2015 there were no other-than-temporary impairments (“OTTI”) recognized. The net realized investment gains on the investment portfolio are as follows:



	Three Months Ended March 31,
(In thousands)	2016		2015
Realized investment gains (losses) on investments:
Fixed maturities	$	3,054	$	26,324
Equity securities	2		3
Net realized investment gains	$	3,056	$	26,327



	Three Months Ended March 31,
(In thousands)	2016			2015
Realized investment gains (losses) on investments:
Gains on sales	$	4,104		$	27,206
Losses on sales	(1,048		)	(879		)
Net realized investment gains	$	3,056		$	26,327

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Note 8 – Fair Value Measurements

Our estimates of fair value for financial assets and financial liabilities are based on the framework established in the fair value accounting guidance. The framework is based on the inputs used in valuation, gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available.

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. This model combines all inputs to arrive at a value assigned to each security. Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports, trading information, data changes, and directional moves compared to market moves. In addition, on a quarterly basis, we perform quality controls over values received from the pricing sources which also include reviewing tolerance reports, trading information, data changes, and directional moves compared to market moves. We have not made any adjustments to the prices obtained from the independent pricing sources.

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 U.S. Treasury securities, equity securities, 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 obligations of U.S. government corporations and agencies, corporate bonds, mortgage-backed securities, and most municipal bonds.

The independent pricing sources utilize these approaches to determine the fair value of the securities in Level 2 of the fair value hierarchy based on type of investment:

Corporate Debt & U.S. Government and Agency Bonds are evaluated by surveying the dealer community, obtaining relevant trade data, benchmark quotes and spreads and incorporating this information into the evaluation process.

Obligations of U.S. States & Political Subdivisions are evaluated by tracking, capturing, and analyzing quotes for active issues and trades reported via the Municipal Securities Rulemaking Board records. Daily briefings and reviews of current economic conditions, trading levels, spread relationships, and the slope of the yield curve provide further data for evaluation.

Residential Mortgage-Backed Securities are evaluated by monitoring interest rate movements, and other pertinent data daily. Incoming market data is enriched to derive spread, yield and/or price data as appropriate, enabling known data points to be extrapolated for valuation application across a range of related securities.

Commercial Mortgage-Backed Securities are evaluated using valuation techniques that reflect market participants’ assumptions and maximize the use of relevant observable inputs including quoted prices for similar assets, benchmark yield curves and market corroborated inputs. Evaluation utilizes regular reviews of the inputs for securities covered, including executed trades, broker quotes, credit information, collateral attributes and/or cash flow waterfall as applicable.

Asset-Backed Securities are evaluated using spreads and other information solicited from market buy- and sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts. Cash flows are generated for each tranche, benchmark yields are determined, and deal collateral performance and tranche level attributes including market color as available are used, resulting in tranche-specific spreads.

Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable or from par values for equity securities restricted in their ability to be redeemed or sold. The inputs used to derive the fair value of Level 3 securities reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets

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utilizing Level 3 inputs primarily include equity securities that can only be redeemed or sold at their par value and only to the security issuer and certain state premium tax credit investments. The state premium tax credit investments have an average maturity of less than 2 years, credit ratings of AA+ or higher, and their balance reflects their remaining scheduled payments discounted at an average annual rate of

7.2%. Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement. The fair value of real estate acquired is the lower of our acquisition cost or a percentage of the appraised value. The percentage applied to the 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, 2016 and December 31, 2015:

March 31, 2016

(In thousands)	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	148,528	$	51,448	$	97,080	$	—
Obligations of U.S. states and political subdivisions	1,913,130		—		1,911,938		1,192
Corporate debt securities	1,854,207		—		1,854,207		—
Asset-backed securities	110,328		—		110,328		—
Residential mortgage-backed securities	250,641		—		250,641		—
Commercial mortgage-backed securities	220,696		—		220,696		—
Collateralized loan obligations	60,384		—		60,384		—
Total debt securities	4,557,914		51,448		4,505,274		1,192
Equity securities ⁽¹⁾	6,289		2,868		—		3,421
Total investment portfolio	$	4,564,203	$	54,316	$	4,505,274	$	4,613
Real estate acquired ⁽²⁾	$	12,849	$	—	$	—	$	12,849

December 31, 2015

(In thousands)	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	160,584	$	46,197	$	114,387	$	—
Obligations of U.S. states and political subdivisions	1,792,527		—		1,791,299		1,228
Corporate debt securities	2,004,763		—		2,004,763		—
Asset-backed securities	116,617		—		116,617		—
Residential mortgage-backed securities	257,648		—		257,648		—
Commercial mortgage-backed securities	233,491		—		233,491		—
Collateralized loan obligations	60,200		—		60,200		—
Debt securities issued by foreign sovereign governments	31,731		31,731		—		—
Total debt securities	4,657,561		77,928		4,578,405		1,228
Equity securities ⁽¹⁾	5,645		2,790		—		2,855
Total investment portfolio	$	4,663,206	$	80,718	$	4,578,405	$	4,083
Real estate acquired ⁽²⁾	$	12,149	$	—	$	—	$	12,149


⁽¹⁾	Equity securities in Level 3 are carried at cost, which approximates fair value.


⁽²⁾	Real estate acquired through claim settlement, which is held for sale, is reported in Other assets on the consolidated balance sheets.

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There were no transfers of securities between Level 1 and Level 2 during the first three months of 2016.

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, 2016 and 2015 is shown in the following tables. There were no transfers into or out of Level 3 in those periods and there were no losses included in earnings for those periods attributable to the change in unrealized losses on assets still held at the end of the applicable period.



(In thousands)	Debt Securities			Equity Securities			Total Investments			Real Estate Acquired
Balance at December 31, 2015	$	1,228		$	2,855		$	4,083		$	12,149
Total realized/unrealized gains (losses):
Included in earnings and reported as losses incurred, net	—			—			—			(293		)
Purchases	—			3,091			3,091			12,267
Sales	(36		)	(2,525		)	(2,561		)	(11,274		)
Balance at March 31, 2016	$	1,192		$	3,421		$	4,613		$	12,849



(In thousands)	Debt Securities			Equity Securities		Total Investments			Real Estate Acquired
Balance at December 31, 2014	$	1,846		$	321	$	2,167		$	12,658
Total realized/unrealized gains (losses):
Included in earnings and reported as losses incurred, net	—			—		—			(503		)
Purchases	7			—		7			10,797
Sales	(62		)	—		(62		)	(12,055		)
Balance at March 31, 2015	$	1,791		$	321	$	2,112		$	10,897

Authoritative guidance over disclosures about the fair value of financial instruments requires additional disclosure for financial instruments not measured at fair value. Certain financial instruments, including insurance contracts, are excluded from these fair value disclosure requirements. The carrying values of cash and cash equivalents (Level 1) and accrued investment income (Level 2) approximated their fair values. Additional fair value disclosures related to our investment portfolio are included in Note 7 – “Investments.”

Financial Liabilities Not Measured at Fair Value

We incur financial liabilities in the normal course of our business. The following tables present the carrying value and fair value of our financial liabilities disclosed, but not carried, at fair value at March 31, 2016 and December 31, 2015. The fair values of our Convertible Senior Notes and Convertible Junior Subordinated Debentures were based on observable market prices and the fair value of the Federal Home Loan Bank Advance was estimated using discounted cash flows on current incremental borrowing rates for similar borrowing arrangements, and in all cases they are categorized as Level 2.



March 31, 2016
(In thousands)	Carrying Value		Fair Value
Financial liabilities:
FHLB Advance due 2023	$	155,000	$	156,831
Convertible Senior Notes due 2017	194,319		203,771
Convertible Senior Notes due 2020	491,305		630,310
Convertible Junior Subordinated Debentures due 2063	256,872		292,754
Total Debt	$	1,097,496	$	1,283,666



December 31, 2015
(In thousands)	Carrying Value		Fair Value
Financial liabilities:

Convertible Senior Notes due 2017	$	331,546	$	345,616
Convertible Senior Notes due 2020	490,755		701,955
Convertible Junior Subordinated Debentures due 2063	389,522		455,067
Total Debt	$	1,211,823	$	1,502,638

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Note 9 – Other Comprehensive Income

The pretax components of our other comprehensive income (loss) and the related income tax (expense) benefit for the three months ended March 31, 2016 and 2015 are included in the following table.



	Three Months Ended March 31,
(In thousands)	2016			2015
Net unrealized holding gains arising during the period	$	78,383		$	19,721
Income tax expense	(27,556		)	(6,876		)
Valuation allowance ⁽¹⁾	—			6,718
Net of taxes	50,827			19,563

Net changes in benefit plan assets and obligations	(474		)	(700		)
Income tax benefit	166			245
Valuation allowance ⁽¹⁾	—			(245		)
Net of taxes	(308		)	(700		)

Net changes in unrealized foreign currency translation adjustment	(1,496		)	(3,102		)
Income tax benefit	521			1,088
Net of taxes	(975		)	(2,014		)

Total other comprehensive income	76,413			15,919
Total income tax (expense) benefit, net of valuation allowance	(26,869		)	930
Total other comprehensive income, net of tax	$	49,544		$	16,849


⁽¹⁾	See Note 11 – “Income Taxes” for a discussion of the valuation allowance recorded against deferred tax assets.

The pretax and related income tax (expense) benefit components of the amounts reclassified from our accumulated other comprehensive loss to our consolidated statements of operations for the three months ended March 31, 2016 and 2015 are included in the following table.



	Three Months Ended March 31,
(In thousands)	2016			2015
Reclassification adjustment for net realized gains (losses) included in net income ⁽¹⁾	$	612		$	11,234
Income tax expense	(92		)	(3,931		)
Valuation allowance ⁽²⁾	—			3,926
Net of taxes	520			11,229

Reclassification adjustment related to benefit plan assets and obligations ⁽³⁾	474			700
Income tax expense	(166		)	(245		)
Valuation allowance ⁽²⁾	—			245
Net of taxes	308			700

Total reclassifications	1,086			11,934
Total income tax expense, net of valuation allowance	(258		)	(5		)
Total reclassifications, net of tax	$	828		$	11,929


⁽¹⁾	Increases (decreases) Net realized investment gains on the consolidated statements of operations.


⁽²⁾	See Note 11 – “Income Taxes” for a discussion of the valuation allowance recorded against deferred tax assets.


⁽³⁾	Decreases (increases) Other underwriting and operating expenses, net on the consolidated statements of operations.

Changes in our accumulated other comprehensive loss, including amounts reclassified from other comprehensive income (loss), for the three months ended March 31, 2016 are included in the table below.



	Three Months Ended March 31, 2016
(In thousands)	Net unrealized gains and losses on available-for-sale securities			Net benefit plan assets and obligations recognized in shareholders' equity			Net unrealized foreign currency translation			Total accumulated other comprehensive loss
Balance at December 31, 2015, net of tax	$	(17,148	)	$	(44,652	)	$	920		$	(60,880	)
Other comprehensive income (loss) before reclassifications	51,347			—			(975		)	50,372
Less: Amounts reclassified from accumulated other comprehensive income (loss)	520			308			—			828
Balance at March 31, 2016, net of tax	$	33,679		$	(44,960	)	$	(55	)	$	(11,336	)

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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,
(In thousands)	Pension and Supplemental Executive Retirement Plans						Other Postretirement Benefits
	2016			2015			2016			2015
Service cost	$	2,163		$	2,448		$	175		$	202
Interest cost	3,929			3,908			172			178
Expected return on plan assets	(4,889		)	(5,295		)	(1,222		)	(1,248		)
Recognized net actuarial loss (gain)	1,361			1,209			—			(35		)
Amortization of prior service cost	(172		)	(211		)	(1,662		)	(1,662		)
Net periodic benefit cost (benefit)	$	2,392		$	2,059		$	(2,537	)	$	(2,565	)

We currently intend to make a contribution of $11.4 million to our qualified pension plan and supplemental executive retirement plan in 2016.

Note 11 – Income Taxes

Valuation Allowance

We review the need to maintain a deferred tax asset valuation allowance on a quarterly basis. We analyze many 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, operating results on a three year cumulative basis, the expected occurrence of future income or loss, the expiration dates of the loss carryforwards, the cyclical nature of our operating results, and available tax planning strategies. Based on our analysis, we reduced our benefit from income tax through the recognition of a valuation allowance from the first quarter of 2009 through the second quarter of 2015. In the third quarter of 2015, based on our analysis, we concluded that it was more likely than not that our deferred tax assets would be fully realizable and that the valuation allowance was no longer necessary. Therefore, we reversed the valuation allowance.

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



	Three months ended March 31,
(In thousands)	2016		2015
Provision for income tax	$	34,497	$	47,883
Change in valuation allowance	—		(44,498		)
Provision for income taxes	$	34,497	$	3,385

The change in the valuation allowance that was included in other comprehensive income for the three months ended March 31, 2015 was a decrease of $6.5 million.

We have approximately $1.9 billion of net operating loss (“NOL”) carryforwards on a regular tax basis and $1.0 billion of NOL carryforwards for computing the alternative minimum tax as of March 31, 2016. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.

Tax Contingencies

As previously disclosed, the Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed assessments for 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. We appealed these assessments within the IRS and in August 2010, we reached a tentative settlement agreement with the IRS which was not finalized.

In 2014, we received Notices of Deficiency (commonly referred to as “90 day letters”) covering the 2000-2007 tax years. The Notices of Deficiency reflect taxes and penalties related to the REMIC matters of $197.5 million and at March 31, 2016, there would also be interest related to these matters of approximately $187.4 million. In 2007, we made a payment of $65.2 million to the United States Department of the Treasury which will reduce any amounts we would ultimately owe. The Notices of Deficiency also reflect additional amounts due of $261.4 million, which are primarily associated with the disallowance of the carryback of the 2009 net operating loss to the 2004-2007 tax years. We believe the IRS included the carryback adjustments as a precaution to keep open the statute of limitations on collection of the tax that was refunded when this loss was carried back, and not because the IRS actually intends to disallow the carryback permanently.

We filed a petition with the U.S. Tax Court contesting most of the IRS’ proposed adjustments reflected in the Notices of Deficiency and the IRS has filed an answer to our petition which continues to assert their claim. The case has twice been scheduled for trial and in each instance, the parties jointly filed, and the U.S. Tax Court approved (most recently in February 2016), motions

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for continuance to postpone the trial date. Also in February 2016, the U.S. Tax Court approved a joint motion to consolidate for trial, briefing, and opinion, our case with similar cases of Radian Group, Inc., as successor to Enhance Financial Services Group, Inc., et al. Litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached and finalized. 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, 2016, those state taxes and interest would approximate $49.3 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of March 31, 2016 is $107.4 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, available assets and statutory capital. In this regard, see Note 15 – “Capital Requirements.”

The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue that would affect our effective tax rate is $94.1 million. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. As of March 31, 2016 and December 31, 2015, we had accrued $28.1 million and $27.8 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 defaulted 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; exposure on insured loans; the amount of time between default and claim filing; and curtailments. 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 borrower income and thus their ability to make mortgage payments, and a drop in housing values which 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, 2016 and 2015:



	Three months ended March 31,
(In thousands)	2016			2015
Reserve at beginning of period	$	1,893,402		$	2,396,807
Less reinsurance recoverable	44,487			57,841
Net reserve at beginning of period	1,848,915			2,338,966

Losses incurred:
Losses and LAE incurred in respect of defaults related to:
Current year	92,479			109,381
Prior years ⁽¹⁾	(7,467		)	(27,596		)
Subtotal	85,012			81,785

Losses paid:
Losses and LAE paid in respect of defaults related to:
Current year	204			312
Prior years	221,457			231,230
Reinsurance terminations ⁽²⁾	(4