MGIC Investment
Annual Report 2016

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MGIC Investment Corporation Annual Report 2016 Financial Summary Net income ($ millions) Diluted income per share ($) Net operating income (1) ($ millions) Net operating income per diluted share (1) ($) 2014 2015 2016 $ $ $ $ 251.9 $ 1,172.0 0.64 162.8 0.43 $ $ $ 2.60 306.1 0.75 $ $ $ $ 342.5 0.86 395.6 0.99 (1) We believe that use of the Non-GAAP measures of net operating income (loss) and net operating income (loss) per diluted share facilitate the evaluation of the company's core financial performance thereby providing relevant information. See "Explanation and Reconciliation of our use of Non-GAAP Financial Measures" of this Annual Report for further information. (2) Includes the impact of the 2015 reversal of the deferred tax asset valuation allowance. MGIC Investment Corporation 2016 Annual Report | 1 Dear Fellow Shareholders: In last year’ s letter I informed you that our efforts would be focused on the following business strategies: 1) prudently growing insurance in force, 2) pursuing new business opportunities that leverage our core competencies, 3) preserving and expanding our role and that of the private mortgage insurance industry in housing finance policy, 4) managing and deploying capital to optimize creation of shareholder value and 5) developing and diversifying the talents of our co-workers. I am pleased to report that in 2016 we executed exceptionally well and made great progress in furthering each of the strategies. Specifically, in 2016 we: • • • • • Earned $342.5 million of GAAP Net Income and $395.6 million of Net Operating Income compared to $1,172.0 of GAAP Net Income (which reflects a one-time benefit of $847.8 million associated with the reversal of a valuation allowance against our deferred tax assets) and $306.1 million of Net Operating Income for 2015. Net Operating Income is a non-GAAP measure of performance. For a description of how we calculate this measure and for a reconciliation of this measure to its nearest comparable GAAP measure, see "Explanation and Reconciliation of our use of Non-GAAP Financial Measures" in Management’ s Discussion and Analysis of Financial Condition and Results of Operations. Increased insurance in force by 4.3% despite persistency declining from 79.7% in 2015 to 76.9% in 2016. Increased new insurance written by 11.4% from $43.0 billion in 2015 to $47.9 billion in 2016. The new insurance written is consistent with the Company’ s risk and return goals. Exceeded the Minimum Required Assets of the GSEs’ private mortgage insurer eligibility requirements, or PMIERs, by $0.6 billion and the statutory capital requirement of the State of Wisconsin by $1.6 billion. Improved our capital profile, including: 1) the elimination of 66 million potentially dilutive shares through various capital market transactions, 2) the re-establishment of dividend payments ($64 million for 2016) from our writing company, MGIC, to our holding company and 3) a return of investment grade rating for our writing company. • Maintained our industry low expense ratio while making additional investments in co-worker professional development. The growth in insurance in force reflects the expanding purchase mortgage market, our company’ s market share and the hard work and dedication of my fellow co-workers to deliver stellar customer service. The increasing size and quality of our insurance in force, the runoff of the older books, solid housing market fundamentals such as household formations and home sales, and our improved capital structure, position us well to provide credit enhancement and low down payment solutions to lenders, GSEs and borrowers. The growth in insurance in force also reflects the value proposition we offer to both lenders (ease of execution and ancillary services) and consumers (faster equity buildup and ability to cancel, when compared to FHA execution). As reported by Inside Mortgage Finance, the private mortgage insurance industry’ s 2016 market share of total originations increased to 13.1% from 12.5% in 2015, and MGIC’ s 2016 market share within the PMI industry, excluding the U.S. Treasury’ s Home Affordable Refinance Program (HARP), was 17.9%. In 2017, we are looking for an increase in home purchase activity and a decrease in refinance activity. This would be a net positive for us and the industry, as we estimate that our industry’ s market share is approximately 3-4 times higher for purchase loans compared to refinances. Among the factors influencing increased purchase activity are: 1) an improving economy, which typically leads consumers to have more confidence in their future employment and increases their desire to purchase a home, 2) household formations continuing to modestly increase as they return to long-term averages, 3) the national homeownership rate remaining stable to marginally higher, and 4) mortgage interest rates remaining relatively affordable. And since the majority of purchasers who need a mortgage do not have a 20% down payment, over the long term, we should have a wonderful opportunity in front of us. Despite an expected smaller total mortgage origination market, as the decrease in refinance transactions is expected to be greater than the increase in purchase transactions, we expect to write approximately the same amount of new insurance in 2017 that we did in 2016. This combined with increasing persistency should lead to a modest increase in our insurance in force. 2 | MGIC Investment Corporation 2016 Annual Report Fellow Shareholders As of December 31, 2016, the book years beginning in 2009 account for approximately 71% of our primary risk in force. The portion of the 2005 - 2008 book years that have not been refinanced under HARP, which have experienced higher incurred losses, now account for just 16% of our primary risk in force. The risk in force associated with the total 2005 - 2008 books has decreased 19% from 2015. The quality and profitability of the book years beginning in 2009 is best captured by the following statistics: • • delinquencies from those book years represent approximately 8% of the total delinquent inventory at year-end 2016, and as of December 31, 2016, the ever-to-date incurred loss ratio of the 2009, 2010, 2011, 2012 and 2013, books are 14.0%, 7.0%, 4.5%, 2.9% and 3.8%, respectively. The life-to-date development of the 2014 - 2016 books suggests that, as they season, they will also provide meaningful contributions to our future success. Net losses incurred were 30% lower in 2016 than 2015. The improvement was primarily due to a decrease in losses and loss adjustment expenses incurred in respect to defaults reported in 2016, and more favorable loss reserve development on prior-year defaults. In 2016, we received 9% fewer default notices than in 2015 and we applied a lower claim rate assumption to those new notices, primarily reflecting the underlying improvements in the housing and labor markets and the ability of borrowers to cure their delinquencies. In 2016, favorable loss reserve development on prior-year defaults was primarily the result of a lower claim rate assumption for those defaults. The lower claim rate assumption reflects that the actual cure rate experience has outperformed our previous estimates. We expect to receive fewer new default notices and to see the inventory decrease again in 2017 when compared to 2016. Our capital management objectives include a continuation of our positive credit ratings trajectory of the last several quarters, and the elimination of potentially dilutive shares that resulted from the capital raises during the Great Recession. In 2016, with our improved capital position, we accessed the non-convertible senior debt market when we issued $425 million 7-year 5.75% Senior Notes. This is the first time since 2006 that we accessed the non- convertible senior debt market and marked an important milestone for our company. We used the majority of the proceeds to purchase $292.4 million of our 2% Convertible Senior Notes and the common shares that were issued as part of that transaction. Earlier in the year, MGIC purchased $132.7 million of our 9% Convertible Junior Debentures. Finally, we repurchased $188.5 million of our 5% Convertible Senior Notes. Combined, these transactions eliminated 66 million potentially dilutive shares. Further reflecting the improving financial condition of the company, during 2016, MGIC was returned to investment grade by both Moody’ s and Standard and Poor’ s. While credit ratings are not inhibiting our ability to write new primary business, we think that long-term, ratings will become more relevant. Therefore in the future, when we analyze various options to improve our capital profile, as well as the ability to minimize potentially dilutive shares, we need to consider the resulting leverage ratio, the impact on ratings, and the debt service capability of the holding company. Regarding housing reform, our initial reaction to the tone coming from the Administration and Congress is generally positive. It is hard to predict the actions that may be taken and the timing of such actions, but the message that private capital can play a greater role in housing policy is positive for MGIC and our industry. As an individual company, and through various trade associations including USMI, we are actively engaged in Washington with the goal of shaping a greater role for private mortgage insurance. Regarding the FHA, we don’ t believe that it makes sense to change FHA pricing without first addressing the larger question of the government’ s role in housing. Simply put, another FHA price reduction would likely shift business away from private capital and expose the taxpayer to increased risk at a time when private capital, primarily in the form of private mortgage insurance, is ready, willing, and able to take this risk. I want to be clear: the FHA has played and continues to play a very important role in our country’ s housing market; however, the discussion needs to be around a comprehensive housing policy that includes the proper role for the FHA, the GSEs and private capital. MGIC has a reputation of not only offering a compelling business proposition for its customers, but also offering a compelling value proposition for its employees. This is one way we have been able to maintain a low turnover rate and to keep our expense ratio the lowest in the industry. This is also why we invest in co- worker development programs that promote accountability and a continuous-improvement culture, and that MGIC Investment Corporation 2016 Annual Report | 3 Fellow Shareholders address issues arising from the changing workforce, evolving work environment, and ever changing competitive landscape. 2016 was indeed a good year. We achieved strong financial results and continued to position our company for further success. 2017 marks the 60th anniversary of MGIC and the dream of Max Karl, our company’ s and industry’ s founder, to allow private capital to help support the US housing market and help individuals and families find a better way to homeownership. I am very excited and confident about the opportunities MGIC has to continue to serve the housing market for another 60 years and keep Max’ s vision alive. Much like last year, in 2017, our energies will be focused on the strategies outlined at the beginning of this letter. I firmly believe that there is a greater opportunity for us to play in providing increased access to credit for consumers and reducing GSE credit risk while generating good returns for shareholders. We are committed to pursuing those opportunities. I would like thank our shareholders and customers for their support and my fellow co-workers for their hard work and dedication which has enabled our company to accomplish all that it did in 2016. Respectfully, Patrick Sinks President and Chief Executive Officer Standing from left: Sal Miosi, Executive Vice President - Business Strategies and Operations Tim Mattke, Executive Vice President and Chief Financial Officer Jeff Lane, Executive Vice President, General Counsel and Secretary Seated from left: Jay Hughes, Executive Vice President - Sales and Business Development Pat Sinks, President and Chief Executive Officer Steve Mackey, Executive Vice President and Chief Risk Officer 4 | MGIC Investment Corporation 2016 Annual Report Five-Year Summary of Financial Information MGIC Investment Corporation & Subsidiaries (In thousands, except per share data) 2016 2015 2014 2013 2012 As of and for the Years Ended December 31, Summary of Operations Revenues: Net premiums written Net premiums earned Investment income, net Realized investment gains, net including net impairment losses Other revenue Total revenues Losses and expenses: Losses incurred, net $ 975,091 $ 1,020,277 $ 881,962 $ 923,481 $ 1,017,832 925,226 110,666 8,932 17,659 896,222 103,741 28,361 12,964 844,371 87,647 943,051 1,033,170 80,739 121,640 1,357 9,259 5,731 9,914 195,409 28,145 1,062,483 1,041,288 942,634 1,039,435 1,378,364 240,157 343,547 496,077 838,726 2,067,253 Change in premium deficiency reserve — (23,751) (24,710) (25,320) (61,036) Underwriting and other expenses Interest expense Loss on debt extinguishment Total losses and expenses Income (loss) before tax Provision for (benefit from) income taxes (1) 160,409 56,672 90,531 547,769 514,714 172,197 164,366 68,932 507 553,601 487,687 146,059 69,648 837 192,518 79,663 — 201,447 99,344 — 687,911 1,085,587 2,307,008 254,723 (46,152) (928,644) (684,313) 2,774 3,696 (1,565) Net income (loss) $ 342,517 $ 1,172,000 $ 251,949 $ (49,848) $ (927,079) Weighted average common shares outstanding (2) 431,992 468,039 413,547 311,754 201,892 Diluted income (loss) per share Dividends per share $ $ 0.86 $ 2.60 $ 0.64 $ (0.16) $ (4.59) — $ — $ — $ — $ — Balance sheet data Total investments $ 4,692,350 $ 4,663,206 $ 4,612,669 $ 4,866,819 $ 4,230,275 Cash and cash equivalents 155,410 181,120 197,882 332,692 1,027,625 Total assets Loss reserves Premium deficiency reserve Short- and long-term debt Convertible senior notes Convertible junior subordinated debentures Shareholders' equity Book value per share 5,734,529 5,868,343 5,251,414 5,582,579 5,566,894 1,438,813 1,893,402 2,396,807 3,061,401 4,056,843 — 572,406 349,461 256,872 — — 822,301 389,522 23,751 61,883 830,015 389,522 2,548,842 2,236,140 1,036,903 7.48 6.58 3.06 48,461 82,662 826,300 389,522 744,538 2.20 73,781 99,700 338,419 378,970 196,940 0.97 (1) (2) In the third quarter of 2015 we reversed the valuation allowance against our deferred tax assets. See Note 12 – "Income Taxes" to our consolidated financial statements for a discussion of the reversal of the valuation allowance and impact on our consolidated financial statements. Includes dilutive shares in years with net income. See Note 4 – "Earnings Per Share" to our consolidated financial statements for a discussion of our Earnings Per Share. MGIC Investment Corporation 2016 Annual Report | 5 Five-Year Summary of Financial Information Other data New primary insurance written ($ millions) New primary risk written ($ millions) $ $ 47,875 11,831 $ $ 43,031 10,824 $ $ 33,439 8,530 $ $ 29,796 7,541 $ $ 24,125 5,949 Years Ended December 31, 2016 2015 2014 2013 2012 IIF (at year-end) ($ millions) Direct primary IIF RIF (at year-end) ($ millions) Direct primary RIF Direct pool RIF With aggregate loss limits Without aggregate loss limits Primary loans in default ratios Policies in force Loans in default $ 182,040 $ 174,514 $ 164,919 $ 158,723 $ 162,082 $ 47,195 $ 45,462 $ 42,946 $ 41,060 $ 41,735 244 303 271 388 303 505 376 636 439 879 998,294 50,282 992,188 62,633 968,748 79,901 960,163 103,328 1,006,346 139,845 Percentage of loans in default 5.04% 6.31% 8.25% 10.76% 13.90% Insurance operating ratios (GAAP) Loss ratio Expense ratio Risk-to-capital ratio (statutory) Mortgage Guaranty Insurance Corporation Combined insurance companies 26.0% 15.3% 38.3% 14.9% 58.8% 14.7% 88.9% 18.6% 200.1% 15.2% 10.7:1 12.0:1 12.1:1 13.6:1 14.6:1 16.4:1 15.8:1 18.4:1 44.7:1 47.8:1 6 | MGIC Investment Corporation 2016 Annual Report Management's Discussion and Analysis of Financial Condition and Results of Operations We have reproduced below the “Management’ s Discussion and Analysis of Financial Condition and Results for the year ended of Operations” and “Risk Factors” that appeared in our Annual Report on Form December 31, 2016, which was filed with the Securities and Exchange Commission on February 21, 2017. Except for various cross-references, we have not changed what appears below from what was in our Form 10-K. As a result, the Management’ s Discussion and Analysis and Risk Factors are not updated to reflect any events or changes in circumstances that have occurred since our Annual Report on Form 10-K was filed with the SEC. Our Risk Factors are an integral part of Management’ s Discussion and Analysis and appear immediately after it. Forward Looking and Other Statements As discussed under “Forward Looking Statements and Risk Factors” in this Annual Report, actual results may differ materially from the results contemplated by forward looking statements. We are not undertaking any obligation to update any forward looking statements or other statements we may make in the following discussion or elsewhere 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 SEC. See the "Glossary of terms and acronyms" for definitions and descriptions of terms used throughout this Annual Report. Introduction Through our subsidiary, MGIC, we are a leading provider of PMI in the United States, as measured by $182.0 billion of primary IIF on a consolidated basis at December 31, 2016. As used below, “we” and “our” refer to MGIC Investment Corporation’ s consolidated operations or to MGIC Investment Corporation, as a separate entity, as the context requires. References to "we" and "our" in the context of debt obligations refer to MGIC Investment Corporation. MGIC Investment Corporation 2016 Annual Report | 7 Management's Discussion and Analysis Overview This Overview of the MD&A highlights selected information and may not contain all of the information that is important to readers of this Annual Report. Hence, this Overview is qualified by the information that appears elsewhere in this Annual Report, including the other portions of the MD&A. Summary Financial Results of MGIC Investment Corporation Year Ended December 31, 2016 2015 Change (In millions, except per share data, unaudited) Selected statement of operations data Total revenues $1,062.5 $1,041.3 Losses incurred, net 240.2 343.5 Loss on debt extinguishment Income before tax Provision for (benefit from) income taxes Net income 90.5 514.7 172.2 342.5 0.5 487.7 (684.3) 1,172.0 Diluted income per share $ 0.86 $ 2.60 Non-GAAP Financial Measures (1) Pretax operating income $ 596.3 $ 459.8 Net operating income 395.6 306.1 2 % (30)% N/M 6 % N/M (71)% (67)% 30 % 29 % Net operating income per diluted share $ 0.99 $ 0.75 32 % (1) See "Explanation and Reconciliation of our use of Non- GAAP Financial Measures". SUMMARY OF 2016 RESULTS Net operating income for 2016 was $395.6 million (2015: $306.1 million) and net operating income per diluted share was $0.99 (2015: $0.75). The 29% increase in net operating income was driven primarily by lower losses incurred, net. We recorded full-year 2016 net income of $342.5 million, and diluted income per share of $0.86. Net income decreased by $829.5 million compared with net income of $1.2 billion in 2015, primarily due to the $847.8 million of tax benefits realized during 2015 from changes in our deferred tax asset valuation allowance, including its reversal in the third quarter of 2015; and the $90.5 million loss on debt extinguishment resulting from our debt transactions completed during 2016. The decline in net income was partially offset primarily by a decrease in losses incurred, net. on prior year delinquencies and on our IBNR when compared to the prior year. The loss on debt extinguishment recorded during 2016 resulted from debt transactions in which we, or MGIC, repurchased portions of our outstanding long- term debt at amounts that in aggregate were in excess of our carrying values. In addition, we wrote- issuance costs on the off unamortized debt repurchased portions of some of our long-term debt. See Note 7 - "Debt" to our consolidated financial statements for further discussion of the accounting for these transactions. We will continue to assess opportunities to improve our debt profile and / or reduce potential dilution remaining outstanding convertible debt, which could result in additional debt extinguishment losses in the future. from our The provision for (benefit from) income taxes in our 2016 results reflects a tax provision at the statutory rate while our prior year results reflect the impact of the changes in our valuation allowance against our deferred tax assets, including its reversal in that year. Our operating results for 2016 reflect a larger mortgage origination market compared to the prior year and improved credit performance of our primary RIF. We grew our IIF to $182.0 billion, or 4.3%, during 2016 and we wrote our highest annual level of new insurance since 2008. Importantly, the NIW in 2016 in our view, strong underlying credit has, characteristics. Our 2009 and later books continued to experience a low level of losses and accounted for 71% of our total primary RIF as of December 31, 2016. Our legacy books, particularly those written in 2005-2008, continued to drive our new delinquent notice and claim activity, but they have experienced a continued decline in default inventory and paid claims. In 2016, we completed a series of financing transactions that, in our view, improved our debt profile and reduced potentially dilutive shares, while maintaining strong levels of regulatory capital. Specifically, we issued senior notes in the third quarter, which allowed us to repurchase a significant portion of our 2% Notes, and in the first half of the year we repurchased a portion of our 5% Notes with cash on hand and MGIC purchased a portion of our 9% Debentures. transactions total, eliminated approximately 66 million potentially dilutive shares and reduced our annual consolidated interest expense. these In Losses incurred, net were $240.2 million, down 30% as new delinquent notice activity declined and we experienced higher favorable reserve development MGIC's capital position in relation to the PMIERs requirements continued to strengthen as MGIC held 8 | MGIC Investment Corporation 2016 Annual Report over $630 million of Available Assets in excess of the Minimum Required Assets at December 31, 2016. Our current strategy is to maintain an excess of 10%-15% over the Minimum Required Assets. Our ability to manage to this range is primarily subject to OCI approval of dividends from MGIC to our holding company (which would reduce MGIC's Available Assets), the credit performance of our RIF (which would increase or decrease its Minimum Required Assets), and any changes made to the PMIERs financial requirements (which could increase or decrease Available Assets and/or Minimum Required Assets). During 2016, MGIC distributed $64 million of its excess Available Assets as dividends to our holding company. These dividends were the first dividends from MGIC since 2008. the to operating under In the first half of 2016, the PMI industry broadly adopted new premium rates, we believe, primarily in response financial requirements of the PMIERs, which first became effective on December 31, 2015. We revised both our BPMI and LPMI premium rates effective in April, which are competitively positioned within the industry, and are structured to generate comparable risk-adjusted returns across the spectrum of loans we insure. Premium rates within the marketplace, which includes PMI and government programs offered by the FHA and VA, have an impact on the PMI industry's total market share, as well as our share within the PMI industry from period to period. In 2016, PMI as an industry captured a greater share of mortgage originations having insurance, but our estimated market share within the PMI industry declined to 17.8% from 19.9% in 2015. OUTLOOK FOR 2017 Our outlook for 2017 should be viewed against the backdrop of the U.S. economy, competition, mortgage origination levels, and regulatory and legislative developments. Each of these interrelated factors will affect our performance. Our 2017 NIW is expected to be comparable to our 2016 NIW. Our NIW is affected by total mortgage originations, the percentage of total mortgage originations utilizing private mortgage insurance (the "PMI penetration rate") and our market share within the PMI industry. As of late January 2017, total mortgage originations are forecasted to decline in 2017 from 2016 levels due to declines in refinancing originations more than offsetting a small increase in purchase originations. We expect the PMI penetration rate to increase because historically PMI has captured a share of purchase originations that is estimated to be 3-4 times greater than that of refinancing originations. This increase in the PMI penetration rate should serve to mitigate the decline Management's Discussion and Analysis in total mortgage originations. Although we cannot predict our 2017 market share, recent industry consolidation may have a positive influence if lenders re-allocate the combined share of the consolidating companies among the remaining companies in the industry. Although our expectation is for our 2017 NIW to be comparable to that of 2016, this will be highly dependent on the actual mortgage origination market and competition. If pricing competition intensifies and customers can obtain lower prices elsewhere, our NIW may be lower than we expect. Our book of IIF is the main driver of our revenues and earnings and its growth is driven by our ability to generate NIW and retain existing policies in force, as measured by our persistency. Interest rates influence both our NIW and persistency. Since the Presidential election, mortgage rates, as reflected in the 30-year fixed rate, have risen. In a rising rate environment, we expect the level of cancellation activity to decelerate, and in turn increase persistency, although the impact generally lags the change in interest rates. Higher interest for borrowers, which could slow housing activity, and of particular importance to our industry, slow first time home buyer purchase activity resulting in less NIW. Historically however, purchase origination volume has not been significantly impacted by interest rate changes of less than 100 bps on a year-over-year basis. reduce affordability rates could We expect to face challenges growing our earned premium revenues in 2017 from 2016 levels, even with a larger book of IIF, as the impact of changing premium rates on our IIF continues to adversely impact our premium yield. Our premium yield is expected to decline in 2017 from the 2016 level as a greater percentage of our IIF will be from book years 2009 and later, which were generally written at lower premium rates than the earlier books. In addition, premium rates are resetting to lower rates on a substantial portion of our monthly and annual premium policies that have not been refinanced under HARP and remain in force on their ten year anniversary. The initial ten-year period is reset when a loan is refinanced under HARP. As of December 31, 2016, the 2007 book year IIF that is subject to premium rate resets during 2017 was approximately 4% of our total IIF. Counter to this trend, our net premiums earned may continue to benefit from cancellations on single premium policies in 2017, which increases our premium yield when persistency is less than was assumed when the policy was written, as the premium is generally non-refundable and becomes fully earned. Higher persistency on our monthly and annual premium business would also counteract the impact of lower premium rates. MGIC Investment Corporation 2016 Annual Report | 9 Management's Discussion and Analysis Credit trends on our RIF continue to improve and we have experienced a declining level of new delinquent notices, losses paid and total delinquent notice inventory. We expect these trends to continue in 2017. Significant favorable reserve development due to lower claims rates on prior year delinquencies has occurred over the past two years, but this may not continue in 2017. As of December 31, 2016, our PMIERs Available Assets were 16% greater than our Minimum Required Assets. We believe that maintaining Available Assets at a level of 10-15% in excess of our Minimum Required Assets is prudent to preserve our ability to write new business, meet unexpected losses without the need to access the capital markets, pursue new business opportunities, and continually comply with the PMIERs which are subject to change and the GSEs could make them more onerous in future periods, which could materially affect our Available Assets and/or Minimum Required Assets. We expect the GSEs to perform a comprehensive review of the PMIERs financial requirements and to update them in 2017 as the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated at least every two years. As part of the GSEs' comprehensive review, changes may also be made to provisions of the PMIERs that determine our Available Assets. As of December 31, 2016, we believe any reasonably foreseeable changes to the PMIERs financial requirements would not result in our failing to be in compliance with those new requirements. In 2016, MGIC paid a total of $64 million in dividends to our holding company, its first dividends since 2008, and we expect MGIC to continue to pay quarterly dividends. OCI authorization is sought before MGIC pays dividends and MGIC will pay a dividend of $20 million to our holding company in the first quarter of 2017. Dividends from MGIC allow us to effectively utilize excess capital at MGIC to manage liquidity at our holding company, deploy capital to other business opportunities, or repurchase debt or shares of our common stock. CAPITAL GSEs We must comply with the PMIERs to be eligible to insure loans purchased by the GSEs. In addition to their financial requirements, the PMIERs include business, quality control and certain transaction approval requirements. The financial requirements of the PMIERs require a mortgage insurer’ s Available Assets to equal or exceed its Minimum Required Assets. Based on our interpretation of the PMIERs, as of December 31, 2016, MGIC’ s Available Assets are $4.7 billion and its Minimum Required Assets are 10 | MGIC Investment Corporation 2016 Annual Report $4.1 billion; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. If MGIC ceases to be eligible to insure loans purchased by one or both of the GSEs, it would significantly reduce the volume of our NIW. Factors that may negatively impact MGIC’ s ability to continue to comply with the PMIERs include the following: • The GSEs could make the PMIERs more onerous in the future; in this regard, the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated every two years and may be updated more frequently to reflect changes in macroeconomic conditions or loan performance. The GSEs will provide notice 180 days prior to the effective date of table updates. In addition, the GSEs may otherwise amend the PMIERs at any time. • The GSEs may reduce the amount of credit they allow under the PMIERs for the risk ceded under our quota share reinsurance transaction. The GSEs’ ongoing approval of that transaction is subject to several conditions and the transaction will be reviewed under the PMIERs at least annually by the GSEs. For more information about the transaction, see our risk factor titled “The mix of business we write affects our Minimum Required Assets under the PMIERs, our premium yields and the likelihood of losses occurring.” • Our future operating results may be negatively impacted by the matters discussed in our risk factors. Such matters could decrease our revenues, increase our losses or require the use of liquid assets, thereby creating a shortfall in Available Assets. • Should capital be needed by MGIC in the future, capital contributions from our holding company may not be available due to competing demands on holding company resources, including for repayment of debt. On an overall basis, the amount of Available Assets MGIC must hold in order to continue to insure GSE loans increased under the PMIERs over what state regulation currently requires. State Regulations The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to its RIF (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “State Capital Requirements.” While they vary among jurisdictions, the most common State Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk-to-capital ratio will increase if (i) the percentage decrease in capital exceeds the percentage decrease in insured risk, or (ii) the percentage increase in capital is less than the percentage increase in insured risk. Wisconsin does not regulate capital by using a risk-to-capital measure but instead requires an MPP. At December 31, 2016, MGIC’ s risk-to-capital ratio was 10.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $1.6 billion above the required MPP of $1.1 billion. In calculating our risk- to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance transaction, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read our risk factors for information about matters that could negatively affect such compliance. At December 31, 2016, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 12.0 to 1. Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it its own under certain state-specific could on requirements. The NAIC previously announced that it plans to revise the minimum capital and surplus requirements for mortgage insurers that are provided for in its Mortgage Guaranty Insurance Model Act. In May 2016, a working group of state regulators released an exposure draft of a risk-based capital framework to establish capital requirements for mortgage insurers, although no date has been established by which the NAIC must propose revisions the capital requirements. We continue to evaluate the impact of the framework contained in the exposure draft, including the potential impact of certain items that have not yet been completely addressed by the framework which include: the treatment of ceded risk, minimum capital floors, and action level triggers. Currently we believe that the PMIERs contain the more restrictive capital requirements in most circumstances. to Management's Discussion and Analysis increase the GSE REFORM The FHFA has been the conservator of the GSEs since 2008 and has the authority to control and direct their operations. The increased role that the federal government has assumed in the residential housing finance system through the GSE conservatorship may likelihood that the business practices of the GSEs change in ways that have a material adverse effect on us and that the charters of the GSEs are changed by new federal legislation. In the past, members of Congress have introduced several bills intended to change the business practices of the GSEs and the FHA; however, no legislation has been enacted. The new Presidential the administration conservatorship of the GSEs should end; however, it is unclear whether and when that would occur and how that would impact us. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including PMI, will play in the residential housing finance system in the future or the impact of any such changes on our business. In addition, the timing of the impact of any resulting changes on our business is uncertain. Most meaningful changes would require Congressional action to implement and it is difficult to estimate when Congressional action would be final and how long any associated phase-in period may last. indicated that has For additional information about the business practices of the GSEs, see our risk factor titled “Changes in the business practices of the GSEs, federal legislation that changes their charters or a restructuring of the GSEs could reduce our revenues or increase our losses.” loans more affordable LOAN MODIFICATIONS AND OTHER SIMILAR PROGRAMS The federal government, including through the U.S. Department of the Treasury and the GSEs, and several lenders have modification and refinance programs to make outstanding to borrowers with the goal of reducing the number of foreclosures. These programs included HAMP and similar modification programs, and HARP. During 2015 and 2016, we were notified of modifications that cured delinquencies that had they become paid claims would have resulted in approximately $0.6 billion and $0.5 billion, respectively, of estimated claim payments. These levels are down from a high of $3.2 billion in 2010. HAMP expired at the end of 2016 and although HARP has been extended through September 2017, we believe that we have realized the majority of the benefits from that program because the number of loans insured by us that we are aware are entering MGIC Investment Corporation 2016 Annual Report | 11 Management's Discussion and Analysis that program has decreased significantly. The GSEs have introduced the "Flex Modification" program to replace HAMP effective in October 2017. Until it becomes effective, loan servicers must still evaluate borrowers for other GSE modification programs. We cannot determine the total benefit we may derive from loan modification programs, particularly given the uncertainty around the re-default rates for defaulted loans that have been modified. Our loss reserves do not account for potential re-defaults of current loans whose defaults were cured through modifications. As shown in the following table, as of December 31, 2016 approximately 19% of our primary RIF has been modified: Policy Year 2003 and Prior 2004 2005 2006 2007 2008 2009 2010 - 2016 Total HARP (1) Modifications HAMP & Other Modifications 11.1% 18.1% 24.9% 27.8% 38.7% 53.0% 29.2% —% 10.3% 36.0% 35.3% 35.7% 35.9% 29.5% 17.2% 3.5% 0.1% 8.8% (1) Includes proprietary programs that are substantially the same as HARP. As of December 31, 2016 based on loan count, the loans associated with 97.5% of all HARP modifications and 75.3% of HAMP and other modifications were current. FACTORS AFFECTING OUR RESULTS Our results of operations are affected by: • Cancellations, which reduce IIF. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage coupon rates throughout the in force book, current home values compared to values when the loans in the in force book were insured and the terms on which mortgage credit is available. Home price appreciation can give homeowners the right to cancel mortgage insurance on their loans if sufficient home equity is achieved. Cancellations also result from policy rescissions, which require us to return any premiums received on the rescinded policies and claim payments, which require us to return any premium received on the related policies from the date of default on the insured loans. • Premium rates, which are affected by product type, competitive pressures, the risk characteristics of the insured loans and the percentage of coverage on the insured loans. The substantial majority of our monthly and annual mortgage insurance premiums are under premium plans for which, for the first ten years of the policy, the amount of premium is determined by multiplying the initial loan balance; premium rate by the original thereafter, the premium resets and a lower premium rate is used for the remaining life of the policy. However, for loans that have utilized HARP, the initial ten-year period resets as of the date of the HARP transaction. The remainder of our monthly and annual premiums are under premium plans for which premiums are determined by a fixed percentage of the loan’ s amortizing balance over the life of the policy. • Premiums ceded, net of a profit commission, under reinsurance agreements. See Note 9 – “Reinsurance” financial statements for a discussion of our reinsurance agreements. to our consolidated Premiums written and earned Premiums written and earned in a year are influenced by: • NIW, which increases IIF, is the aggregate principal amount of the mortgages that are insured during a period. Many factors affect NIW, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from the FHA, the VA, other mortgage insurers, GSE programs that may reduce or eliminate the demand for mortgage insurance and other alternatives to mortgage insurance. NIW does not include loans previously insured by us that are modified, such as loans modified under HARP. Premiums are generated by the insurance that is in force during all or a portion of the period. A change in the average IIF in the current period compared to an earlier period is a factor that will increase (when the average in force is higher) or reduce (when it is lower) premiums written and earned in the current period, although this effect may be enhanced (or mitigated) by differences in the average premium rate between the two periods, as well as by premiums that are returned or expected to be returned in connection with claim payments and rescissions, and premiums ceded under reinsurance agreements. Also, NIW and cancellations during a period will generally have a greater effect on premiums written and earned in subsequent periods than in the period in which these events occur. 12 | MGIC Investment Corporation 2016 Annual Report Management's Discussion and Analysis Investment income Our investment portfolio is composed principally of investment grade fixed income securities. The principal factors that influence investment income are the size of the portfolio and its yield. As measured by amortized cost (which excludes changes in fair value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from (or used in) operations, such as NPW, investment income, net claim payments and expenses, and cash provided by (or used for) non- operating activities, such as debt or stock issuances or repurchases. • The distribution of claims over the life of a book. Historically, the first few years after loans are originated are a period of relatively low claims, with claims increasing substantially for several years then declining, although subsequent and the economy, persistency, the condition of including unemployment and housing prices, and other factors can affect this pattern. For example, a weak economy or housing value declines can lead to claims from older books increasing, continuing at stable levels or experiencing a lower rate of decline. See further information under “Mortgage Insurance Earnings and Cash Flow Cycle” below. Losses incurred Losses incurred are the current expense that reflects estimated payments that will ultimately be made as a result of delinquencies on insured loans. As explained under “Critical Accounting Policies” below, except in the case of a premium deficiency reserve, we recognize an estimate of this expense only for delinquent loans. The level of new delinquencies has historically followed a seasonal pattern, with new delinquencies in the first part of the year lower than new delinquencies in the latter part of the year, though this pattern can be affected by the state of the economy and local housing markets. Losses incurred are generally affected by: • The state of the economy, including unemployment and housing values, each of which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency. Changes in housing values also affect our ability to mitigate our losses through sales of properties we acquire after paying a claim as well as borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. • The product mix of the in force book, with loans risk characteristics generally having higher resulting in higher delinquencies and claims. • The size of loans insured, with higher average loan amounts tending to increase losses incurred. • The percentage of coverage on insured loans, with deeper average coverage tending to increase incurred losses. • The rate at which we rescind policies. Our estimated loss reserves reflect mitigation from rescissions of policies and denials of claims. We collectively refer to such rescissions and denials as “rescissions” and variations of this term. • Losses ceded under reinsurance agreements. See Note 9 – “Reinsurance” to our consolidated financial statements for a discussion of our reinsurance agreements. Underwriting and other expenses The majority of our operating expenses are fixed, with some variability due to contract underwriting volume. Contract underwriting generates fee income included in “Other revenue.” Underwriting and other expenses are net of any ceding commission associated with reinsurance agreements. See Note 9 – our “Reinsurance” financial to our consolidated statements for a discussion of our reinsurance agreements. Interest expense Interest expense reflects the interest associated with our outstanding debt obligations discussed in Note 7 – “Debt” to our consolidated financial statements and under “Liquidity and Capital Resources” below. Other Certain activities that we do not consider to be part of our fundamental operating activities may also impact our results of operations and are described below. Net realized investment gains (losses) Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security’ s cost basis, as well as any OTTI recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale. Loss on debt extinguishment At times, we may undertake activities to improve our debt profile and/or reduce potential dilution from our outstanding convertible debt. Extinguishing our MGIC Investment Corporation 2016 Annual Report | 13 Management's Discussion and Analysis outstanding debt obligations early through these discretionary activities may result in losses primarily driven by the payment of consideration in excess of our carrying value, and the write off of unamortized debt issuance costs on the extinguished portion of the long-term debt. Refer to “Explanation and reconciliation of our use of Non-GAAP financial measures” below to understand how these items impact our evaluation of our fundamental financial performance. MORTGAGE INSURANCE EARNINGS AND CASH FLOW CYCLE In general, the majority of any underwriting profit that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book generally result in either underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments) and increasing losses. The typical pattern is also a function of premium rates generally resetting to lower levels after ten years. 14 | MGIC Investment Corporation 2016 Annual Report Explanation and Reconciliation of our use of Non-GAAP Financial Measures Management's Discussion and Analysis NON-GAAP FINANCIAL MEASURES We believe that use of the Non-GAAP measures of pretax operating income (loss), net operating income (loss) and net operating income (loss) per diluted share facilitate the evaluation of the company's core financial performance thereby providing relevant information. These measures are not recognized in accordance with accounting principles generally accepted in the United States of America (GAAP) and should not be viewed as alternatives to GAAP measures of performance. The measures described below have been established increase transparency for the purpose of evaluating our fundamental operating trends. to Pretax operating income (loss) is defined as GAAP income (loss) before tax, excluding the effects of net realized investment gains (losses), gain (loss) on losses debt extinguishment, net recognized in income (loss) and infrequent or unusual non-operating items, if any. impairment Net operating income (loss) is defined as GAAP net income (loss) excluding the after-tax effects of net realized investment gains (losses), gain (loss) on debt extinguishment, net losses recognized in income (loss), and infrequent or unusual non-operating items, and the effects of changes in our deferred tax valuation allowance. The amounts of adjustments to net income (loss) are tax effected using a federal statutory tax rate of 35%. impairment Net operating income (loss) per diluted share is calculated by dividing (i) net operating income (loss) adjusted for interest expense on convertible debt, share dilution from convertible debt, and the impact of arrangements consistent with the accounting standard regarding earnings per share, whenever the impact is dilutive, by (ii) diluted weighted average common shares outstanding. compensation stock-based Although pretax operating income (loss) and net operating income (loss) exclude certain items that have occurred in the past and are expected to occur in the future, the excluded items represent items that are: (1) not viewed as part of the operating performance of our primary activities; or (2) impacted by both discretionary and other economic factors and are not necessarily indicative of operating trends, or both. These adjustments, along with the reasons for treatment, are described below. Other their companies may these measures calculate differently. Therefore, their measures may not be comparable to those used by us. (1) Net realized investment gains (losses). The recognition of net realized investment gains or losses can vary significantly across periods as the timing of individual securities sales is highly discretionary and is influenced by such factors as market opportunities, our tax and capital profile, and overall market cycles. Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized investment gains and losses. (2) Gains and losses on debt extinguishment. Gains and losses on debt extinguishment result from discretionary activities that are undertaken to enhance our capital position, improve our debt profile, and/or reduce potential dilution from our outstanding convertible debt. (3) Net impairment losses recognized in earnings. The recognition of net impairment losses on investments can vary significantly in both size and timing, depending on market credit cycles, individual issuer performance, and general economic conditions. (4) Deferred tax asset valuation allowance. The recognition, or reversal, of a valuation allowance against deferred tax assets is subject to significant management judgment and such recognition or reversal may significantly impact the discrete accounting period in which it is recorded. MGIC Investment Corporation 2016 Annual Report | 15 Management's Discussion and Analysis Non-GAAP Reconciliations Reconciliation of Income before tax to pretax operating income and calculation of Net operating income (In thousands) Years Ended December 31, 2016 2015 2014 Income before tax per Statement of Operations $ 514,714 $ 487,687 $ 254,723 Adjustments: Net realized investment gains Loss on debt extinguishment Pretax operating income Income taxes: Provision for income taxes (1) Net operating income (8,932) 90,531 596,313 (28,361) 507 459,833 (1,357) 837 254,203 200,757 153,748 91,425 $ 395,556 $ 306,085 $ 162,778 (1) Income before tax within operating income is tax effected at our effective tax rate. The effective tax rate for the years December 31, 2015 and 2014 exclude the effects of the change in our valuation allowance. Adjustments are tax effected at the federal statutory rate of 35%. Reconciliation of Net income to Net operating income (In thousands) Net income Years Ended December 31, 2016 2015 2014 $ 342,517 $ 1,172,000 $ 251,949 Effect of change in deferred tax asset valuation allowance — (847,810) (88,833) Adjustments, net of tax(1): Net realized investment gains Loss on debt extinguishment Net operating income (1) Adjustments are tax effected at the federal statutory rate of 35%. (5,806) 58,845 (18,435) 330 (882) 544 $ 395,556 $ 306,085 $ 162,778 Reconciliation of Net operating income per diluted share to Net income per diluted share Net income per diluted share Effect of change in deferred tax asset valuation allowance (1) Net realized investment gains Loss on debt extinguishment Net operating income per diluted share Years Ended December 31, 2016 2015 2014 $ $ 0.86 $ 2.60 $ — (0.01) 0.14 (1.81) (0.04) — 0.64 (0.21) — — 0.99 $ 0.75 $ 0.43 (1) The change in our deferred tax asset valuation allowance includes a $686.7 million reduction to our tax provision for amounts to be realized in future periods, or $1.47 per diluted share. 16 | MGIC Investment Corporation 2016 Annual Report Mortgage Insurance Portfolio MORTGAGE ORIGINATIONS GREW AGAIN IN 2016; FORECASTED TO DECLINE IN 2017 (see chart 01) lower in 2017 In 2016, the primary mortgage insurance market grew, driven by a larger mortgage origination market as solid housing fundamentals, such as household formations, an improved employment environment, and low interest rates supported housing activity. Mortgage origination estimates indicate that both purchase and refinance volume increased in 2016 compared to the prior year. The expected decline in is based upon mortgage originations significantly refinancing originations as mortgage interest rates are anticipated to trend higher. Generally, the purchase origination market has a greater impact on the PMI industry as historically the industry's share is 3-4 times higher for purchase originations than refinancing originations. While a smaller mortgage origination market is expected to result in lower NIW for the overall PMI industry in 2017 recent industry consolidation is expected to result in lenders allocating NIW away from combining insurers to other private mortgage insurers. Competition from government mortgage programs, discussed below, will also continue to impact the market share of PMI. In consideration of these factors, our 2017 NIW is expected to be comparable to that of 2016. insurance 01 MORTGAGE ORIGINATIONS IN BILLIONS Management's Discussion and Analysis ESTIMATED TOTAL OF PMI, FHA, and VA PRIMARY MORTGAGE INSURANCE IN BILLIONS Primary mortgage insurance 2016 $744 2015 $628 2014 $438 Source: Inside Mortgage Finance - February 16, 2017 (excluding USDA insured amounts), or SEC filings. Includes HARP NIW. THE MORTGAGE REMAINS INTENSELY COMPETITIVE (see tables 02 and 03) INSURANCE INDUSTRY team pricing, financial strength, including We compete against five other private mortgage insurers, as well as government mortgage insurance programs such as the FHA and VA. There are various ways in which we compete with other mortgage underwriting insurers, requirements, customer relationships, reputation, and the strength of our management field organization. and Competition in 2016 primarily centered on pricing practices in the market and included: (i) reductions in standard filed rates on BPMI policies, (ii) use by certain competitors of a spectrum of filed rates to allow for formulaic, risk-based pricing (commonly referred to as "black-box" pricing); and (iii) use of customized rates (discounted from published rates) on LPMI single premium policies. These pricing practices were driven by both the implementation of PMIERs at the end of 2015, as well as industry competition to maintain or grow market share. The result of in which we participated, generally decreased filed premium rates on higher-FICO score loans and increased rates on lower-FICO score loans. We also continue to use authority set forth in our rate filings to provide customized LPMI single premium policy rates on a selective basis. We believe our current rates allow us to compete effectively across many FICO scores; however that pricing competition will not intensify further, which could result in a decrease in our NIW and/or product-based returns. the pricing changes, is no guarantee there Purchase originations Refinance originations Source: GSEs and MBA estimates/forecasts as of January 2017. Amounts represent the average of all sources. The FHA offers fixed premium rates across all FICO scores and often has lower monthly premium rates across lower FICO business, which are effectively cross-subsidized by higher-FICO score premium rates. As a result, we have seen, and expect to continue to see some lenders utilize FHA insurance for the lower-FICO score business for which we compete. However, not all lower-FICO score business is migrating to the FHA because PMI may be cancelable when FHA insurance is not, lenders value our customer service, PMI continues to be an efficient MGIC Investment Corporation 2016 Annual Report | 17 Management's Discussion and Analysis and cost-effective alternative to the FHA for many borrowers, and some lenders perceive greater legal risks under FHA versus GSE programs. Any reduction in premium rates by the FHA that create a larger payment differential than at present could result in more business utilizing FHA mortgage insurance. Even though the PMI industry's pricing changes raised premiums on lower-FICO score loans, the PMI industry captured a greater share of the total PMI and government insured volume in 2016. The increase in PMI share was due in part to new 97% LTV loan offerings from lenders that securitize loans with the GSEs, which provided an alternative to similar FHA loan programs for qualified borrowers, and some lenders are shifting business away from the FHA due to perceived legal risks. While our market share in 2016 declined from 2015 levels due to the overall competitive environment, we believe the decline is principally attributable to our maintaining greater pricing discipline than certain competitors in LPMI single premium policies. We plan to continue to focus on writing new insurance that meets our risk-adjusted return thresholds across the spectrum of loans we insure and provide market- leading customer service. Our market share in 2017 will again primarily be influenced by competitive pricing practices, but is also expected to be influenced by customer service, and changes in ownership of our competitors as lenders prefer to allocate business across a spectrum of mortgage insurers, with limitations on amounts allocated to any individual mortgage insurer. 02 ESTIMATED PRIMARY MI MARKET SHARE % OF TOTAL PRIMARY MI VOLUME INSURANCE WRITTEN NEW INCREASED 11% WITH STRONG UNDERLYING CREDIT CHARACTERISTICS For the full-year 2016, NIW was higher than our initial expectations due to a stronger than expected mortgage origination market. From our perspective, the 2016 NIW has strong underlying credit characteristics as lenders maintained high underwriting standards and our pricing is competitive for higher-FICO score business (see tables 04 and 05). Our mix between policy payment types was relatively stable from the prior year, and we maintained a high mix of monthly premium business, which is almost exclusively BPMI (see table 06). Refinances were a larger percentage of our NIW in 2016 (see table 07) driven by a significant increase in refinancing activity in the second half of 2016 as average interest rates on 30-year fixed rate loans fell to multi-year lows in the third quarter following Britain's vote to exit the European Union. Across the spectrum of loan-to- value ratios, we had a greater increase in the percentage of NIW from LTVs 95.01 and above, which was largely a function of new 97% LTV loan programs offered by lenders and a shift by lenders from the FHA to PMI. The percentage of NIW from LTVs 80.01% to 85% also increased for a number of reasons: our lowering of premiums in this LTV segment and for borrowers with higher FICO scores, and a higher amount of refinancing originations by borrowers whose home values increased but still were required to have PMI. 04 PRIMARY NIW BY FICO SCORE IN BILLIONS Years Ended December 31, 2016 2015 2014 740 and greater $ 28.3 $ PMI FHA VA 2016 36.3% 36.4% 27.3% 2015 35.0% 40.4% 24.6% 2014 40.7% 33.9% 25.4% 700 - 739 660 - 699 659 and less Total 12.2 5.9 1.5 24.8 10.8 5.8 1.6 $ 18.8 8.6 4.8 1.2 $ 47.9 $ 43.0 $ 33.4 Source: Inside Mortgage Finance - February 16, 2017 (excluding USDA insured amounts). Includes HARP NIW. 05 LOAN-TO-VALUE % OF PRIMARY NIW 03 ESTIMATED MGIC MARKET SHARE % OF TOTAL PRIMARY PRIVATE MI VOLUME MGIC 2016 17.8% 2015 19.9% 2014 19.8% Source: Inside Mortgage Finance - February 16, 2017 or SEC filings. Excludes HARP NIW. 95.01% and above 90.01% to 95.00% 85.01% to 90.00% 80.01% to 85% Years Ended December 31, 2016 2015 2014 5.8% 47.8% 31.7% 14.7% 4.4% 50.1% 33.1% 12.4% 1.8% 55.5% 31.5% 11.2% 18 | MGIC Investment Corporation 2016 Annual Report 06 POLICY PAYMENT TYPE % OF PRIMARY NIW 08 INSURANCE AND RISK IN FORCE IN BILLIONS Management's Discussion and Analysis Monthly premiums Single premiums Annual Premiums Years Ended December 31, 2016 2015 2014 80.6% 19.1% 0.3% 79.3% 20.4% 0.3% 84.8% 14.9% 0.3% 07 TYPE OF MORTGAGE % OF PRIMARY NIW Purchases Refinances Years Ended December 31, 2016 2015 2014 80.4% 19.6% 81.3% 18.7% 86.6% 13.4% IIF INCREASED 4% TO $182B; RIF INCREASED 4% TO $47.2B (see table 08) The amount of our IIF and RIF is impacted by the amount of NIW and cancellations of primary IIF during the year. Although we wrote $47.9 billion of new insurance in 2016, we experienced an increasing level of cancellation volume, which hindered our IIF growth from the prior year. Cancellation activity is primarily due to refinancing activity, but is also impacted by rescissions, cancellations due to claim payment, and policies cancelled when borrowers achieve the required amount of home equity. Refinancing activity has historically been affected by the level of mortgage interest rates and the level of home price appreciation. Cancellations generally move inversely to the change in the direction of interest rates, although they generally lag a change in direction. Persistency Our persistency at December 31, 2016 was 76.9% compared to 79.7% at December 31, 2015. Since 2000, our year-end persistency ranged from a high of 84.7% at December 31, 2009 to a low of 47.1% at December 31, 2003. We expect our persistency to trend higher during 2017 from the level experienced at the end of 2016 because interest rates are forecasted to increase during 2017. Years Ended December 31, 2016 2015 2014 NIW $ 47.9 $ 43.0 $ 33.4 Cancellations (40.4) (33.4) (27.2) Increase in primary IIF Direct primary IIF as of December 31, Direct primary RIF as of December 31, $ 7.5 $ 9.6 $ 6.2 $ 182.0 $ 174.5 $ 164.9 $ 47.2 $ 45.5 $ 42.9 CREDIT PROFILE OF OUR PRIMARY RIF IS IMPROVING (see table 09) The proportion of our total primary RIF written after 2008 has been steadily increasing in proportion to our total primary RIF. Our 2009 and later books possess significantly improved credit characteristics when compared to our 2005-2008 origination years. The loans we insured beginning in 2009, on average, have substantially higher FICO scores and lower LTVs than those insured in 2005-2008. The credit profile of our RIF has also benefited from programs such as HARP. HARP allows borrowers who are not delinquent, but who may not otherwise be able to refinance their loans under the current GSE underwriting standards due to, for example, the current LTV exceeding 100%, to refinance and lower their note rate. Loans associated with 97.5% of all of our HARP modifications were current as of December 31, 2016. The following chart shows the composition of our primary RIF as of December 31, 2016. As shown in the chart below, the aggregate of our 2009-2016 books and our HARP modifications accounted for approximately 81% of our total primary RIF at December 31, 2016. MGIC Investment Corporation 2016 Annual Report | 19 reasons, POOL AND OTHER INSURANCE MGIC has written no new pool insurance since 2009, however, for a variety of including responding to capital market alternatives to private mortgage insurance and customer demands, MGIC may write pool risk in the future. Our direct pool RIF was $547 million ($244 million on pool policies with limits and $303 million on pool aggregate loss policies without aggregate limits) at loss December 31, 2016 compared to $659 million ($271 million on pool policies with aggregate loss limits and $388 million on pool policies without aggregate loss limits) at December 31, 2015. If claim payments associated with a specific pool reach the aggregate loss limit, the remaining IIF within the pool would be cancelled and any remaining defaults under the pool would be removed from our default inventory. In the second half of 2016 we participated in GSE credit risk transfer transactions through an affiliate of MGIC. Each GSE launched a new credit risk transfer offering that involved credit insurance policies with a pool structure that primarily covered loans to be delivered to the GSE in the future. The policies provide additional coverage beyond primary mortgage insurance on 30-year fixed-rate mortgages with 80.01-95% LTVs. These transactions were immaterial to our financial statements in 2016 and given the risk insured will remain immaterial to our financial statements in future periods. Future participation in GSE credit risk transfer transactions will need to be evaluated based upon the terms offered and expected returns. Management's Discussion and Analysis 09 PRIMARY RISK IN FORCE IN BILLIONS December 31, 2016 December 31, 2015 December 31, 2014 RIF % of RIF RIF % of RIF RIF % of RIF $33,368 71% $28,339 62% $22,590 53% 4,489 9% 5,237 12% 5,758 13% 396 1% 509 1% 591 1% 2009+ 2005 - 2008 (HARP) Other years (HARP) Subtotal 38,253 81% 34,085 75% 28,939 67% 1,475 3% 1,933 4% 2,488 6% Other years (Non- HARP) 2005- 2008 (Non- HARP) 7,467 16% 9,444 21% 11,520 Subtotal 8,942 19% 11,377 25% 14,008 27% 33% Total Primary RIF $47,195 100% $45,462 100% $42,947 100% 20 | MGIC Investment Corporation 2016 Annual Report Consolidated Results of Operations Management's Discussion and Analysis The following section of the MD&A provides a comparative discussion of our Consolidated Results of Operations for the three-year period ended December 31, 2016. For a discussion of the Critical Accounting Policies used by us that affect the Consolidated Results of Operations, see "Critical Accounting Policies" below. Revenues Year Ended December 31, (In millions) 2016 2015 2014 Net premiums written $ 975.1 $ 1,020.3 $ 882.0 Net premiums earned $ 925.2 $ 896.2 $ 844.4 Investment income, net of expenses Net realized investment gains Other revenue 110.7 103.7 87.6 8.9 17.7 28.4 13.0 1.4 9.3 Total revenues $1,062.5 $ 1,041.3 $ 942.6 transaction. As part of NPE INCREASED 3.2% IN 2016 AND 6.1% IN 2015 2016 compared to 2015. NPW declined 4.4% from the prior year, primarily because ceded premiums were lower in 2015 due to the commutation of our 2013 QSR Transaction in the third quarter, which was a non-recurring the commutation, unearned ceded premiums were remitted back to us from the reinsurers, and we returned the related ceding commissions, which had the effect of increasing our profit commission. Partially offsetting the higher 2016 ceded premiums was an increase in new business premiums in 2016 and a reduction in premium refunds, and our related accrual, due to lower claim activity. NPE increased 3.2% from the prior year reflecting higher earned premiums from single premium policies and lower premium refunds and accruals. The increase in earned premiums on single premium policies was driven by refinance activity as single premium policies are generally non-refundable. The decrease in premium refund accruals was due to lower claim activity. The increase in net premiums earned was offset in part by the effects of our 2013 in 2015, which QSR Transaction commutation resulted in a non-recurring increase in our profit commission. See "Overview – Factors Affecting Our Results" above for additional factors that also influence the amount of net premiums written and earned in a year. 2015 compared to 2014. NPW increased 15.7% from the prior year. The increase reflects higher premiums refund accruals. from new business, as well as a reduction to our In addition, ceded premium the premiums were commutation of our 2013 QSR Transaction in the third quarter. in 2015 due lower to NPE increased 6.1% from the prior year reflecting higher profit commission and higher earned premiums on single premium policies. The higher profit commission was the result of the 2015 return of ceding commissions to reinsurers as part of the commutation of our 2013 QSR Transaction. The increase in earned premiums from single premium policies was driven by refinance activity as singles are generally non-refundable. Premium Yield (see table 10) Premium yield decreased to 51.9 basis points for 2016 (2015: 52.8, 2014: 52.2) The amount of premiums earned from our average IIF during the year is important to understanding our consolidated results of operations and is influenced by a number of key drivers, which are described below. The impact each driver has from period to period will vary. Change in premium rates Changing premium rates have decreased our premium yield in 2016 primarily due to the following factors. • The books we wrote in 2009 and after were 72% of our IIF as of December 31, 2016, compared to 64% as of December 31, 2015 and these book years have a lower average premium rate than prior books due to several risk characteristics. including, factors, lower • The monthly premium program used for the substantial majority of loans we insured provides for a set premium rate for the first ten years of the policy and a lower premium rate thereafter. The initial ten-year period is reset when the loan is refinanced under HARP. As of December 31, 2016 approximately 4% and 2% of our total primary IIF was written in 2007 and 2008; respectively, was not refinanced under HARP and is subject to reset after ten years. Change in premium refunds and premium refund accruals (excluding most single premium policies) • Premium refunds upon claim payment or rescission decrease our premium yield. Generally, the level of premiums we refund and our premium MGIC Investment Corporation 2016 Annual Report | 21 commutation of our 2013 QSR Transaction in 2015 that resulted in a non-recurring increase in our profit commission and in turn reduced ceded premiums. These reductions were partially negated by a lower amount of premium refunds and a higher amount of earned premiums from single premium policies due to refinancings. 2015 compared to 2014. Our 2015 full-year premium yield increased when compared to full-year 2014 (see table 10). As shown in the chart the increase in our premium yield was due to lower premium refunds, higher earned premiums from single premium policies due to refinancings, and a less adverse impact from reinsurance due to the commutation of our 2013 QSR Transaction in 2015. These increases were offset in part by a lower average premium rate on the 2015 average IIF. 10 PREMIUM YIELD IN BASIS POINTS 2016 2015 Prior year premium yield 52.8 52.2 Reconciliation: change in premium rates (3.0) (2.9) change in premium refunds and accruals single premium policy persistency reinsurance End of year premium yield 2.6 1.0 (1.5) 51.9 2.2 0.7 0.6 52.8 Management's Discussion and Analysis refund accrual are highly variable from period to period. • When a policy is cancelled for a reason other than rescission or claim payment, all premium that is non-refundable is immediately earned and any refundable premium from the cancellation date is returned to the servicer or borrower. Non- refundable premium is primarily associated with our single premium policies, which are discussed below. When a policy is rescinded, all previously collected premium is returned to the servicer. When a policy is cancelled due to claim payment, we return any premium received since the date of default. Single premium policy persistency • The recent decrease in single premium policy persistency has increased our premium yield, with an increasing impact in recent periods as single premium policies have become a larger portion of our IIF and mortgage interest rates have remained low resulting in greater cancellations of policies. • Generally, the premium on a single premium policy is not refundable and is earned over the estimated policy life. Therefore, if persistency is less than was assumed when the policy was written, the effective premium yield will increase. Reinsurance • The use of reinsurance lowers our premium yield, however the magnitude of the impact varies from period following considerations. to period due the to The 2015 QSR Transaction increased the amount of our IIF covered by reinsurance and results in an increase in the amount of premiums and losses ceded. We cede 30% of earned and received premiums and losses incurred. The premiums we cede are reduced by a profit commission, which primarily varies by the level of losses we cede. Our reinsurance affects premiums, underwriting expenses and losses incurred and should be analyzed by reviewing its total effect on our statements of operations, as discussed below under “Reinsurance agreements.” 2016 compared to 2015. Our 2016 full-year premium yield declined when compared to full-year 2015 (see table 10). As shown in the chart the decline in our premium yield was primarily due to a lower average premium rate on the 2016 average IIF. Our reinsurance reduced our premium yield an additional 1.5 basis points from 2015, which was in part due the 22 | MGIC Investment Corporation 2016 Annual Report Reinsurance agreements Our quota share reinsurance affects various lines of our statements of operations and therefore we believe it should be analyzed by reviewing its effect on our pre-tax net income, as described below. • We cede a fixed percentage of premiums earned insurance covered by the and received on agreement. • We receive the benefit of a profit commission through a reduction in the premiums we cede. The profit commission varies directly and inversely with the level of losses on a "dollar for dollar" basis and is eliminated at levels of losses that we do not expect to occur. This means that lower levels of losses result in a higher profit commission and less benefit from ceded losses; higher levels of losses result in more benefit from ceded losses and a lower profit commission (or for levels of losses we do not expect, its elimination). • We receive the benefit of a ceding commission through a reduction in underwriting expenses equal to 20% of premiums ceded (before the effect of the profit commission). • We cede a fixed percentage of losses incurred on insurance covered by the agreement. The effects described above result in a net cost of the reinsurance, with respect to a covered loan, of 6% (but can be lower if losses are materially higher than we expect). This cost is derived by dividing the reduction in our pre-tax net income from such loans with reinsurance by our direct (that is, without reinsurance) premiums from such loans. Although the net cost of the reinsurance is generally constant at 6%, the effect of the reinsurance on the various components of pre- tax income discussed above will vary from period to period, depending on the level of ceded losses. Because more of our IIF is covered under the 2015 QSR Transaction than was covered under the commuted 2013 QSR Transaction, the absolute dollar cost of the 2015 QSR Transaction will be higher than the cost of the 2013 QSR Transaction. Although the use of reinsurance reduces our pre-tax net income, we receive credit under the PMIERs for risk ceded under our 2015 QSR Transaction, which mitigates the negative effect of the PMIERs on our returns. Management's Discussion and Analysis The following table provides additional information related to our premiums written and earned and RIF subject to reinsurance agreements for 2016, 2015, and 2014. (Dollars in thousands) NIW subject to quota share reinsurance agreements IIF subject to quota share reinsurance agreements IIF subject to captive reinsurance agreements As of and For the Years Ended December 31, 2016 2015 2014 89% 91 % 90% 76% 73 % 56% 2% 3 % 5% 2015 QSR Transaction (1) Ceded premiums written, net of profit commission % of direct premiums written Ceded premiums earned, net of profit commission % of direct premiums earned Ceding commissions Ceded RIF $ 125,460 $ 52,588 11% 5 % $ 125,460 $ 52,588 12% 5 % $ 47,629 $ 20,582 $10,763,637 $9,886,952 2013 QSR Transaction (1) n/a n/a n/a n/a n/a n/a Ceded premiums written, net of profit commission % of direct premiums written Ceded premiums earned, net of profit commission % of direct premiums earned Ceding commissions Ceded RIF Captives Ceded premiums written % of direct premiums written Ceded premiums earned % of direct premiums earned n/a $ (11,355) $ 100,031 n/a (1)% 10% n/a $ 35,999 $ 88,528 n/a n/a n/a $ $ 4 % 9% 10,234 $ 37,833 — $8,229,173 $ $ 7,987 $ 13,547 $ 18,794 1.0% 1.3 % 1.9% 8,090 $ 13,650 $ 18,917 1.0% 1.4 % 2.0% (1) As discussed in Note 9 - "Reinsurance" to our consolidated financial statements, the 2013 QSR Transaction was commuted on July 1, 2015 and replaced with our 2015 QSR Transaction, which increased the IIF and corresponding RIF covered by reinsurance. Premiums are ceded on an earned and received basis under the 2015 QSR Transaction. MGIC Investment Corporation 2016 Annual Report | 23 Management's Discussion and Analysis INVESTMENT INCOME INCREASED IN 2016 AND INVESTMENT YIELDS 2015 AS AVERAGE INCREASED (see chart 11) The net unrealized (losses) gains position of our investment portfolio (see chart 12) as of December 31, 2016, 2015, and 2014 is as follows. 2016 compared to 2015. Net investment income increased 6.7% to $111 million in 2016 compared to $104 million in 2015. The increase in investment income was due to higher average investment yields, as well as a higher average investment portfolio balance. 2015 compared to 2014. Net investment income increased 18.4% to $104M in 2015 compared to $88M in 2014. The increase in investment income was due to higher average investment yields. See "Balance Sheet Analysis" in this MD&A for further discussion regarding our investment portfolio. 11 PORTFOLIO DURATION IN YEARS INVESTMENT YIELD % OF AVERAGE INVESTMENT PORTFOLIO ASSETS NET REALIZED INVESTMENT GAINS LOWER IN 2016; 2015 GAINS REFLECT OPPORTUNISTIC SALES ACTIVITY Net realized gains were $9 million in 2016 compared to $28 million in 2015 and $1M in 2014. Net realized gains in 2015 were primarily taken from our fixed income portfolio as we sold securities to realize gains under favorable market conditions. 12 NET UNREALIZED INVESTMENT (LOSSES) GAINS IN MILLIONS The net unrealized losses (gains) position of our investments as of December 31, 2016, 2015, 2014 was primarily caused by changes in interest rates between the time of purchase and the respective year end. See Note 5 - "Investments" for additional information on our investment portfolio. OTHER REVENUE IN 2016 ON FOREIGN CURRENCY GAINS AND 2015 ON CONTRACT UNDERWRITING ACTIVITY INCREASED 2016 compared to 2015. Other revenue increased to $18M in 2016 from $13M in 2015, primarily due to the substantial liquidation of our Australian operations for which we recognized approximately $4 million of gains related to changes in foreign currency exchange rates in the first quarter of 2016. Other revenue also increased compared to the prior year due to an increase in contract underwriting fees attributable to higher mortgage origination volumes. 2015 compared to 2014. Other revenue increased to $13M in 2015 from $9 million in 2014 primarily due to an increase in our contract underwriting fees attributable to higher mortgage origination volumes. 24 | MGIC Investment Corporation 2016 Annual Report Losses and expenses (In millions) 2016 2015 2014 Year Ended December 31, Losses incurred, net $ 240.2 $ 343.5 $ 496.1 Change in premium deficiency reserve Amortization of deferred policy acquisition costs Other underwriting and operating expenses, net Interest expense Loss on debt extinguishment Total losses and expenses — (23.8) (24.7) 9.6 8.8 7.6 150.8 56.7 155.6 68.9 138.4 69.6 90.5 0.5 0.8 $ 547.8 $ 553.6 $ 687.9 LOSSES INCURRED, NET CONTINUED TO DECLINE AS CREDIT QUALITY CONTINUED TO IMPROVE and “default” As discussed in “Critical Accounting Policies” below and consistent with industry practices, we establish loss reserves for future claims only for loans that are currently delinquent. The terms “delinquent” used interchangeably by us. We consider a loan in default when it is two or more payments past due. Loss reserves are established based on estimating the number of loans in our default inventory 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. are factors, 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. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several 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, that could result in, among other things, greater losses on loans, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Historically, losses incurred have followed a seasonal trend in which the second half of the year has weaker credit performance than the first half, with higher new notice activity and a lower cure rate. Our estimates are also affected by any Management's Discussion and Analysis agreements we enter into regarding our claims the settlement paying practices, such as agreements discussed in Note 17 – “Litigation and Contingencies” to our consolidated financial statements. Changes to our estimates could result in a material impact to our consolidated results of operations and capital position, even in a stable economic environment. Losses incurred, net 2016 compared to 2015. Losses incurred, net decreased 30% to $240 million compared to $344 million in 2015. The decrease was primarily due to a decrease in losses and LAE incurred in respect to defaults reported in the current year and favorable development on defaults that occurred in prior years. Current year losses declined due to a 9% reduction in new notices received and a lower claim rate applied to the new notices. The claim rate applied to new notices in each quarter of 2016 and 2015 generally ranged from 12% to 13% with the full-year 2016 claim rate on new notices declining by approximately 0.5 percentage points compared to the full-year 2015 claim rate. Favorable development on prior year defaults occurred in 2016 and 2015 due to a lower claim rate on previously reported defaults. In 2015, the amount of development was also favorably impacted by $21 million due to re-estimation of previously recorded reserves related to disputes on our claims paying practices and IBNR. The favorable development recognized in both 2016 and 2015 due to lower claim rates on prior year defaults was partially offset by increases in our expected severity assumption on prior year defaults. The increases in our severity assumption reflected a rising trend, following periods of relative stability, in our average claim paid, expressed as a percentage of our exposure (the unpaid principal balance of the loan times our insurance coverage percentage), from the first quarter of 2015 through the first quarter of 2016 (see table 17). Our loss reserves estimates take into consideration the development of the delinquencies may vary from period to period without establishing a meaningful trend. time, because trends over 2015 compared to 2014. Losses incurred, net decreased 31% to $344 million compared to $496 million in 2014. The decrease was primarily due to a decrease in losses and LAE incurred in respect to defaults reported in 2015 and favorable development on defaults that occurred in prior years. The 2015 current year losses declined due to a 16% reduction in new notices received and a lower claim rate applied to the new notices. The claim rate applied to new notices in each quarter of 2015 and 2014 generally ranged from 12% to 16%, with the full-year 2015 claim MGIC Investment Corporation 2016 Annual Report | 25 Management's Discussion and Analysis rate on new notices declining by approximately 2 percentage points compared to the full-year 2014 claim rate. The claim rate declined due to improved housing and economic conditions. The favorable development recognized in 2015 resulting from lower claim rates on prior year defaults was partially offset by increases in our expected severity assumption on prior year's defaults. The increases in our severity assumption reflected a rising trend, following periods of relative stability, in our average paid claim expressed as a percentage of our exposure, throughout 2015 (see table 17). In 2014, the favorable development reflected a lower claim rate and a lower severity assumption on prior years defaults. 13 COMPOSITION OF LOSSES INCURRED IN MILLIONS Loss Ratio (see chart 14) The loss ratio is the ratio, expressed as a percentage, of the sum of incurred losses and LAE, net to net premiums earned. The decline in the loss ratio in 2016 when compared to 2015, and in 2015 when compared to 2014 was primarily due to a lower level of losses incurred, net. 14 LOSS RATIO Claim Rate (see chart 15) Loans insured in 2008 and prior continue to represent a substantial portion of our new default notices received each quarter, with many new default notices relating to loans that previously had been reported delinquent (see chart 16). For 2016, loans insured in 2008 and prior represented approximately 87% of the new notices received and 90% of those notices related to loans that were previously delinquent. For 2015, loans insured in 2008 and prior represented approximately 92% of the new notices received and 88% of those notices related to loans that were previously delinquent. For 2014, loans insured in 2008 and prior represented approximately 96% of new notices received and 86% of those notices related to loans that were previously delinquent (see chart 16). As a result of this cycle (in which loans default, cure, and re-default, along with the duration that defaults may ultimately remain in our notice inventory), significant judgment is required in establishing the claim rate. 26 | MGIC Investment Corporation 2016 Annual Report 15 PRIMARY NEW NOTICES IN VOLUME NEW NOTICE CLAIM RATE (1) % 17 CLAIMS SEVERITY TREND Note: Table excludes material settlements (1). Management's Discussion and Analysis (1) Claim rate is the respective full year weighted average rate and is rounded to nearest whole percent. 16 NEW NOTICES FROM BOOK YEARS 2008 AND PRIOR IN VOLUME PREVIOUSLY DELINQUENT % Claims Severity (see table 17) Factors that impact claim severity include the exposure on the loan, the amount of time between default and claim filing (which impacts the amount of interest and expenses) and curtailments. All else being equal, the longer the period between default and claim filing, the greater the severity. The majority of loans from 2005-2008 (which represent the majority of loans in the delinquent inventory) are covered by master policy terms that, except under certain circumstances, do not limit the number of years that an insured can include interest when filing a claim if they comply with their obligations under the terms of the master policy. Average exposure on claim paid Average claim paid % Paid to exposure Period Q4 2016 $ 43,200 $ 48,297 Q3 2016 $ 43,747 $ 48,050 Q2 2016 Q1 2016 Q4 2015 Q3 2015 Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 43,709 44,094 44,342 44,159 44,683 44,403 44,321 43,769 43,402 43,711 47,953 49,281 49,134 48,156 48,587 47,366 46,714 45,849 45,531 45,897 111.8% 109.8% 109.7% 111.8% 110.8% 109.1% 108.7% 106.7% 105.4% 104.8% 104.9% 105.0% Average number of missed payments at claim received date 35 34 35 34 35 33 34 33 32 30 30 28 (1) Settlements include amounts paid in settlement disputes for claims paying practices and NPL settlements. See Note 8 – “Loss Reserves” to our consolidated financial statements and “Critical Accounting Policies” below for a discussion of our losses incurred and claims paying practices (including curtailments). MGIC Investment Corporation 2016 Annual Report | 27 Management's Discussion and Analysis NET LOSSES AND LAE PAID CONTINUED TO IMPROVED ON OUR DECLINE AS CREDIT PRIMARY RIF This section provides information on our claim payment trends and exposure on our outstanding RIF for the three years ending December 31, 2016. Net losses and LAE paid decreased 16% in 2016 compared to 2015 driven by lower claim activity on our primary business as the credit profile of our RIF continued to improve and our delinquent inventory declined. This is a continuation of the trend experienced in 2015 as net losses and LAE paid decreased 28% compared to 2014. During 2016, there was an increase in loss payments from settlements of disputes for claims paying practices and NPL settlements to NPL settlements with the GSEs to resolve legacy defaults. Pool losses paid included our 2011 settlement with Freddie Mac; our final payment under this settlement was made on December 1, 2016. We believe paid claims will continue to decline in 2017. increased, primarily due The following table presents our net losses and LAE paid for the years ended December 31, 2016, 2015 and 2014. Net Losses and LAE Paid (In millions) 2016 2015 2014 Total primary (excluding settlements) Claims paying practices and NPL settlements(1) Pool (2) Other Direct losses paid Reinsurance Net losses paid LAE Net losses and LAE paid before terminations Reinsurance terminations Net losses and LAE paid $ 599 $ 767 $ 1,082 53 56 (1) 707 (23) 684 20 704 (3) 10 68 5 850 (23) 827 22 849 (15) (8) 84 1 1,159 (34) 1,125 29 1,154 — Primary losses paid for the top 15 jurisdictions (based on 2016 losses paid, excluding settlement amounts) and all other jurisdictions for the years ended December 31, 2016, 2015 and 2014 appears in the following table. Paid Losses by Jurisdiction (In millions) Florida New Jersey Illinois New York Maryland California Pennsylvania Ohio Puerto Rico Washington Virginia Michigan Massachusetts Connecticut Georgia 2016 2015 2014 $ 85 60 43 35 29 27 26 21 17 15 15 14 14 14 13 $ 154 $ 256 44 60 31 45 38 33 26 14 24 16 17 15 18 19 38 91 27 49 55 42 41 16 38 18 29 12 18 29 All other jurisdictions 171 213 323 Total primary (excluding settlements) $ 599 $ 767 $ 1,082 Note: Jurisdictions in italics in the table above are those that predominately use a judicial foreclosure process, which generally increases the amount of time it takes for a foreclosure to be completed. The primary average claim paid for the top 5 jurisdictions (based on 2016 losses paid, excluding settlement amounts) for the years ended December 31, 2016, 2015 and 2014 appears in the table below. The primary average claim paid can vary materially from period to period based upon a variety of factors, including the local market conditions, average loan amount, average coverage percentage, and loss mitigation efforts on loans for which claims are paid. $ 701 $ 834 $ 1,154 Primary average claim paid (1) (2) See Note 8 - "Loss Reserves" for additional information on our settlements of disputes for claims paying practices and NPL settlements. 2016, 2015 and 2014 each include $42 million paid under the terms of our settlement with Freddie Mac as discussed in Note 8 - "Loss Reserves" to our consolidated financial statements. Florida New Jersey Illinois New York Maryland All other jurisdictions 2016 2015 2014 $ 60,737 $ 58,709 $ 55,537 81,955 50,047 70,869 72,396 40,828 74,160 49,673 68,341 77,404 41,065 74,477 48,278 68,377 66,270 40,419 All jurisdictions $ 48,416 $ 47,931 $ 46,039 Note: Jurisdictions in italics in the table above are those that predominately use a judicial foreclosure process, which generally increases the amount of time it takes for a foreclosure to be completed. 28 | MGIC Investment Corporation 2016 Annual Report The primary average exposure for the top 5 jurisdictions (based on 2016 losses paid, excluding settlement amounts) for the years ended December 31, 2016, 2015 and 2014 appears in the table below. Primary average exposure Florida New Jersey Illinois New York Maryland All other jurisdictions 2016 2015 2014 $ 49,908 $ 49,095 $ 47,487 63,351 40,696 52,006 63,812 46,481 62,496 40,368 50,964 62,912 44,887 61,484 39,888 50,042 62,630 43,301 All jurisdictions 47,276 45,820 44,332 Management's Discussion and Analysis LOSS RESERVES CONTINUED TO DECLINE ON LOWER DEFAULT INVENTORY Our primary default rate at December 31, 2016 was 5.04% (2015: 6.31%, 2014: 8.25%). Our primary default inventory was 50,282 loans at December 31, 2016, representing a decrease of 20% from 2015 and 37% from 2014. The reduction in our primary default inventory is the result of the total number of defaulted loans: (1) that have cured; (2) for which claim payments have been made; or (3) that have resulted in rescission, claim denial, or removal from inventory due to NPL settlements, collectively exceeding the total number of new defaults on insured loans. In recent periods we have experienced improved cure rates and the overall mix of our default inventory, as represented by the number of missed payments, has improved compared to the prior years. As of December 31, 2016, the percentage of our default inventory that has 12 or more missed payments was 38% (2015: 43%, 2014: 47%). Generally, the fewer missed payments a defaulted loan has the lower the likelihood it will result in a claim. The NPL settlements were each completed at amounts approximating the loss reserves previously established on the defaulted loans. We expect our default inventory to continue to decline in 2017 from 2016 levels; however, the pace of decline is expected to moderate as our more recent book years naturally season. The primary and pool loss reserves as of December 31, 2016, 2015 and 2014 appear in the table below. MGIC Investment Corporation 2016 Annual Report | 29 Management's Discussion and Analysis Gross Reserves Primary: Direct loss reserves (in millions) IBNR and LAE Total primary loss reserves Ending default inventory Percentage of loans delinquent (default rate) Average direct reserve per default Primary claims received inventory included in ending default inventory Pool (1): Direct loss reserves (in millions): With aggregate loss limits Without aggregate loss limits Reserves related to Freddie Mac settlement (2) Total pool direct loss reserves Ending default inventory: With aggregate loss limits Without aggregate loss limits Total pool ending default inventory Pool claims received inventory included in ending default inventory 2016 December 31, 2015 2014 $ 1,334 79 1,413 $ 1,681 126 1,807 $ 2,114 132 2,246 50,282 5.04% $ 28,104 62,633 6.31% $ 28,859 79,901 8.25% $ 28,107 1,385 2,769 4,746 18 7 — 25 34 9 42 85 53 12 84 149 1,382 501 1,883 72 2,126 613 2,739 60 3,020 777 3,797 99 Other gross reserves (in millions) 1 1 2 (1) (2) Since a number of our pool policies include aggregate loss limits and/or deductibles, we do not disclose an average direct reserve per default for our pool business. See our Form 8-K filed with the Securities and Exchange Commission on November 30, 2012 for a discussion of our settlement with Freddie Mac regarding a pool policy. As of December 31, 2016 we had completed our obligation under this settlement agreement. 30 | MGIC Investment Corporation 2016 Annual Report The primary default inventory for the top 15 jurisdictions (based on 2016 losses paid, excluding settlement amounts) at December 31, 2016, 2015 and 2014 appears in the table below. Primary Default Inventory by Jurisdiction 2016 2015 2014 Florida New Jersey Illinois New York Maryland California Pennsylvania Ohio Puerto Rico Washington Virginia Michigan Massachusetts Connecticut Georgia 4,150 2,586 2,649 3,171 1,312 1,590 2,984 2,614 1,844 754 885 1,482 1,108 690 1,853 5,903 3,498 3,301 3,901 1,609 2,019 3,574 3,209 2,221 1,049 1,109 1,877 1,390 832 2,225 9,442 4,077 4,481 4,595 2,119 2,777 4,480 3,908 2,453 1,415 1,355 2,447 1,631 1,095 2,726 All other jurisdictions Total 20,610 50,282 24,916 62,633 30,900 79,901 Note: Jurisdictions in italics in the table above are those that predominately use a judicial foreclosure process, which generally increases the amount of time it takes for a foreclosure to be completed. The primary default inventory by policy year at December 31, 2016, 2015 and 2014 appears in the table below. Primary Default Inventory by Policy Year 2016 2015 2014 2004 and prior 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 11,116 5,826 9,267 15,816 4,140 421 222 246 364 686 1,142 814 222 14,599 7,890 11,853 20,000 5,418 515 274 246 388 615 672 163 — 19,797 10,630 15,529 25,232 6,721 648 300 260 316 335 133 — — Total 50,282 62,633 79,901 Our results of operations continue to be negatively impacted by the mortgage insurance we wrote during Management's Discussion and Analysis 2005 through 2008 (see chart 18). Although uncertainty remains with respect to the ultimate losses we will experience on these books of business, as we continue to write new insurance on mortgages, those books have become a smaller percentage of our total mortgage insurance portfolio. Our 2005 through 2008 books of business represented approximately 25% and 32% of our total primary RIF at December 31, 2016 and 2015, respectively. Approximately 38% of the remaining primary RIF on our 2005-2008 books of business benefited from HARP as of December 31, 2016, compared to 36% as of December 31, 2015. 18 DEFAULT INVENTORY MIX BY BOOK YEAR % OF TOTAL INVENTORY On our primary business, the highest claim frequency years have typically been the third and fourth year after the year of loan origination. However, the pattern of claims frequency can be affected by many factors, including persistency and deteriorating economic conditions. Low persistency can accelerate the period in the life of a book during which the highest claim frequency occurs. Deteriorating economic conditions can result in increasing claims following a period of declining claims. As of December 31, 2016, 54% of our primary RIF was written subsequent to December 31, 2013, 62% of our primary RIF was written subsequent to December 31, 2012, and 67% of our primary RIF was written subsequent to December 31, 2011. UNDERWRITING AND OTHER EXPENSES, NET AS A PERCENTAGE OF NPW REMAIN LOW includes 2016 compared to 2015. Underwriting and other expenses items such as employee compensation costs, fees for professional services, and premium taxes, and are reported net of ceding commissions. Underwriting and other expenses for 2016 decreased when compared to 2015 due to an increase in ceding commissions from reinsurers, MGIC Investment Corporation 2016 Annual Report | 31 Management's Discussion and Analysis offset by increases professional services. in employee costs and 2015 compared to 2014. Underwriting and other expenses for 2015 increased when compared to 2014. The increase was primarily due to a return of ceding commissions to reinsurers as a result of commuting our 2013 QSR Transaction and an increase in employee costs. Underwriting expense ratio (see chart 19). The underwriting expense ratio is the ratio, expressed as a percentage, of the underwriting and operating expenses, net and amortization of DAC of our combined insurance operations (which excludes underwriting and operating expenses of our non- insurance operations) to NPW. The increase in the underwriting expense ratio in 2016 when compared to 2015 was primarily due to a decrease in NPW. The increase in the underwriting expense ratio in 2015 when compared to 2014 was due to an increase in employee compensation expense and a decrease in ceding commissions, offset in part by an increase in NPW. 19 UNDERWRITING EXPENSE RATIO INTEREST EXPENSE IN 2016 DECLINED FROM 2015 AND 2014 LEVELS ON DEBT TRANSACTION ACTIVITY, WHICH ALSO RESULTED IN DEBT EXTINGUISHMENT LOSSES 2016 compared to 2015. Interest expense for 2016 decreased when compared to 2015 reflecting the following activities. Reductions to interest expense: • maturity of our 5.375% Notes; • repurchase of $188.5 million in par value of our 5% Notes in the first half of 2016; • purchase by MGIC of $132.7 million in par value of our 9% Debentures, which are eliminated in consolidation, in the first quarter of 2016; • repurchase of $292.4 million in par value of our 2% Notes in the third quarter of 2016. 32 | MGIC Investment Corporation 2016 Annual Report Increases to interest expense: • MGIC borrowed $155 million in the form of a 1.91% fixed rate advance from the FHLB in the first quarter of 2016; and • we issued $425 million of 5.75% Senior Notes in the third quarter of 2016. 2015 compared to 2014. Interest expense for 2015 decreased when compared to 2014 due to the maturity of our 5.375% Notes on November 1, 2015, which were repaid with holding company cash on hand. Loss on debt extinguishment Loss on debt extinguishment in 2016 reflects our repurchases of a portion of our 2% Notes, 5% Notes, and MGIC's purchase of a portion of our 9% Debentures, which were all completed at amounts that were in excess of the purchased debt's carrying value. The loss also includes the write-off of debt issuance costs on the extinguished portion of the outstanding 2% Notes. The 9% Debentures held by MGIC are eliminated in consolidation. INCOME TAX EXPENSE (BENEFIT) REFLECTS THE CHANGE IN OUR TAX STATUS AND VALUATION ALLOWANCE REVERSAL (In millions, except rate) 2016 2015 2014 Income before tax $ 514,714 $ 487,687 $ 254,723 Provision for (benefit from) income taxes Effective tax provision (benefit) rate 172,197 (684,313) 2,774 33.5% (140.3)% 1.1% 2016 compared to 2015. Income tax expense for 2016 increased compared to 2015. This change is primarily due to the reversal of our deferred tax valuation allowance in 2015 and because we were required to establish a full tax provision for 2016. The difference between our statutory tax rate of 35% and our effective tax provision rate of 33.5% in 2016 was primarily due to the benefits of tax preferenced securities. The difference between our statutory tax rate of 35% and our effective tax (benefit) rate on our pre-tax income of (140.3%) in 2015 was primarily due to the impact of the changes in our valuation allowance against our deferred tax assets. 2015 compared to 2014. Income tax (benefit) for 2015 increased compared to 2014. This change is primarily due to the reversal of our deferred tax valuation allowance in 2015. During 2014, our effective tax rate provision was reduced by the change in the deferred tax asset valuation allowance. Management's Discussion and Analysis During 2015 and 2014, the difference between our statutory tax rate of 35% and our effective tax (benefit) provision rate was primarily due to the impact of the changes in our overall valuation allowance against our deferred tax assets. See Note 12 – “Income Taxes” to our consolidated financial statements for a discussion of our tax position. MGIC Investment Corporation 2016 Annual Report | 33 Management's Discussion and Analysis Balance Sheet Analysis Assets As of December 31, 2016 total assets were $5,735 million compared to $5,868 million in the prior year. The investment portfolio increased to $4,692 million as of December 31, 2016 (2015: $4,663 million). Deferred income tax assets decreased 20% to $607.7 million at the end of December 31, 2016 (2015: $762.1 million) as our net income utilized a portion of our net operating loss carryforwards. The combined other assets increased to $279 million as of December 31, 2016 (2015: $262 million), primarily due to increases in accrued investment income, reinsurance recoverables, and home office and equipment, net. These increases were offset in part by a decrease in the funded status of our defined pension plan resulting from an increase in the projected benefit obligation as the discount rate decreased from the prior year. STRUCTURE OF BALANCE SHEET % OF TOTAL ASSETS (in thousands) Assets December 31, 2016 December 31, 2015 $ 5,734,529 $ 5,868,343 2016 2015 Investments Analysis The return we generate on our investment portfolio, which primarily consists of investment income, is an important component of our consolidated financial results and the protection of principal is an important component of our portfolio objectives. Our investment portfolio primarily consists of a diverse mix of highly rated fixed income securities (see chart 20) and targets an intermediate 4 to 6 year duration that is designed to achieve the following main portfolio objectives: • protect principal; • preserve statutory capital; • minimize realized losses; • meet projected liabilities; and • maximize yield. To achieve our portfolio objectives, we employ a strategic asset allocation approach which considers the risk and return parameters of the various asset classes in which we invest. This asset allocation is informed by, and based on the following factors: • our economic and market outlooks; • diversification effects; • security duration; • liquidity; and • capital considerations. The credit risk of specific securities is evaluated through analysis of the underlying fundamentals that includes consideration of the issuer's sector, scale, profitability, debt coverage, and ratings. The investment policy guidelines limit the amount of our credit exposure to any one issue, issuer and type of instrument. 34 | MGIC Investment Corporation 2016 Annual Report 20 FIXED INCOME SECURITY RATINGS (1) % OF FIXED INCOME SECURITIES AT FAIR VALUE December 31, 2016 December 31, 2015 (1) Ratings are provided by one or more of: Moody's, Standard & Poor's and Fitch Ratings. If three ratings are available, the middle rating is utilized; otherwise the lowest rating is utilized. See Note 5 – “Investments” to our consolidated financial statements for additional disclosure on our investment portfolio. Investments outlook In the fourth quarter of 2016, the FOMC increased its benchmark interest rate 25 basis points, which was a highly anticipated move that had been signaled for months. At the time, the FOMC cited strong employment gains and other economic indicators as the reason for the increase. In conjunction with the most recent rate increase the FOMC indicated that increases will continue at a gradual pace. It is widely expected that further interest rate increases will take place in 2017 as the economy continues to add jobs and expand. Our investment portfolio of fixed income securities is subject to interest rate risk and fair values of fixed rate securities are likely to decline in a rising rate environment. We seek to manage our exposure to interest rate risk and volatility by maintaining a diverse mix of high quality securities that have an intermediate duration profile. While Management's Discussion and Analysis higher interest rates may adversely impact the fair values of our fixed income securities from current levels, they present an opportunity to reinvest investment income and proceeds from security maturities into higher yielding securities. In addition to our interest rate exposure, the new Presidential administration could make policy changes that affect both economic and market conditions. A federal statutory tax rate reduction has been discussed, which could impact the relative value between taxable and tax-exempt fixed income securities, but we do not expect this to have a material impact on our investment portfolio if enacted. Other policy changes, which are uncertain at this time, could result in both market volatility and/or opportunity which we will monitor. DEFERRED INCOME TAXES Deferred income taxes primarily consist of net operating loss carryforwards from operating losses experienced in prior years that we expect to realize in future periods. During 2015, we reversed the valuation allowance that had been recorded against our deferred tax assets since 2009. The reversal of the valuation allowance was based on analysis that it was more likely than not that our deferred tax assets would be fully realizable. The reversal of our valuation allowance against our deferred tax assets was a discrete period item and was recognized as a component of our tax provision in continuing operations during 2015. As a result, we received a benefit tax provision of approximately $687 million for the year ended December 31, 2015. As this benefit increased our net income, the benefit had the effect of substantially increasing our retained earnings as of December 31, 2015. in our As of December 31, 2016, our deferred tax asset is recorded at $607.7 million. A decrease in the federal statutory rate will result in a one-time reduction in the amount at which our deferred tax asset is recorded, thereby reducing our net income and book value; however, such a decrease will also reduce our effective tax rate in future periods, thereby increasing net income. We estimate that every 1 percentage point reduction in the federal statutory rate would result in a one-time reduction in our deferred tax asset of $17.2 million. Other tax matters We continue to have unresolved tax matters primarily related to reviews of our 2000-2007 federal income tax returns by the IRS. In January 2017, we and the IRS informed the Tax Court that we had reached a basis for settlement of the major unresolved tax MGIC Investment Corporation 2016 Annual Report | 35 Management's Discussion and Analysis matters. Any agreed settlement terms will ultimately be subject to review by the Joint Committee on Taxation before a settlement can be completed and there is no assurance that a settlement will be completed. Our consolidated financial statements reflect our estimates of the tax contingencies discussed more fully in Note 12 - "Income Taxes" to our consolidated financial statements. Based on information we have regarding the status of the dispute, we expect to record a provision for additional taxes and interest of $15-$25 million in the first quarter of 2017. Liabilities and Shareholders' Equity Total liabilities decreased 12% to $3,186 million as of December 31, 2016 from $3,632 million in the prior year. Loss reserves, which represent our estimated liability for losses and settlement expenses under MGIC's mortgage guaranty insurance policies, net of reinsurance balances recoverable on our estimated losses and settlement expenses decreased, 25% to $1,388 million as of December 31, 2016 versus $1,849 million as of December 31, 2015. This decrease was driven by the payment of losses during 2016 and favorable development on delinquencies received in prior years, offset in part by losses incurred on new delinquency notices received in 2016. Unearned premiums increased 18% to $330 million as of December 31, 2016 (2015: $280 million), primarily due to an increase in the amount of NIW from LPMI single premium policies. Long-term debt is down 3% to $1,179 million as of December 31, 2016 versus $1,212 million as of December 31, 2015 due to a net repayment of borrowings during 2016 through our various debt transactions, which also extended the maturity profile of our debt. See Note 7 - "Debt" for further discussion of these transactions. Other liabilities decreased 3% to $238 million as of December 31, 2016 (2015: $247 million), primarily due to a decline in our premium refund accrual, offset in part by an increase in our interest payable. Total equity increased 14% to $2,549 million as of December 31, 2016 from $2,236 million as of December 31, 2015. This increase from the prior year was driven by net income generated during 2016. 36 | MGIC Investment Corporation 2016 Annual Report STRUCTURE OF BALANCE SHEET % OF TOTAL LIABILITIES AND EQUITY (in thousands) December 31, 2016 December 31, 2015 Liabilities and equity $ 5,734,529 $ 5,868,343 2016 2015 BENEFIT PLANS We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. Retirement benefits are based on compensation and years of service. We maintain plan assets to fund our benefit obligations. As of December 31, 2016 and 2015 our pension and post-retirement benefit plans have plan assets in excess of their projected obligations. The supplemental executive retirement plan benefits are paid from MGIC assets following retirements. Our projected benefit employee obligations under these plans are subject to numerous actuarial assumptions that may change in the future and as a result could substantially increase or decrease our obligations. Plan assets held to pay our obligations are primarily invested in a portfolio of debt securities to preserve capital and to provide monthly cash flows aligned with the liability component of our obligations, with a lesser allocation to a mix of equity securities. If the performance of our invested plan assets differs from our expectations, the funded status of the benefit plans may decline, even with no significant change in the obligations. See Note 11 - "Benefit Plans" to our consolidated financial statements for a complete discussion of these plans and their effect on the consolidated financial statements. Liquidity and Capital Resources Consolidated Cash Flow Analysis We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our insurance operations and income earned on our investment portfolio, less amounts paid for claims, interest expense and operating expenses, (2) investing cash flows related to the purchase, sale and maturity of investments and (3) financing cash flows generally from activities that impact our capital structure, such as changes in debt table and shares outstanding. The summarizes flows on a these consolidated basis for the last three years. three cash following (In thousands) 2016 2015 2014 Years ended December 31, Net cash and cash equivalents provided by (used in): Operating activities $ 219,663 $ 152,036 $(405,277) Investing activities (93,392) (96,958) 292,234 Financing activities (151,981) (71,840) (21,767) Decrease in cash and cash equivalents $ (25,710) $ (16,762) $(134,810) Operating activities The following list highlights the major sources and uses of cash flow from operating activities: Sources + Premiums received + Loss payments from reinsurers + Investment income Uses - Claim payments - Ceded premium to reinsurers - Interest expense - Operating expenses installment basis Our largest source of cash is from premiums received from our insurance policies, which we receive on a monthly for most policies. Premiums are received at the beginning of the coverage period for single premium and annual premium policies. Our largest cash outflow is for claims that arise when a default results in an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest. We also use cash to pay for our ongoing expenses such as salaries, debt interest, and rent. We also utilize reinsurance to manage the risk we take Management's Discussion and Analysis on our insurance policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. Net cash provided by operating activities in 2016 increased compared to 2015 primarily due to a lower level of losses paid. The increase was offset in part by the commutation of our 2013 QSR Transaction in 2015, which resulted in a return to us of unearned ceded premiums written and settlement of our profit commission accrued during the term of the agreement. The increase in net cash from operating activities in 2015 compared to 2014 was primarily due to a lower level of losses paid and the result of commuting our 2013 QSR Transaction. Cash flows from operations in 2015 also increased compared to 2014 due to an increase in premiums collected as our mix of single premium policies written and our IIF increased, and also from a higher level of investment income. Investing activities The following list highlights the major sources and uses of cash flow from investing activities: Sources + Proceeds from fixed income securities sold, called or matured + Decreases in restricted cash Uses - Purchases of fixed income securities - Purchases of property and equipment We maintain an investment portfolio that is primarily invested in a diverse mix of fixed income securities. As of December 31, 2016, our portfolio had a fair value of $4.7 billion. As of December 31, 2016 the value of our investment portfolio increased by $29.1 million, or 0.6% from December 31, 2015. In addition to investment portfolio activities, our investing activities to property and included additions equipment. In 2016, we began an initiative to update our corporate headquarters building and continued to invest in our technology infrastructure to enhance our ability to conduct business and execute our strategies. Net cash flows used in investing activities in 2016 primarily reflect purchasing fixed income securities in an amount that exceeded our proceeds from sales MGIC Investment Corporation 2016 Annual Report | 37 Management's Discussion and Analysis and maturities of fixed income securities during the year. Investing cash flows also include an increase in amounts spent on property and equipment. Net cash flows used in investing activities in 2015 primarily reflect purchasing investment securities in an amount that exceeded our proceeds from sales and maturities of fixed income securities during the year. This outflow was offset in part by a reduction of cash restricted in its use. In 2014, net cash flows provided by investing activities primarily reflect proceeds from sales and maturities of our fixed income securities exceeding our investment purchases. Financing activities The following list highlights the major sources and uses of cash flow from financing activities: Sources For a further discussion of matters affecting our cash flows, see "Balance Sheet Analysis" and "Debt at our Holding Company" and Holding Company Liquidity" below. Capitalization Capital Risk Capital risk is the risk that we have an insufficient level and composition of capital to comply with applicable requirements and to support our business activities and associated risks during normal economic environments and stressed conditions. A strong capital position is essential to our business strategy and is important to maintain a competitive position in our industry. Our capital strategy focuses on long-term stability, which enables us to build and in a stressed invest environment. in our business, even + Proceeds from debt and/or common stock issuances Our capital management objectives are to: • Cover claim obligations arising from our underlying mortgage insurance activities; • Maintain compliance with financial requirements of PMIERs, and regulatory capital, and sizing the level of capital to balance competitive needs, handle contingencies, and create shareholder value; the • Position our mix of debt, equity and/or reinsurance to support our business strategy while considering the competing needs of credit ratings, regulators, and shareholders; • Retain flexibility to pursue new business opportunities; • Provide additional holding company liquidity; and • Achieve our target leverage ratio over time. These objectives are achieved through ongoing monitoring and management of our capital position, mortgage insurance portfolio stress modeling, and a capital governance framework. Capital management is intended to be flexible in order to react to a range of potential events. Uses - Repayment/repurchase of debt - Repurchases of common stock - Payment of debt issuance costs Net cash flows used in financing activities for 2016 primarily reflect the transactions in which we repurchased a portion of the outstanding principal on our 5% Notes and 2% Notes, and in which MGIC purchased a portion of the outstanding principal on our 9% Debentures. MGIC's ownership of our 9% Debentures by MGIC is eliminated in consolidation. These transactions were completed at amounts in excess of the carrying value of the debt obligations and the excess amount settled in cash is reflected in our financing activities. These transactions were offset in part by the issuance of long-term debt that included an FHLB borrowing and our 5.75% Notes offering, net of related issuance fees. Net cash flows used in financing activities for 2015 reflect the repayment of our Senior Notes that matured on November 1, 2015 and repurchases of $11.5 million par value of our Convertible Senior Notes due in May 2017, offset in part by tax benefits related to share-based compensation. Net cash flows used in financing activities for 2014 reflect the repurchase of $20.9 million of our Senior Notes due in November 2015. * * * 38 | MGIC Investment Corporation 2016 Annual Report Capital Structure The following table summarizes our capital structure as of December 31, 2016, 2015, and 2014. 21 HOLDING COMPANY LONG-TERM DEBT IN MILLIONS Management's Discussion and Analysis (In thousands, except ratio) Common stock, paid- in capital, retained earnings (deficit), less treasury stock Accumulated other comprehensive loss, net of tax Total shareholders' equity Long-term debt, par value Total capital resources Ratio of long-term debt to shareholders' equity 2016 2015 2014 $2,623,942 $2,297,020 $1,118,244 (75,100) (60,880) (81,341) 2,548,842 2,236,140 1,036,903 1,189,472 1,223,025 1,296,475 $3,738,314 $3,459,165 $2,333,378 46.7% 54.7% 125.0% 2016 2015 Net income in 2016 increased our total shareholders' equity from 2015. The increase was offset in part by the cost of repurchasing the shares issued in our 2% Notes repurchases and an increase in accumulated other comprehensive losses. Net income and a decrease in accumulated other comprehensive losses in 2015 increased our total shareholders' equity from 2014. The net income generated in 2015 included a substantial tax benefit from the reversal of our valuation allowance on deferred tax assets. DEBT AT OUR HOLDING COMPANY AND HOLDING COMPANY LIQUIDITY Investment Corporation, and not of Debt - holding company (see charts 21 and 22) The 5.75% Notes, 2% Notes, 5% Notes, and 9% Debentures are obligations of our holding company, MGIC its subsidiaries. In 2016, we accessed the senior debt market and issued $425.0 million aggregate principal amount of 5.75% Notes due in 2023 to simplify and lengthen our debt structure. The proceeds received were primarily used as (i) cash consideration to repurchase a portion of our 2% Notes, and (ii) to repurchase the shares issued as partial consideration in the repurchases of our 2% Notes. In total, we purchased $292.4 million in par value of our outstanding 2% Notes. In addition, during 2016 we repurchased $188.5 million of our 5% Notes with funds held at our holding company. MGIC's ownership of $132.7 million of our 9% Debentures is eliminated in consolidation, but they remain outstanding obligations owed by us to MGIC. The result of these transactions reduced our holding company's outstanding debt obligations by 5% from the prior year to $1,167.1 million. 22 REMAINING TIME TO MATURITY OF HOLDING COMPANY LONG-TERM DEBT IN MILLIONS 2016 2015 Liquidity analysis - holding company As of December 31, 2016, we had approximately $283 million in cash and investments at our holding company. These resources are maintained primarily to service our debt interest expense, pay debt maturities, repurchase outstanding debt obligations as opportunities arise, and to settle intercompany obligations. We may also use available holding company cash to repurchase shares of our common stock. While these assets are held, we generate investment income that serves to offset a portion of our interest expense. In addition to investment income, the payment of dividends from our insurance subsidiaries and/or raising capital in the public MGIC Investment Corporation 2016 Annual Report | 39 Management's Discussion and Analysis markets are the principal sources of holding company cash inflow. MGIC is the principal source of dividend- paying capacity, which is restricted by insurance regulation. The ability to raise capital in the public markets is subject to prevailing market conditions, investor demand for the securities to be issued, and our deemed creditworthiness. In 2016, our holding company cash and investments decreased by $119 million, to $283 million as of December 31, 2016. Our holding company received $418 million in net proceeds from the issuance of our 5.75% Notes. The net proceeds were primarily used in the repurchases of our 2% Notes; this use consisted of approximately $231 million in cash consideration and $147 million for the repurchase of shares issued as consideration in the 2% Notes repurchases. Cash on hand at our holding company was used to repurchase a portion of our 5% Notes at a cost of $196 million. Our holding company made interest payments of approximately $55 million, of which approximately $12 million was paid to MGIC for the portion of our 9% Debentures owned by MGIC. Cash included an inflows to our holding company aggregate of $64 million of dividends received from MGIC, and we dissolved other insurance subsidiaries resulting in a net cash infusion to the holding company of approximately $16 million. Investment income was approximately $7 million and other net cash inflows were approximately $5 million. The net unrealized losses on our holding company investment portfolio were approximately $2.0 million at December 31, 2016 and the portfolio has a modified duration of approximately 1.5 years. The dividends paid by MGIC to our holding company were the first since 2008. We expect MGIC to continue to pay quarterly dividends. OCI authorization is sought before MGIC pays dividends and MGIC will pay a dividend of $20 million to our holding company in the first quarter of 2017. Over the next twelve months the principal demand on holding company resources will be the maturity of the remaining $145 million of 5% Notes outstanding that mature in May 2017. We currently hold sufficient cash and investments to repay the outstanding obligations at their maturity. Based on our holding company debt obligations at December 31, 2016, interest payments for 2017 are expected to approximate $68 million. Dividends from MGIC provide additional quarterly liquidity. We believe our holding company has sufficient liquidity to meet its payment obligations for the foreseeable future. Scheduled debt maturities beyond the next twelve months include $207.6 million of our 2% Notes in 40 | MGIC Investment Corporation 2016 Annual Report 2020, $425 million of our 5.75% Notes in 2023, and $389.5 million of our 9% Debentures in 2063, of which MGIC owns $132.7 million. Both the 2% Notes and 9% Debentures are convertible debt issues. Subject to certain limitations and restrictions, holders of each of the convertible debt issues may convert their notes into shares of our common stock at their option prior to certain dates prescribed under the terms of their issuance, in which case our corresponding obligation will be eliminated. The holders of the 2% Notes may convert all or part of their notes into shares of our common stock, at a rate of 143.8332 shares per $1,000 of notes, in any quarter following a quarter in which the closing price our common stock was at least $9.04 for at least 20 of the last 30 trading days of that quarter (the “Conversion Stock Price Condition”). The Conversion Stock Price Condition was met for the quarter ended December 31, 2016, therefore, the 2% Notes are convertible in the first quarter of 2017. They will also be convertible in later quarters in which the Conversion Stock Price Condition was met for the prior quarter. We may redeem all or part of the 2% Notes if the closing price our common stock was at least $9.04 for at least 20 of the last 30 trading days (including on the last trading day) preceding the date notice is provided to the holders of the notes that we intend to redeem the notes (the “Redemption Notice”). The Redemption Notice is irrevocable and must be given not less than 30 days and not more than 60 calendar days prior to the redemption date, which cannot be before April 10, 2017. Once the Redemption Notice is given, holders may convert their notes at any time before the redemption date specified in the Redemption Notice and we expect they will do so if the price of our common stock remains above the conversion price of $6.95 In 2015, we purchased $11.5 million in aggregate principal of our 5% Notes at a purchase price of $12.0 million, plus accrued interest using funds held at our holding company. See Note 7 – “Debt” to our consolidated financial statements for additional information about the conversion terms of these issuances and the terms of our indebtedness, including our option to defer interest on our 9% Debentures. Any deferred interest compounds at the stated rate of 9%. The description in Note 7 - “Debt" to our consolidated financial statements is qualified in its entirety by the terms of the notes and debentures. The terms of our 5% Notes are contained in a Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as trustee, which is included as an exhibit to our 8-K filed with the SEC on April 30, 2010, and in the Indenture dated as of October 15, 2000, between us and the trustee ("2000 Indenture"). The terms of our 2% Notes are contained in a Second Supplemental Indenture, dated as of March 12, 2013, between us and U.S. Bank National Association, as trustee, which is included as an exhibit to our 8-K filed with the SEC on March 15, 2013, and the 2000 Indenture. The terms of our 9% Debentures are contained in the Indenture dated as of March 28, 2008, between us and U.S. Bank National Association filed as an exhibit to our Form 10-Q filed with the SEC on May 12, 2008. Although not anticipated in the near term, we may also contribute funds to our insurance operations to comply with the PMIERs or the State Capital Requirements. See “Overview – Capital” above for a discussion of these requirements. See the discussion of our non-insurance contract underwriting services in Note 17 – “Litigation and Contingencies” to our consolidated financial statements for other possible uses of holding company resources. We may from time to time continue to seek to acquire our debt obligations through cash purchases and/or exchanges for other securities. We may also from time to time seek to acquire our common stock through cash purchases, including with funds provided by debt. We may make such acquisitions in open market purchases, privately negotiated acquisitions or other transactions. The amounts involved may be material. DEBT AT SUBSIDIARIES During the third quarter of 2015, MGIC became a member of the FHLB. Membership in the FHLB provides MGIC access to an additional source of liquidity via a secured lending facility. In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the FHLB. 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. Capital Adequacy PMIERs We operate under the PMIERs of the GSEs that became effective December 31, 2015. The PMIERS were most recently revised in December 2016, which had had no impact on our calculation of Available Management's Discussion and Analysis Assets or Minimum Required Assets, and did not impact our operations. The GSEs may further amend the PMIERs at any time, and they have broad discretion to interpret the requirements, which could impact the calculation of our Available Assets and/ or Minimum Required Assets. The PMIERS specifically provided that the tables of factors used to determine Minimum Required Assets will be updated every two years following a minimum of 180 days' notice and may be updated more frequently to reflect changes in macroeconomic conditions or loan performance. We expect the GSEs to perform a more comprehensive review of the PMIERs, including their financial requirements, in 2017. is As of December 31, 2016, MGIC’ s Available Assets under PMIERs totaled approximately $4.7 billion, an in excess of approximately $630 million over its Minimum Required Assets of approximately $4.1 billion; and MGIC in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. Maintaining a sufficient level of excess Available Assets will allow MGIC to remain in compliance with the PMIERs financial requirements, including , we believe, to the extent they are modified further in the next scheduled review; and will also allow us flexibility to participate in additional business opportunities as they may arise. The 2015 QSR Transaction provided an aggregate of approximately $730 million of PMIERs capital credit as of December 31, 2016. Our 2017 QSR transaction terms are similar to our 2015 QSR transaction and will also provide PMIERs capital credit. We plan to continuously comply with the PMIERs through our operational activities or through the contribution of funds from our holding company, subject to demands on the holding company's resources, as outlined above. RISK-TO-CAPITAL We compute our risk-to-capital ratio on a separate company statutory basis, as well as on a combined insurance operations basis. The risk-to-capital ratio is our net RIF divided by our policyholders’ position. Our net RIF includes both primary and pool RIF, and excludes risk on policies that are currently in default and for which loss reserves have been established and those covered by reinsurance. The risk amount includes pools of loans with contractual aggregate loss limits and without these limits. Policyholders’ position consists primarily of statutory policyholders’ surplus (which increases as a result of statutory net income and decreases as a result of statutory net loss and dividends paid), plus the statutory contingency reserve and a portion of the reserves for unearned premiums. The statutory contingency reserve is MGIC Investment Corporation 2016 Annual Report | 41 factor titled “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis.” Financial Strength Ratings The financial strength of MGIC, is as follows: Rating Agency Moody's Investor Services Standard and Poor's Rating Services' Rating Outlook Baa3 BBB+ Stable Stable For further information about the importance of MGIC’ s ratings, see our risks factor titled “We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility” and “Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/or increase our losses.” Management's Discussion and Analysis reported as a liability on the statutory balance sheet. A mortgage insurance company is required to make annual additions to the contingency reserve of approximately 50% of net earned premiums. These contributions must generally be maintained for a period of ten years. However, with regulatory approval a mortgage insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net earned premiums in a calendar year. MGIC’ s separate company risk-to-capital calculation appears in the table below. (In millions, except ratio) RIF - net (1) December 31, 2016 2015 $ 28,668 $ 27,301 Statutory policyholders' surplus $ 1,505 $ 1,574 Statutory contingency reserve 1,181 691 Statutory policyholders' position $ 2,686 $ 2,265 Risk-to-capital 10.7:1 12.1:1 (1) RIF – net, as shown in the table above, is net of reinsurance and exposure on policies currently in default and for which loss reserves have been established. Our combined insurance companies’ risk-to-capital calculation appears in the table below. (In millions, except ratio) RIF - net (1) December 31, 2016 2015 $ 34,465 $ 33,072 Statutory policyholders' surplus $ 1,507 $ 1,608 Statutory contingency reserve 1,360 827 Statutory policyholders' position $ 2,867 $ 2,435 Risk-to-capital 12.0:1 13.6:1 (1) RIF – net, as shown in the table above, is net of reinsurance and exposure on policies currently in default ($2.6 billion at December 31, 2016 and $3.2 billion at December 31, 2015) and for which loss reserves have been established. to an increase The reductions in MGIC's and our combined insurance companies risk-to-capital in 2016 were primarily due in statutory policyholders' position due to an increase in statutory contingency reserves, partially offset by an increase in net RIF in both calculations. Our RIF, net of reinsurance, increased in 2016, due to an increase in our IIF. Our risk-to-capital ratio will decrease if the percentage the increase percentage increase in insured risk. in capital exceeds For additional information regarding regulatory capital see Note 14 – “Statutory Information” to our consolidated financial statements as well as our risk 42 | MGIC Investment Corporation 2016 Annual Report Management's Discussion and Analysis Contractual Obligations As of December 31, 2016, the approximate future payments under our contractual obligations of the type described in the table below are as follows: Contractual Obligations: Payments due by period (In millions) Long-term debt obligations Operating lease obligations Tax obligations Purchase obligations Pension, SERP and other post-retirement benefit plans Other long-term liabilities Total Less than More than Total 1 year 1-3 years 3-5 years 5 years $ 2,472.7 $ 204.0 $ 109.4 $ 310.8 $ 1,848.5 2.6 44.0 11.6 287.1 1,438.8 0.7 44.0 10.4 22.7 676.2 1.4 — 1.2 52.4 575.5 0.5 — — 57.0 187.1 — — — 155.0 — $ 4,256.8 958.0 $ 739.9 $ 555.4 $ 2,003.5 Note 8 – “Loss Reserves” to our consolidated financial statements and “Critical Accounting Policies” below. In accordance with GAAP for the mortgage insurance industry, we establish loss reserves only for loans in default. Because our reserving method does not take account of the impact of future losses that could occur from loans that are not delinquent, our obligation for ultimate losses that we expect to occur under our policies in force at any period end is not reflected in our consolidated financial statements or in the table above. Our long-term debt obligations as of December 31, 2016 include their related interest and are discussed in Note 7 – “Debt” to our consolidated financial statements and under “Liquidity and Capital Resources” above. Our operating lease obligations include operating leases on certain office space, data processing equipment and autos, as discussed in Note 16 – “Leases” to our consolidated financial statements. Tax obligations consist primarily of amounts related to our current dispute with the IRS, as discussed in Note 12 – “Income Taxes” to our consolidated financial statements. Purchase obligations consist primarily of agreements to purchase items related to our ongoing infrastructure projects and information technology investments in the normal course of business. See Note 11 - “Benefit Plans” to our consolidated financial statements for discussion of expected benefit payments under our benefit plans. Our other long-term liabilities represent the loss reserves established to recognize the liability for losses and LAE related to existing defaults on insured mortgage loans. The timing of the future claim payments associated with the established loss reserves was determined primarily based on two key assumptions: the length of time it takes for a notice of default to develop into a received claim and the length of time it takes for a received claim to be ultimately paid. The future claim payment periods are estimated based on historical experience, and could emerge significantly different than this estimate. Due to the uncertainty regarding how certain factors, such as loss mitigation protocols established by servicers and changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation process, will affect our future paid claims it is difficult to estimate the amount and timing of future claim payments. See MGIC Investment Corporation 2016 Annual Report | 43 rate, interest The claim rates and claim severities are likely to be including actual affected by external events, in economic conditions such as changes unemployment rate or housing values. Our estimation process does not include a correlation between claim rates and claim amounts to projected economic conditions such as changes in unemployment rate, interest rate or housing values. Our experience is that analysis of that nature would not produce reliable results. The results would not be reliable as the change in one economic condition cannot be isolated to determine its sole effect on our ultimate paid losses as our ultimate paid losses are also influenced at the same time by other economic conditions. Additionally, the changes and interaction of these economic conditions are not likely homogeneous throughout the regions in which we conduct business. Each economic environment influences our ultimate paid losses differently, even if apparently similar in nature. Furthermore, changes in economic conditions may not necessarily be reflected in our loss development in the quarter or year in which the changes occur. Actual claim results often lag changes in economic conditions by at least nine to twelve months. In considering the potential sensitivity of the factors underlying our estimate of loss reserves, it is possible that even a relatively small change in our estimated claim rate or severity could have a material impact on reserves and, correspondingly, on our consolidated results of operations even in a stable economic environment. For example, assuming all other factors remain constant, a $1,000 increase/ decrease in the average severity reserve factor would change the reserve amount by approximately +/- $27 million. A 1 percentage point increase/decrease in the average claim rate reserve factor would change the reserve amount by approximately +/- $28 million as of December 31, 2016. Historically, it has not been uncommon for us to experience variability in the development of the loss reserves through the end of the following year at this level or higher, as shown by the historical development of our loss reserves in the table below: Management's Discussion and Analysis Critical Accounting Policies The accounting policies described below require significant the preparation of our consolidated financial statements. judgments and estimates in Loss reserves Reserves are established for reported insurance losses and LAE based on when notices of default on insured mortgage loans are received. For reporting purposes, we consider a loan in default when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excluded mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently in default. We establish reserves using estimated claim rates and claim severities in estimating the ultimate loss. The liability for reinsurance assumed is based on information provided by the ceding companies. The estimated claim rates and claim severities represent what we estimate will actually be paid on the loans in default as of the reserve date. If a policy is rescinded we do not expect that it will result in a claim payment and thus the rescission generally reduces the historical claim rate used in establishing reserves. In addition, if a loan cures its delinquency, including successful loan modifications that result in a cure being reported to us, the cure reduces the historical claim rate used in establishing reserves. Our methodology to estimate claim rates and claim amounts is based on our review of recent trends in the default inventory. To establish reserves we utilize a reserving model that continually incorporates historical data into the estimated claim rate. The model also incorporates an estimate for the amount of the claim we will pay, or severity. The severity is estimated using the historical percentage of our claim paid compared to our loan exposure, as well as the RIF of the loans currently in default. We do not utilize an explicit rescission rate in our reserving methodology, but rather our reserving methodology incorporates the effects rescission activity has had on our historical claim rate and claim severities. We review recent trends in the claim rate, severity, levels of defaults by geography and average loan exposure. As a result, the process to determine reserves does not include quantitative ranges of outcomes that are reasonably likely to occur. 44 | MGIC Investment Corporation 2016 Annual Report (In thousands) Losses incurred related to prior years (1) Reserve at end of prior year 2016 2015 2014 2013 2012 $ (147,658) $ (110,302) (100,359) (59,687) 573,120 1,893,402 2,396,807 3,061,401 4,056,843 4,557,512 (1) A negative number for a prior year indicates a redundancy of loss reserves, and a positive number for a prior year indicates a deficiency of loss reserves. See Note 8 – “Loss Reserves” to our consolidated financial statements for a discussion of recent loss development. IBNR Reserves Reserves are also established for estimated IBNR, which results from defaults occurring prior to the close of an accounting period, but which have not been reported to us. Consistent with reserves for reported defaults, IBNR reserves are established using estimated claim rates and claim severities for the estimated number of defaults not reported. As of December 31, 2016 and 2015, we had IBNR reserves of approximately $54 million and $98 million, respectively. LAE Reserves also provide for the estimated costs of settling claims, including legal and other expenses and general expenses of administering the claims settlement process. loss than our The actual amount of the claim payments may be reserve substantially different 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, that could result in, among other things, greater losses on loans, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Our estimates are also affected by any agreements we enter into regarding our claims paying practices, such as the settlement agreements discussed in Note 17 – “Litigation and Contingencies” to our consolidated financial statements. Revenue recognition When a policy term ends, the primary mortgage insurance written by us is renewable at the insured’ s option through continued payment of the premium in accordance with the schedule established at the Management's Discussion and Analysis inception of the policy life. We have no ability to reunderwrite or reprice these policies after issuance. Premiums written under policies having single and annual premium payments are initially deferred as unearned premium reserve and earned over the policy life. Premiums written on policies covering more than one year are amortized over the policy life in relationship to the anticipated incurred loss pattern based on historical experience. Premiums written on annual policies are earned on a monthly pro rata basis. Premiums written on monthly policies are earned as the monthly coverage is provided. When a policy is cancelled, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. Cancellations also include rescissions and policies cancelled due to claim payment. When a policy is rescinded, all previously collected premium is returned to the servicer and when a claim is paid we return any premium received since the date of default. The liability associated with our estimate of premium to be returned is accrued for separately and this liability is included in “Other liabilities” on our consolidated balance sheets. Changes in these liabilities affect premiums written and earned and change in premium deficiency reserve, respectively. The actual return of premium affects premium written and earned. Policy cancellations also lower the persistency rate which is a variable used in calculating the rate of amortization of deferred policy acquisition costs discussed below. Fee income of our non-insurance subsidiaries is earned and recognized as the services are provided and the customer is obligated to pay. Deferred insurance policy acquisition costs Costs directly associated with the successful acquisition of mortgage insurance business, consisting of employee compensation and other policy issuance and underwriting expenses, are initially deferred and reported as deferred insurance policy acquisition costs ("DAC"). The deferred costs are net of any ceding commissions received associated with our reinsurance agreements. For each underwriting year of business, these costs are amortized to income in proportion to estimated gross profits over the estimated life of the policies. We utilize anticipated in our calculation. This includes accruing interest on the unamortized balance of DAC. The estimates for each underwriting year are reviewed quarterly and updated when necessary to reflect actual experience and any changes to key variables such as persistency or loss development. investment income Because our insurance premiums are earned over time, changes in persistency result in DAC being MGIC Investment Corporation 2016 Annual Report | 45 Management's Discussion and Analysis amortized against revenue over a comparable period of time. At December 31, 2016, the persistency rate of our primary mortgage insurance was 76.9%, compared to 79.7% at December 31, 2015. This change did not significantly affect the amortization of deferred insurance policy acquisition costs for the period ended December 31, 2016. A 10% change in persistency would not have a material effect on the amortization of DAC in the subsequent year. Fair Value Measurements Investment Portfolio Our entire investment portfolio is classified as available-for-sale and is reported at fair value or, for certain equity securities carried at cost, amounts that approximate fair value. The related unrealized investment gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income in shareholders' equity. Realized investment gains and losses on investments are recognized in income based upon specific identification of securities sold. 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, two sided markets, benchmark securities, bids, offers and reference data including data published research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. issuer spreads, in market 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 trading tolerance include reviewing reports, 46 | MGIC Investment Corporation 2016 Annual Report 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 certain municipal bonds. The independent pricing sources used for our Level 2 investments varies by type of investment See Note 3 - "Significant Accounting Policies" for further information on the independent pricing sources used. - Valuations derived from valuation Level 3 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. 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 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. 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. Unrealized losses and other-than-temporary impairment ("OTTI") Each quarter we perform reviews of our investments in order to determine whether declines in fair value below amortized cost were considered other-than- temporary. In evaluating whether a decline in fair Management's Discussion and Analysis value is other-than-temporary, we consider several factors including, but not limited to: our intent to sell the security or whether it is more likely than not that we will be required to its sell the security before recovery of amortized cost basis; the present value of the discounted cash flows we expect to collect compared to the amortized cost basis of the security; extent and duration of the decline; failure of the issuer to make scheduled interest or principal payments; change in rating below investment grade; and adverse conditions specifically related to the security, an industry, or a geographic area. Based on our evaluation, we will record an OTTI adjustment on a security if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis, or if the present value of the discounted cash flows we expect to collect is less than the amortized costs basis of the security. If the fair value of a security is below its amortized cost at the time of our intent to sell, the is classified as other-than-temporarily security impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, when a security is considered to be other- than-temporarily impaired, the losses are separated into the portion of the loss that represents the credit loss; and the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other in accumulated other factors comprehensive income (loss), net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’ s original yield, expected to be collected from the security is less than the cost basis of the security. recognized is Fair Value Option For the years ended December 31, 2016, 2015, and 2014, we did not elect the fair value option for any financial instruments acquired, or issued, such as our outstanding debt obligations, for which the primary basis of accounting is not fair value. MGIC Investment Corporation 2016 Annual Report | 47 GLOSSARY OF TERMS AND ACRONYMS / A ARMs Adjustable rate mortgages ABS Asset-backed securities ASC Accounting Standards Codification Available Assets Assets, as designated under the PMIERs, that are readily available to pay claims, and include the most liquid investments / B operations (which excludes underwriting and operating expenses of our non-insurance operations) to NPW / F Fannie Mae Federal National Mortgage Association FCRA Fair Credit Reporting Act FHA Federal Housing Administration FHFA Federal Housing Finance Agency Book or book year A group of loans insured in a particular calendar year FHLB Federal Home Loan Bank of Chicago, of which MGIC is a member BPMI Borrower-paid mortgage insurance / C CECL Current expected credit losses CFPB Consumer Financial Protection Bureau CLO Collateralized loan obligations CMBS Commercial mortgage-backed securities / D FICO score A measure of consumer credit risk provided by credit bureaus, typically produced from statistical models by Fair Isaac Corporation utilizing data collected by the credit bureaus FOMC Federal Open Market Committee Freddie Mac Federal Home Loan Mortgage Corporation / G GAAP Generally Accepted Accounting Principles in the United States DAC Deferred insurance policy acquisition costs GSEs Collectively, Fannie Mae and Freddie Mac / E ETFs Exchange traded funds Expense ratio The ratio, expressed as a percentage, of the underwriting and operating expenses, net and amortization of DAC of our combined insurance 48 | MGIC Investment Corporation 2016 Annual Report / H HAMP Home Affordable Modification Program HARP Home Affordable Refinance Program HOPA Homeowners Protection Act / I IBNR Losses incurred but not reported IIF Insurance in force, which for loans insured by us, is equal to the unpaid principal balance, as reported to us / J JCT Joint Committee on Taxation / L LAE Loss adjustment expenses Legacy book Mortgage insurance policies written prior to 2009 Loan-to-value ("LTV") ratio The ratio, expressed as a percentage, of the dollar amount of the first mortgage loan to the value of the property at the time the loan became insured and reflect subsequent housing price does not appreciation or depreciation. Subordinate mortgages may also be present. Long-term debt: 5.375% Notes 5.375% Senior Notes due on November 2, 2015, with interest payable semi-annually on May 1 and November 1 of each year. 5% Notes 5% Convertible Senior Notes due May 1, 2017, with interest payable semi-annually on May 1 and November 1 of each year 2% Notes 2% Convertible Senior Notes due on April 1, 2020, with interest payable semi-annually on April 1 and October 1 of each year 5.75% Notes 5.75% Senior Notes due on August 15, 2023, with interest payable semi-annually on February 15 and August 15 of each year Glossary 9% Debentures 9% Convertible Junior Subordinated Debentures due on April 1, 2063, with interest payable semi-annually on April 1 and October 1 of each year FHLB Advance or the Advance 1.91% Fixed rate advance from the FHLB due on February 10, 2023, with interest payable monthly Loss ratio The ratio, expressed as a percentage, of the sum of incurred losses and loss adjustment expenses to NPE Low down payment loans or mortgages Loans with less than 20% down payments LPMI Lender-paid mortgage insurance / M MBA Mortgage Bankers Association MBS Mortgage-backed securities MD&A Management's discussion and analysis MGIC Mortgage Guaranty subsidiary of MGIC Investment Corporation Insurance Corporation, a MIC MGIC Indemnity Corporation Minimum Required Assets The greater of $400 million or the total of the minimum amount of Available Assets that must be held under the PMIERs based upon a percentage of RIF weighted by certain risk attributes MPP Minimum Policyholder Position, as required under “policyholder requirements. The certain state position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums / N N/A Not applicable for the period presented MGIC Investment Corporation 2016 Annual Report | 49 Glossary NAIC National The Commissioners Association of Insurance NIW New Insurance Written / R REMIC Real Estate Mortgage Investment Conduit RESPA Real Estate Settlement Procedures Act N/M Data, or calculation, deemed not meaningful for the period presented NPE The amount of premiums earned, net of premiums assumed and ceded under reinsurance agreements NPL Non-performing loan, which is a delinquent loan, at any stage in its delinquency RIF Risk in force, which for an individual loan insured by us, is equal to the unpaid loan principal balance, as reported to us, multiplied by the insurance coverage percentage. RIF is sometimes referred to as exposure Risk-to-capital Under certain state regulations, the ratio of RIF, net of reinsurance and exposure on policies currently in default and for which loss reserves have been established, to the level of statutory capital NPW The amount of premiums written, net of premiums assumed and ceded under reinsurance agreements RMBS Residential mortgage-backed securities / O OCI Office of the Commissioner of Insurance of the State of Wisconsin / S SAP Statutory accounting practices / U / P Persistency The percentage of our insurance remaining in force from one year prior PMI Private Mortgage Insurance (as an industry or product type) PMIERs Private Mortgage Insurer Eligibility Requirements issued by the GSEs Underwriting Expense Ratio The ratio, expressed as a percentage, of the underwriting and operating expenses, net and amortization of DAC of our combined insurance (which excludes underwriting and operations operating non-insurance our expenses subsidiaries) to NPW of Underwriting profit NPE minus incurred losses USDA U.S. Department of Agriculture Premium Yield The ratio of NPE divided by the average IIF outstanding for the period measured / V VA U.S. Department of Veterans Affairs / Q QSR Transaction Quota share reinsurance transaction 50 | MGIC Investment Corporation 2016 Annual Report Quantitative and Qualitative Disclosures About Market Risk Our investment portfolio is essentially a fixed income portfolio and is exposed to market risk. Important drivers of the market risk are credit spread risk and interest rate risk. Credit spread risk is the risk that we will incur a loss due to adverse changes in credit spreads. Credit spread is the additional yield on fixed income (typically securities above referenced as the yield on U.S. Treasury securities) that market participants require to compensate them for assuming credit, liquidity and/or prepayment risks. risk-free rate the We manage credit risk via our investment policy guidelines which primarily place our investments in investment grade securities and limit the amount of our credit exposure to any one issue, issuer and type of instrument. Interest rate risk is the risk that we will incur a loss due to adverse changes in interest rates relative to the characteristics of our interest bearing assets. One of the measures used to quantify interest rate this exposure is modified duration. Modified duration measures the price sensitivity of the assets to the changes in spreads. At December 31, 2016, the modified duration of our fixed income investment portfolio was 4.6 years, which means that an instantaneous parallel shift in the yield curve of 100 basis points would result in a change of 4.6% in the fair value of our fixed income portfolio. For an upward shift in the yield curve, the fair value of our portfolio would decrease and for a downward shift in the yield curve, the fair value would increase. A discussion of portfolio strategy appears "Management's Discussion and Analysis – Balance Sheet Analysis." in MGIC Investment Corporation 2016 Annual Report | 51 Risk Factors As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’ s consolidated operations or to MGIC Investment Corporation, as the context requires; “MGIC” refers to Mortgage Guaranty Insurance Corporation; and “MIC” refers to MGIC Indemnity Corporation. Our actual results could be affected by the risk factors below. These risk factors are an integral part of this annual report. These risk factors may also cause actual results to differ materially from the results contemplated by forward looking statements that we may make. Forward looking statements consist of statements which relate to matters other than historical fact, including matters that inherently refer to future events. Among others, statements that include words such as “believe,” “anticipate,” “will” or “expect,” or words of similar import, are forward looking statements. We are not undertaking any obligation to update any forward looking statements or other statements we may make even though these statements may be affected by events or circumstances occurring after the forward looking statements or other statements were made. No reader of this annual report should rely on these statements being current at any time other than the time at which this annual report was filed with the Securities and Exchange Commission. Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and / or increase our losses. Our private mortgage insurance competitors include: • Arch Mortgage Insurance Company, which completed its acquisition of United Guaranty Residential Insurance Company in the fourth quarter of 2016, • Essent Guaranty, Inc., • Genworth Mortgage Insurance Corporation, • National Mortgage Insurance Corporation, and • Radian Guaranty Inc. The private mortgage insurance industry is highly competitive and is expected to remain so. We believe that we currently compete with other private mortgage insurers based on pricing, underwriting requirements, financial strength (including based on credit or financial strength ratings), customer 52 | MGIC Investment Corporation 2016 Annual Report relationships, name recognition, reputation, the strength of our management team and field organization, the ancillary products and services provided to lenders (including contract underwriting services), the depth of our databases covering insured loans and the effective use of technology and innovation in the delivery and servicing of our mortgage insurance products. Much of the competition in the industry has centered on pricing practices which, in the last few years included: (i) reductions in standard filed rates on borrower-paid policies, (ii) use by certain competitors of a spectrum of filed rates to allow for formulaic, risk- based pricing (commonly referred to as “black-box” pricing); and (iii) use of customized rates (discounted from published rates) on lender-paid, single premium policies. The willingness of mortgage insurers to offer reduced pricing (through filed or customized rates) has been met with an increased demand from various lenders for reduced rate products. There can be no assurance that pricing competition will not intensify further, which could result in a decrease in our new insurance written and/or returns. In each of 2015 and 2016, approximately 5% of our new insurance written was for loans for which one lender was the original insured. Our relationships with our customers could be adversely affected by a variety of factors, including if our premium rates are higher those of our competitors, our underwriting requirements result in our declining to insure some of the loans originated by our customers, or our insurance rescissions and curtailments affect the customer. than Substantially all of our insurance written since 2008 has been for loans purchased by Fannie Mae and Freddie Mac (the "GSEs"). The current private mortgage insurer eligibility requirements ("PMIERs") of the GSEs require a mortgage insurer to maintain a minimum amount of assets to support its insured risk, as discussed in our risk factor titled “We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility.” The PMIERs do not require an insurer to maintain minimum financial strength ratings; however, our financial strength ratings can affect us in the following ways: • A downgrade in our financial strength ratings could result increased scrutiny of our financial condition by our customers, potentially resulting in in a decrease in the amount of our new insurance written. first mortgage with a 90%, 95% or 100% loan-to- value ratio that has private mortgage insurance. Risk Factors ratings for our mortgage • Our ability to participate in the non-GSE mortgage market (which has been limited since the financial crisis, but may grow in the future), could depend on our ability to maintain and improve our investment insurance grade subsidiaries. We competitively could disadvantaged with some market participants because the financial strength ratings of our insurance subsidiaries are lower than those of some competitors. MGIC's financial strength rating from Moody’ s is Baa3 (with a stable outlook) and from Standard & Poor’ s is BBB+ (with a stable outlook). be • Financial strength ratings may also play a greater role if the GSEs no longer operate in their current capacities, for example, due to legislative or regulatory action. In addition, although the PMIERs do not require minimum financial strength ratings, the GSEs consider financial strength ratings to be forms of credit important when utilizing enhancement other than traditional mortgage insurance, including in the credit risk transfer offering discussed in our risk factor titled "The amount of insurance we write could be adversely affected if lenders and investors select alternatives to private mortgage insurance." If we are unable to compete effectively in the current or any future markets as a result of the financial strength ratings assigned to our insurance subsidiaries, our future new insurance written could be negatively affected. The amount of insurance we write could be adversely affected if lenders and investors select alternatives to private mortgage insurance. Alternatives to private mortgage insurance include: • lenders using FHA, VA and other government mortgage insurance programs, • lenders and other investors holding mortgages in portfolio and self-insuring, • investors using risk mitigation and credit risk transfer techniques other than private mortgage insurance, and • lenders originating mortgages using piggyback structures to avoid private mortgage insurance, such as a first mortgage with an 80% loan-to-value ratio and a second mortgage with a 10%, 15% or 20% loan-to-value ratio (referred to as 80-10-10, 80-15-5 or 80-20 loans, respectively) rather than a investors; using other Investors (including the GSEs) have used risk mitigation and credit risk transfer techniques other than private mortgage insurance, such as obtaining insurance from non-mortgage insurers, engaging in credit-linked note transactions executed in the capital markets, or using other forms of debt issuances or securitizations that transfer credit risk directly to risk mitigation other techniques in conjunction with reduced levels of private mortgage insurance coverage; or accepting credit risk without credit enhancement. Although the risk mitigation and credit risk transfer techniques used by the GSEs in the past several years have not displaced primary mortgage insurance, we cannot predict the impact of future transactions. In the second half of 2016, the GSEs each launched a new credit risk transfer offering that involved forward credit insurance policies written by a panel of mortgage insurance company affiliates, including an affiliate of MGIC. The policies provide additional coverage beyond the primary mortgage insurance on 30-year fixed-rate mortgages with 80-95% loan-to- value ratios ("LTVs"). It is difficult to predict the amount of risk that will be insured under such transactions in the future. The amount of capital we have allocated to this pilot program and the associated premiums are immaterial. Future participation in credit risk transfers will need to be evaluated based upon the terms offered and expected returns. The FHA's share of the low down payment residential mortgages that were subject to FHA, VA or primary private mortgage insurance was an estimated 36.4% in 2016, compared to 40.4% in 2015 and 33.9% in 2014. In the past ten years, the FHA’ s share has been as low as 15.5% in 2006 and as high as 70.8% in 2009. Factors that influence the FHA’ s market share include relative rates and fees, underwriting guidelines and loan limits of the FHA, VA, private mortgage insurers and the GSEs; lenders' perceptions of legal risks under FHA versus GSE programs; flexibility for the FHA to establish new products as a result of federal legislation and programs; returns expected to be obtained by lenders for Ginnie Mae securitization of FHA-insured loans compared to those obtained from selling loans to Fannie Mae or Freddie Mac for securitization; and differences in policy terms, such as the ability of a borrower to cancel insurance coverage under certain circumstances. In January 2017, the FHA announced a significant premium Presidential reduction, the administration suspended reduction indefinitely. We cannot predict how the factors that however, new rate the MGIC Investment Corporation 2016 Annual Report | 53 Risk Factors affect the FHA’ s share of new insurance written will change in the future. coverage and, if so, any transactions that are related to that selection, The VA's share of the low down payment residential mortgages that were subject to FHA, VA or primary private mortgage insurance was an estimated 27.3% in 2016, compared to 24.6% in 2015 and 25.4% in 2014. The VA’ s 2016 market share was its highest in the past ten years and its lowest market share in the past ten years was 5.4% in 2007. We believe that the VA’ s market share has generally been increasing because the VA offers 100% LTV loans and charges a one-time funding fee that can be included in the loan amount but no additional monthly expense, and because of an increase in the number of borrowers who are eligible for the VA’ s program. Changes in the business practices of the GSEs, federal legislation that changes their charters or a restructuring of the GSEs could reduce our revenues or increase our losses. The GSEs’ charters generally require credit enhancement for a low down payment mortgage loan (a loan amount that exceeds 80% of a home’ s value) in order for such loan to be eligible for purchase by the GSEs. Lenders generally have used private this credit mortgage enhancement requirement and low down payment mortgages purchased by the GSEs generally are insured with private mortgage insurance. As a result, the business practices of the GSEs greatly impact our business and include: to satisfy insurance • private mortgage insurer eligibility requirements of the GSEs (for information about the financial requirements included in the PMIERs, see our risk factor titled “We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility”), • the level of private mortgage insurance coverage, subject to the limitations of the GSEs’ charters (which may be changed by federal legislation), when private mortgage insurance is used as the required credit enhancement on low down payment mortgages, • the amount of loan level price adjustments and guaranty fees (which result in higher costs to borrowers) that the GSEs assess on loans that require private mortgage insurance, • whether the GSEs influence the mortgage lender’ s insurer providing selection of the mortgage 54 | MGIC Investment Corporation 2016 Annual Report • the underwriting standards that determine which loans are eligible for purchase by the GSEs, which can affect the quality of the risk insured by the mortgage insurer and the availability of mortgage loans, • the terms on which mortgage insurance coverage can be canceled before reaching the cancellation thresholds established by law, • the programs established by the GSEs intended to avoid or mitigate loss on insured mortgages and the circumstances in which mortgage servicers must implement such programs, • the terms that the GSEs require to be included in mortgage insurance policies for loans that they purchase, • the terms on which the GSEs offer lenders relief on their representations and warranties made at the time of sale of a loan to the GSEs, which creates pressure on mortgage insurers to limit their rescission rights to conform to such relief, and the extent to which the GSEs intervene in mortgage insurers’ rescission practices or rescission settlement practices with lenders, and • the maximum loan limits of the GSEs in comparison to those of the FHA and other investors. The Federal Housing Finance Agency (“FHFA”) has been the conservator of the GSEs since 2008 and has the authority to control and direct their operations. The increased role that the federal government has assumed in the residential housing finance system through the GSE conservatorship may increase the likelihood that the business practices of the GSEs change in ways that have a material adverse effect on us and that the charters of the GSEs are changed by new federal legislation. In the past, members of Congress have introduced several bills intended to change the business practices of the GSEs and the FHA; however, no legislation has been enacted. The new Presidential administration has indicated that the conservatorship of the GSEs should end; however, it is unclear whether and when that would occur and how that would impact us. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including private mortgage insurance, will play in the residential housing finance system in the future or the impact of any such changes on our business. In addition, the timing of the impact of any resulting changes on our business is uncertain. Most meaningful changes would require Congressional action to implement and it is difficult to estimate when Congressional action would be final and how long any associated phase-in period may last. We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility. We must comply with the PMIERs to be eligible to insure loans purchased by the GSEs. The PMIERs include financial requirements, as well as business, quality control and certain transaction approval requirements. The financial requirements of the PMIERs require a mortgage insurer’ s “Available Assets” (generally only the most liquid assets of an insurer) to equal or exceed its “Minimum Required Assets” (which are based on an insurer’ s book and are calculated from tables of factors with several risk dimensions and are subject to a floor amount). Based on our interpretation of the PMIERs, as of December 31, 2016, MGIC’ s Available Assets are $4.7 billion and its Minimum Required Assets are $4.1 billion. MGIC is in compliance with the PMIERs and eligible to insure loans purchased by the GSEs. If MGIC 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. Factors that may negatively impact MGIC’ s ability to continue to comply with the financial requirements of the PMIERs include the following: • The GSEs could make the PMIERs more onerous in the future; in this regard, the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated every two years and may be updated more frequently to reflect changes in macroeconomic conditions or loan performance. The GSEs will provide notice 180 days prior to the effective date of table updates. In addition, the GSEs may amend the PMIERs at any time. • The GSEs may reduce the amount of credit they allow under the PMIERs for the risk ceded under our quota share reinsurance transaction. The GSEs’ ongoing approval of that transaction is subject to several conditions and the transaction will be reviewed under the PMIERs at least annually by the GSEs. For more information about the transaction, see our risk factor titled “The mix of business we write affects our Minimum Required Assets under the PMIERs, our premium yields and the likelihood of losses occurring.” Risk Factors • Our future operating results may be negatively impacted by the matters discussed in the rest of these risk factors. Such matters could decrease our revenues, increase our losses or require the use of assets, thereby creating a shortfall in Available Assets. • Should capital be needed by MGIC in the future, capital contributions from our holding company may not be available due to competing demands on holding company resources, including for repayment of debt. While on an overall basis, the amount of Available Assets MGIC must hold in order to continue to insure GSE loans increased under the PMIERs over what state regulation currently requires, our reinsurance transaction mitigates the negative effect of the PMIERs on our returns. In this regard, see the second bullet point above. The benefit of our net operating loss carryforwards may become substantially limited. As of December 31, 2016, we had approximately $1.5 billion of net operating losses for tax purposes that we can use in certain circumstances to offset future taxable income and thus reduce our federal income tax liability. Any unutilized carryforwards are scheduled to expire at the end of tax years 2030 through 2033. Our ability to utilize these net operating losses to offset future taxable income may be significantly limited if we experience an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general, an ownership change will occur if there is a cumulative change in our ownership by “5-percent shareholders” (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. A corporation that experiences an ownership change will generally be subject to an annual limitation on the corporation’ s subsequent use of net operating loss carryovers that arose from pre-ownership change periods and use of losses that are subsequently recognized with respect to assets that had a built-in- loss on the date of the ownership change. The amount of the annual limitation generally equals the fair value of the corporation immediately before the ownership change multiplied by the long-term tax- exempt interest rate (subject to certain adjustments). To the extent that the limitation in a post-ownership- change year is not fully utilized, the amount of the limitation for the succeeding year will be increased. While we have adopted our Amended and Restated Rights Agreement to minimize the likelihood of transactions in our stock resulting in an ownership change, future issuances of equity-linked securities MGIC Investment Corporation 2016 Annual Report | 55 Risk Factors or transactions in our stock and equity-linked securities that may not be within our control may cause us to experience an ownership change. If we experience an ownership change, we may not be able to fully utilize our net operating losses, resulting in additional income taxes and a reduction in our shareholders’ equity. As of December 31, 2016, our deferred tax asset is recorded at $607.7 million, which relates primarily to the future tax effects of our prior year net operating losses expected to be carried forward to offset future taxable income. A decrease in the federal statutory income tax rate will result in a one-time reduction in the amount at which our deferred tax asset is recorded, thereby reducing our net income and book value in that period; however, such a decrease will also reduce our effective income tax rate, thereby increasing net income in future periods. We are involved in legal proceedings and are subject to the risk of additional legal proceedings in the future. Before paying an insurance claim, we review the loan and servicing files to determine the appropriateness of the claim amount. When reviewing the files, 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 addition, 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 recent quarters, an immaterial percentage of claims in a quarter have been resolved by received rescissions. In 2015 and 2016, curtailments reduced our average claim paid by approximately 6.7% and 5.5%, respectively. 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. When the insured disputes our right to rescind coverage or curtail claims, 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. Under ASC 450-20, until a liability associated with legal proceedings settlement discussions or 56 | MGIC Investment Corporation 2016 Annual Report becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes and do not accrue an estimated loss. Where we have determined that a loss is probable and can be reasonably estimated, we have recorded our best estimate of our probable loss. 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 matters for which we have recorded a probable 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 the maximum exposure associated with matters where a loss is reasonably possible to be approximately $295 million, although we believe (but can give no assurance that) we will ultimately resolve these matters for significantly less than this amount. This estimate of our maximum exposure does not include interest or consequential or exemplary damages. liability. We estimate insurers, Mortgage including MGIC, have been involved in litigation and regulatory actions related to alleged 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. While these proceedings in the aggregate have not resulted in material liability for MGIC, there can be no assurance that the outcome of future proceedings under these laws, if any, would not have a material adverse affect on us. In addition, various the CFPB, state including 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. regulators, 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. We are subject to comprehensive regulation and other requirements, which we may fail to satisfy. 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. State insurance regulatory authorities could take actions, including changes in capital requirements, that could have a material adverse effect on us. For more information about state capital requirements, see our risk factor titled “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis.” To the extent that we are construed to make independent credit decisions in connection with our contract underwriting activities, we also could be subject to increased regulatory requirements under the Equal Credit Opportunity Act, commonly known as ECOA, the FCRA, and other laws. In addition to regulation by state insurance regulators, the CFPB may issue additional rules or regulations, which may materially affect our business. 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. Resolution of our dispute with the Internal Revenue Service could adversely affect us. 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 Risk Factors matters of $197.5 million and at December 31, 2016, there would also be interest related to these matters of approximately $200.6 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. 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 December 31, 2016, those state taxes and interest would approximate $50.7 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of December 31, 2016 is $108.2 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 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 filed an answer to our petition which continued 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 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. In January 2017, the parties informed the Tax Court that they had reached a basis for settlement of the major issues in the case. Any agreed settlement terms will ultimately be subject to review by the Joint Committee on Taxation (“JCT”) before a settlement can be completed and there is no assurance that a settlement will be completed. Based on information that we currently have regarding the status of our ongoing dispute, we expect to record a provision for additional taxes and interest of $15-25 million in the first quarter of 2017. Should a settlement not be completed, ongoing litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We would need further 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 to make MGIC Investment Corporation 2016 Annual Report | 57 Risk Factors 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 our risk factors titled “We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility” and “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis.” Because we establish loss reserves only upon a loan default rather than based on estimates of our ultimate losses on risk losses may have a disproportionate adverse effect on our earnings in certain periods. in force, In accordance with accounting principles generally accepted in the United States, commonly referred to as GAAP, we establish reserves for insurance losses and loss adjustment expenses only when notices of default on insured mortgage loans are received and for loans we estimate are in default but for which notices of default have not yet been reported to us by the servicers (this is often referred to as “IBNR”). Because our reserving method does not take account of losses that could occur from loans that are not delinquent, such losses are not reflected in our financial statements, except in the case where a premium deficiency exists. As a result, future losses on loans that are not currently delinquent may have a material impact on future results as such losses emerge. Because loss reserve estimates are subject to uncertainties, paid claims may be substantially different than our loss reserves. rescissions curtailments. When we establish reserves, we estimate the ultimate loss on delinquent loans using estimated claim rates and claim amounts. The estimated claim rates and claim amounts represent our best estimates of what we will actually pay on the loans in default as of the reserve date and incorporate anticipated mitigation from The and establishment of loss reserves is subject to inherent uncertainty and requires judgment by management. The actual amount of the claim payments may be substantially different reserve estimates. Our estimates could be affected by several factors, including a change in regional or national economic conditions, and a change in the length of time loans are delinquent before claims are received. The change in conditions may include changes in unemployment, affecting borrowers’ income and thus their ability to make mortgage payments, and changes in housing values, which may affect borrower willingness to continue to make mortgage than our loss 58 | MGIC Investment Corporation 2016 Annual Report payments when the value of the home is below the mortgage balance. Changes to our estimates could have a material impact on our future results, even in a stable economic environment. In addition, historically, losses incurred have followed a seasonal trend in which the second half of the year has weaker credit performance than the first half, with higher new default notice activity and a lower cure rate. We rely on our management team and our business could be harmed if we are unable to retain qualified personnel or successfully develop and/or recruit their replacements. Our success depends, in part, on the skills, working relationships and continued services of our management team and other key personnel. The unexpected departure of key personnel could adversely affect the conduct of our business. In such event, we would be required to obtain other personnel to manage and operate our business. In addition, we will be required to replace the knowledge and expertise of our aging workforce as our workers retire. In either case, there can be no assurance that we would be able to develop or recruit suitable replacements for the departing individuals; that replacements could be hired, if necessary, on terms that are favorable to us; or that we can successfully transition such replacements in a timely manner. We currently have not entered into any employment agreements with our officers or key personnel. Volatility or lack of performance in our stock price may affect our ability to retain our key personnel or attract replacements should key personnel depart. Without a properly skilled and experienced workforce, our costs, including productivity costs and costs to replace employees may increase, and this could negatively impact our earnings. Loan modification and other similar programs may not continue to provide substantial benefits to us. The federal government, including through the U.S. Department of the Treasury and the GSEs, and several lenders have modification and refinance programs to make loans more affordable to borrowers with the goal of reducing the number of foreclosures. These programs include the Home Affordable Modification Program (“HAMP”) and the Home Affordable Refinance Program (“HARP”). During 2015 and 2016, we were notified of modifications that cured delinquencies that had they become paid claims would have resulted in approximately $0.6 billion and respectively, of estimated claim $0.5 billion, payments. These levels are down from a high of $3.2 billion in 2010. HAMP expired at the end of 2016 and although HARP has been extended through September 2017,we believe that we have realized the majority of the benefits from that program because the number of loans insured by us that we are aware are entering that program has decreased significantly. The GSEs have introduced the "Flex Modification" program to replace HAMP effective in October 2017. Until it becomes effective, loan servicers must still evaluate borrowers for other GSE modification programs. We cannot determine the total benefit we may derive from loan modification programs, particularly given the uncertainty around the re-default rates for defaulted loans that have been modified. Our loss reserves do not account for potential re-defaults of current loans. If the volume of low down payment home mortgage originations declines, the amount of insurance that we write could decline. The factors that affect the volume of low down payment mortgage originations include: • restrictions on mortgage credit due to more stringent underwriting standards, liquidity issues or requirements risk-retention affecting lenders, capital and/or • the level of home mortgage interest rates and the deductibility of mortgage interest or mortgage insurance premiums for income tax purposes, • the health of the domestic economy as well as conditions in regional and local economies and the level of consumer confidence, • housing affordability, • population trends, including the rate of household formation, • the rate of home price appreciation, which in times of heavy refinancing can affect whether refinanced loans have loan-to-value ratios that require private mortgage insurance, and • government housing policy encouraging loans to first-time homebuyers. A decline in the volume of low down payment home mortgage originations could decrease demand for mortgage insurance and decrease our new insurance written . For other factors that could decrease the demand for mortgage insurance, see our risk factor titled “The amount of insurance we write could be Risk Factors adversely affected if lenders and investors select alternatives to private mortgage insurance.” State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis. The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to its risk in force (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “State Capital Requirements.” While they vary among jurisdictions, the most common State Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk-to- capital ratio will increase if (i) the percentage decrease in capital exceeds the percentage decrease in insured risk, or (ii) the percentage increase in capital is less than the percentage increase in insured risk. Wisconsin does not regulate capital by using a risk-to-capital measure but instead requires a (“MPP”). The minimum policyholder position “policyholder position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums. At December 31, 2016, MGIC’ s risk-to-capital ratio was 10.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $1.6 billion above the required MPP of $1.1 billion. In calculating our risk- to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance transaction, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read the rest of these risk factors for information about matters that could negatively affect such compliance. At December 31, 2016, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 12.0 to 1. Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it its own under certain state-specific could on requirements. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC to continue to utilize reinsurance arrangements with MGIC Investment Corporation 2016 Annual Report | 59 Risk Factors reinsurance its contributions to the affiliate could be needed. additional affiliate, capital The NAIC it plans to revise the minimum capital and surplus requirements for mortgage insurers that are provided for in its Mortgage Guaranty Insurance Model Act. In May 2016, a working group of state regulators released an exposure draft of a risk-based capital framework to establish capital requirements for mortgage insurers, although no date has been established by which the NAIC must propose revisions to the capital requirements. We continue to evaluate the impact of the framework contained in the exposure draft, including the potential impact of certain items that have not yet been completely addressed by the framework which include: the treatment of ceded risk, minimum capital floors, and action level triggers. Currently we believe that the restrictive capital the more PMIERs contain requirements in most circumstances. While MGIC currently meets the State Capital Requirements of Wisconsin and all other jurisdictions, it could be prevented from writing new business in the future in all jurisdictions if it fails to meet the State Capital Requirements of Wisconsin, or it could be prevented from writing new business in a particular jurisdiction if it fails to meet the State Capital Requirements of that jurisdiction, and in each case MGIC does not obtain a waiver of such requirements. It is possible that regulatory action by one or more jurisdictions, including those that do not have specific State Capital Requirements, may prevent MGIC from continuing to write new insurance in such jurisdictions. If we are unable to write business in all jurisdictions, lenders may be unwilling to procure insurance from us anywhere. In addition, a lender’ s assessment of the future ability of our insurance operations to meet the State Capital Requirements or its willingness to procure insurance from us. In this regard, see our risk factor titled “Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/ or increase our losses.” A possible future failure by MGIC to meet the State Capital Requirements or the PMIERs will not necessarily mean that MGIC lacks sufficient resources to pay claims on its insurance liabilities. While we believe MGIC has sufficient claims paying resources to meet its claim obligations on its insurance in force on a timely basis, you should read the rest of these risk factors for information about matters that could negatively affect MGIC’ s claims paying resources. the PMIERs may affect 60 | MGIC Investment Corporation 2016 Annual Report Downturns in the domestic economy or declines in the value of borrowers’ homes from their value at the time their in more loans closed may result homeowners defaulting and our losses increasing, with a corresponding decrease in our returns. Losses result from events that reduce a borrower’ s ability or willingness to continue to make mortgage payments, such as unemployment, health issues, family status, and whether the home of a borrower who defaults on his mortgage can be sold for an amount that will cover unpaid principal and interest and the expenses of the sale. In general, favorable economic conditions reduce the likelihood that borrowers will lack sufficient income to pay their mortgages and also favorably affect the value of homes, thereby reducing and in some cases even eliminating a loss from a mortgage default. A deterioration in economic conditions, including an increase in unemployment, generally increases the likelihood that borrowers will not have sufficient income to pay their mortgages and can also adversely affect housing values, which in turn can influence the willingness of borrowers with sufficient resources to make mortgage payments to do so when the mortgage balance exceeds the value of the home. Housing values may decline even absent a deterioration in economic conditions due to declines in demand for homes, which in turn may result from changes in buyers’ perceptions of the potential for future appreciation, restrictions on and the cost of mortgage credit due to more stringent underwriting standards, higher interest rates generally, changes to the deductibility of mortgage interest or mortgage insurance premiums for income tax purposes, or other factors. Changes in housing values and inherently difficult to unemployment forecast given the uncertainty in the current market environment, including uncertainty about the effect of actions the federal government has taken and may take with respect to tax policies, mortgage finance programs and policies, and housing finance reform. levels are The mix of business we write affects our Minimum Required Assets under the PMIERs, our premium yields and the likelihood of losses occurring. The Minimum Required Assets under the PMIERs are, in part, a function of the direct risk-in-force and the risk profile of the loans we insure, considering loan- to-value ratio, credit score, vintage, HARP status and delinquency status; and whether the loans were insured under insurance policies or other policies that are not subject to automatic the Homeowners Protection Act requirements for borrower paid mortgage insurance. Therefore, if our direct risk-in-force increases through increases in lender-paid mortgage consistent with termination new insurance written, or if our mix of business changes to include loans with higher loan-to-value ratios or lower FICO scores, for example, or if we insure more loans under lender-paid mortgage insurance policies, all other things equal, we will be required to hold more Available Assets in order to maintain GSE eligibility. The minimum capital required by the risk-based capital framework contained in the exposure draft released by the NAIC in May 2016 would be, in part, a function of certain loan factors, including property location, loan-to-value ratio and credit score; general underwriting quality in the market at the time of loan origination; the age of the loan; and the premium rate we charge. Depending on the provisions of the capital requirements when they are released in final form and become effective, our mix of business may affect the minimum capital we are required to hold under the new framework. Beginning in 2014, we have increased the percentage of our business from lender-paid single premium policies. Depending on the actual life of a single premium policy and its premium rate relative to that of a monthly premium policy, a single premium policy may generate more or less premium than a monthly premium policy over its life. We have in place a quota share reinsurance transaction with a group of unaffiliated reinsurers that covers most of our insurance written from 2013 through 2016, and a portion of our insurance written prior to 2013. We expect that in the first quarter of 2017, we will enter into a similar agreement covering most of our new insurance written in 2017. Although the transactions reduce our premiums, they have a lesser impact on our overall results, as losses ceded under the transactions reduce our losses incurred and the ceding commission we receive reduce our underwriting expenses. The net cost of reinsurance, with respect to a covered loan, is 6% (but can be lower if losses are materially higher than we expect). This cost is derived by dividing the reduction in our pre-tax net income from such loan with reinsurance by our direct (that is, without reinsurance) premiums from such loan. Although the net cost of the reinsurance is generally constant at 6%, the effect of the reinsurance on the various components of pre-tax income will vary from period to period, depending on the level of ceded losses. In addition to the effect of reinsurance on our premiums, we expect a modest decline in our premium yield resulting from the premium rates themselves: the books we wrote before 2009, which have a higher average premium rate than subsequent books, are expected to continue to decline as a Risk Factors percentage of the insurance in force; and the average premium rate on these books is also expected to decline as the premium rates reset to lower levels at the time the loans reach the ten-year anniversary of their initial coverage date. However, for loans that have utilized HARP, the initial ten-year period was reset to begin as of the date of the HARP transaction. As of December 31, 2016, approximately 4% and 2% of our total primary insurance in force was written in 2007 and 2008, respectively, has not been refinanced under HARP and is subject to a reset after ten years. The circumstances in which we are entitled to rescind coverage have narrowed for insurance we have written in recent years. During the second quarter of 2012, we began writing a portion of our new insurance under an endorsement to our then existing master policy (the “Gold Cert Endorsement”), which limited our ability to rescind coverage compared to that master policy. To comply with requirements of the GSEs, we introduced our current master policy in 2014. Our rescission rights under our current master policy are comparable to those under our previous master policy, as modified by the Gold Cert Endorsement, but may be further narrowed if the GSEs permit modifications to them. Our current master policy is filed as Exhibit 99.19 to our quarterly report on Form 10-Q for the quarter ended September 30, 2014 (filed with the SEC on November 7, 2014). All of our primary new insurance on loans with mortgage insurance application dates on or after October 1, 2014, was written under our current master policy. As of December 31, 2016, approximately 63% of our flow, primary insurance in force was written under our Gold Cert Endorsement or our current master policy. From time to time, in response to market conditions, we change the types of loans that we insure and the requirements under which we insure them. We also change our underwriting guidelines, in part through aligning some of them with Fannie Mae and Freddie Mac for loans that receive and are processed in accordance with certain approval recommendations from a GSE automated underwriting system. As a result of changes to our underwriting guidelines and requirements and other factors, our business written beginning in the second half of 2013 is expected to have a somewhat higher claim incidence than business written in 2009 through the first half of 2013. However, we believe this business presents an acceptable risk. Our underwriting requirements are available on our website at http:// www.mgic.com/underwriting/index.html. We monitor the competitive landscape and will make adjustments to our pricing and underwriting guidelines as warranted. We also make exceptions to our underwriting requirements on a loan-by-loan level of MGIC Investment Corporation 2016 Annual Report | 61 Risk Factors basis and for certain customer programs. Together, the number of loans for which exceptions were made accounted for fewer than 2% of the loans we insured in each of 2015 and 2016. including limited underwriting, Even when housing values are stable or rising, mortgages with certain characteristics have higher probabilities of claims. These characteristics include loans with higher loan-to-value ratios, lower FICO scores, limited borrower documentation, or higher total debt-to- income ratios, as well as loans having combinations of higher risk factors. As of December 31, 2016, approximately 14.4% of our primary risk in force consisted of loans with loan-to-value ratios greater than 95%, 3.8% had FICO scores below 620, and 3.7% had limited underwriting, including limited borrower documentation, each attribute as determined at the time of loan origination. A material number of these loans were originated in 2005 - 2007 or the first half of 2008. For information about our classification of loans by FICO score and documentation, see footnotes (6) and (7) to the Characteristics of Primary Risk in Force table under “Business – Our Products and Services” in Item 1 of our Annual Report on Form for the year ended December 31, 2016, which was filed with the SEC on February 21, 2017. As of December 31, 2016, approximately 2% of our primary risk in force consisted of adjustable rate mortgages in which the initial interest rate may be adjusted during the five years after the mortgage closing (“ARMs”). We classify as fixed rate loans adjustable rate mortgages in which the initial interest rate is fixed during the five years after the mortgage closing. If interest rates should rise between the time of origination of such loans and when their interest rates may be reset, claims on ARMs and adjustable rate mortgages whose interest rates may only be adjusted after five years would be substantially higher than for fixed rate loans. In addition, we have insured “interest-only” loans, which may also be ARMs, and loans with negative amortization features, such as pay option ARMs. We believe claim rates on these loans will be substantially higher than on loans without scheduled payment increases that are made to borrowers of comparable credit quality. If state or federal regulations or statutes are changed in ways that ease mortgage lending standards and/ or requirements, it is possible that more mortgage loans could be originated with higher risk characteristics than are currently being originated such as loans with lower FICO scores, higher debt to income ratios and non-amortizing payments. Lenders could pressure mortgage insurers to insure such loans. Although we attempt to incorporate these higher expected claim rates into our underwriting and 62 | MGIC Investment Corporation 2016 Annual Report pricing models, there can be no assurance that the premiums earned and the associated investment income will be adequate to compensate for actual losses even under our current underwriting requirements. We do, however, believe that our insurance written beginning in the second half of 2008 will generate underwriting profits. The premiums we charge may not be adequate to compensate us for our liabilities for losses and as a result any inadequacy could materially affect our financial condition and results of operations. We set premiums at the time a policy is issued based on our expectations regarding likely performance of the insured risks over the long-term. Our premiums are subject to approval by state regulatory agencies, which can delay or limit our ability to increase our premiums. Generally, we cannot cancel mortgage insurance coverage or adjust renewal premiums during the life of a mortgage insurance policy. As a result, higher than anticipated claims generally cannot be offset by premium increases on policies in force or mitigated by our non-renewal or cancellation of insurance coverage. The premiums we charge, and the associated investment income, may not be adequate to compensate us for the risks and costs associated with the insurance coverage provided to customers. An increase in the number or size of claims, compared to what we anticipate, could adversely affect our results of operations or financial condition. Our premium rates are also based in part on the amount of capital we are required to hold against the insured risk. If the amount of capital we are required to hold increases from the amount we were required to hold when a policy was written, we cannot adjust premiums to compensate for this and our returns may be lower than we assumed. The losses we have incurred on our 2005-2008 books have exceeded our premiums from those books. Our current expectation is that the incurred losses from those books, although declining, will continue to generate a material portion of our total incurred losses for a number of years. The ultimate amount of these losses will depend in part on general economic conditions, the direction of home prices. including unemployment, and We are susceptible to disruptions in the servicing of mortgage loans that we insure. We depend on reliable, consistent third-party servicing of the loans that we insure. Over the last several years, the mortgage loan servicing industry has experienced consolidation and an increase in the number of specialty servicers servicing delinquent loans. The resulting change in the composition of servicers could lead to disruptions in the servicing of mortgage loans covered by our insurance policies. Further changes in the servicing industry resulting in the transfer of servicing could cause a disruption in the servicing of delinquent loans which could reduce servicers’ ability to undertake mitigation efforts that could help limit our losses. Future housing market conditions could lead to additional increases in delinquencies and transfers of servicing. Changes in interest rates, house prices or mortgage insurance cancellation requirements may change the length of time that our policies remain in force. The premium from a single premium policy is collected upfront and generally earned over the estimated life of the policy. In contrast, premiums from a monthly premium policy are received and earned each month over the life of the policy. In each year, most of our premiums received are from insurance that has been written in prior years. As a result, the length of time insurance remains in force, which is also generally referred to as persistency, is a significant determinant of our revenues. Future premiums on our monthly premium policies in force represent a material portion of our claims paying resources and a low persistency rate will reduce those future premiums. In contrast, a higher than expected persistency the profitability from single premium policies because they will remain in force longer than was estimated when the policies were written. rate will decrease The monthly premium policies for the substantial majority of loans we insured provides that, for the first ten years of the policy, the premium is determined by the product of the premium rate and the initial loan balance; thereafter, a lower premium rate is applied to the initial loan balance. The initial ten-year period is reset when the loan is refinanced under HARP. The premiums on many of the policies in our 2006 book that were not refinanced under HARP reset in 2016. As of December 31, 2016, approximately 4% and 2% of our total primary insurance in force was written in 2007 and 2008, respectively, has not been refinanced under HARP, and is subject to a rate reset after ten years. Our persistency rate was 76.9% at December 31, 2016, compared to 79.7% at December 31, 2015 and 82.8% at December 31, 2014. Since 2000, our year- end persistency ranged from a high of 84.7% at December 31, 2009 to a low of 47.1% at December 31, 2003. Risk Factors which affects the vulnerability of the insurance in force to refinancing. Our persistency rate is also affected by mortgage insurance cancellation policies of mortgage investors along with the current value of the homes underlying the mortgages in the insurance in force. Your ownership in our company may be diluted by additional capital that we raise or if the holders of our outstanding convertible debt convert that debt into shares of our common stock. As noted above under our risk factor titled “ We may not continue to meet the GSEs’ private mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain more capital in order to maintain our eligibility,” although we are currently in compliance with the requirements of the PMIERs, there can be no assurance that we would not seek to issue non-dilutive debt capital or to raise additional equity capital to manage our capital position under the PMIERs or for other purposes. Any future issuance of equity securities may dilute your ownership interest in our company. In addition, the market price of our common stock could decline as a result of sales of a large number of shares or similar securities in the market or the perception that such sales could occur. in 2063 At December 31, 2016, we had outstanding $390 million principal amount of 9% Convertible Junior ("9% Subordinated Debentures due Debentures") (of which approximately $133 million was purchased by and is held by MGIC, and is eliminated on the consolidated balance sheet), $145 million principal amount of 5% Convertible Senior Notes due in 2017 ("5% Notes") and $208 million principal amount of 2% Convertible Senior Notes due in 2020 ("2% Notes"). The principal amount of the 9% Debentures is 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. This represents an initial conversion price of approximately $13.50 per share. We have the right, and may elect, to defer interest payable under the debentures in the future. If a holder elects to convert its debentures, the interest that has been deferred on the debentures being converted is also convertible into shares of our common stock. The conversion rate for such 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 the associated debentures. We may elect to pay cash for some or all of the shares issuable upon a conversion of the debentures. Our persistency rate is primarily affected by the level of current mortgage interest rates compared to the mortgage coupon rates on our insurance in force, The 5% Notes are convertible, at the holder’ s option, at an initial conversion rate, which is subject to MGIC Investment Corporation 2016 Annual Report | 63 Risk Factors adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents conversion price of approximately $13.44 per share. initial an Prior to January 1, 2020, the 2% Notes are convertible only upon satisfaction of one or more conditions. One such condition is that conversion may occur during any calendar quarter commencing after March 31, 2014, if 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 is 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 conversion price of represents approximately $6.95 per share. 130% of such conversion price is $9.04. This condition was met for the quarter ended December 31, 2016, therefore, the 2% Notes are convertible in the first quarter of 2017. They will also be convertible in later quarters in which the stock price condition was met for the prior quarter. On or after January 1, 2020, holders may convert their notes irrespective of satisfaction of the conditions. initial an Beginning on April 10, 2017, we may redeem all or part of the 2% Notes if the last reported sale price of our common stock was at least $9.04 for each of at least 20 trading days during the 30 consecutive trading days (including on the last trading day) preceding the date notice is provided to the holders of the notes that we intend to redeem the notes (the “Redemption Notice”). The Redemption Notice is irrevocable and must be given not less than 30 days and not more than 60 calendar days prior to the redemption date. Once the Redemption Notice is given, holders may convert their notes at any time before the redemption date specified in the Redemption Notice and we expect they will do so if the price of our common stock remains above the conversion price of $6.95 We do not have the right to defer interest on our 5% Notes or 2% Notes. For a discussion of the dilutive effects of our convertible securities on our earnings per share, see Note 6 – “Summary of Significant Accounting Policies Earnings per Share” to our consolidated financial statements in our Quarterly Report on Form 10-Q filed with the SEC on November 7, 2016. 64 | MGIC Investment Corporation 2016 Annual Report Our holding company debt obligations materially exceed our holding company cash and investments. At December 31, 2016, we had approximately $283 million in cash and investments at our holding company and our holding company’ s debt obligations were $1,168 million in aggregate principal amount, consisting of $145 million of 5% Notes, $208 million of 2% Notes, $425 million of 5.75% Senior Notes due in 2023 ("5.75% Notes"), and $390 million of 9% Debentures (of which approximately $133 million was purchased by and is held by MGIC, and is eliminated on the consolidated balance sheet). Annual debt service on the outstanding holding is company debt as of December 31, 2016, approximately $71 million (of which approximately $12 million will be paid to MGIC and will be eliminated on the consolidated statement of operations). For more information about the purchase by MGIC of a portion of our outstanding 9% Convertible Junior Subordinated Debentures, see "Management's Discussion and Analysis – Debt at Our Holding Company and Holding Company Capital Resources" in our Annual Report on Form 10-K filed with the SEC on February 26, 2016. For information about our 2016 public offering of the 5.75% Notes and the use of proceeds from the offering to purchase a portion of the 2% Notes, see Note 3 – “Debt” to our consolidated financial statements in our Quarterly Report on Form 10-Q filed with the SEC on November 7, 2016. We may continue to purchase our debt securities in the future. The Convertible Senior Notes, Senior Notes and Convertible Junior Subordinated Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. The payment of dividends from our insurance subsidiaries which, other than investment income and raising capital in the public markets, is the principal source of our holding company cash inflow, is restricted by insurance regulation. MGIC is the principal source of dividend-paying capacity. In 2016, MGIC paid a total of $64 million in dividends to our holding company, its first dividends since 2008, and we expect MGIC to continue to pay quarterly dividends. OCI authorization is sought before MGIC pays dividends and MGIC will pay a dividend of $20 million to our holding company in the first quarter of 2017. If any additional capital contributions to our subsidiaries were required, such contributions would decrease our holding company cash and investments. As described in our Current Report on Form 8-K filed on February 11, 2016, MGIC borrowed $155 million from the Federal Home Loan Bank of Chicago. This is an obligation of MGIC and not of our holding company. Risk Factors We could be adversely affected if personal information on consumers that we maintain is improperly disclosed and our information technology systems may become outdated and we may not be able to make timely modifications to support our products and services. We rely on the efficient and uninterrupted operation of complex information technology systems. All information technology systems are potentially vulnerable to damage or interruption from a variety of sources, including through the actions of third parties. Due to our reliance on our information technology systems, their damage or interruption could severely disrupt our operations, which could have a material adverse effect on our business, business prospects and results of operations. As part of our business, we maintain large amounts of personal information on consumers. While we believe we have appropriate information security policies and systems to prevent unauthorized disclosure, there can be no assurance that unauthorized disclosure, either through the actions of third parties or employees, will not occur. Unauthorized disclosure could adversely affect our reputation and expose us to material claims for damages. In addition, we are in the process of upgrading certain of our information systems that have been in place for a number of years. The implementation of these technological improvements is complex, expensive and time consuming. If we fail to timely and successfully technology systems, or if the systems do not operate as expected, it could have an adverse impact on our business, business prospects and results of operations. implement the new MGIC Investment Corporation 2016 Annual Report | 65 Management's Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, however, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our internal control over financial reporting using the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2016. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements and effectiveness of internal control over financial reporting as of December 31, 2016, as stated in their report which appears herein. 66 | MGIC Investment Corporation 2016 Annual Report Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of MGIC Investment Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income, shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MGIC Investment Corporation and its subsidiaries (the “Company”) at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’ s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’ s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’ s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Milwaukee, Wisconsin February 21, 2017 MGIC Investment Corporation 2016 Annual Report | 67 MGIC INVESTMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) ASSETS Investment portfolio: Securities, available-for-sale, at fair value: December 31, Note 2016 2015 5 / 6 Fixed income (amortized cost, 2016 - $4,717,211; 2015 - $4,684,148) $ 4,685,222 $ 4,657,561 7,128 5,645 4,692,350 4,663,206 155,410 181,120 44,073 50,493 4,964 52,392 36,088 17,759 607,655 73,345 40,224 44,487 3,319 48,469 30,095 15,241 762,080 80,102 $ 5,734,529 $ 5,868,343 $ 1,438,813 $ 1,893,402 329,737 155,000 417,406 349,461 256,872 238,398 279,973 — — 822,301 389,522 247,005 3,185,687 3,632,203 359,400 340,097 1,782,337 1,670,238 (150,359) (75,100) 632,564 (3,362) (60,880) 290,047 2,548,842 2,236,140 $ 5,734,529 $ 5,868,343 9 9 12 8 7 7 7 7 17 13 10 Equity securities Total investment portfolio Cash and cash equivalents Accrued investment income Reinsurance recoverable on loss reserves Reinsurance recoverable on paid losses Premiums receivable Home office and equipment, net Deferred insurance policy acquisition costs Deferred income taxes, net Other assets Total assets LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Loss reserves Unearned premiums FHLB Advance Senior notes Convertible senior notes Convertible junior subordinated debentures Other liabilities Total liabilities Contingencies Shareholders' equity: Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2016 - 359,400; 2015 - 340,097; outstanding 2016 - 340,663; 2015 - 339,657) Paid-in capital Treasury stock (shares at cost 2016 - 18,737; 2015 - 440) Accumulated other comprehensive loss, net of tax Retained earnings Total shareholders' equity Total liabilities and shareholders' equity See accompanying notes to consolidated financial statements. 68 | MGIC Investment Corporation 2016 Annual Report MGIC INVESTMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Note 2016 2015 2014 Years Ended December 31, Revenues: Premiums written: Direct Assumed Ceded Net premiums written Increase in unearned premiums Net premiums earned Investment income, net of expenses Net realized investment gains (losses): Total other-than-temporary impairment losses Portion of losses recognized in other comprehensive income (loss), before taxes Net impairment losses recognized in earnings Other realized investment gains Net realized investment gains Other revenue Total revenues Losses and expenses: Losses incurred, net Change in premium deficiency reserve Amortization of deferred policy acquisition costs Other underwriting and operating expenses, net Interest expense Loss on debt extinguishment Total losses and expenses Income before tax Provision for (benefit from) income taxes Net income Earnings per share: Basic Diluted Weighted average common shares outstanding - basic Weighted average common shares outstanding - diluted 9 9 5 5 $ 1,107,923 $ 1,074,490 $ 999,943 1,053 1,178 1,653 (133,885) (55,391) (119,634) 975,091 (49,865) 925,226 1,020,277 (124,055) 896,222 881,962 (37,591) 844,371 110,666 103,741 87,647 — — — 8,932 8,932 17,659 — — — 28,361 28,361 12,964 (144) — (144) 1,501 1,357 9,259 1,062,483 1,041,288 942,634 8 / 9 240,157 3 7 7 12 4 4 4 — 9,646 150,763 56,672 90,531 547,769 514,714 172,197 343,547 (23,751) 8,789 155,577 68,932 507 553,601 487,687 (684,313) 496,077 (24,710) 7,618 138,441 69,648 837 687,911 254,723 2,774 $ 342,517 $ 1,172,000 $ 251,949 $ $ $ 1.00 0.86 $ $ 3.45 2.60 $ $ 0.74 0.64 342,890 431,992 339,552 468,039 338,523 413,522 — $ — $ — Dividends per share See accompanying notes to consolidated financial statements. MGIC Investment Corporation 2016 Annual Report | 69 MGIC INVESTMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands) Net income Other comprehensive (loss) income, net of tax: Change in unrealized investment gains and losses Benefit plans adjustment Foreign currency translation adjustment Other comprehensive (loss) income, net of tax Comprehensive income Years Ended December 31, Note 2016 2015 2014 $ 342,517 $ 1,172,000 $ 251,949 10 5 11 (3,649) (9,620) (951) (14,220) 40,403 (15,714) (4,228) 20,461 91,139 (52,112) (2,642) 36,385 $ 328,297 $ 1,192,461 $ 288,334 See accompanying notes to consolidated financial statements. 70 | MGIC Investment Corporation 2016 Annual Report MGIC INVESTMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, Note 2016 2015 2014 (In thousands) Common stock Balance, beginning of year Common stock issuance Net common stock issued under share-based compensation plans Balance, end of year Paid-in capital Balance, beginning of year Common stock issuance 13 13 Net common stock issued under share-based compensation plans Reissuance of treasury stock, net Tax benefit from share-based compensation Equity compensation Reacquisition of convertible junior subordinated debentures-equity component 7 Balance, end of year $ 340,097 $ 340,047 $ 340,047 18,313 990 — 50 — — 359,400 340,097 340,047 1,670,238 1,663,592 1,661,269 113,146 (6,020) (130) 67 11,373 — (478) (6,894) 2,116 11,902 — — (6,680) — 9,003 (6,337) — — 1,782,337 1,670,238 1,663,592 Treasury stock Balance, beginning of year Purchases of common stock Reissuance of treasury stock, net Balance, end of year Accumulated other comprehensive loss Balance, beginning of year Other comprehensive (loss) income Balance, end of year Retained earnings (deficit) Balance, beginning of year Net income Reissuance of treasury stock, net Balance, end of year (3,362) (32,937) (64,435) 13 (147,127) 130 (150,359) — 29,575 (3,362) — 31,498 (32,937) 10 (60,880) (14,220) (75,100) (81,341) (117,726) 20,461 (60,880) 36,385 (81,341) 290,047 342,517 (852,458) (1,074,617) 1,172,000 — (29,495) 251,949 (29,790) 632,564 290,047 (852,458) Total shareholders' equity $ 2,548,842 $ 2,236,140 $ 1,036,903 See accompanying notes to consolidated financial statements. MGIC Investment Corporation 2016 Annual Report | 71 MGIC INVESTMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and other amortization Deferred tax expense (benefit) Net realized investment gains Loss on debt extinguishment Excess tax benefits related to share-based compensation Change in certain assets and liabilities: Accrued investment income Prepaid reinsurance premium Reinsurance recoverable on loss reserves Reinsurance recoverable on paid losses Premiums receivable Deferred insurance policy acquisition costs Profit commission receivable Loss reserves Premium deficiency reserve Unearned premiums Return premium accrual Income taxes payable - current Other, net Net cash provided by (used in) operating activities Cash flows from investing activities: Purchases of investments: Fixed income Equity securities Proceeds from sales of fixed income Proceeds from maturity of fixed income Proceeds from sale of equity securities Net decrease in payables for securities Net decrease in restricted cash Additions to property and equipment Net cash (used in) provided by investing activities Cash flows from financing activities: Proceeds from issuance of long-term debt Repayment of long-term debt Repurchase of convertible senior notes Payment of original issue discount - convertible senior notes Purchase of convertible junior subordinated debentures Payment of original issue discount-convertible junior subordinated debentures Cash portion of loss on debt extinguishment Repurchase of common stock Payment of debt issuance costs Years Ended December 31, 2016 2015 2014 $ 342,517 $1,172,000 $ 251,949 61,342 52,559 162,356 (692,810) 48,861 312 (8,932) (28,361) (1,357) 90,531 507 (67) (2,117) 837 — (3,849) (9,706) 101 (6,006) (1,645) (3,923) (2,518) (747) 47,457 13,354 3,105 8,973 (3,001) 64,525 1,142 (11,380) 6,244 4,001 4,859 (2,519) (89,132) (454,589) (503,405) (664,594) — (23,751) (24,710) 49,764 (18,800) 1,123 13,005 76,559 (9,600) 2,518 (16,770) 48,935 22,200 (674) (251) 219,663 152,036 (405,277) (1,360,386) (2,462,844) (1,979,917) (3,197) (2,623) (94) 728,042 1,796,153 1,147,624 547,444 559,774 1,129,087 5,257 — — (10,552) — — 17,212 (4,630) — 13 228 (4,707) (93,392) (96,958) 292,234 573,094 — (363,778) (11,250) (100,860) (41,540) (59,460) (147,127) (1,127) — (61,953) (11,152) (345) — — — (20,772) — (158) — — (507) (837) — — — — — Excess tax benefits related to share-based compensation 67 2,117 Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year See accompanying notes to consolidated financial statements. 72 | MGIC Investment Corporation 2016 Annual Report (151,981) (71,840) (21,767) (25,710) (16,762) (134,810) 181,120 197,882 332,692 $ 155,410 $ 181,120 $ 197,882 MGIC INVESTMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2016, 2015 and 2014 Note 1. Nature of Business Note 2. Basis of Presentation through Mortgage Guaranty MGIC Investment Corporation is a holding company which, 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. Our principal product is insurance. Primary insurance primary mortgage provides mortgage default protection on individual loans and covers unpaid loan principal, delinquent interest and certain expenses associated with the default and subsequent foreclosure or sale approved by us. Through certain other non-insurance subsidiaries, we also provide various services for the industry, such as contract mortgage loan originations and underwriting, analysis of lead generation. An portfolios, and mortgage insurance subsidiary of MGIC provides credit insurance for certain mortgages under Fannie Mae and Freddie Mac (the "GSEs") credit risk transfer programs. finance At December 31, 2016, our direct domestic primary insurance in force ("IIF") was $182.0 billion, which represents the principal balance in our records of all mortgage loans that we insure, and our direct domestic primary risk in force ("RIF") was $47.2 billion, which represents the insurance in force multiplied by the insurance coverage percentage. Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. We operate under the Private Mortgage Insurer Eligibility Requirements ("PMIERs") of the GSEs that became effective December 31, 2015, and were most recently revised financial in December 2016. The requirements of the PMIERs require a mortgage insurer’ s "Available Assets" (generally only the most liquid assets of an insurer) to equal or exceed its "Minimum Required Assets" (which are based on an insurer's book and are calculated from tables of factors with several risk dimensions and are subject to a floor amount). Based on our interpretation of the PMIERs, as of December 31, 2016, MGIC’ s Available Assets are in excess of its Minimum Required Assets; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. The revisions to the PMIERs in December 2016 had no impact on our calculation of Available Assets or Minimum Required Assets, and did not impact our operations. include consolidated Basis of presentation The financial accompanying statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), as codified in the Accounting Standards Codification ("ASC"). Our consolidated the financial statements accounts of MGIC Investment Corporation and its majority-owned subsidiaries. Intercompany transactions and balances have been eliminated. In accordance with GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. We have considered subsequent events through the date of this filing. Reclassifications Certain reclassifications to 2015 and 2014 amounts have been made in the accompanying consolidated financial statements to conform to the 2016 presentation. See Note 3 - "Significant Accounting Policies" for a discussion of our adoption of accounting guidance in 2016 related to: (1) the presentation of debt issuance costs in the first quarter of 2016, and (2) clarification of certain cash receipts and cash payments. Both of the adopted accounting updates were retrospectively applied to all periods presented, as applicable. Note 3. Significant Accounting Policies Cash and Cash Equivalents We consider money market funds and investments with original maturities of three months or less to be cash equivalents. Fair value measurements The authoritative guidance around fair value established a framework for measuring fair value. Fair value is disclosed using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value and includes Levels 1, 2, and 3. 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 MGIC Investment Corporation 2016 Annual Report | 73 Notes 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 two sided markets, quotes, benchmark securities, bids, offers and reference data including data published research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. issuer spreads, in market 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 trading tolerance 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. reviewing reports, In accordance with fair value accounting 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 that we can access; 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 instrument. The observable inputs are used in valuation models to calculate the fair value of the instruments. Financial assets utilizing Level 2 inputs primarily include obligations of U.S. government corporations and agencies, corporate bonds, mortgage-backed securities, asset-backed securities, and most municipal bonds. 74 | MGIC Investment Corporation 2016 Annual Report The independent pricing sources utilize these approaches to determine the fair value of the instruments in Level 2 of the fair value hierarchy based on type of instrument: 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 ("RMBS") 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 ("CMBS") 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 ("ABS") 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 trade activity, bids, and offers are applied, resulting in tranche specific prices. Collateralized loan obligations ("CLO") Collateralized Loan Obligations are evaluated by manager rating, seniority in the capital structure, assumptions about prepayment, default and recovery and their impact on cash flow generation. Loan level net asset values are determined and aggregated for tranches and as a final step prices are checked against available recent trade activity. 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 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. 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. Investments Our entire investment portfolio is classified as available-for-sale and is reported at fair value or, for certain equity securities carried at cost, amounts that approximate fair value. The related unrealized investment gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income (loss) in shareholders' equity. Realized investment gains and losses are reported in income based upon specific identification of securities sold. (See Note 5 – “Investments.”) Each quarter we perform reviews of our investments in order to determine whether declines in fair value below amortized cost were considered other-than- temporary. In evaluating whether a decline in fair value is other-than-temporary, we consider several factors including, but not limited to: our intent to sell the security or whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; the present value of the discounted cash flows we expect to collect compared to the amortized cost basis of the security; extent and duration of the decline; failure of the issuer to make scheduled interest or principal payments; change in rating below investment grade; and adverse conditions specifically related to the security, an industry, or a geographic area. Based on our evaluation, we will record an other-than- temporary impairment ("OTTI") adjustment on a Notes security if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the its impaired security prior to recovery of amortized cost basis, or if the present value of the discounted cash flows we expect to collect is less than the amortized cost basis of the security. If the fair value of a security is below its amortized cost at the time of our intent to sell, the security is classified as other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, when a security is considered to be other-than-temporarily impaired, the losses are separated into the portion of the loss that represents the credit loss and the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive loss, net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’ s original yield, expected to be collected from the security is less than the cost basis of the security. Home office and equipment Home office and equipment is carried at cost net of depreciation. For financial reporting purposes, depreciation is determined on a straight-line basis for the home office and equipment over estimated lives ranging from 3 to 45 years. For income tax purposes, we use accelerated depreciation methods. is shown net of Home office and equipment accumulated depreciation of $30.6 million, $26.1 million and $54.9 million as of December 31, 2016, 2015 and 2014, respectively. Depreciation expense for the years ended December 31, 2016, 2015 and 2014 was $4.6 million, $3.2 million and $2.2 million, respectively. Deferred Insurance Policy Acquisition Costs Costs directly associated with the successful acquisition of mortgage insurance business, consisting of employee compensation and other policy issuance and underwriting expenses, are initially deferred and reported as deferred insurance policy acquisition costs ("DAC"). The deferred costs are net of any ceding commissions received associated with our reinsurance agreements. For each underwriting year of business, these costs are amortized to income in proportion to estimated gross profits over the estimated life of the policies. We utilize anticipated in our calculation. This includes accruing interest on the unamortized balance of DAC. The estimates for each underwriting year are reviewed quarterly and updated when necessary to reflect actual experience and any changes to key variables such as persistency or loss development. If a premium deficiency exists (in other investment income MGIC Investment Corporation 2016 Annual Report | 75 Notes words, no gross profit is expected), we reduce the related DAC by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the related DAC balance, we then establish a premium deficiency reserve equal to the excess, through a charge to current period earnings. expected future premium and already established reserves. The discount rate used in the calculation of the premium deficiency reserve is based upon our pre-tax investment yield at year-end. Products are grouped for premium deficiency testing purposes based on similarities in the way the products are acquired, serviced and measured for profitability. Loss Reserves Reserves are established for insurance losses and loss adjustment expenses ("LAE") when we receive notices of default on insured mortgage loans. We consider a loan in default when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excludes mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently in default. 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. Our loss estimates are established based upon historical experience, including rescission and loan modification activity. Adjustments to reserve estimates are reflected in the financial statements in the years in which the adjustments are made. The liability for reinsurance assumed is based on information provided by the ceding companies. Reserves are also established for estimated losses from defaults occurring prior to the close of an accounting period on notices of default not yet reported to us. These incurred but not reported reserves are also established using ("IBNR") estimated claim rates and claim severities. Reserves are also established for the estimated costs of settling claims, including legal and other expenses and general expenses of administering the claims settlement process. Reserves are also ceded to reinsurers under our reinsurance agreements. (See Note 8 – “Loss Reserves” and Note 9 – “Reinsurance.”) Premium Deficiency Reserve After our loss reserves are initially established, we perform premium deficiency tests using our best estimate assumptions as of the testing date. Premium deficiency reserves are established, if necessary, when the present value of expected future losses and expenses exceeds the present value of 76 | MGIC Investment Corporation 2016 Annual Report The calculation of premium deficiency reserves requires the use of significant judgments and estimates to determine the present value of future premium and present value of expected losses and expenses on our business. The calculation of future premium depends on, among other things, assumptions about persistency and repayment patterns on underlying loans. The calculation of expected losses and expenses depends on assumptions relating to severity of claims and claim rates on current defaults, and expected defaults in future periods. These assumptions also include an estimate of expected rescission activity. Similar to our loss reserve estimates, our estimates for premium deficiency reserves could be adversely affected by several factors, including a deterioration of regional or economic conditions leading to a reduction in borrowers' income and thus their ability to make mortgage payments, and a drop in housing values can influence the willingness of borrowers with sufficient to make mortgage payments to do so when the mortgage balance exceeds the value of the home, which could expose us to greater losses. Assumptions used in calculating the deficiency reserves can also be affected by volatility in the current housing and mortgage lending industries. To the extent premium patterns and actual loss experience differ from the assumptions used in calculating the premium deficiency reserves, the differences between the actual results and our estimate will affect future period earnings and could be material. resources We previously established a premium deficiency reserve in 2007 on our Wall Street Bulk business, which we also ceased writing in that year. As of December 31, 2015 a premium deficiency reserve was no longer required. Changes in the premium deficiency reserve from period to period were primarily due to the recognition of previously estimated premiums, losses, and expenses, and changes in our assumptions relating to the present value of expected future premiums, losses, and expenses on the remaining Wall Street Bulk IIF. Our consolidated statements of operations for the years ended December 31, 2015 and 2014 were affected by decreases in our premium deficiency reserves of $24 million and $25 million, respectively. The decreases represented the net result of actual premiums, losses and expenses as well as a net change in assumptions for these periods. Revenue Recognition We write policies which are guaranteed renewable contracts at the insured's option on a monthly, single, or annual premium basis. We have no ability to reunderwrite or reprice these contracts. Premiums written on monthly premium policies are earned as coverage is provided. Premiums written on single premium policies and annual premium policies are initially deferred as unearned premium reserve and earned over the estimated policy life. Premiums written on policies covering more than one year are amortized over the policy life in relationship to the anticipated incurred loss pattern based on historical experience. Premiums written on annual premium policies are earned on a monthly pro rata basis. When a policy is cancelled for a reason other than rescission or claim payment, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. When a policy is cancelled due to rescission, all previously collected premium is returned to the servicer and when a policy is cancelled because a claim is paid, we return any premium received since the date of default. The liability associated with our estimate of premium to be returned is accrued for separately and included in "Other liabilities" on our consolidated balance sheets. When a premium deficiency exists the premium refund liability is included in “Premium deficiency reserves” on our consolidated balance sheets. Changes in these liabilities affect premiums written and earned and change in premium deficiency reserve, respectively. The actual return of premium for all periods affects premiums written and earned. Policy cancellations also lower the persistency rate which is a variable used in calculating the rate of amortization of deferred insurance policy acquisition costs. Fee income of our non-insurance subsidiaries is earned and recognized as the services are provided and the customer is obligated to pay. Fee income consists primarily of contract underwriting and related fee-based services provided to lenders and is included in “Other revenue” on the consolidated statements of operations. Income Taxes Deferred income taxes are provided under the liability method, which recognizes the future tax effects of temporary differences between amounts reported in the consolidated financial statements and the tax bases of these items. The expected tax effects are computed at the enacted regular federal statutory tax rate. Using this method, we have recorded a net deferred tax asset primarily due to net operating Notes losses incurred in prior years. On a quarterly basis, we review the need to maintain a deferred tax asset valuation allowance as an offset to the net deferred tax asset, before valuation allowance. 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, operating results on a three year cumulative basis, the expected occurrence of future income or loss, the expiration dates of the 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, as discussed in Note 12 –“Income Taxes,” we concluded that it was more likely than not that our deferred tax assets would be fully realizable and we reversed the valuation allowance. We provide for uncertain tax positions and the related interest and penalties based on our assessment of whether a tax benefit is more likely than not to be taxing sustained under any examination by authorities. supplemental Benefit Plans We have a non-contributory defined benefit pension plan covering substantially all employees, as well as a retirement plan. executive Retirement benefits are based on compensation and years of service. We recognize these retirement benefit costs over the period during which employees render the service that qualifies them for benefits. Our policy is to fund pension cost as required under the Employee Retirement Income Security Act of 1974. We offer both medical and dental benefits for retired domestic employees, their eligible spouses and dependents until the retiree reaches the age of 65. Under the plan retirees pay a premium for these benefits. We accrue the estimated costs of retiree medical and dental benefits over the period during which employees render the service that qualifies them for benefits. (See Note 11 – “Benefit Plans.”) Reinsurance Loss reserves and unearned premiums are reported before taking credit for amounts ceded under reinsurance agreements. Ceded loss reserves are reflected as "Reinsurance recoverable on loss reserves." Ceded unearned premiums are included in “Other assets.” Amounts due from reinsurers on paid claims are reflected as “Reinsurance recoverable on paid losses.” Ceded premiums payable are included in “Other liabilities.” Any profit commissions are included with “Premiums written – Ceded” and any included with “Other ceding commissions are MGIC Investment Corporation 2016 Annual Report | 77 Notes underwriting and operating expenses, net.” We remain liable for all insurance ceded. (See Note 9 – “Reinsurance.”) Share-Based Compensation We have certain share-based compensation plans. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period which generally corresponds to the vesting period. The fair value of awards classified as liabilities is remeasured at each reporting period until the award is settled. Awards under our plans generally vest over periods ranging from one to three years. (See Note 15 – “Share-based Compensation Plans.”) Earnings per Share Basic earnings per share ("EPS") is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common stock equivalents. We calculate diluted EPS using the treasury stock method and if-converted method. Under the treasury stock method, diluted EPS reflects the potential dilution that could occur if our unvested restricted stock units result in the issuance of common stock. Under the if-converted method, diluted EPS reflects the potential dilution that could occur if our convertible debt instruments result in the issuance of common stock. The determination of potentially issuable shares does not consider the 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. We have several debt issuances that could result in contingently issuable shares and consider each potential issuance of shares separately to reflect the maximum potential dilution. Nonetheless, our dilutive common stock equivalents may not reflect all of the contingently issuable shares that could be required to be issued upon any debt conversion. For purposes of calculating basic and diluted EPS, vested restricted stock and restricted stock units ("RSUs") are considered outstanding. Related party transactions There were no related party transactions during 2016, 2015 or 2014. 78 | MGIC Investment Corporation 2016 Annual Report Notes Recent accounting and reporting developments Standard Summary of guidance Presentation of Debt Issuance Costs • 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 as a deferred charge. Effects on financial statements and/or disclosures • Adopted March 31, 2016 with retrospective application to prior periods. • Does not impact the amortization method for these • There was no material impact on costs. Accounting for Share-Based Compensation When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period • Requires that a performance target that affects vesting and that can be achieved after the requisite service period be treated as a performance condition. in which • Compensation cost should be recognized in the it become probable that the period 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 consolidated balance sheets, and no impact on our statements of operations. • For further information, see Note 7. "Debt." • Adopted March 31, 2016 with application to performance based awards granted in 2016. • There was no material impact on our consolidated financial statements. • For further information, see Note 15. "Share-based Compensation Plans". Disclosures about Short- Duration Contracts • Requires expanded disclosures designed to provide additional insight into an insurance entity's ability to underwrite and anticipate costs associated with claims. • This standard is not considered applicable to our business and therefore we have not adopted these disclosure requirements. • 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. • Expanded disclosures also include more transparent information in methodologies and assumptions used to estimate claims, and the timing, frequency, and severity of claims. significant changes about Classification of Certain Cash Receipts and Cash Payments • Provides specific guidance on the presentation of certain cash flow items including, but not limited to, debt prepayment and debt issuance costs and proceeds from the settlement of insurance claims. • Adopted December 31, 2016 with application to prior periods. • Cash flows related to debt prepayment and debt issuance transactions have been reclassified as financing activities from operating activities. • For further information on the impact our transactions had on our cash and cash equivalents see our consolidated statements of cash flows. MGIC Investment Corporation 2016 Annual Report | 79 Notes Financial Accounting Standards Board ("FASB") Standards Issued but not yet Adopted Standard Summary of guidance • Requires equity for under investments, except those accounted 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 earnings. Effects on financial statements and/or disclosures • Required effective date: January 1, 2018. Recognition and Measurement of Financial Assets and Financial Liabilities Issued January 2016 Improvements to Employee Share-Based Compensation Accounting Issued March 2016 Measurement of Credit Losses on Financial Statements Issued June 2016 • 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 potential impact from the adoption of this guidance is not expected to have a material impact our consolidated balance sheets, consolidated statements of operations, or liquidity. • Requires recognition of a cumulative effect adjustment to retained earnings as of the beginning of the reporting period of adoption. • For further information on our current equity investments see Note 5. "Investments." • Required effective date: January 1, 2017. • We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements. • Required effective date: January 1, 2020. • We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact. • Requires that, prospectively, all tax effects related to share-based compensation be made through the statement of operations at the time of settlement, rather than recognizing excess tax benefits within paid-in capital. • 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. • Requires all tax related cash flows resulting from share-based compensation to be reported as operating activities, a change from the existing requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. • Entities, for tax withholding purposes, will be allowed to withhold an amount of shares up to an 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. • Requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities are required to use a current expected credit loss ("CECL") methodology that incorporates their forecasts of future economic conditions, unless such forecast is not reasonable or supportable, in which case the entity will revert to historical loss experience. • Amends existing guidance for available-for-sale fixed income securities to incorporate an allowance, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which the fair value is less than amortized cost. The guidance will allow for reversals of impairment losses in the event that the credit of an issuer improves. The length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. • Updated guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore will require significant in application. judgment 80 | MGIC Investment Corporation 2016 Annual Report Note 4. Earnings Per Share The computation of basic EPS includes as "participating securities" unvested share-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, under the "two-class" method. Our participating securities are composed of vested restricted stock and restricted stock units with non- forfeitable rights to dividends (of which none have these been declared since participating securities). For each of the years ended December 31, 2016, 2015, and 2014, participating securities of 0.1 million have been included in basic EPS. issuance of the The computation of diluted EPS for the years ended December 31, 2016, 2015, and 2014 includes weighted average unvested restricted stock units outstanding of 1.5 million, 2.1 million, and 3.1 million, respectively. For the years ended December 31, 2016 and 2015, all of our outstanding Convertible Senior Notes and Convertible Junior Subordinated Debentures are reflected in diluted earnings per share using the “if- converted” method. Under this method, if dilutive, the common stock related to the outstanding Convertible Senior Notes and/or Convertible Junior Debentures is assumed issued as of the beginning of the reporting period and the related interest expense, net of tax, is added back to earnings in calculating diluted EPS. For the year ended December 31, 2014 our 5% Notes and 9% Debentures were not included in calculating diluted EPS as the result was anti-dilutive under the "if-converted" method. Notes The following table reconciles basic and diluted EPS amounts: (In thousands, except per share data) Basic earnings per share: Years Ended December 31, 2016 2015 2014 Net income $342,517 $1,172,000 $251,949 Weighted average common shares outstanding 342,890 339,552 338,523 Basic income per share $ 1.00 $ 3.45 $ 0.74 Diluted earnings per share: Net income $342,517 $1,172,000 $251,949 Interest expense, net of tax (1): 2% Notes 5% Notes 9% Debentures Diluted income available to common shareholders Weighted-average shares - Basic Effect of dilutive securities: Unvested restricted stock units 2% Notes 5% Notes 9% Debentures 6,111 6,362 15,893 7,928 12,197 12,228 22,786 — — $370,883 $1,214,942 $264,146 342,890 339,552 338,523 1,470 54,450 13,107 20,075 2,113 71,917 25,603 28,854 3,082 71,917 — — Weighted-average shares - Diluted 431,992 468,039 413,522 Diluted earnings per share $ 0.86 $ 2.60 $ 0.64 Anti-dilutive securities (in millions) — — 54.5 (1) Interest expense for the years ended December 31, 2016 and December 31, 2015 has been tax effected at a rate of 35%. Due to the valuation allowance recorded against deferred tax assets, interest expense for the year ended December 31, 2014 was not tax effected. MGIC Investment Corporation 2016 Annual Report | 81 Notes Note 5. Investments The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio as of December 31, 2016 and 2015 are shown below: December 31, 2016 (In thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Total debt securities Equity securities Total investment portfolio December 31, 2015 (In thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Debt securities issued by foreign sovereign governments Total debt securities Equity securities Total investment portfolio Amortized Cost Gross Unrealized Gains Gross Unrealized Losses (1) Fair Value $ 73,847 $ 407 $ (724) $ 73,530 2,147,458 1,756,461 59,519 231,733 327,042 121,151 20,983 6,059 74 102 769 226 (25,425) (18,610) (28) (7,626) (7,994) (202) 2,143,016 1,743,910 59,565 224,209 319,817 121,175 4,717,211 28,620 (60,609) 4,685,222 7,144 8 (24) 7,128 $ 4,724,355 $ 28,628 $ (60,633) $ 4,692,350 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses (1) Fair Value $ 160,393 $ 2,133 $ (1,942) $ 160,584 1,766,407 2,046,697 116,764 265,879 237,304 61,345 29,359 4,684,148 5,625 33,410 2,836 56 161 162 3 2,474 41,235 38 (7,290) 1,792,527 (44,770) 2,004,763 (203) (8,392) (3,975) (1,148) (102) 116,617 257,648 233,491 60,200 31,731 (67,822) 4,657,561 (18) 5,645 $ 4,689,773 $ 41,273 $ (67,840) $ 4,663,206 (1) There were no OTTI losses recorded in other comprehensive (loss) income as of December 31, 2016 and 2015. total investment portfolio amount shown above with a total fair value of $164.4 million. The amortized cost and fair values of debt securities as of December 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. including proceeds During the first quarter of 2016 we substantially liquidated our Australian entities and repatriated most assets, the monetization of our Australian investment portfolio. As of December 31, 2016 we held no investments in foreign sovereign governments. As of December 31, 2015 our foreign investments primarily consisted of Australian government and semi government securities. from As discussed in Note 7 - "Debt" we are required to maintain collateral of at least 102% of the outstanding principal balance of the FHLB Advance. As of December 31, 2016 that collateral is included in our 82 | MGIC Investment Corporation 2016 Annual Report December 31, 2016 (In thousands) Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years ABS RMBS CMBS CLOs Total as of December 31, 2016 Notes Amortized Cost Fair Value $ 433,464 $ 433,770 1,211,034 1,212,650 1,157,091 1,139,552 1,176,177 1,174,484 3,977,766 3,960,456 59,519 231,733 327,042 121,151 59,565 224,209 319,817 121,175 $ 4,717,211 $ 4,685,222 At December 31, 2016 and 2015, the investment portfolio had gross unrealized losses of $61 million and $68 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: December 31, 2016 Less Than 12 Months 12 Months or Greater Total (In thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Equity securities Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 48,642 $ (724) $ — $ — $ 48,642 $ (724) 1,136,676 915,777 3,366 46,493 205,545 13,278 568 (24,918) (16,771) (28) (857) (7,529) (73) (15) 13,681 35,769 656 (507) 1,150,357 (1,839) 951,546 — 171,326 (6,769) 38,587 34,760 137 (465) (129) (9) 4,022 217,819 244,132 48,038 705 (25,425) (18,610) (28) (7,626) (7,994) (202) (24) Total investment portfolio $ 2,370,345 $ (50,915) $ 294,916 $ (9,718) $ 2,665,261 $ (60,633) December 31, 2015 Less Than 12 Months 12 Months or Greater Total (In thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Debt securities issued by foreign sovereign governments Equity securities Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ 60,548 $ (1,467) $ 1,923 $ (475) $ 62,471 $ (1,942) 417,615 1,470,628 86,604 35,064 134,488 — 4,463 355 (6,404) (38,519) (173) (312) (2,361) — (102) (8) 37,014 114,982 5,546 209,882 69,927 51,750 — 171 (886) 454,629 (6,251) 1,585,610 (30) (8,080) (1,614) (1,148) — (10) 92,150 244,946 204,415 51,750 4,463 526 (7,290) (44,770) (203) (8,392) (3,975) (1,148) (102) (18) Total investment portfolio $ 2,209,765 $ (49,346) $ 491,195 $ (18,494) $ 2,700,960 $ (67,840) The unrealized losses in all categories of our investments as of December 31, 2016 and 2015 were primarily caused by changes in interest rates between the time of purchase and the respective year end. MGIC Investment Corporation 2016 Annual Report | 83 Notes There were 607 and 303 securities in an unrealized loss position as of December 31, 2016 and 2015, respectively. As of December 31, 2016, the fair value as a percent of amortized cost of the securities in an unrealized loss position was 98% and approximately 14% of the securities in an unrealized loss position were backed by the U.S. Government. There were no OTTI losses in earnings during 2016 and 2015. We recognized OTTI losses of $0.1 million during 2014. For the years ended December 31, 2016, 2015, and 2014, there were no credit losses recognized in earnings for which a portion of an OTTI loss was recognized in accumulated other comprehensive loss. The source of net investment income is as follows: 2016 2015 2014 $ 112,513 $ 105,882 $ 89,437 182 754 433 208 191 455 227 179 711 113,882 106,736 90,554 (In thousands) Fixed income Equity securities Cash equivalents Other Investment income Investment expenses Net investment income realized The net including impairment losses, and change in net unrealized gains (losses) of investments are as follows: investment gains, (In thousands) 2016 2015 2014 Net realized investment gains on investments: Fixed income $ 5,310 $ 28,335 $ 1,000 3,622 — 26 — 356 1 $ 8,932 $ 28,361 $ 1,357 Equity securities Other Total net realized investment gains Change in net unrealized gains (losses): Fixed income $ (5,403) $ (33,687) $ 91,718 Equity securities Other Total (decrease) increase in net unrealized gains/ losses (36) 14 (32) 1 66 (4) $ (5,425) $ (33,718) $ 91,780 The gross realized gains, gross realized losses and impairment losses are as follows: (3,216) (2,995) (2,907) Gross realized gains $ 11,909 $ 30,039 $ 4,966 (In thousands) 2016 2015 2014 $ 110,666 $ 103,741 $ 87,647 Gross realized losses Other-than- temporary- impairment losses Net realized gains on securities (2,977) (1,678) (3,465) — — (144) $ 8,932 $ 28,361 $ 1,357 We had $13.6 million and $18.9 million of investments at fair value on deposit with various states as of December 31, 2016 and 2015, respectively, due to regulatory requirements of those state insurance departments. 84 | MGIC Investment Corporation 2016 Annual Report Note 6. Fair Value Measurements Assets measured at fair value included those listed, by hierarchy level, in the following tables as of December 31, 2016 and 2015: Notes December 31, 2016 (In thousands) Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) — 691 — — — — — 691 4,268 4,959 — 1,228 — — — — — — 1,228 2,855 4,083 U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Total debt securities Equity securities (1) Total investments Real estate acquired (2) December 31, 2015 $ 73,530 $ 30,690 $ 42,840 $ 2,143,016 1,743,910 59,565 224,209 319,817 121,175 4,685,222 7,128 $ $ 4,692,350 11,748 $ $ — — — — — — 30,690 2,860 2,142,325 1,743,910 59,565 224,209 319,817 121,175 4,653,841 — 33,550 $ 4,653,841 $ — $ — $ 11,748 (In thousands) Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 160,584 $ 46,197 $ 114,387 $ U.S. Treasury securities and obligations of U.S. government corporations and agencies Obligations of U.S. states and political subdivisions Corporate debt securities ABS RMBS CMBS CLOs Debt securities issued by foreign sovereign governments Total debt securities Equity securities (1) Total investments Real estate acquired (2) 1,792,527 2,004,763 116,617 257,648 233,491 60,200 31,731 4,657,561 5,645 $ $ 4,663,206 12,149 $ $ — — — — — — 31,731 77,928 2,790 1,791,299 2,004,763 116,617 257,648 233,491 60,200 — 4,578,405 — 80,718 $ 4,578,405 $ — $ — $ 12,149 (1) (2) Equity securities in Level 3 are carried at cost, which approximates fair value. Real estate acquired through claim settlement, which is held for sale, is reported in other assets on the consolidated balance sheets. MGIC Investment Corporation 2016 Annual Report | 85 Notes For assets and liabilities measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the years ended December 31, 2016, 2015, and 2014 is shown in the following tables. There were no transfers into or out of Level 3 in those years and there we no losses included in earnings for those years attributable to the change in unrealized losses on assets still held at the end of each applicable year. Level 3 reconciliations: (In thousands) Obligations of U.S. States and Political Subdivisions 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 net realized investment gains Included in earnings and reported as losses incurred, net Purchases Sales — — — (537) 3,579 3,579 — — 4,258 (6,424) — 4,258 (6,961) (1,142) 36,859 (36,118) 11,748 Balance at December 31, 2016 $ 691 $ 4,268 $ 4,959 $ (In thousands) Obligations of U.S. States and Political Subdivisions 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 Purchases Sales — 7 (625) — 2,534 — — 2,541 (625) Balance at December 31, 2015 $ 1,228 $ 2,855 $ 4,083 $ (2,322) 34,624 (32,811) 12,149 (In thousands) Obligations of U.S. States and Political Subdivisions Equity Securities Total Investments Real Estate Acquired 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 Purchases Sales — 30 (607) — — — — 30 (607) Balance at December 31, 2014 $ 1,846 $ 321 $ 2,167 $ (4,129) 42,247 (38,740) 12,658 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. As of December 31, 2016, the majority of the $5.0 million balance of Level 3 securities are equity securities that can only be redeemed or sold at their 86 | MGIC Investment Corporation 2016 Annual Report its remaining par value and only to the security issuer, with the remainder of the balance held in a state premium tax credit investment. The state premium tax credit investment has an average maturity of less than 3 years and a credit rating of AAA, and its balance reflects scheduled payments discounted at an average annual rate of 7.1%. As of December 31, 2015 our Level 3 securities were equity securities that can only be redeemed or sold at their par value and only to the security issuer and state premium tax credit investments. As of December 31, 2014 the majority of our Level 3 securities were state premium tax credit investments. Additional fair value disclosures related to our investment portfolio are included in Note 5 – “Investments.” We incur financial liabilities in the normal course of our business. The following table presents the carrying value and fair value of our financial liabilities disclosed, but not carried, at fair value at December 31, 2016 and 2015. The fair values of our 5% Notes, 2% Notes, 5.75% Notes, and 9% Debentures were based on observable market prices and the fair value of the FHLB 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. See Note 7 - "Debt" for a description of the financial liabilities in the table below. (In thousands) Financial liabilities: FHLB Advance 5% Notes 2% Notes 5.75% Notes 9% Debentures Total financial liabilities December 31, 2016 December 31, 2015 Carrying Value Fair Value Carrying Value Fair Value $ 155,000 $ 151,905 n/a n/a 144,789 147,679 331,546 345,616 204,672 308,605 490,755 701,955 417,406 445,987 n/a n/a 256,872 323,040 389,522 455,067 $1,178,739 $1,377,216 $1,211,823 $1,502,638 The 5% Notes, 2% Notes, 5.75% Notes, and 9% Debentures are obligations of our holding company, MGIC its subsidiaries. Investment Corporation, and not of Note 7. Debt Accounting standard update As of March 31, 2016 we adopted the accounting update related to the presentation of debt issuance costs in the consolidated 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 impact on our consolidated statements of no 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. Notes December 31, 2015 As previously reported Adjustment As Adjusted $ 333.5 $ (2.0) $ 500.0 389.5 (9.2) — 331.5 490.8 389.5 $ 1,223.0 $ (11.2) $ 1,211.8 (In millions) 5% Notes 2% Notes 9% Debentures Total long- term debt Long-term debt Long-term debt as of December 31, 2016 and 2015 consisted of the following obligations. (In millions) FHLB Advance 5% Notes 2% Notes 5.75% Notes 9% Debentures Long-term debt, par value Less: debt issuance costs December 31, 2016 2015 $ 155.0 $ 145.0 207.6 425.0 256.9 1,189.5 10.8 — 333.5 500.0 — 389.5 1,223.0 11.2 Long-term debt, carrying value $ 1,178.7 $ 1,211.8 Interest payments, on a consolidated basis, for our debt obligations existing during 2016 and 2015 appear below. (In millions) 5.375% Notes FHLB Advance 5% Notes 2% Notes 5.75% Notes 9% Debentures Years Ended December 31, 2016 2015 $ — $ 2.4 10.6 9.1 — 27.4 3.3 — 17.3 10.0 — 35.1 65.7 Total interest payments $ 49.5 $ 5.75% Notes In August 2016, we issued $425 million aggregate principal amount of 5.75% Senior Notes due in 2023 ("5.75% Notes") and received net proceeds, after the deduction of underwriting fees, of $418.1 million. Interest on the 5.75% Notes is payable semi-annually on February 15 and August 15 of each year, commencing on February 15, 2017. We have the option to redeem these notes, in whole or in part, at any time or from time to time prior to maturity at a redemption price equal to the greater of (i)100% of the aggregate principal amount of the notes to be redeemed and (ii) the make-whole amount, which is the sum of the present values of the remaining scheduled payments of principal and interest discounted at the treasury rate defined in the notes MGIC Investment Corporation 2016 Annual Report | 87 Notes plus 50 basis points, plus, in each case, accrued interest thereon to, but excluding, the redemption date. In addition to underwriting fees, we incurred approximately $1.2 million of other expenses associated with the issuance of these notes. The 5.75% Notes have covenants customary for securities of this nature, including customary events of default and further provide that the trustee or holders of at least 25% in aggregate principal amount of the outstanding 5.75% Notes may declare them immediately due and payable upon the occurrence of certain events of default after the expiration of the applicable grace period. In addition, in the case of an event of default arising from certain events of bankruptcy, insolvency or reorganization relating to the Company or any of its significant subsidiaries, the 5.75% Notes will become due and payable immediately. This description is not intended to be complete in all respects and is qualified in its entirety by the terms of the 5.75% Notes, including their covenants and events of default. The net proceeds from the 5.75% Notes issuance were primarily used as (i) cash consideration to repurchase a portion of our 2% Notes, and (ii) to repurchase the shares issued as partial consideration repurchases of our 2% Notes, as in further described below. The remaining proceeds are being held for general corporate purposes. the FHLB Advance In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the Federal Home Loan Bank of Chicago ("FHLB Advance"). 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. 5.375% Notes We repaid the outstanding 5.375% Notes with cash at the holding company on November 2, 2015. Interest on these notes was payable semi-annually in arrears on May 1 and November 1 each year. The repayment of our Senior Notes had no material impact on our financial position or liquidity. 88 | MGIC Investment Corporation 2016 Annual Report 5% Notes As of December 31, 2016 and 2015 we had outstanding $145.0 million and $333.5 million, respectively, principal amount of 5% Notes due in 2017 ("5% Notes"). In 2016, we repurchased $188.5 million in aggregate principal of our 5% Notes at a purchase price of $195.5 million, plus accrued interest using funds held at our holding company. In 2015, we purchased $11.5 million in aggregate principal of our 5% Notes at a purchase price of $12.0 million, plus accrued interest, using funds held at our holding company. In each of 2016 and 2015, the excess of the purchase price over carrying value, plus the write-off of unamortized issuance costs on the par value repurchased, is reflected as a loss on debt extinguishment on our consolidated statements of operations. Our 5% Notes repurchase in 2015 reduced our potentially dilutive shares by approximately 0.9 million shares, and our 2016 5% Notes repurchases reduced our potentially dilutive shares by approximately 14.0 million shares. Interest on the 5% Notes is payable semi-annually in arrears on May 1 and November 1 of each year. The 5% Notes will mature on May 1, 2017. 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 and will be senior in right of payment to our 9% Debentures. Debt issuance costs are being amortized to interest expense over the contractual life of the 5% Notes. We have 10.8 million authorized shares reserved for conversion under our 5% Notes. The provisions of the 5% Notes are complex. Covenants in the 5% Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the holders of the 5% Notes. A designated subsidiary is any of our consolidated subsidiaries which has shareholders' equity of at least 15% of our consolidated shareholders' equity. Further, the notes are subject to the indenture between us and the trustee that, among other terms, includes provisions that would constitute an event of default under the indenture. Upon such a default, the trustee could accelerate the maturity of the notes independent of any action by holders of the 5% Notes. This description is not intended to be complete in all respect and is qualified in its entirety by the terms of the 5% Notes, including their covenants and events of default. We were in compliance with all covenants at December 31, 2016. convert their notes irrespective of satisfaction of the conditions. Notes 2% Notes As of December 31, 2016 and 2015, we had outstanding $207.6 million and $500.0 million, respectively, principal amount of our 2% Notes due in 2020 ("2% Notes"). In the third quarter of 2016, we entered into privately negotiated agreements to repurchase $292.4 million in aggregate principal of our outstanding 2% Notes at a purchase price of $362.1 million, plus accrued interest. We funded the purchases with $230.7 million in cash, using proceeds from the issuance of our 5.75% Notes, and by issuing to certain sellers approximately 18.3 million shares of our common stock. The excess of the purchase price over carrying value, plus the write- off of unamortized issuance costs on the par value repurchased, loss on debt is reflected as a extinguishment on our consolidated statements of operations for the year ended December 31, 2016. The shares issued as consideration for the notes repurchases have been repurchased as of December 31, 2016 using cash from our 5.75% Notes issuance. The repurchases of the 2% Notes reduced potentially dilutive shares by approximately 42.1 million shares, without considering the shares issued as partial consideration in the purchases of the 2% Notes or the repurchase of shares to offset such shares issued. Interest on the 2% Notes is payable semi-annually in arrears on April 1 and October 1 of each year. Debt issuance costs are being amortized to interest expense over the contractual life of the 2% Notes. 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. This condition was met for the quarter ended December 31, 2016. The 2% Notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 initial principal amount. This conversion price of approximately $6.95 per share. 130% of such conversion price is approximately $9.04. On or after January 1, 2020, holders may represents an 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. We have 29.9 million authorized shares reserved for conversion under our 2% Notes. The provisions of the 2% Notes are complex. Covenants in the 2% Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to holders of the 2% Notes. Further, the notes are subject to the indenture between us and the trustee that, among other that would includes provisions constitute an event of default under the indenture. Upon such a default, the trustee could accelerate the maturity of the notes independent of any action by holders of the 2% Notes. This description is not intended to be complete in all respect and is qualified in its entirety by the terms of the 2% Notes, including their covenants and events of default. We were in compliance with all covenants at December 31, 2016. 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 9% Debentures. terms, 9% Debentures As of December 31, 2016 and 2015 we had outstanding $256.9 million and $389.5 million, respectively, principal amount of our 9% Debentures due in 2063 ("9% Debentures"). In February 2016, in aggregate MGIC purchased $132.7 million principal of our outstanding 9% Debentures 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 the between liability component and the equity component. The purchase of the 9% Debentures loss on debt resulted the extinguishment of reacquisition of in an $8.3 million MGIC Investment Corporation 2016 Annual Report | 89 Notes extinguishment on the consolidated statement of operations for the year ended December 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 $6.3 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. When interest on the 9% Debentures is deferred, we are required, not later than a specified time, to use reasonable commercial efforts to begin selling qualifying securities to persons who are not our affiliates. The specified time is one business day after we pay interest on the 9% Debentures that was not deferred, or if earlier, the fifth anniversary of the scheduled interest payment date on which the deferral started. Qualifying securities are common stock, certain warrants and certain non-cumulative perpetual preferred stock. The requirement to use such efforts to sell such securities is called the Alternative Payment Mechanism. The 9% 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 the 9% 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 9% Debentures, deferred interest owed on the 9% 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 9% 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. We have 19.0 million authorized shares reserved for conversion under our 9% debentures. We may redeem the 9% 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 9% 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 9% Debentures for at least 20 of the 30 trading days preceding notice of the redemption. 130% of such conversion price is $17.55. Interest on the 9% 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 interest, under an optional deferral may defer provision, for one or more consecutive interest periods up to 10 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. The net proceeds of Alternative Payment Mechanism sales are to be applied to the payment of deferred interest, including the compound portion. We cannot pay deferred interest other than from the net proceeds of Alternative Payment Mechanism sales, except at the final maturity of the debentures or at the tenth anniversary of the start of the interest deferral. The Alternative Payment Mechanism does not require us to sell common stock or warrants before the fifth anniversary of the interest payment date on which that deferral started if the net proceeds (counting any net proceeds of those securities previously sold under the Alternative Payment Mechanism) would exceed the 2% cap. The 2% cap is 2% of the average closing price of our common stock times the number of our outstanding shares of common stock. The average price is determined over a specified period ending before the issuance of the common stock or warrants being sold, and the number of outstanding shares is determined as of the date of our most recent publicly released financial statements. We are not required to issue under the Alternative Payment Mechanism a total of more than 10 million shares of common stock, including shares underlying qualifying warrants. In addition, we may not issue under the Alternative Payment Mechanism qualifying preferred stock if the total net proceeds of all issuances would exceed 25% of the aggregate principal amount of the debentures. The Alternative Payment Mechanism does not apply during any period between scheduled interest payment dates if there is a “market disruption event” that occurs over a specified portion of such period. include any material Market disruption events adverse change international economic or financial conditions. in domestic or The provisions of the 9% Debentures are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the 9% Debentures, 90 | MGIC Investment Corporation 2016 Annual Report including their covenants and events of default. We in compliance with all covenants at were December 31, 2016. The 9% Debentures rank junior to all of our existing and future senior indebtedness. Note 8. Loss Reserves As described in Note 3 – “Summary of Significant Accounting Policies – Loss Reserves,” we establish reserves to recognize the estimated liability for losses and 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, the current and future strength of local housing markets; exposure on insured loans; the amount of time between default and claim filing, and curtailments and rescissions. 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 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 “Losses incurred” section of the table below shows losses incurred on defaults that occurred in the current year and in prior years. The amount of losses incurred relating to defaults that occurred in the current year represents the estimated amount to be ultimately paid on such defaults. The amount of losses incurred relating to defaults that occurred in prior years represents the actual claim rate and severity associated with those defaults 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 continuing from the end of the prior year. This re-estimation of the claim rate and 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 relative to the average loan Notes exposure, 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 2016 compared to 2015, and in 2015 compared to 2014, primarily due to a decrease in the number of new defaults, net of cures, as well as a decrease in the estimated claim rate on recently reported defaults. The “Losses paid” section of the table below shows the breakdown between claims paid on new default notices in the current year, and claims paid on defaults from prior years. 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. During 2016, our losses paid included $53 million associated with settlements for claims paying practices and NPL settlements. These settlements reduced our delinquent inventory by 1,273 notices. During 2015, our losses paid included $10 million associated with settlements for claim paying practices. These settlements reduced our delinquent inventory by 1,121 notices. These settlements had no material impact on our losses incurred in either year. liability associated with our estimate of The premiums to be refunded on expected claim payments is accrued for separately at December 31, 2016 and 2015 and approximated $85 million and $102 million, respectively. This liability was included in "Other liabilities" on our consolidated balance sheets. In each of 2016, 2015, and 2014, we paid $42 million in connection with a 2012 settlement agreement with Freddie Mac regarding the aggregate loss limit under certain pool insurance policies. The final payment under that settlement agreement was made on December 1, 2016. MGIC Investment Corporation 2016 Annual Report | 91 Notes The following table provides a reconciliation of beginning and ending loss reserves for each of the past three years: (In thousands) 2016 2015 2014 $1,893,402 $2,396,807 $3,061,401 44,487 57,841 64,085 1,848,915 2,338,966 2,997,316 Reserve at beginning of year Less reinsurance recoverable Net reserve at beginning of year Losses incurred: Losses and LAE incurred in respect of default notices received in: Current year Prior years (1) 387,815 453,849 596,436 (147,658) (110,302) (100,359) Total losses incurred 240,157 343,547 496,077 Losses paid: Losses and LAE paid in respect of default notices received in: Current year Prior years Reinsurance terminations (2) 14,823 25,980 32,919 689,258 823,058 1,121,508 (3,329) (15,440) — Total losses paid 700,752 833,598 1,154,427 Net reserve at end of year Plus reinsurance recoverables 1,388,320 1,848,915 2,338,966 50,493 44,487 57,841 Reserve at end of year $1,438,813 $1,893,402 $2,396,807 (1) A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves. See table below for more information about prior year loss development. (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. (See Note 9 – “Reinsurance”) For the years ended December 31, 2016, 2015 and 2014 we experienced favorable prior year loss reserve development. This development was, in part, due to the resolution of approximately 63%, 60% and 58% for the years ended December 31, 2016, 2015 and 2014, respectively, of the prior year default inventory. In 2016, 2015, and 2014 we experienced improved cure rates on prior year defaults. Additionally, during 2015 the claim rate development was favorably impacted by re-estimations of previously recorded reserves relating to disputes on our claims paying practices and adjustments to IBNR. The favorable development for the years ended 2016 and 2015 was offset, in part, by an increase in the estimated severity on prior year defaults remaining in the delinquent inventory. The 92 | MGIC Investment Corporation 2016 Annual Report decrease in the estimated severity in 2014 was based on the resolution of the prior year default inventory. The prior year development of the reserves in 2016, 2015 and 2014 is reflected in the table below. (In millions) 2016 2015 2014 Decrease in estimated claim rate on primary defaults Increase (decrease) in estimated severity on primary defaults Change in estimates related to pool reserves, LAE reserves, reinsurance and other Total prior year loss development (1) $ (148) $ (141) $ (43) 9 43 (35) (9) (12) (22) $ (148) $ (110) $ (100) (1) A negative number for prior year loss development indicates a redundancy of prior year loss reserves. in the table below. The Default Inventory A rollforward of our primary default inventory for the years ended December 31, 2016, 2015 and 2014 appears 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 transfers of servicing between loan servicers. Default inventory at beginning of year New Notices Cures Paids (including those charged to a deductible or captive) Rescissions and denials Other items removed from inventory Default inventory at end of year 2016 2015 2014 62,633 67,434 79,901 103,328 74,315 88,844 (65,516) (73,610) (87,278) (12,367) (16,004) (23,494) (629) (848) (1,306) (1,273) (1,121) (193) 50,282 62,633 79,901 The decrease in the primary default inventory experienced during 2016 and 2015 was generally across all markets and all book years prior to 2013. In 2016 and 2015, the percentage of loans in the inventory that had been in default for 12 or more consecutive months had decreased compared to the respective prior years. Historically as a default ages it becomes more likely to result in a claim. The percentage of loans that have been in default for 12 or more consecutive months and the number of loans in our primary claims received inventory have been affected by our suspended rescissions and the resolution of certain of those rescissions discussed below and in Note 17 - "Litigation and Contingencies". Pool insurance default inventory decreased to 1,883 at December 31, 2016 from 2,739 at December 31, 2015 and 3,797 at December 31, 2014. Notes The number of consecutive months that a borrower has been delinquent is shown in the table below. Consecutive months in default December 31, 2016 2015 2014 12,194 24% 13,053 21% 15,319 19% 13,450 27% 15,763 25% 19,710 25% 24,638 49% 33,817 54% 44,872 56% 50,282 100% 62,633 100% 79,901 100% 3 months or less 4 - 11 months 12 months or more (1) Total primary default inventory Primary claims received inventory included in ending default inventory Claims paying practices Our loss reserving methodology incorporates our estimates of future rescissions. A variance between ultimate actual rescission rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses. is accrued The liability associated with our estimate of premiums to be refunded on expected future rescissions separately. At December 31, 2016 and 2015 the estimate of this liability totaled $5 million and $7 million, respectively. This liability was included in "Other liabilities" on our consolidated balance sheets. for For legal information about discussions and proceedings with customers with respect to our claims paying practices, including settlements that we believe are probable, as defined in ASC 450-20, see Note 17 – “Litigation and Contingencies.” 1,385 3% 2,769 4% 4,746 6% Note 9. Reinsurance Our consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related earned premiums) we have underwritten to other insurance companies who agree to share these risks. The primary purpose of ceded reinsurance is to protect us, at a cost, against a fixed percentage of losses arising from policies covered by the agreement; however we also utilize reinsurance to manage our capital requirements under PMIERs. Reinsurance is currently placed on a quota-share basis, but we also have captive reinsurance agreements that remain in effect. The reinsurance agreements we have entered into are discussed below. (1) Approximately 47%, 50% and 53% of the primary default inventory in default for 12 consecutive months or more has been in default for at least 36 consecutive months as of December 31, 2016, 2015 and 2014, respectively. The length of time a loan is in the default inventory can differ from the number of payments that the borrower has not made or is considered delinquent. These differences typically result from a borrower making monthly payments that do not result in the loan becoming fully current. The number of payments that a borrower is delinquent is shown in the table below. Number of payments delinquent December 31, 2016 2015 2014 3 payments or less 4 - 11 payments 12 payments or more Total primary default inventory 18,419 36% 20,360 33% 23,253 29% 12,892 26% 15,092 24% 19,427 24% 18,971 38% 27,181 43% 37,221 47% 50,282 100% 62,633 100% 79,901 100% MGIC Investment Corporation 2016 Annual Report | 93 Notes The effect of all reinsurance agreements on premiums earned and losses incurred, which is reflected the consolidated statements of in operations, is as follows: (In thousands) 2016 2015 2014 Years ended December 31, Premiums earned: Direct Assumed Ceded Net premiums earned Losses incurred: Direct Assumed Ceded Net losses incurred $ 1,058,545 $ 997,892 $ 950,973 662 1,178 1,653 (133,981) (102,848) (108,255) $ 925,226 $ 896,222 $ 844,371 $ 273,207 $ 369,680 $ 524,051 1,138 1,552 2,012 (34,188) (27,685) (29,986) $ 240,157 $ 343,547 $ 496,077 Quota share reinsurance 2015 QSR Transaction We utilize a quota-share reinsurance agreement with a group of unaffiliated reinsurers, each with an insurer financial strength rating of A- or better by Standard and Poor's Rating Services, A.M. Best, or both, to manage our exposure to losses resulting from our mortgage guaranty policies and to provide reinsurance capital credit under the PMIERs. Our 2015 quota share reinsurance agreement("2015 QSR Transaction"), which became effective July 1, 2015 provides coverage on policies that were in the 2013 quota share reinsurance agreement ("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. 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 PMIERs for the risk ceded in any required calculation period. The 2015 QSR Transaction increased the amount of our IIF covered by reinsurance and will increase the amount of premiums and losses ceded. A higher level of losses ceded will reduce our profit commission. The structure of the 2015 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding 94 | MGIC Investment Corporation 2016 Annual Report 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%. 2013 QSR Transaction Effective July 1, 2015, we settled our 2013 QSR Transaction by commutation. The settlement included unearned premiums, loss reserves, and profit commission. The commutation resulted in an increase in net premiums written and earned of $69.4 million and $11.6 million, respectively, and a decrease in ceding commissions of $11.6 million in the third quarter of 2015. Receipt of our profit commission of $142.5 million, in addition to other premium and loss amounts, was also completed as part of the settlement. 2017 QSR Transaction We have agreed to terms on a quota-share reinsurance agreement for 2017 ("2017 QSR Transaction") with a group of unaffiliated reinsurers, each with an insurer financial strength rating of A- or better by Standard and Poor's, A.M. Best or both, to manage our exposure to losses resulting from our to provide mortgage guaranty policies and reinsurance capital credit under the PMIERs. The GSEs have approved the terms of our proposed 2017 QSR Transaction. The 2017 QSR Transaction is expected to be executed during the first quarter of 2017 with an effective date retroactive to January 1, 2017, and will provide coverage on new business written January 1, 2017 through December 29, 2017 that meets certain eligibility requirements. Under the agreed upon terms, the 2017 QSR Transaction will cede losses incurred and premiums on or after the effective date through December 31, 2028, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 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 PMIERs for the risk ceded in any required calculation period. The agreed upon structure of the 2017 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 2017 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%. Following is a summary of our quota share reinsurance agreements, excluding captive agreements, for 2016, 2015 and 2014. (In thousands) 2016 2015 2014 Years ended December 31, 2015 QSR Transaction (Effective July 1, 2015) Ceded premiums written, net of profit commission (1) Ceded premiums earned, net of profit commission (1) Ceded losses incurred Ceding commissions (2) Profit commission 2013 QSR Transaction Ceded premiums written, net of profit commission Ceded premiums earned, net of profit commission Ceded losses incurred Ceding commissions (2) Profit commission $ 125,460 $ 52,588 n/a 125,460 52,588 30,201 11,424 47,629 20,582 112,685 50,322 n/a n/a n/a n/a n/a $ (11,355) (3) $100,031 n/a n/a n/a n/a 35,999 (3) 88,528 6,060 15,163 10,235 (3) 37,833 62,525 (3) 89,133 (1) As of 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. (3) The year ended December 31, 2015 includes the non- recurring impact of commuting our 2013 QSR Transaction. The commutation had no impact on ceded losses incurred. Under the terms of 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 $31.8 Notes million as of December 31, 2016 and $10.9 million reinsurance as of December 31, 2015. The 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 CFPB in 2013 and with the Minnesota Department of Commerce in 2015, MGIC has agreed to 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 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. The reinsurance recoverable on loss reserves related to captive agreements was $19 million at December 31, 2016 which was supported by $91 million of trust assets, while at 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. 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. MGIC Investment Corporation 2016 Annual Report | 95 Notes Note 10. Other Comprehensive (Loss) Income income and related The pretax components of our other comprehensive (loss) income tax benefit (expense) for the years ended December 31, 2016, 2015 and 2014 are included in the table below: 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 years ended December 31, 2016, 2015 and 2014 are included in the table below: (In thousands) 2016 2015 2014 (In thousands) 2016 2015 2014 Net unrealized investment (losses) gains arising during the year Income tax benefit (expense) Valuation allowance (1) $ (5,425) $(33,718) $ 91,782 1,776 11,738 (32,017) — 62,383 31,374 Net of taxes (3,649) 40,403 91,139 Net changes in benefit plan assets and obligations Income tax benefit Valuation allowance (1) (14,799) (12,818) (52,112) 5,179 4,487 18,239 — (7,383) (18,239) Net of taxes (9,620) (15,714) (52,112) Reclassification adjustment for net realized gains (losses) included in net income (1) Income tax (expense) benefit Valuation allowance (2) $ 6,207 $11,693 $ (6,816) (2,050) (4,076) 2,402 — 3,635 (2,502) Net of taxes 4,157 11,252 (6,916) Reclassification adjustment related to benefit plan assets and obligations (3) Income tax expense Valuation allowance (2) Net of taxes 1,480 2,184 6,930 (518) (764) (2,425) — 962 574 1,994 2,425 6,930 Net changes in unrealized foreign currency translation adjustment Income tax benefit Valuation allowance (1) (1,463) (5,699) (4,067) Reclassification adjustment related to foreign currency (4) 512 — 2,000 1,425 (529) — Income tax expense Net of taxes 1,467 (513) 954 — — — — — — Net of taxes (951) (4,228) (2,642) Total other comprehensive (loss) income Total income tax benefit, net of valuation allowance Total other comprehensive (loss) income, net of tax (21,687) (52,235) 35,603 7,467 72,696 782 $(14,220) $ 20,461 $ 36,385 (1) See Note 12 – “Income Taxes” for a discussion of the valuation allowance recorded against deferred tax assets. Total reclassifications 9,154 13,877 114 Total income tax expense, net of valuation allowance Total reclassifications, net of tax (3,081) (631) (100) $ 6,073 $13,246 $ 14 (1) Increases (decreases) Net realized investment gains on the consolidated statements of operations. (2) See Note 12 – “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. (4) Increases (decreases) Other revenue on the consolidated statements of operations. 96 | MGIC Investment Corporation 2016 Annual Report Notes A rollforward of accumulated other comprehensive loss ("AOCL") for the years ended December 31, 2016, 2015, and 2014, including amounts reclassified from accumulated other comprehensive loss, are included in the table below. Net unrealized gains and losses on available- for-sale securities Net benefit plan assets and obligations recognized in shareholde rs' equity Net unrealized foreign currency translation Total AOCL (In thousands) Balance, December 31, 2013, net of tax $(148,690) $ 23,174 $ 7,790 $(117,726) Other comprehensive income (loss) before reclassifications Less: Amounts reclassified from AOCL 84,223 (45,182) (2,642) 36,399 (6,916) 6,930 — 14 Balance, December 31, 2014, net of tax (57,551) (28,938) 5,148 (81,341) Other comprehensive income (loss) before reclassifications Less: Amounts reclassified from AOCL 51,655 (13,720) (4,228) 33,707 11,252 1,994 — 13,246 Balance, December 31, 2015, net of tax (17,148) (44,652) 920 (60,880) Other comprehensive income (loss) before reclassifications Less: Amounts reclassified from AOCL 508 (8,658) 3 (8,147) 4,157 962 954 6,073 Balance, December 31, 2016, net of tax $ (20,797) $ (54,272) $ (31) (75,100) MGIC Investment Corporation 2016 Annual Report | 97 Notes Note 11. Benefit Plans We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. We also offer both medical and dental benefits for retired domestic employees and their eligible spouses under a postretirement benefit plan. The following tables provide the components of aggregate annual net periodic benefit cost for each of the years ended December 31, 2016, 2015, and 2014 and changes in the benefit obligation and the funded status of the pension, supplemental executive retirement and other postretirement benefit plans as recognized in the consolidated balance sheets as of December 31, 2016 and 2015. Components of Net Periodic Benefit Cost Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits (In thousands) 12/31/2016 12/31/2015 12/31/2014 12/31/2016 12/31/2015 12/31/2014 1. Company Service Cost $ 9,130 $ 10,256 $ 8,565 $ 2. Interest Cost 15,906 15,847 15,987 $ 751 704 $ 833 697 659 653 3. Expected Return on Assets (19,508) (21,109) (21,030) (4,886) (4,991) (4,648) 4. Other Adjustments Subtotal 5. Amortization of : a. Net Transition Obligation/(Asset) b. Net Prior Service Cost/(Credit) c. Net Losses/(Gains) Total Amortization 6. Net Periodic Benefit Cost 7. Cost of settlements or curtailments — 5,528 — (687) 5,856 5,169 10,697 1,277 — 4,994 — (845) 5,485 4,640 9,634 3,172 — 3,522 — (930) 1,083 153 3,675 302 — — — (3,431) (3,461) (3,336) — (6,649) — (6,649) — (6,649) (175) (6,824) — (6,649) (435) (7,084) (10,080) (10,285) (10,420) — — — 8. Total Expense for Year $ 11,974 $ 12,806 $ 3,977 $ (10,080) $ (10,285) $ (10,420) Development of Funded Status (In thousands) Actuarial Value of Benefit Obligations 1. Measurement Date Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 12/31/2016 12/31/2015 12/31/2016 12/31/2015 2. Accumulated Benefit Obligation $ 360,423 $ 338,450 $ 17,378 $ 16,423 Funded Status/Asset (Liability) on the Consolidated Balance Sheet 1. Projected Benefit Obligation 2. Plan Assets at Fair Value 3. Funded Status - Overfunded/Asset 4. Funded Status - Underfunded/Liability Accumulated Other Comprehensive Income (Loss) (In thousands) 1. Net Actuarial (Gain)/Loss 2. Net Prior Service Cost/(Credit) 3. Net Transition Obligation/(Asset) 4. Total at Year End $ (369,808) $ (349,483) $ (17,378) $ (16,423) 360,900 350,107 70,408 N/A $ 624 $ 53,030 $ (8,908) N/A N/A 65,568 49,145 N/A Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 $ 103,861 $ 95,636 $ (6,088) $ (5,311) (2,286) (2,989) (11,991) (18,640) — — — — $ 101,575 $ 92,647 $ (18,079) $ (23,951) 98 | MGIC Investment Corporation 2016 Annual Report Notes The amortization of gains and losses resulting from actual experience different from assumed experience or changes in assumptions including discount rates is included as a component of Net Periodic Benefit Cost/ (Income) for the year. The gain or loss in excess of a 10% corridor is amortized by the average remaining service period of participating employees expected to receive benefits under the plan. The changes in the projected benefit obligation are as follows: Change in Projected Benefit/Accumulated Benefit Obligation (In thousands) Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 1. Benefit Obligation at Beginning of Year $ 349,483 $ 379,324 $ 16,423 $ 18,225 2. Company Service Cost 3. Interest Cost 4. Plan Participants' Contributions 5. Net Actuarial (Gain)/Loss due to Assumption Changes 6. Net Actuarial (Gain)/Loss due to Plan Experience 7. Benefit Payments from Fund (1) 8. Benefit Payments Directly by Company 9. Plan Amendments 10. Other Adjustment 9,130 15,906 — 14,450 5,428 (21,831) (2,669) 16 (105) 10,256 15,847 — (24,118) 7,155 (32,646) (7,661) 19 1,307 751 704 408 497 357 (1,678) — — (84) 833 697 361 (2,083) (397) (1,147) — — (66) 11. Benefit Obligation at End of Year $ 369,808 $ 349,483 $ 17,378 $ 16,423 (1) Includes lump sum payments of $11.2 million and $22.4 million in 2016 and 2015, respectively, from our pension plan to eligible participants, which were former employees with vested benefits. The increase in our pension and supplemental executive retirement plans obligation in 2016 compare to 2015 was primarily due to a decrease in the discount rate used to calculate the obligation and a lower amount of benefits paid from the fund. The increase in our other postretirement plan obligation was primarily due a decrease in the discount rate used to calculate the obligation. The changes in the fair value of the net assets available for plan benefits are as follows: Change in Plan Assets (In thousands) Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 1. Fair Value of Plan Assets at Beginning of Year $ 350,107 $ 378,701 $ 65,568 $ 66,940 2. Company Contributions 3. Plan Participants' Contributions 4. Benefit Payments from Fund 5. Benefit Payments paid directly by Company 6. Actual Return on Assets 7. Other Adjustment 11,369 17,311 — — 408 — 361 — (21,831) (2,669) 23,924 — (32,646) (1,678) (1,147) (7,661) (5,094) (504) — 6,518 (408) — (225) (361) 8. Fair Value of Plan Assets at End of Year $ 360,900 $ 350,107 $ 70,408 $ 65,568 MGIC Investment Corporation 2016 Annual Report | 99 Notes Change in Accumulated Other Comprehensive Income (Loss) ("AOCI") (In thousands) 1. AOCI in Prior Year 2. Increase/(Decrease) in AOCI a. Recognized during year - Prior Service (Cost)/Credit b. Recognized during year - Net Actuarial (Losses)/Gains c. Occurring during year - Prior Service Cost d. Occurring during year - Net Actuarial Losses/(Gains) e. Occurring during year - Net Settlement Losses/(Gains) f. Other adjustments 3. AOCI in Current Year Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 $ 92,647 $ 89,390 $ (23,951) $ (33,511) 687 (5,856) 16 15,358 (1,277) — 845 (5,485) 19 11,050 (3,172) — 6,649 — — (777) — — 6,649 175 — 2,736 — — $ 101,575 $ 92,647 $ (18,079) $ (23,951) Amortizations Expected to be Recognized During Next Fiscal Year Ending (In thousands) Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2017 12/31/2017 1. Amortization of Net Transition Obligation/(Asset) $ — $ 2. Amortization of Prior Service Cost/(Credit) 3. Amortization of Net Losses/(Gains) (428) 6,141 — (6,649) — The projected benefit obligations, net periodic benefit costs and accumulated postretirement benefit obligation for the plans were determined using the following weighted average assumptions. Actuarial Assumptions Weighted-Average Assumptions Used to Determine Benefit Obligations at year end 1. Discount Rate 2. Rate of Compensation Increase Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Year 1. Discount Rate 2. Expected Long-term Return on Plan Assets 3. Rate of Compensation Increase Assumed Health Care Cost Trend Rates at year end 1. Health Care Cost Trend Rate Assumed for Next Year 2. Rate to Which the Cost Trend Rate is Assumed to Decline (Ultimate Trend Rate) 3. Year That the Rate Reaches the Ultimate Trend Rate Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 4.30% 3.00% 4.65% 3.00% 3.95% N/A 4.30% N/A 4.65% 5.75% 3.00% N/A N/A N/A 4.25% 5.75% 3.00% N/A N/A N/A 4.30% 7.50% N/A 4.00% 7.50% N/A 6.50% 7.00% 5.00% 2020 5.00% 2020 100 | MGIC Investment Corporation 2016 Annual Report Notes data including market 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 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. In addition, on a quarterly basis, we perform quality controls over values received from the pricing source (the “Trustee”) which include comparing values to other independent pricing sources. In addition, we review annually the Trustee’ s auditor’ s report on internal controls in order to determine their controls around valuing securities are operating effectively. We have not made any adjustments to the prices obtained from the independent sources. that The following table sets forth by level, within the fair value hierarchy, the pension plan assets at fair value as of December 31, 2016 and 2015. There were no securities that utilized Level 3 inputs. Pension Plan Assets at Fair Value as of December 31, 2016 (In thousands) Level 1 Level 2 Total Domestic Mutual Funds Corporate Bonds U.S. Government Securities Municipal Bonds Foreign Bonds ETFs Pooled Equity Accounts $ 11,805 $ — $ 11,805 — 178,412 178,412 6,761 — — 5,694 354 63,492 27,917 — 7,115 63,492 27,917 5,694 — 66,465 66,465 Total Assets at fair value $ 24,260 $ 336,640 $ 360,900 In selecting a discount rate, we performed a hypothetical cash flow bond matching exercise, matching our expected pension plan and postretirement medical plan cash flows, respectively, against a selected portfolio of high quality corporate bonds. The modeling was performed using a bond portfolio of noncallable bonds with at least $50 million outstanding. The average yield of these hypothetical bond portfolios was used as the benchmark for determining the discount rate. In selecting the expected long-term rate of return on assets, we considered the average rate of earnings expected on the classes of funds invested or to be invested to provide for the benefits of these plans. This included considering the trusts' targeted asset allocation for the year and the expected returns likely to be earned over the next 20 years. The year-end asset allocations of the plans are as follows: Plan Assets 1. Equity Securities 2. Debt Securities 3. Total Pension Plan Other Postretirement Benefits 12/31/2016 12/31/2015 12/31/2016 12/31/2015 23% 20% 100% 100% 77% 100% 80% 100% —% 100% —% 100% In accordance with fair value guidance, we applied the following fair value hierarchy in order to measure fair value of our benefit plan assets: Level 1 – Quoted prices for identical instruments in active markets that we can access. Financial assets utilizing Level 1 inputs include equity securities, mutual funds, money market funds, certain U.S. Treasury securities and exchange traded funds ("ETFs"). 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 instrument. The observable inputs are used in valuation models to calculate the fair value of the instruments. Financial assets utilizing Level 2 inputs include certain municipal, corporate and foreign bonds, obligations of U.S. government corporations and agencies, and pooled equity accounts. To determine the fair value of securities 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 MGIC Investment Corporation 2016 Annual Report | 101 Notes Pension Plan Assets at Fair Value as of December 31, 2015 (In thousands) Level 1 Level 2 Total following table sets the other The postretirement benefits plan assets at fair value as of December 31, 2016 and 2015. All are Level 1 assets. forth Domestic Mutual Funds Corporate Bonds U.S. Government Securities Municipal Bonds Foreign Bonds ETFs Pooled Equity Accounts Total Assets at fair value $ 1,442 $ — $ 1,442 — 188,332 188,332 Other Postretirement Benefits Plan 3,133 — — 5,676 497 61,206 25,251 — 3,630 61,206 25,251 5,676 — 64,570 64,570 Assets at Fair Value as of December 31, 2016 (In thousands) Level 1 Total Domestic Mutual Funds $ 54,426 $ 54,426 International Mutual Funds 15,982 15,982 Total Assets at fair value $ 70,408 $ 70,408 $ 10,251 $ 339,856 $ 350,107 Other Postretirement Benefits Plan The pension plan has implemented a strategy to reduce risk through the use of a targeted funded ratio. The liability driven component is key to the asset allocation. The liability driven component seeks to align the duration of the fixed income asset allocation with the expected duration of the plan liabilities or is benefit payments. Overall asset allocation dynamic and specifies target allocation weights and ranges based on the funded status. An improvement in funded status results in the de- risking of the portfolio, allocating more funds to fixed income and less to equity. A decline in funded status would result in a higher allocation to equity. The maximum equity allocation is 40%. The equity investments utilize combinations of mutual funds, ETFs, and pooled equity account structures focused on the following strategies: Strategy Objective Investment types Return seeking growth Return seeking bridge Funded ratio improvement over the long term Downside protection in the event of a declining equity market Global quality growth Global low volatility Enduring asset Durable company agency, government The fixed income objective is to preserve capital and to provide monthly cash flows for the payment of plan liabilities. Fixed income investments can include government, corporate, mortgage-backed, asset-backed, and municipal securities, and other classes of bonds. The duration of the fixed income portfolio has an objective of being within one year of the duration of the accumulated benefit obligation. The fixed income investments have an objective of a weighted average credit of A3/ A-/A- by Moody’ s, S&P, and Fitch, respectively. Assets at Fair Value as of December 31, 2015 (In thousands) Level 1 Total Domestic Mutual Funds $ 49,887 $ 49,887 International Mutual Funds 15,681 15,681 Total Assets at fair value $ 65,568 $ 65,568 Our postretirement plan portfolio is designed to achieve the following objectives over each market cycle and for at least 5 years: • Total return should exceed growth Consumer Price Index by 5.75% annually in the • Achieve competitive investment results The primary focus in developing asset allocation ranges for the portfolio is the assessment of the portfolio's investment objectives and the level of risk that is acceptable to obtain those objectives. To achieve these goals the minimum and maximum allocation ranges for fixed income securities and equity securities are: Equities (long only) Real estate Commodities Fixed income/Cash Minimum Maximum 70% 0% 0% 0% 100% 15% 10% 10% Given the long term nature of this portfolio and the lack of any immediate need for significant cash flow, it is anticipated that the equity investments will consist of growth stocks and will typically be at the higher end of the allocation ranges above. Investment in international mutual funds is limited to a maximum of 30% of the equity range. The allocation as of December 31, 2016 included 3% that was primarily invested in equity securities of emerging market countries and another 20% was invested in securities of companies primarily based in Europe and the Pacific Basin. 102 | MGIC Investment Corporation 2016 Annual Report The following tables show the current and estimated future contributions and benefit payments. Company Contributions Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits (In thousands) 12/31/2016 12/31/2016 Company Contributions for the Year Ending: 1. Current 2. Current + 1 $ 11,369 $ 9,500 — — Notes Profit sharing and 401(k) We have a profit sharing and 401(k) savings plan for employees. At the discretion of the Board of Directors, we may make a contribution of up to 5% of each participant's eligible compensation. We provide for a matching 401(k) savings contribution employees on their before-tax contributions at a rate of 80% of the first $1,000 contributed and 40% of the next $2,000 contributed. For employees hired after January 1, 2014, the match is 100% up to 4% contributed. We recognized expenses related to these plans of $5.9 million, $5.1 million and $5.0 million in 2016, 2015 and 2014, respectively. Benefit Payments (Total) Note 12. Income Taxes Pension and Supplemental Executive Retirement Plans Other Postretirement Benefits Net deferred tax assets and December 31, 2016 and 2015 are as follows: liabilities as of (In thousands) 2016 2015 (In thousands) 12/31/2016 12/31/2016 Total deferred tax assets $ 636,449 $ 791,286 Actual Benefit Payments for the Year Ending: 1. Current $ 24,500 $ 1,355 Expected Benefit Payments for the Year Ending: 2. Current + 1 3. Current + 2 4. Current + 3 5. Current + 4 6. Current + 5 21,831 23,439 26,927 27,199 27,151 7. Current + 6 - 10 146,471 847 978 1,068 1,257 1,410 8,574 Health care sensitivities For measurement purposes, a 7.0% health care trend rate was used for benefits for retirees before they reach age 65 years for 2016. In 2017, the rate is assumed to be 6.5%, decreasing to 5.0% by 2020 and remaining at this level beyond. Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefits plan. A 1 percentage point change in the health care trend rate assumption would have following effects on other postretirement benefits: the 1-Percentage Point Increase 1-Percentage Point Decrease $ 237 $ (205) (In thousands) Effect on total service and interest cost components Effect on postretirement benefit obligation Total deferred tax liabilities (28,794) (29,206) Net deferred tax asset $ 607,655 $ 762,080 The components of the net deferred tax asset as of December 31, 2016 and 2015 are as follows: (In thousands) 2016 2015 Unearned premium reserves $ 40,153 $ 33,262 Benefit plans Federal net operating loss Loss reserves Unrealized depreciation in investments Mortgage investments Deferred compensation Other, net (12,350) (14,283) 520,812 10,883 680,975 15,536 11,211 17,751 12,517 6,678 8,904 17,386 12,927 7,373 Net deferred tax asset 607,655 762,080 We review the need to maintain 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 losses, the carryback or carryforward of any 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 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. 2,382 (2,102) In the third quarter of 2015, we concluded that it was more likely than not that our deferred tax assets MGIC Investment Corporation 2016 Annual Report | 103 Notes would be fully realizable and that the valuation allowance was no longer necessary and we reversed the valuation allowance. For the year ended December 31, 2015, we reversed $161.1 million of our valuation allowance based on income from 2015. The portion of the valuation allowance reversed related to deferred tax assets that are expected to be realized in future years, totaling $747.5 million, is treated as a is recognized as a discrete period component of the tax provision in continuing operations in the period of release. Furthermore, in determining the discrete period impact from the reversal, we period disproportionate tax effects that had arisen in other comprehensive income because of the valuation allowance. This reduced the amount of tax benefit included in net income and resulted in an allocation of tax benefit of $60.8 million to components of other comprehensive income. item and removed prior the The following table provides a rollforward of our deferred tax asset valuation allowance for the year ended December 31, 2015. (In millions) Balance at December 31, 2014 For the year ended December 31, 2015 $ 902.3 Reduction in tax provision in current year (161.1) Amounts recorded in other comprehensive income in the current year Change in valuation allowance for deferred tax assets in the current year Reduction in tax provision for amounts to be realized in future years Amounts recorded in other comprehensive income to be realized in future years Change in valuation allowance for deferred tax assets realizable in future years 6.3 (154.8) (686.7) (60.8) The total valuation allowance as of December 31, 2014 was $902.3 million. The remaining valuation allowance was reversed in the third quarter of 2015. The change in the valuation allowance that was included in other comprehensive income was a decrease of $54.5 million, and $13.1 million for the years ended December 31, 2015 and 2014, respectively. Giving full effect to the carryback of net operating losses for federal income tax purposes, we have approximately $1,489 million of net operating loss ("NOL") carryforwards on a regular tax basis and $589 million of net operating loss carryforwards for computing the alternative minimum tax as of December 31, 2016. Any unutilized carryforwards are scheduled to expire at the end of tax years 2030 through 2033. The following summarizes the components of the provision for (benefit from) income taxes: (In thousands) 2016 2015 2014 Current Federal $ 9,470 $ 8,067 $ 2,391 Deferred Federal 160,657 (686,652) Other 2,070 (5,728) 1 382 Provision for (benefit from) income taxes $ 172,197 $(684,313) $ 2,774 We paid $4.5 million, $5.4 million, and $1.3 million in federal in 2016, 2015 and 2014, respectively. income tax The reconciliation of the federal statutory income tax rate to the effective tax provision (benefit) rate is as follows: 2016 2015 2014 Federal statutory income tax rate 35.0 % 35.0 % 35.0 % (747.5) Valuation allowance — % (173.8)% (34.9)% Balance at December 31, 2015 $ — The effect of the change in valuation allowance on the provision for (benefit from) income taxes was as follows: (In thousands) 2016 2015 2014 Provision for income taxes before valuation allowance Change in valuation allowance Reversal of the valuation allowance Provision for (benefit from) income taxes $ 172,197 $ 163,497 $ 91,607 — — (161,158) (88,833) (686,652) — $ 172,197 $(684,313) $ 2,774 Tax exempt municipal bond interest Other, net Effective tax provision (benefit) rate (1.9)% 0.4 % (0.8)% (0.7)% (0.4)% 1.4 % 33.5 % (140.3)% 1.1 % 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. 104 | MGIC Investment Corporation 2016 Annual Report 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 December 31, 2016, there would also be interest related to these matters of approximately $200.6 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. 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 December 31, 2016, those state taxes and interest would approximate $50.7 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of December 31, 2016 is $108.2 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 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 filed an answer to our petition which continued 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 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. In January 2017, the parties informed the Tax Court that they had reached a basis for settlement of the major issues in the case. Any agreed settlement terms will ultimately be subject to review by the Joint Committee on Taxation ("JCT") before a settlement can be completed and there is no assurance that a settlement will be completed. Based on information that we currently have regarding the status of our ongoing dispute, we expect to record a provision for additional taxes and interest of $15 to $25 million in the first quarter of 2017. Notes to make Should a settlement not be completed, ongoing litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We would need further 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 14 - "Statutory Information." In October 2014, we received a Revenue Agent’ s Report from the IRS related to the examination of our federal income tax returns for the years 2011 and 2012. The result of this examination had no material effect on the financial statements. Under current guidance, when evaluating a tax position for recognition and measurement, an entity shall presume that the tax position will be examined by the relevant taxing authority that has full information. The relevant knowledge of all interpretation adopts a benefit recognition model with a two-step approach, a more-likely-than-not threshold for recognition and derecognition, and a measurement attribute that is the greatest amount of benefit that is cumulatively greater than 50% likely of being realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: (In thousands) 2016 2015 2014 Balance at beginning of year Additions based on tax positions related to the current year Additions for tax positions of prior years Reductions for tax positions of prior years Settlements $107,120 $ 106,230 $ 105,366 — — — 1,125 890 864 — — — — — — Balance at end of year $108,245 $ 107,120 $ 106,230 The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue, which would affect our effective tax rate, is $94.6 million. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. During 2016, we recognized $1.1 million in interest. As of December 31, 2016 and 2015, we had $28.9 million and $27.8 million of accrued interest related to uncertain tax positions, respectively. The statute of limitations related to the consolidated federal income tax return is closed for all years prior to 2000. It is MGIC Investment Corporation 2016 Annual Report | 105 Notes reasonably possible that our 2000-2007 federal tax case will be resolved, other than through litigation. If it is resolved under the basis of settlement as disclosed above, our total unrecognized tax benefits would be reduced by $108.2 million during 2017. After taking into account prior payments and the effect of available net operating loss carrybacks, any net cash outflows would approximate $52 million. Note 13. Shareholders' Equity As described in Note 7 - "Debt", we entered into privately negotiated agreements to repurchase, for cash, together with, in certain cases, shares of our common stock, $292.4 million aggregate principal amount of our outstanding 2% Notes. We issued approximately 18.3 million shares of our common stock as partial consideration under these agreements. As of December 31, 2016 we have repurchased all of the shares issued as partial consideration for our 2% Notes repurchases. The the share weighted average price paid repurchases was includes commissions, and the aggregate purchase amount was $147.1 million. $8.03, which for As described in Note 7 - "Debt" the purchase of a portion of our 9% Debentures by MGIC, and corresponding elimination of the purchased 9% Debentures in consolidation, resulted in a reduction to our consolidated shareholders' equity of approximately $6.3 million as of December 31, 2016. This reduction represents the allocated portion of the consideration paid to reacquire the equity component of the 9% Debentures, net of tax. The reduction was recognized in paid-in capital and was less than the amount ascribed to paid-in capital at original issuance of the 9% Debentures. Our Amended and Restated Rights Agreement dated July 23, 2015 seeks to diminish the risk that our ability to use our NOLs to reduce potential future federal income tax obligations may become substantially limited and to deter certain abusive takeover practices. The benefit of the NOLs would be substantially limited, and the timing of the usage of the NOLs could be substantially delayed, if we were to experience an “ownership change” as defined by Section 382 of the Internal Revenue Code. Under the Agreement each outstanding share of our Common Stock is accompanied by one Right. The Distribution Date occurs on the earlier of ten days after a public announcement that a person has become an Acquiring Person, or ten business days after a person announces or begins a tender offer in which consummation of such offer would result in a person becoming an Acquiring Person. An Acquiring 106 | MGIC Investment Corporation 2016 Annual Report Person is any person that becomes, by itself or together with its affiliates and associates, a beneficial owner of 5% or more of the shares of our Common Stock then outstanding, but excludes, among others, certain exempt and grandfathered persons as defined in the Agreement. The Rights are not exercisable until the Distribution Date. Each Right will initially entitle shareholders to buy one-tenth of one share of our Common Stock at a Purchase Price of $45 per full share (equivalent to $4.50 for each one- tenth share), subject to adjustment. Each exercisable Right (subject to certain limitations) will entitle its holder to purchase, at the Rights’ then-current Purchase Price, a number of our shares of Common Stock (or if after the Shares Acquisition Date, we are acquired in a business combination, common shares of the acquiror) having a market value at the time equal to twice the Purchase Price. The Rights will expire on August 1, 2018, or earlier as described in the Agreement. The Rights are redeemable at a price of $0.001 per Right at any time prior to the time a person becomes an Acquiring Person. Other than certain amendments, the Board of Directors may amend the Rights in any respect without the consent of the holders of the Rights. Note 14. Statutory Information Statutory Accounting Principles The statutory financial statements of our insurance companies are presented on the basis of accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (the "OCI"), which has adopted the National Association of Insurance Commissioners ("NAIC") statutory accounting practices as the basis of its In statutory accounting practices converting typical adjustments include deferral of policy acquisition costs, the inclusion of net unrealized holding gains or losses in shareholders' equity relating to fixed maturities and the inclusion of statutory non- admitted assets. from statutory to GAAP, ("SSAP"). In addition to the typical adjustments from statutory to GAAP, mortgage insurance companies are required to maintain contingency loss reserves equal to 50% of premiums earned under SSAP and practices prescribed by the OCI, Such amounts cannot be withdrawn for a period of ten years except as permitted by insurance regulations. With regulatory approval a mortgage guaranty insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net premiums earned in a calendar year. For the year ended 2016, MGIC's losses incurred were 26% of net premiums earned. Changes in contingency loss the statutory statement of reserves impact operations. Contingency loss reserves are not reflected as liabilities under GAAP and changes in contingency loss reserves do not impact the GAAP statements of operations. A premium deficiency reserve that may be recorded on a GAAP basis when the present value of expected future losses and expenses exceeds the present value of expected future premiums and already established loss reserves, may not be recorded on a statutory basis if the present value of expected future premiums and already established loss reserves and statutory contingency reserves, exceeds the present value of expected future losses and expenses. On a GAAP basis, when calculating a premium deficiency reserve policies are grouped based on how they are acquired, serviced and measured. On a statutory basis, a premium deficiency reserve is calculated on all policies in force. The statutory net income (loss), policyholders' surplus and contingency reserve liability of the insurance subsidiaries of our holding company are show in the following table. The statutory net loss in 2015 was driven by the dissolution of an MGIC non- insurance subsidiary. The surplus amounts included in the following table are the combined policyholders' surplus of our insurance operations as utilized in our risk-to-capital calculations. As of and for the Years Ended December 31, (In thousands) 2016 2015 2014 Statutory net income (loss) Statutory policyholders' surplus Contingency reserve $ 106,326 $ (72,767) (1) $ 13,203 1,506,475 1,608,214 1,585,164 (1) 1,360,088 826,706 318,247 (1) The dissolution of an MGIC non-insurance subsidiary in 2015 had no impact on statutory surplus as the equity value of the investment was fully reflected in surplus as an unrealized loss prior to 2015. The surplus contributions made to MGIC and dividends paid by MGIC and distributions from other insurance subsidiaries to us, are shown in the table below. (In thousands) 2016 2015 2014 Years Ended December 31, Additions to the surplus of MGIC from parent company funds Dividends paid by MGIC to the parent company Distributions from other insurance subsidiaries to the parent company $ 36,025 $ 64,000 — — $ 52,001 38,500 — — — Notes the Statutory Capital Requirements The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the RIF (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “State Capital Requirements” and, together with the GSE Financial Requirements, “Financial Requirements.” While they vary among jurisdictions, the most common State Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk- to-capital ratio will increase if (i) the percentage decrease in capital exceeds the percentage decrease in insured risk, or (ii) the percentage increase in capital is less than the percentage increase in insured risk. Wisconsin does not regulate capital by using a instead requires a risk-to-capital measure but ("MPP"). The minimum policyholder position “policyholder position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums. At December 31, 2016, MGIC’ s risk-to-capital ratio was 10.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements and its policyholder position was $1.6 billion above the required MPP of $1.1 billion. In calculating our risk- to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may reinsurance agreement, without terminate penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read the rest of these financial statement footnotes for information about matters that could negatively affect such compliance. the At December 31, 2016, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 12.0 to 1. Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC to continue to utilize reinsurance arrangements with its capital contributions to the affiliate could be needed. reinsurance additional affiliate, The NAIC previously announced that it plans to revise the minimum capital and surplus requirements for mortgage insurers that are provided for in its MGIC Investment Corporation 2016 Annual Report | 107 Notes Mortgage Guaranty Insurance Model Act. In May 2016, a working group of state regulators released an exposure draft of a risk-based capital framework to establish capital requirements for mortgage insurers, although no date has been established by which the the capital NAIC must propose revisions requirements. We continue to evaluate the impact of the framework contained in the exposure draft, including the potential impact of certain items that have not yet been completely addressed by the framework which include: the treatment of ceded risk, minimum capital floors, and action level triggers. Currently we believe that the PMIERs contain the more restrictive capital requirements in most circumstances. to While MGIC currently meets the State Capital Requirements of Wisconsin and all other jurisdictions, it could be prevented from writing new business in the future in all jurisdictions if it fails to meet the State Capital Requirements of Wisconsin, or it could be prevented from writing new business in a particular jurisdiction if it fails to meet the State Capital Requirements of that jurisdiction and in each case MGIC does not obtain a waiver of such requirements. It is possible that regulatory action by one or more jurisdictions, including those that do not have specific State Capital Requirements, may prevent MGIC from continuing to write new insurance in such jurisdictions. If we are unable to write business in all jurisdictions, lenders may be unwilling to procure insurance from us anywhere. In addition, a lender’ s assessment of the future ability of our insurance operations to meet the State Capital Requirements or its willingness to procure insurance from us. A possible future failure by MGIC to meet the State Capital Requirements or the PMIERs will not necessarily mean that MGIC lacks sufficient resources to pay claims on its insurance liabilities. While we believe MGIC has sufficient claims paying resources to meet its claim obligations on its IIF on a timely basis, you should read the rest of these financial statement footnotes for information about matters that could negatively affect MGIC’ s claims paying resources. the PMIERs may affect Dividend restrictions In 2016, MGIC paid a total of $64 million in dividends to our holding company, its first dividends since 2008, and we expect MGIC to continue to pay quarterly dividends. During 2016, distributions of $52 million were paid to our holding company from other insurance subsidiaries. These distributions were completed in conjunction with the transfer of risk and the final dissolution of those insurance entities during 2016. Our subsequently contributed the majority of the funds to MGIC in relation to the transfer of risk. During 2015, company holding 108 | MGIC Investment Corporation 2016 Annual Report distributions of $38.5 million were paid to our holding company from other insurance subsidiaries. MGIC is subject to statutory regulations as to payment of dividends. The maximum amount of dividends that MGIC may pay in any twelve-month period without regulatory approval by the OCI is the lesser of adjusted statutory net income or 10% of statutory policyholders' surplus as of the preceding calendar year end. Adjusted statutory net income is defined for this purpose to be the greater of statutory net income, net of realized investment gains, for the calendar year preceding the date of the dividend or statutory net income, net of realized investment gains, for the three calendar years preceding the date of the dividend less dividends paid within the first two of the preceding three calendar years. The OCI recognizes only statutory accounting practices prescribed or permitted by the State of Wisconsin for determining and reporting the financial condition and results of operations of an insurance company. The OCI has adopted certain prescribed accounting practices that differ from those found in other states. Specifically, Wisconsin domiciled companies record changes in the contingency reserves through the income statement as a change in underwriting deduction. As a result, in periods in which MGIC is increasing contingency reserves, statutory net income is lowered. For the year ended December 31, 2016, MGIC’ s statutory net income was reduced by $490 million to account for the in contingency reserves. increase Note 15. Share-based Compensation Plans We have certain share-based compensation plans. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period which generally corresponds to the vesting period. The fair value of awards classified as liabilities is remeasured at each reporting period until the award is settled. Awards under our plans generally vest over periods ranging from one to three years. We have an omnibus incentive plan that was adopted on April 23, 2015. When the 2015 plan was adopted, no further awards could be made under our previous 2011 plan. The purpose of the 2015 plan is to motivate and incent performance by, and to retain the services of, key employees and non-employee directors through receipt of equity-based and other incentive awards under the plan. The maximum number of shares of stock that can be awarded under the 2015 plan is 10.0 million. Awards issued under the plan that are subsequently forfeited will not count against the limit on the maximum number of shares that may be issued under the plan. The 2015 plan provides for the award of stock options, stock appreciation rights, restricted stock and restricted stock units, as well as cash incentive awards. No awards may be granted after April 23, 2025 under the 2015 plan. The vesting provisions of options, restricted stock and restricted stock units are determined at the time of grant. Shares issued under the 2015 plan will be newly issued shares. The compensation cost that has been charged against income for share-based plans was $11.4 million, $11.9 million, and $9.2 million for the years ended December 31, 2016, 2015 and 2014, tax benefit respectively. The recognized for share-based plans was $4.0 million and $4.2 million for the years ended December 31, 2016 and 2015, respectively. The related income tax benefit, before valuation allowance, recognized for share-based plans was, and $3.2 million for the year ended December 31, 2014. income related Notes vested shares. A portion of the unrecognized costs associated with the performance shares may or may not be recognized in future periods, depending upon whether or not the performance and service conditions are met. The cost associated with the time vested shares is expected to be recognized over a weighted-average period of 1.3 years. At December 31, 2016, 8.3 million shares were available for future grant under the 2015 omnibus incentive plan. Note 16. Leases We lease certain office space as well as data processing equipment and autos under operating leases that expire during the next five years. Generally, rental payments are fixed. Total rental expense under operating leases was $2.1 million in 2016, $2.2 million in 2015, and $2.8 million in 2014. A summary of restricted stock or restricted stock unit (collectively called “restricted stock”) activity during 2016 is as follows: At December 31, 2016, minimum future operating lease payments are as follows (in thousands): Weighted Average Grant Date Fair Market Value Shares Restricted stock outstanding at December 31, 2015 $ Granted Vested Forfeited 7.97 5.66 7.00 4.24 3,319,467 1,689,300 (1,707,711) (154,384) Restricted stock outstanding at December 31, 2016 $ 7.44 3,146,672 At December 31, 2016, the 3.1 million shares of restricted stock outstanding consisted of 2.3 million shares that are subject to performance conditions (“performance shares”) and 0.8 million shares that are subject only to service conditions (“time vested shares”). The weighted-average grant date fair value of restricted stock granted during 2015 and 2014 was $9.03 and $8.43, respectively. The fair value of restricted stock granted is the closing price of the common stock on the New York Stock Exchange on the date of grant. The total fair value of restricted stock vested during 2016, 2015 and 2014 was $12.2 million, $17.2 million, and $12.1 million, respectively. As of December 31, 2016, there was $11.7 million of total unrecognized compensation cost related to non- vested share-based compensation agreements granted under the plans. Of this total, $8.9 million of unrecognized compensation costs to performance shares and $2.8 million relates to time relate 2017 2018 2019 2020 2021 and thereafter Total $ $ 665 676 688 490 46 2,565 Note 17. Litigation and Contingencies Before paying an insurance claim, we review the loan and servicing files to determine the appropriateness of the claim amount. When reviewing the files, we may determine that we have the right to rescind coverage on the loan. We refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term. In addition, 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 2016, curtailments reduced our average claim paid by approximately 6.7% and 5.5%, respectively. 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. MGIC Investment Corporation 2016 Annual Report | 109 the terms of Through a non-insurance subsidiary, we utilize our to provide an outsourced underwriting skills 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 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 related contract underwriting remedy expense for the years ended December 31, 2016, 2015, and 2014, respectively, was immaterial to our consolidated financial statements. 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 consolidated results of operations. See Note 12 – “Income Taxes” for a description of federal income tax contingencies. Notes When the insured disputes our right to rescind coverage or curtail claims, 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. Under ASC 450-20, until a liability associated with settlement discussions or legal proceedings becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes and do not accrue an estimated loss. Where we determine that a loss is probable and can be reasonably estimated we have recorded our best estimate of our probable loss. 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 matters for which we have recorded a probable 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 the maximum exposure associated with matters where a loss is reasonably possible to be approximately $295 million, although we believe (but can give no assurance that) we will ultimately resolve these matters for significantly less than this amount. This estimate of our maximum exposure does not include interest or consequential or exemplary damages. liability. We estimate insurers, Mortgage including MGIC, have been involved in litigation and regulatory actions related to alleged violations of the anti-referral fee provisions of RESPA, and the notice provisions of the FCRA. While these proceedings in the aggregate have not resulted in material liability for MGIC, there can be no assurance that the outcome of future proceedings under these laws, if any, would have a material adverse affect on us. In addition, 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. 110 | MGIC Investment Corporation 2016 Annual Report Note 18. Unaudited Quarterly Financial Data 2016: Quarter (In thousands, except per share data) First Second Third Fourth Notes Full Year Net premiums earned $ 221,341 $ 231,456 $ 237,376 $ 235,053 $ 925,226 28,094 110,666 Investment income, net of expenses Realized gains Other revenue Loss incurred, net Underwriting and other expenses, net Loss on debt extinguishment Provision for income tax Net income Income per share (a) (b): Basic Diluted 2015: 27,809 3,056 6,373 85,012 56,439 13,440 34,497 69,191 0.20 0.17 27,515 5,092 3,867 60,897 53,981 75,223 27,131 56,618 0.16 0.14 27,248 836 3,994 46,590 49,837 1,868 56,018 109,221 0.32 0.26 Quarter (52) 3,425 47,658 56,824 — 54,551 107,487 0.31 0.28 8,932 17,659 240,157 217,081 90,531 172,197 342,517 1.00 0.86 Full Year (In thousands, except per share data) First Second Third Fourth Net premiums earned $ 217,288 $ 213,508 $ 239,234 $ 226,192 $ 896,222 Investment income, net of expenses Realized (losses) gains Other revenue Loss incurred, net Underwriting and other expenses, net Loss on debt extinguishment Provision for (benefit from) income tax Net income Income per share (a) (b): Basic Diluted 24,120 26,327 2,480 81,785 51,969 — 3,385 25,756 166 3,699 90,238 37,915 — 1,322 133,076 113,654 25,939 640 3,698 76,458 65,805 — (695,604) 822,852 27,926 1,228 3,087 95,066 53,858 507 6,584 103,741 28,361 12,964 343,547 209,547 507 (684,313) 102,418 1,172,000 0.39 0.32 0.33 0.28 2.42 1.78 0.30 0.24 3.45 2.60 (a) Due to the use of weighted average shares outstanding when calculating earnings per share, the sum of the quarterly per share data may not equal the per share data for the year. (b) In periods where convertible debt instruments are dilutive to earnings per share the “if-converted” method of computing diluted EPS requires an interest expense adjustment, net of tax, to net income available to shareholders. The interest expense adjustment was not tax effected for the first and second quarter of 2015 due to our valuation allowance on deferred tax assets. See Note 4 – “Earnings Per Share” for further discussion on our calculation of diluted EPS. MGIC Investment Corporation 2016 Annual Report | 111 Directors Daniel A. Arrigoni Former President & Chief Executive Officer U.S. Bank Home Mortgage Corp. Home loan originator and servicer Cassandra C. Carr Consultant C. Edward Chaplin Former President & CFO MBIA Inc. Provider of financial guarantee insurance Officers MGIC Investment Corporation President & Chief Executive Officer Patrick Sinks Executive Vice Presidents Jeffrey H. Lane General Counsel and Secretary Curt S. Culver Chairman Former Chief Executive Officer MGIC Investment Corporation Timothy A. Holt Former Senior Vice President & Chief Investment Officer Aetna, Inc. Diversified health care benefits company Kenneth M. Jastrow, II Corporate Director & Private Investor Former Chairman & Chief Executive Officer Temple-Inland Inc. Paper & forest products company with previous financial services and real estate interests Michael E. Lehman Interim Chief Information Officer & Special Advisor to the Chancellor University of Wisconsin Gary A. Poliner Former President Northwestern Mutual Life Ins. Co. Financial services company Patrick Sinks President & Chief Executive Officer MGIC Investment Corporation Mark M. Zandi Chief Economist Moody’ s Analytics, Inc. Risk measurement and management firm Stephen C. Mackey Chief Risk Officer Timothy J. Mattke Chief Financial Officer Vice Presidents Heidi A. Heyrman Assistant Secretary Lisa M. Pendergast Treasurer Brain M. Remington Assistant Secretary Julie K. Sperber Controller & Chief Accounting Officer Paul A. Spiroff Assistant Treasurer Dan D. Stilwell Assistant Secretary Martha F. Tsuchihashi Assistant Secretary Mortgage Guaranty Insurance Corporation President & Chief Executive Officer Patrick Sinks Gary A. Antonovich Internal Audit Executive Vice Presidents James J. Hughes Sales and Business Development Jeffrey H. Lane General Counsel and Secretary Stephen C. Mackey Chief Risk Officer Timothy J. Mattke Chief Financial Officer Salvatore A. Miosi Business Strategies and Operations Senior Vice Presidents Gregory A. Chi Chief Information Officer Sean A. Dilweg Government Relations Carla A. Gallas Claims Robert K. Bates National Accounts Robert J. Candelmo Chief Technology Officer Geoffrey F. Cooper Product Development Margaret M. Crowley Marketing and Customer Experience Dean D. Dardzinski Managing Director Stephen M. Dempsey Managing Director Hans F. DeSelms Loss Forecasting & Analytics Sandra K. Dunst Claims Operations Edward G. Durant Analytic Services Kurt J. Thomas Chief Human Resources Officer Mary L. Elkins Systems Development Michael J. Zimmerman Investor Relations David A. Greco Operational Risk Vice Presidents Terry A. Aikin Managing Director Heidi A. Heyrman Regulatory Relations, Assistant General Counsel and Assistant Secretary Eric B. Klopfer Corporate Strategy Mark J. Krauter National Accounts Michael L. Kull National Accounts Elyse M. Mitchell National Accounts Peter A. Semenak Underwriting Bryan D. Specht Policy Acquisition & Servicing Julie K. Sperber Controller and Chief Accounting Officer Paul A. Spiroff Investments Jerome J. Murphy Business Process Transformation Stacey B. Murphy Talent Management Dan D. Stilwell Chief Compliance Officer, Assistant General Counsel and Assistant Secretary Jeffrey N. Nielsen Financial Planning/Analysis Steven M. Thompson Credit Policy and Pricing Lisa M. Pendergast Treasurer Christopher T. Perry Sales W. Todd Pittman Managing Director Brian M. Remington Loss Mitigation Counsel & Assistant Secretary David H. Schroeder Claims John R. Schroeder Risk Management Martha F. Tsuchihashi Securities Law Counsel, Assistant General Counsel and Assistant Secretary Kathleen E. Valenti Loss Mitigation Carie L. Vos Claims Administration William E. Walker Chief Information Security Officer John S. Wiseman Managing Director Jerry L. Wormmeester National Accounts 112 | MGIC Investment Corporation 2016 Annual Report Performance Graph The graph below compares the cumulative total return on (a) our Common Stock, (b) a composite peer group index selected by us, (c) the Russell 2000 Financial Index and (d) the S&P 500. Our peer group index consists of the peers against which we analyzed our 2016 executive compensation: Ambac Financial Group, Inc., Arch Capital Group Ltd., Assured Guaranty Ltd., Essent Group Ltd., Fidelity National Financial Inc., First American Financial Corp., Genworth Financial Inc., MBIA Inc., NMI Holdings Inc. and Radian Group. We selected this peer group because it includes all of our direct competitors that were public throughout 2016 and whose mortgage insurance operations are a significant part of their overall business, financial guaranty insurers, and other financial services companies focused on the residential real estate industry that are believed to be potential competitors for executive talent. Russell 2000 Financial Index S&P 500 Peer Index (AMBC, ACGL, AGO, ESNT, FNF, FAF, GNW, MBI, NMIH, & RDN) MGIC 2011 100 100 2012 121 116 100 100 125 71 2013 160 154 189 226 2014 174 174 187 250 2015 175 177 176 237 2016 229 198 214 273 MGIC Investment Corporation 2016 Annual Report | 113 MGIC Stock MGIC Investment Corporation Common Stock is listed on the New York Stock Exchange under the symbol MTG. At June 2, 2017, 370,556,561 shares were outstanding. The following table sets forth for 2016 and 2015 by quarter the high and low sales prices of the Common Stock on the New York Stock Exchange. 2016 2015 Quarter 1st 2nd 3rd 4th Low Low High High $ 8.72 $ 5.63 $ 9.96 $ 8.00 9.47 9.07 8.72 11.55 11.72 10.05 6.31 8.23 10.58 5.92 5.45 7.84 In October 2008, the Company’ s Board suspended payment of our dividend. Accordingly, no cash dividends were paid in 2016 or 2015. The payment of future dividends is subject to the discretion of our Board and will depend on many factors, including our operating results, financial condition and capital position. See Note 7 - “Debt” to our consolidated financial statements for dividend restrictions that apply when we elect to defer interest on our Convertible Junior Debentures. The Company is a holding company and the payment of dividends insurance subsidiaries is restricted by insurance regulations. For a discussion of these restrictions, see Note 14 - "Statutory Information, Dividend Restrictions” to our consolidated financial statements. from its As of June 2, 2016, the number of shareholders of record was 213. In addition, we estimate that there are approximately 39,700 beneficial owners of shares held by brokers and fiduciaries. Shareholder Information The Annual Meeting The Annual Meeting of Shareholders of MGIC Investment Corporation will convene at 2 p.m. Central Time on July 26, 2017, at the Corporation's headquarters, 270 East Kilbourn Avenue, Milwaukee, Wisconsin. 10-K Report Copies of the Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission, are available without charge to shareholders on request from: Secretary MGIC Investment Corporation P. O. Box 488 Milwaukee, WI 53201 The Annual Report on Form 10-K referred to above includes as exhibits certifications from the Company’ s Chief Executive Officer and Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act. Following the 2016 Annual Meeting of Shareholders, the Company’ s Chief Executive Officer submitted a Written Affirmation to the New York Stock Exchange that he was not aware of any violation by the Company of the corporate governance listing standards of Exchange. Transfer Agent and Registrar Wells Fargo Shareowner Services P. O. Box 64874 St. Paul, Minnesota 55164-0874 (800) 468-9716 Corporate Headquarters MGIC Plaza 250 East Kilbourn Avenue Milwaukee, Wisconsin 53202 Mailing Address P. O. Box 488 Milwaukee, Wisconsin 53201 Shareholder Services (414) 347-6596 114 | MGIC Investment Corporation 2016 Annual Report

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