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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2006
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to
Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
     
WISCONSIN   39-1486475
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
250 E. KILBOURN AVENUE   53202
MILWAUKEE, WISCONSIN   (Zip Code)
(Address of principal executive offices)    
(414) 347-6480
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES þ       NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ       Accelerated filer o       Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o       NO þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
                       
 
  CLASS OF STOCK     PAR VALUE     DATE     NUMBER OF SHARES  
 
Common stock
    $1.00     10/31/06     83,016,733  
 
 
 

 


Table of Contents

MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
             
        Page No.
PART I.          
   
 
       
Item 1.          
   
 
       
        3  
   
 
       
        4  
   
 
       
        5  
   
 
       
        6-22  
   
 
       
Item 2.       23-44  
   
 
       
Item 3.       44  
   
 
       
Item 4.       44-45  
   
 
       
PART II.          
   
 
       
Item 1A.       46-48  
   
 
       
Item 2.       49  
   
 
       
Item 6.       50  
   
 
       
SIGNATURES     51  
   
 
       
INDEX TO EXHIBITS        
 Statement Re Computation of Net Income Per Share
 302 Certification of CEO
 302 Certification of CFO
 906 Certification of CEO and CFO
 Risk Factors

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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2006 (Unaudited) and December 31, 2005
                 
    September 30,     December 30,  
    2006     2005  
    (In thousands of dollars)  
ASSETS
               
Investment portfolio:
               
Securities, available-for-sale, at market value:
               
Fixed maturities (amortized cost, 2006-$5,116,645; 2005-$5,173,091)
  $ 5,247,390     $ 5,292,942  
Equity securities (cost, 2006-$2,716; 2005-$2,504)
    2,705       2,488  
 
           
 
               
Total investment portfolio
    5,250,095       5,295,430  
 
               
Cash and cash equivalents
    257,414       195,256  
Accrued investment income
    64,252       66,369  
Reinsurance recoverable on loss reserves
    13,526       14,787  
Prepaid reinsurance premiums
    10,032       9,608  
Premiums receivable
    83,801       91,547  
Home office and equipment, net
    32,195       32,666  
Deferred insurance policy acquisition costs
    13,872       18,416  
Investments in joint ventures
    591,907       481,778  
Other assets
    198,091       151,712  
 
           
 
               
Total assets
  $ 6,515,185     $ 6,357,569  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities:
               
Loss reserves
  $ 1,095,572     $ 1,124,454  
Unearned premiums
    181,490       159,823  
Short- and long-term debt (note 2)
    782,135       685,163  
Income taxes payable
    42,148       62,006  
Other liabilities
    193,746       161,068  
 
           
 
               
Total liabilities
    2,295,091       2,192,514  
 
           
 
               
Contingencies (note 3)
               
 
               
Shareholders’ equity:
               
Common stock, $1 par value, shares authorized 300,000,000; shares issued, 9/30/06 - 122,964,267 12/31/05 - 122,549,285; shares outstanding, 9/30/06 - 82,995,338 12/31/05 - 88,046,430
    122,964       122,549  
Paid-in capital
    300,564       280,052  
Treasury stock (shares at cost, 9/30/06 - 39,968,929 12/31/05 - 34,502,855)
    (2,186,750 )     (1,834,434 )
Accumulated other comprehensive income, net of tax (note 5)
    85,399       77,499  
Retained earnings
    5,897,917       5,519,389  
 
           
 
               
Total shareholders’ equity
    4,220,094       4,165,055  
 
           
 
               
Total liabilities and shareholders’ equity
  $ 6,515,185     $ 6,357,569  
 
           
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Nine Month Periods Ended September 30, 2006 and 2005
(Unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
    (In thousands of dollars, except per share data)  
Revenues:
                               
Premiums written:
                               
Direct
  $ 340,268     $ 345,236     $ 1,014,751     $ 1,029,523  
Assumed
    597       291       1,441       744  
Ceded
    (34,995 )     (31,349 )     (104,570 )     (94,630 )
 
                       
 
                               
Net premiums written
    305,870       314,178       911,622       935,637  
Increase in unearned premiums, net
    (9,663 )     (8,337 )     (21,245 )     (2,084 )
 
                       
 
                               
Net premiums earned
    296,207       305,841       890,377       933,553  
Investment income, net of expenses
    61,486       57,338       178,830       171,519  
Realized investment gains (losses), net
    185       61       (1,566 )     16,813  
Other revenue
    11,519       12,503       34,292       33,719  
 
                       
 
                               
Total revenues
    369,397       375,743       1,101,933       1,155,604  
 
                       
 
                               
Losses and expenses:
                               
Losses incurred, net
    164,997       146,197       426,349       381,978  
Underwriting and other expenses, net
    70,704       69,695       216,461       205,649  
Interest expense
    9,849       10,084       28,007       31,318  
 
                       
 
                               
Total losses and expenses
    245,550       225,976       670,817       618,945  
 
                       
 
Income before tax and joint ventures
    123,847       149,767       431,116       536,659  
Provision for income tax
    29,731       39,126       110,376       148,391  
Income from joint ventures, net of tax
    35,862       31,741       122,530       110,484  
 
                       
 
                               
Net income
  $ 129,978     $ 142,382     $ 443,270     $ 498,752  
 
                       
 
                               
Earnings per share (note 4):
                               
Basic
  $ 1.56     $ 1.56     $ 5.21     $ 5.36  
 
                       
Diluted
  $ 1.55     $ 1.55     $ 5.17     $ 5.33  
 
                       
 
                               
Weighted average common shares outstanding — diluted (shares in thousands, note 4)
    83,766       91,796       85,762       93,630  
 
                       
 
                               
Dividends per share
  $ 0.2500     $ 0.1500     $ 0.7500     $ 0.3750  
 
                       
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2006 and 2005
(Unaudited)
                 
    Nine Months Ended  
    September 30,  
    2006     2005  
    (In thousands of dollars)  
Cash flows from operating activities:
               
Net income
  $ 443,270     $ 498,752  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of capitalized deferred insurance policy acquisition costs
    10,523       15,253  
Deferred insurance policy acquistion costs
    (5,979 )     (8,262 )
Depreciation and amortization
    17,219       13,581  
Decrease in accrued investment income
    2,117       4,934  
Decrease in reinsurance recoverable on loss reserves
    1,261       2,682  
Increase in prepaid reinsurance premiums
    (424 )     (944 )
Decrease (increase) in premium receivable
    7,746       (456 )
Decrease in loss reserves
    (28,882 )     (84,552 )
Increase in unearned premiums
    21,667       3,029  
Decrease in income taxes payable
    (24,181 )     (28,049 )
Equity earnings in joint ventures
    (180,393 )     (161,760 )
Distributions from joint ventures
    138,874       137,661  
Other
    6,551       21,020  
 
           
 
               
Net cash provided by operating activities
    409,369       412,889  
 
           
 
Cash flows from investing activities:
               
Purchase of equity securities
    (212 )      
Purchase of fixed maturities
    (1,476,014 )     (1,029,732 )
Additional investment in joint ventures
    (68,552 )     (11,948 )
Sale of investment in joint ventures
          15,652  
Sales of equity securities
          9,541  
Proceeds from sale of fixed maturities
    1,291,036       965,558  
Proceeds from maturity of fixed maturities
    229,113       229,286  
 
           
 
               
Net cash (used in) provided by investing activities
    (24,629 )     178,357  
 
           
 
Cash flows from financing activities:
               
Dividends paid to shareholders
    (64,741 )     (35,128 )
Proceeds from issuance of long-term debt
    199,958        
Net repayment of short-term debt
    (108,841 )     (43,084 )
Reissuance of treasury stock
    3,856       (4,386 )
Repurchase of common stock
    (373,049 )     (341,734 )
Common stock issued
    15,912       8,134  
Excess tax benefits from share-based payment arrangements
    4,323        
 
           
 
               
Net cash used in financing activities
    (322,582 )     (416,198 )
 
           
 
               
Net increase in cash and cash equivalents
    62,158       175,048  
Cash and cash equivalents at beginning of period
    195,256       166,468  
 
           
 
               
Cash and cash equivalents at end of period
  $ 257,414     $ 341,516  
 
           
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Note 1 — Basis of presentation and summary of certain significant accounting policies
     The accompanying unaudited consolidated financial statements of MGIC Investment Corporation (the “Company”) and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K for that year.
     The accompanying consolidated financial statements have not been audited by independent auditors in accordance with the standards of the Public Company Accounting Oversight Board (United States), but in the opinion of management such financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to summarize fairly the Company’s financial position and results of operations. The results of operations for the nine months ended September 30, 2006 may not be indicative of the results that may be expected for the year ending December 31, 2006.
New Accounting Standards
     In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 permits an entity to measure at fair value any financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is currently evaluating the provisions of SFAS 155 and believes that adoption will not have a material effect on its financial position or results of operations.
     In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” The Interpretation seeks to reduce the significant diversity in practice associated with recognition and measurement in the accounting for income taxes. The Interpretation applies to all tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” 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 knowledge of all relevant information. The 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. This Interpretation is effective for the first annual period beginning after

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December 15, 2006. The Company is currently evaluating the impact this Interpretation will have on the Company’s results of operations and financial position.
     In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. This statement provides enhanced guidance for using fair value to measure assets and liabilities. This statement also provides expanded disclosure about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. This statement applies whenever other standards require or permit assets or liabilities to be measured at fair value. The statement does not expand the use of fair value in any new circumstances. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the provisions of this statement and the impact, if any, this statement will have on the Company’s results of operations and financial position.
     In September 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, an amendment of FASB Statements No. 87, 88, 106 and 132R. The statement requires, among other things, an employer to recognize in its balance sheet an asset for a plan’s overfunded status or a liability for a plan’s underfunded status and to measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year beginning for fiscal years ending after December 15, 2008. Calendar year-end companies with publicly traded equity securities are required to adopt the recognition and disclosure provisions as of December 31, 2006 on a prospective basis. The Company expects the adoption of this statement to have no material impact on the Company’s financial position and no impact on the Company’s results of operations, since any impact will be recorded on the balance sheet through other comprehensive income.
Reclassifications
     Certain reclassifications have been made in the accompanying financial statements to 2005 amounts to conform to 2006 presentation.
Note 2 — Short- and long-term debt
     The Company has a $300 million commercial paper program, which is rated “A-1” by Standard and Poors (“S&P”) and “P-1” by Moody’s. At September 30, 2006 and 2005, the Company had $84.3 million and $100.0 million in commercial paper outstanding with a weighted average interest rate of 5.36% and 3.80%, respectively.
     The Company has a $300 million, five year revolving credit facility, expiring in 2010. Under the terms of the credit facility, the Company must maintain shareholders’ equity of at least $2.25 billion and Mortgage Guaranty Insurance Corporation (“MGIC”) must maintain a risk-to-capital ratio of not more than 22:1 and maintain policyholders’ position (which includes MGIC’s statutory surplus and its contingency reserve) of not less than the amount required by Wisconsin insurance regulation. At September 30, 2006, these requirements were met. The facility will continue to be used as a liquidity back up facility

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for the outstanding commercial paper. The remaining credit available under the facility after reduction for the amount necessary to support the commercial paper was $215.7 million and $200.0 million at September 30, 2006 and 2005, respectively.
     In September 2006 the Company issued, in a public offering, $200 million, 5.625% Senior Notes due in 2011. Interest on the Senior Notes is payable semiannually in arrears on March 15 and September 15, beginning on March 15, 2007. The Senior Notes were rated “A-1” by Moody’s, “A” by S&P and “A+” by Fitch. In addition to the recent offering, the Company had $300 million, 5.375% Senior Notes due in November 2015 and $200 million, 6% Senior Notes due in March 2007 outstanding at September 30, 2006. At September 30, 2005 the Company had $300 million, 7.5% Senior Notes due in October 2005 and $200 million, 6% Senior Notes due in March 2007. At September 30, 2006 and 2005, the market value of the outstanding debt (which also includes commercial paper) was $776.9 million and $603.6 million, respectively.
     Interest payments on all long-term and short-term debt were $27.3 million and $30.1 million for the nine months ended September 30, 2006 and 2005, respectively.
     During the first quarter of 2006, an outstanding interest rate swap contract was terminated. This swap was placed into service to coincide with the committed credit facility, used as a backup for the commercial paper program. Under the terms of the swap contract, the Company paid a fixed rate of 5.07% and received a variable interest rate based on the London Inter Bank Offering Rate (“LIBOR”). The swap had an expiration date coinciding with the maturity of the credit facility and was designated as a cash flow hedge. At September 30, 2006 the Company has no interest rate swaps outstanding.
     (Income) expense on the interest rate swaps for the nine months ended September 30, 2006 and 2005 of approximately ($0.1) million and $0.7 million, respectively, was included in interest expense. Gains or losses arising from the amendment or termination of interest rate swaps are deferred and amortized to interest expense over the life of the hedged items.
Note 3 — Litigation and contingencies
     The Company is involved in litigation in the ordinary course of business. In the opinion of management, the ultimate resolution of this pending litigation will not have a material adverse effect on the financial position or results of operations of the Company.
     Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. In recent years, seven mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in late December 2004 following denial of class certification in June 2004. There can be no assurance that MGIC will not be subject to future litigation under RESPA or FCRA or that the outcome of any such litigation would not have a material adverse effect on the Company. In August 2005, the United States

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Court of Appeals for the Ninth Circuit decided a case under FCRA to which the Company was not a party that may make it more likely that the Company will be subject to litigation regarding when notices to borrowers are required by FCRA.
     In June 2005, in response to a letter from the New York Insurance Department (the “NYID”), the Company provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the NYID requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the NYID that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years. In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MDC”), which regulates insurance, the Company provided the MDC with information about captive mortgage reinsurance and certain other matters. The Company subsequently provided additional information to the MDC. Other insurance departments or other officials, including attorneys general, may also seek information about or investigate captive mortgage reinsurance.
     The anti-referral fee provisions of RESPA provide that the Department of Housing and Urban Development (“HUD”) as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions 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 the Company believes its captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on the Company or the mortgage insurance industry.
     Under its contract underwriting agreements, the Company may be required to provide certain remedies to its customers if certain standards relating to the quality of the Company’s underwriting work are not met. The cost of remedies provided by the Company to customers for failing to meet these standards has not been material to the Company’s financial position or results of operations for the nine months ended September 30, 2006 and 2005.
     The Internal Revenue Service (“IRS”) has been conducting an examination of the federal income tax returns of the Company for taxable years 2000 though 2004. The IRS has indicated that they intend to propose adjustments to taxable income relating to a portfolio of investments in the residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). This portfolio has been managed and maintained during years prior to, during and subsequent to the examination period. The tax returns have included the flow through of income and losses from these investments in the computation of taxable income. The IRS has indicated that they do not believe that the Company has established sufficient tax basis in the REMIC residual interests to deduct some portion of the flow through losses from income. To date, they have not provided a detailed explanation of their position or the calculation of the dollar amount of any potential adjustment. The Company will contest any such proposal to increase taxable income and believes that income taxes related to these years have been properly provided for in the financial statements.

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Note 4 — Earnings per share
     The Company’s basic and diluted earnings per share (“EPS”) have been calculated in accordance with SFAS No. 128, Earnings Per Share. The Company’s net income is the same for both basic and diluted EPS. Basic EPS is based on the weighted average number of common shares outstanding. Diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include stock awards and stock options. The following is a reconciliation of the weighted average number of shares used for basic EPS and diluted EPS.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
    (Shares in thousands)  
Weighted-average shares — Basic
    83,238       91,087       85,161       92,982  
Common stock equivalents
    528       709       601       648  
 
                       
 
                               
Weighted-average shares — Diluted
    83,766       91,796       85,762       93,630  
 
                       

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Note 5 — Comprehensive income
     The Company’s total comprehensive income, as calculated per SFAS No. 130, Reporting Comprehensive Income, was as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
            (In thousands of dollars)          
Net income
  $ 129,978     $ 142,382     $ 443,270     $ 498,752  
Other comprehensive income (loss)
    72,140       (41,696 )     7,900       (36,183 )
 
                       
 
                               
Total comprehensive income
  $ 202,118     $ 100,686     $ 451,170     $ 462,569  
 
                       
 
Other comprehensive income (loss) (net of tax):
                               
Change in unrealized net derivative gains and losses
  $     $ 4,952     $ 777     $ 103  
Amortization of deferred losses on derivatives
          203             609  
Change in unrealized gains and losses on investments
    72,138       (47,369 )     7,085       (37,849 )
Other
    2       518       38       954  
 
                       
 
                               
Other comprehensive income (loss)
  $ 72,140     $ (41,696 )   $ 7,900     $ (36,183 )
 
                       
     At September 30, 2006, accumulated other comprehensive income of $85.4 million included $85.0 million of net unrealized gains on investments and $0.4 million relating to the accumulated other comprehensive gain of the Company’s joint venture investment, all net of tax. At December 31, 2005, accumulated other comprehensive income of $77.5 million included $77.9 million of net unrealized gains on investments, ($0.8) million relating to derivative financial instruments and $0.4 million relating to the accumulated other comprehensive loss of the Company’s joint venture investment.

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Note 6 — Benefit Plans
     The following table provides the components of net periodic benefit cost for the pension and other postretirement benefit plans:
                                 
    Three Months Ended  
    September 30,  
                    Other Postretirement  
    Pension Benefits     Benefits  
    2006     2005     2006     2005  
    (In thousands of dollars)  
Service cost
  $ 2,348     $ 2,209     $ 907     $ 854  
Interest cost
    2,607       2,370       1,020       931  
Expected return on plan assets
    (3,724 )     (3,354 )     (649 )     (561 )
Recognized net actuarial loss (gain)
    35             105       75  
Amortization of transition obligation
                71       70  
Amortization of prior service cost
    216       186              
 
                       
 
                               
Net periodic benefit cost
  $ 1,482     $ 1,411     $ 1,454     $ 1,369  
 
                       
                                 
    Nine Months Ended  
    September 30,  
                    Other Postretirement  
    Pension Benefits     Benefits  
    2006     2005     2006     2005  
            (In thousands of dollars)          
Service cost
  $ 7,044     $ 6,629     $ 2,721     $ 2,561  
Interest cost
    7,820       7,112       3,058       2,792  
Expected return on plan assets
    (11,172 )     (10,064 )     (1,946 )     (1,682 )
Recognized net actuarial loss (gain)
    106             316       226  
Amortization of transition obligation
                213       212  
Amortization of prior service cost
    648       556              
 
                       
 
                               
Net periodic benefit cost
  $ 4,446     $ 4,233     $ 4,362     $ 4,109  
 
                       
     The Company previously disclosed in its financial statements for the year ended December 31, 2005 that it expected to contribute approximately $10.3 million and $4.6 million, respectively, to its pension and postretirement plans in 2006. As of September 30, 2006, no contributions have been made.
Note 7 – Share-based compensation plans
     The Company has certain share-based compensation plans. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R, “Share- Based Payment,” under the modified prospective method, accordingly prior period amounts have not been restated. SFAS No. 123R requires that the

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compensation cost relating to share-based payment transactions be measured based on the fair value of the equity or liability instrument issued and be recognized in the financial statements of the Company. This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. The fair value recognition provisions of SFAS No. 123 were voluntarily adopted by the Company in 2003 prospectively to all employee awards granted or modified on or after January 1, 2003. The adoption of SFAS No. 123R and SFAS No. 123 did not have a material effect on the Company’s results of operations or its financial position. 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. Awards under the Company’s plans generally vest over periods ranging from one to five years.
     The cost related to stock-based employee compensation included in the determination of net income for 2005 was less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested awards for the three and nine months ended September 30, 2005.
                 
    Three Months Ended     Nine Months Ended  
    September 30,  
    2005     2005  
    (in thousands of dollars,  
    except per share data)  
Net income, as reported
  $ 142,382     $ 498,752  
 
               
Add stock-based employee compensation expense included in reported net income, net of tax
    3,186       8,913  
 
               
Deduct stock-based employee compensation expense determined under fair value method for all awards, net of tax
    (4,273 )     (12,190 )
 
           
 
               
Pro forma net income
  $ 141,295     $ 495,475  
 
           
 
               
Earnings per share:
               
Basic, as reported
  $ 1.56     $ 5.36  
 
           
 
               
Basic, pro forma
  $ 1.55     $ 5.33  
 
           
 
               
Diluted, as reported
  $ 1.55     $ 5.33  
 
           
 
               
Diluted, pro-forma
  $ 1.54     $ 5.29  
 
           
     The compensation cost that has been charged against income for the share-based plans was $8.8 million and $25.4 million for the three and nine months ended

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September 30, 2006, compared to $4.9 million and $13.7 million for the three and nine months ended September 30, 2005. The related income tax benefit recognized for the share-based compensation plans was $8.9 million and $4.8 million for the nine months ended September 30, 2006 and 2005, respectively.
     The Company has stock incentive plans that were adopted in 1991 and 2002. When the 2002 plan was adopted, no further awards could be made under the 1991 plan. The maximum number of shares covered by awards under the 2002 plan is the total of 7.1 million shares plus the number of shares that must be purchased at a purchase price of not less than the fair market value of the shares as a condition to the award of restricted stock under the 2002 plan. The maximum number of shares of restricted stock that can be awarded under the 2002 plan is 5.9 million shares. Both plans provide for the award of stock options with maximum terms of 10 years and for the grant of restricted stock or restricted stock units, and the 2002 plan also provides for the grant of stock appreciation rights. The exercise price of options is the closing price of the common stock on the New York Stock Exchange on the date of grant. The vesting provisions of options and restricted stock are determined at the time of grant. Newly issued shares are used for exercises under the 1991 plan, and treasury shares are used for exercises under the 2002 plan. Directors may receive awards under the 2002 plan and were eligible for awards of restricted stock under the 1991 plan.
     A summary of option activity in the stock incentive plans during 2006 is as follows:
                 
    Weighted    
    Average   Shares
    Exercise   Subject
    Price   to Option
Outstanding, December 31, 2005
  $ 54.19       3,274,731  
 
               
Granted
           
Exercised
    39.20       (238,437 )
Forfeited or expired
    54.80       (13,930 )
 
               
 
               
Outstanding, March 31, 2006
  $ 55.37       3,022,364  
 
               
 
               
Granted
  $        
Exercised
    50.68       (255,745 )
Forfeited or expired
    68.50       (2,800 )
 
               
 
               
Outstanding, June 30, 2006
  $ 55.79       2,763,819  
 
               
 
               
Granted
  $        
Exercised
           
Forfeited or expired
    63.80       (200 )
 
               
 
               
Outstanding, September 30, 2006
  $ 55.79       2,763,619  
 
               

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     During the nine months ended September 30, 2006, the total intrinsic value of options exercised (i.e., the difference in the market price at exercise and the price paid by the employee to exercise the option) was $10.0 million. The total amount of cash received from exercise of options was $15.0 million and the related net tax benefit realized from the exercise of those stock options was $3.5 million for the same period. There were no options exercised during the third quarter of 2006.
     The following is a summary of stock options outstanding at September 30, 2006:
                                                 
    Options Outstanding   Options Exercisable
                    Weighted                   Weighted
Exercise           Remaining   Average           Remaining   Average
Price           Average   Exercise           Average   Exercise
Range   Shares   Life (years)   Price   Shares   Life (years)   Price
$33.81 - 47.31
    1,167,619       4.0     $ 44.17       633,629       3.6     $ 43.70  
 
                                               
$53.70 - 68.63
    1,596,000       5.6     $ 64.28       1,119,300       5.2     $ 63.15  
 
                                               
 
                                               
Total
    2,763,619       4.9     $ 55.79       1,752,929       4.6     $ 56.12  
 
                                               
     The aggregate intrinsic value of options outstanding at September 30, 2006 was $11.6 million. The aggregate intrinsic value of options exercisable was $6.8 million. The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Company’s closing stock price of $59.97 as of September 30, 2006 which would have been received by the option holders had all option holders exercised their options on that date.

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     A summary of restricted stock or restricted stock units during 2006 is as follows:
                 
    Fair Market    
    Value   Shares
Restricted stock outstanding at December 31, 2005
  $ 60.50       912,671  
 
               
Granted
    64.66       564,350  
Vested
    56.87       (262,982 )
Forfeited
    61.53       (6,069 )
 
               
 
               
Restricted stock outstanding at March 31, 2006
  $ 63.26       1,207,970  
 
               
 
               
Granted
    69.96       1,000  
Vested
           
Forfeited
    64.26       (240 )
 
               
 
               
Restricted stock outstanding at June 30, 2006
  $ 63.27       1,208,730  
 
               
 
               
Granted
           
Vested
           
Forfeited
           
 
               
 
               
Restricted stock outstanding at September 30, 2006
  $ 63.27       1,208,730  
 
               
     At September 30, 2006, 4,523,718 shares were available for future grant under the 2002 stock incentive plan. Of the shares available for future grant, 4,440,398 are available for restricted stock awards.
     As of September 30, 2006, there was $61.6 million of total unrecognized compensation cost related to nonvested share-based compensation agreements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.6 years. The total fair value of shares vested during the three and nine months ended September 30, 2006 was zero and $17.1 million, respectively.
     For purposes of determining the pro forma net income, the fair value of options granted was estimated at grant date using the binomial option pricing model for the 2004 options and the Black-Scholes model for the 2003 and prior options with the following weighted average assumptions for each year:

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    Grants Issued in Year Ended December 31,
    2004   2003
Risk free interest rate
    3.27 %     2.91 %
Expected life
  5.50 years    4.87 years 
Expected volatility
    30.20 %     29.40 %
Expected dividend yield
    0.25 %     0.25 %
Fair value of each option
  $ 21.68     $ 13.12  

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Note 8 — Condensed consolidating financial statements
     The following condensed financial information sets forth, on a consolidating basis, the balance sheet, statement of operations, and statement of cash flows for MGIC Investment Corporation (“Parent Company”), which represents the Company’s investments in all of its subsidiaries under the equity method, Mortgage Guaranty Insurance Corporation and Subsidiaries (“MGIC Consolidated”), and all other subsidiaries of the Company (“Other”) on a combined basis. The eliminations column represents entries eliminating investments in subsidiaries, intercompany balances, and intercompany revenues and expenses.

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Condensed Consolidating Balance Sheets
At September 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
ASSETS
                                       
Total investments
  $ 2,420     $ 4,946,219     $ 301,456     $     $ 5,250,095  
Cash and cash equivalents
    179,321       55,130       22,963             257,414  
Reinsurance recoverable on loss reserves
          74,534       21       (61,029 )     13,526  
Prepaid reinsurance premiums
          25,273       2       (15,243 )     10,032  
Deferred insurance policy acquisition costs
          13,872                   13,872  
Investments in subsidiaries/joint ventures
    4,819,322       591,907             (4,819,322 )     591,907  
Other assets
    18,885       383,965       28,431       (52,942 )     378,339  
 
                                       
 
                             
Total assets
  $ 5,019,948     $ 6,090,900     $ 352,873     $ (4,948,536 )   $ 6,515,185  
 
                             
 
                                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                       
Liabilities:
                                       
Loss reserves
  $     $ 1,095,572     $ 61,029     $ (61,029 )   $ 1,095,572  
Unearned premiums
          181,491       15,242       (15,243 )     181,490  
Short- and long-term debt
    782,096       9,364             (9,325 )     782,135  
Other liabilities
    17,758       208,252       42,279       (32,395 )     235,894  
 
                             
 
                                       
Total liabilities
    799,854       1,494,679       118,550       (117,992 )     2,295,091  
 
                             
 
                                       
Total shareholders’ equity
    4,220,094       4,596,221       234,323       (4,830,544 )     4,220,094  
 
                             
 
                                       
Total liabilities and shareholders’ equity
  $ 5,019,948     $ 6,090,900     $ 352,873     $ (4,948,536 )   $ 6,515,185  
 
                             
Condensed Consolidating Balance Sheets
At December 31, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
ASSETS
                                       
Total investments
  $ 2,570     $ 5,047,475     $ 245,385     $     $ 5,295,430  
Cash and cash equivalents
    211       176,370       18,675             195,256  
Reinsurance recoverable on loss reserves
          78,097       36       (63,346 )     14,787  
Prepaid reinsurance premiums
          17,521       3       (7,916 )     9,608  
Deferred insurance policy acquisition costs
          18,416                   18,416  
Investments in subsidiaries/joint ventures
    4,842,932       481,778             (4,842,932 )     481,778  
Other assets
    13,542       356,624       28,274       (56,146 )     342,294  
 
                                       
 
                             
Total assets
  $ 4,859,255     $ 6,176,281     $ 292,373     $ (4,970,340 )   $ 6,357,569  
 
                             
 
                                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                       
Liabilities:
                                       
Loss reserves
  $     $ 1,124,454     $ 63,346     $ (63,346 )   $ 1,124,454  
Unearned premiums
          159,823       7,916       (7,916 )     159,823  
Short- and long-term debt
    685,124       9,364             (9,325 )     685,163  
Other liabilities
    9,076       232,109       13,435       (31,546 )     223,074  
 
                             
 
                                       
Total liabilities
    694,200       1,525,750       84,697       (112,133 )     2,192,514  
 
                             
 
                                       
Total shareholders’ equity
    4,165,055       4,650,531       207,676       (4,858,207 )     4,165,055  
 
                             
 
                                       
Total liabilities and shareholders’ equity
  $ 4,859,255     $ 6,176,281     $ 292,373     $ (4,970,340 )   $ 6,357,569  
 
                             

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Condensed Consolidating Statements of Operations
Three months ended September 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 287,209     $ 18,696     $ (35 )   $ 305,870  
 
                             
 
                                       
Net premiums earned
          276,908       19,334       (35 )     296,207  
 
                                       
Equity in undistributed net income of subsidiaries
    (18,635 )                 18,635        
Dividends received from subsidiaries
    155,000                       (155,000 )      
Investment income, net of expenses
    87       57,119       4,280             61,486  
Realized investment gains, net
          (100 )     34       251       185  
Other revenue
          2,724       8,795             11,519  
 
                             
 
                                       
Total revenues
    136,452       336,651       32,443       (136,149 )     369,397  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          154,632       10,365             164,997  
Underwriting and other expenses
    65       50,788       19,897       (46 )     70,704  
Interest expense
    9,849                         9,849  
 
                             
 
                                       
Total losses and expenses
    9,914       205,420       30,262       (46 )     245,550  
 
                             
 
                                       
Income before tax and joint ventures
    126,538       131,231       2,181       (136,103 )     123,847  
Provision (credit) for income tax
    (3,440 )     32,957       (123 )     337       29,731  
Income from joint ventures, net of tax
          35,862                   35,862  
 
                             
 
                                       
Net income
  $ 129,978     $ 134,136     $ 2,304     $ (136,440 )   $ 129,978  
 
                             
Condensed Consolidating Statements of Operations
Nine months ended September 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 850,926     $ 60,793     $ (97 )   $ 911,622  
 
                             
 
                                       
Net premiums earned
          837,010       53,464       (97 )     890,377  
 
                                       
Equity in undistributed net income of subsidiaries
    (53,555 )                 53,555        
Dividends received from subsidiaries
    515,000                       (515,000 )      
Investment income, net of expenses
    237       168,519       10,074             178,830  
Realized investment gains, net
          (1,948 )     131       251       (1,566 )
Other revenue
          8,081       26,211             34,292  
 
                             
 
                                       
Total revenues
    461,682       1,011,662       89,880       (461,291 )     1,101,933  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          405,984       20,365             426,349  
Underwriting and other expenses
    192       156,067       60,332       (130 )     216,461  
Interest expense
    28,007                         28,007  
 
                             
 
                                       
Total losses and expenses
    28,199       562,051       80,697       (130 )     670,817  
 
                             
 
                                       
Income before tax and joint ventures
    433,483       449,611       9,183       (461,161 )     431,116  
Provision (credit) for income tax
    (9,787 )     118,653       1,118       392       110,376  
Income from joint ventures, net of tax
          122,530                   122,530  
 
                             
 
                                       
Net income
  $ 443,270     $ 453,488     $ 8,065     $ (461,553 )   $ 443,270  
 
                             

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Condensed Consolidating Statements of Operations
Three months ended September 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 293,294     $ 20,947     $ (63 )   $ 314,178  
 
                             
 
                                       
Net premiums earned
          289,439       16,465       (63 )     305,841  
 
                                       
Equity in undistributed net income of subsidiaries
    103,879                   (103,879 )      
Dividends received from subsidiaries
    44,300                       (44,300 )      
Investment income, net of expenses
    1,249       53,528       2,561             57,338  
Realized investment gains, net
          42       19             61  
Other revenue
          455       12,048             12,503  
 
                             
 
                                       
Total revenues
    149,428       343,464       31,093       (148,242 )     375,743  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          139,779       6,418             146,197  
Underwriting and other expenses
    84       47,034       22,651       (74 )     69,695  
Interest expense
    10,083                   1       10,084  
 
                             
 
                                       
Total losses and expenses
    10,167       186,813       29,069       (73 )     225,976  
 
                             
 
                                       
Income before tax and joint ventures
    139,261       156,651       2,024       (148,169 )     149,767  
Provision (credit) for income tax
    (3,121 )     42,099       143       5       39,126  
Income from joint ventures, net of tax
          31,741                   31,741  
 
                             
 
                                       
Net income
  $ 142,382     $ 146,293     $ 1,881     $ (148,174 )   $ 142,382  
 
                             
Condensed Consolidating Statements of Operations
Nine months ended September 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 881,596     $ 54,250     $ (209 )   $ 935,637  
 
                             
 
                                       
Net premiums earned
          883,688       50,074       (209 )     933,553  
 
                                       
Equity in undistributed net income of subsidiaries
    10,445                   (10,445 )      
Dividends received from subsidiaries
    507,900                       (507,900 )      
Investment income, net of expenses
    1,852       162,684       7,407       (424 )     171,519  
Realized investment gains, net
          16,780       33             16,813  
Other revenue
          1,351       32,368             33,719  
 
                             
 
                                       
Total revenues
    520,197       1,064,503       89,882       (518,978 )     1,155,604  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          364,023       17,955             381,978  
Underwriting and other expenses
    214       141,649       64,028       (242 )     205,649  
Interest expense
    31,318       424             (424 )     31,318  
 
                             
 
                                       
Total losses and expenses
    31,532       506,096       81,983       (666 )     618,945  
 
                             
 
                                       
Income before tax and joint ventures
    488,665       558,407       7,899       (518,312 )     536,659  
Provision (credit) for income tax
    (10,087 )     157,759       1,007       (288 )     148,391  
Income from joint ventures, net of tax
          110,484                   110,484  
 
                             
 
                                       
Net income
  $ 498,752     $ 511,132     $ 6,892     $ (518,024 )   $ 498,752  
 
                             

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Condensed Consolidating Statements of Cash Flows
For the Nine Months Ended September 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Net cash from operating activities:
  $ 524,364 (1)   $ 361,916     $ 60,911     $ (537,823 )   $ 409,368  
Net cash (used in) from investing activities:
    (18,350 )     31,844       (56,623 )     18,500       (24,629 )
Net cash used in financing activities:
    (326,904 )     (515,000 )           519,323       (322,581 )
 
                             
Net increase (decrease) in Cash
  $ 179,110     $ (121,240 )   $ 4,288     $     $ 62,158  
 
                             
 
(1)   Includes dividends received from subsidiaries of $515,000.
Condensed Consolidating Statements of Cash Flows
For the Nine Months Ended September 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Net cash from operating activities:
  $ 519,716 (1)   $ 391,328     $ 12,845     $ (511,000 )   $ 412,889  
Net cash (used in) from investing activities:
    (2,948 )     198,415       (20,210 )     3,100       178,357  
Net cash used in financing activities:
    (416,198 )     (507,900 )           507,900       (416,198 )
 
                             
Net increase (decrease) in Cash
  $ 100,570     $ 81,843     $ (7,365 )   $     $ 175,048  
 
                             
 
(1)   Includes dividends received from subsidiaries of $507,900.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Business and General Environment
     Through our subsidiary Mortgage Guaranty Insurance Corporation (“MGIC”), we are the leading provider of private mortgage insurance in the United States to the home mortgage lending industry. Our principal products are primary mortgage insurance and pool mortgage insurance. Primary mortgage insurance may be written through the flow market channel, in which loans are insured in individual, loan-by-loan transactions. Primary mortgage insurance may also be written through the bulk market channel, in which portfolios of loans are individually insured in single, bulk transactions.
     As used below, “we” and “our” refer to MGIC Investment Corporation’s consolidated operations. The discussion below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2005. We refer to this Discussion as the “10-K MD&A.”
Our results of operations are affected by:
  Premiums written and earned
     Premiums written and earned in a year are influenced by:
  o   New insurance written, which increases the size of the in force book of insurance. New insurance written is the aggregate principal amount of the mortgages that are insured during a period and is referred to as “NIW”. NIW is affected by many factors, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from other mortgage insurers and alternatives to mortgage insurance, such as piggyback loans.
 
  o   Cancellations, which reduce the size of the in force book of insurance that generates premiums. 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, as well as by home price appreciation.
 
  o   Premium rates, which are affected by the risk characteristics of the loans insured and the percentage of coverage on the loans.
 
  o   Premiums ceded to reinsurance subsidiaries of certain mortgage lenders and risk sharing arrangements with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (government sponsored entities or “GSEs”).
     Premiums are generated by the insurance that is in force during all or a portion of the

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period. Hence, lower average insurance in force in one period compared to another is a factor that will reduce premiums written and earned, although this effect may be mitigated (or enhanced) by differences in the average premium rate between the two periods as well as by premium that is ceded. 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.
  Investment income and realized gains and losses
     The investment portfolio is comprised almost entirely of highly rated, 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 market value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from operations, including investment earnings, less cash used for non-investment purposes, such as share repurchases. Realized gains and losses are a function of the difference between the amount received on sale of a security and the security’s amortized cost. The amount received on sale is affected by the coupon rate of the security compared to the yield of comparable securities.
  Losses incurred
     Losses incurred are the expense that results from a payment delinquency on an insured loan. As explained under “Critical Accounting Policies” in the 10-K MD&A, this expense is recognized only when a loan is delinquent. Losses incurred are generally affected by:
  o   The state of the economy, which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency. The level of delinquencies has historically followed a seasonal pattern, with a reduction in delinquencies in the first part of the year, followed by an increase in the latter part of the year.
 
  o   The product mix of the in force book, with loans having higher risk characteristics generally resulting in higher delinquencies and claims.
 
  o   The average claim payment, which is affected by the size of loans insured (higher average loan amounts tend to increase losses incurred), the percentage coverage on insured loans (deeper average coverage tends to increase incurred losses), and housing values, which affect our ability to mitigate our losses through sales of properties with delinquent mortgages.
 
  o   The distribution of claims over the life of a book. Historically, the first two years after a loan is originated are a period of relatively low claims, with claims increasing substantially for several years subsequent and then declining, although persistency and the condition of the economy can affect this pattern.
  Underwriting and other expenses

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     Our operating expenses generally vary primarily due to contract underwriting volume, which in turn generally varies with the level of mortgage origination activity. Contract underwriting generates fee income included in “Other revenue.”
  Income from joint ventures
     Our results of operations are also affected by income from joint ventures. Joint venture income principally consists of the aggregate results of our investment in two less than majority owned joint ventures, Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and Sherman Financial Group LLC (“Sherman”).
     C-BASS: C-BASS is primarily an investor in the credit risk of credit-sensitive single-family residential mortgages. It finances these activities through borrowings included on its balance sheet and by securitization activities generally conducted through off-balance sheet entities. C-BASS generally retains the first-loss and other subordinate securities created in the securitization. The mortgage loans owned by C-BASS and underlying C-BASS’s mortgage securities investments are generally serviced by Litton Loan Servicing LP, a subsidiary of C-BASS (“Litton”). Litton’s servicing operations primarily support C-BASS’s investment in credit risk, and investments made by funds managed or co-managed by C-BASS, rather than generating fees for servicing loans owned by third-parties.
     C-BASS’s consolidated results of operations are affected by:
    Portfolio revenue, which in turn is primarily affected by net interest income, gain on sale and liquidation and hedging gains and losses related to portfolio assets, net of mark-to-market and whole loan reserve changes.
  o   Net interest income
 
      Net interest income is principally a function of the size of C-BASS’s portfolio of whole loans and mortgages and other securities, and the spread between the interest income generated by these assets and the interest expense of funding them. Interest income from a particular security is recognized based on the expected yield for the security.
 
  o   Gain on sale and liquidation
 
      Gain on sale and liquidation results from sales of mortgage and other securities, and liquidation of mortgage loans. Securities may be sold in the normal course of business or because of the exercise of call rights by third parties. Mortgage loan liquidations result from loan payoffs, from foreclosure or from sales of real estate acquired through foreclosure.
  Servicing revenue
 
    Servicing revenue is a function of the unpaid principal balance of mortgage loans serviced and servicing fees and charges. The unpaid principal balance of mortgage loans serviced by Litton is affected by mortgages acquired by C-BASS

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    because servicing on subprime and other mortgages acquired is generally transferred to Litton. Litton also services or provides special servicing on loans in mortgage securities owned by funds managed or co-managed by C-BASS. Litton also may obtain servicing on loans in third party mortgage securities acquired by C-BASS or when the loans become delinquent by a specified number of payments (known as “special servicing”).
 
  Revenues from money management activities
 
    These revenues include management fees from C-BASS issued collateralized bond obligations (“CBOs”), equity in earnings from C-BASS investments in investment funds managed or co-managed by C-BASS and management fees and incentive income from investment funds managed or co-managed by C-BASS.
 
  Transaction revenue, which in turn is affected by gain on securitization and hedging gains and losses related to securitization
  o   Gain on securitization
 
      Gain on securitization is a function of the face amount of the collateral in the securitization and the margin realized in the securitization. This margin depends on the difference between the proceeds realized in the securitization and the purchase price paid by C-BASS for the collateral. The proceeds realized in a securitization include the value of securities created in the securitization that are retained by C-BASS.
  Hedging gains and losses, net of mark-to-market and whole loan reserve changes
 
    Hedging gains and losses primarily consist of changes in the value of derivative instruments (including interest rate swaps, interest rate caps and futures) and short positions, as well as realized gains and losses from the closing of hedging positions. C-BASS uses derivative instruments and short sales in a strategy to reduce the impact of changes in interest rates on the value of its mortgage loans and securities. Changes in value of derivative instruments are subject to current recognition because C-BASS does not account for the derivatives as “hedges” under SFAS No. 133.
 
    Mortgage and other securities are classified by C-BASS as trading securities and are carried at fair value, as estimated by C-BASS. Changes in fair value between period ends (a “mark-to-market”) are reflected in C-BASS’s statement of operations as unrealized gains or losses. Changes in fair value of mortgage and other securities may relate to changes in credit spreads or to changes in the level of interest rates or the slope of the yield curve. Mortgage loans are not marked-to-market and are carried at the lower of cost or fair value on a portfolio basis, as estimated by C-BASS.
 
    During a period in which short-term interest rates decline, in general, C-BASS’s hedging positions will decline in value and the change in value, to the extent that

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the hedges related to whole loans, will be reflected in C-BASS’s earnings for the period as an unrealized loss. The related increase, if any, in the value of mortgage loans will not be reflected in earnings but, absent any countervailing factors, when mortgage loans owned during the period are securitized, the proceeds realized in the securitization should increase to reflect the increased value of the collateral.
     Sherman: Sherman is principally engaged in purchasing and collecting for its own account delinquent consumer receivables, which are primarily unsecured, and in originating and servicing subprime credit card receivables. The borrowings used to finance these activities are included in Sherman’s balance sheet.
     Sherman’s consolidated results of operations are affected by:
    Revenues from delinquent receivable portfolios
 
      These revenues are the cash collections on such portfolios, and depend on the aggregate amount of delinquent receivables owned by Sherman, the type of receivable and the length of time that the receivable has been owned by Sherman.
 
    Amortization of delinquent receivable portfolios
 
      Amortization is the recovery of the cost to purchase the receivable portfolios. Amortization expense is a function of estimated collections from the portfolios over their estimated lives. If estimated collections cannot be reasonably predicted, cost is fully recovered before any net revenue (the difference between revenues from a receivable portfolio and that portfolio’s amortization) is recognized.
 
    Credit card interest and fees, along with the coincident provision for losses for uncollectible amounts.
 
    Costs of collection, which include servicing fees paid to third parties to collect receivables.
   2006 Third Quarter Results
     Our results of operations in the third quarter of 2006 were principally affected by:
  Losses incurred
   Losses incurred for the third quarter of 2006 increased compared to the same period in 2005 primarily due to a smaller decrease in the estimates regarding how many delinquencies will result in a claim, when compared to the same period in 2005. The decrease in estimates regarding how many delinquencies will result in a claim (claim rate) is the result of recent historical improvements in the claim rate in certain geographical regions, with the exception of the Midwest where recent historical claim rates have not improved. The states of Michigan, Ohio and Indiana accounted for approximately 35% of our losses paid for the third quarter. Additionally, news from the auto industry suggests continued cuts in Midwest employment for the next couple of years.

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  Premiums written and earned
     During the third quarter of 2006, our written and earned premiums were lower than in the third quarter of 2005 due to lower average premium rates, offset by a slight increase in the average insurance in force.
  Underwriting expenses
     Underwriting expenses increased in the third quarter of 2006 compared to the third quarter of 2005 primarily due to additional expenses related to Myers Internet (acquired in January 2006), equity based compensation and expansion into international operations.
  Investment income
          Investment income in the third quarter of 2006 was higher than in the third quarter of 2005 due to an increase in the pre-tax yield.
  Income from joint ventures
     Income from joint ventures increased in the third quarter of 2006 compared to the same period in 2005 due to higher income from C-BASS and Sherman. See “Results of Consolidate Operations – Joint Ventures.”

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RESULTS OF CONSOLIDATED OPERATIONS
          As discussed under “Forward Looking Statements and Risk Factors” below, 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 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 were made.
NIW
          The amount of MGIC’s NIW (this term is defined in the “Overview-Business and General Environment” section) during the three and nine months ended September 30, 2006 and 2005 was as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    ($ billions)  
    2006     2005     2006     2005  
Flow
  $ 10.9     $ 11.4     $ 28.9     $ 30.7  
Bulk
    5.8       6.8       13.9       15.5  
 
                       
 
                               
Total NIW
  $ 16.7     $ 18.2     $ 42.8     $ 46.2  
 
                       
 
                               
Refinance volume as a % of primary flow NIW
    20 %     27 %     23 %     28 %
     NIW on a flow basis for the third quarter and first nine months of 2006 was less than the volume during the comparable periods in 2005. This decrease was primarily the result of a decrease in refinance volume. Refinance volume in turn is driven by changes in interest rates as discussed with respect to cancellations below. For a discussion of NIW written through the bulk channel, see “Bulk transactions” below.

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Cancellations and insurance in force
     NIW and cancellations of primary insurance in force during the three and nine months ended September 30, 2006 and 2005 were as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
    ($ billions)  
NIW
  $ 16.7     $ 18.2     $ 42.8     $ 46.2  
Cancellations
    (13.1 )     (19.8 )     (39.4 )     (53.1 )
 
                       
 
                               
Change in primary insurance in force
  $ 3.6     $ (1.6 )   $ 3.4     $ (6.9 )
 
                       
     Direct primary insurance in force was $173.4 billion at September 30, 2006 compared to $170.0 billion at December 31, 2005 and $170.2 billion at September 30, 2005. In the third quarter of 2006 insurance in force increased $3.6 billion. The $2.9 billion increase in insurance in force in the second quarter of 2006 was the first quarter of growth in the in force book since the fourth quarter of 2002.
     Cancellation 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. MGIC’s persistency rate (percentage of insurance remaining in force from one year prior) was 67.8% at September 30, 2006, an increase from 61.3% at December 31, 2005 and 60.2% at September 30, 2005. We expect modest improvement in the persistency rate for the remainder of 2006, although this expectation assumes the absence of significant declines in the level of mortgage interest rates from their level in late October 2006.
Bulk transactions
     NIW from bulk transactions during the third quarter and first nine months of 2006 was less than the volume during the comparable periods in 2005.
     Our writings of bulk insurance are in part sensitive to the volume of securitization transactions involving non-conforming loans. Our writings of bulk insurance are also sensitive to competition from other methods of providing credit enhancement in a securitization, including an execution in which the subordinate tranches in the securitization rather than mortgage insurance bear the first loss from mortgage defaults. Competition from such an execution in turn depends on, among other factors, the yield at which investors are willing to purchase tranches of the securitization that involve a higher degree of credit risk compared to the yield for tranches involving the lowest credit risk (the difference in such yields is referred to as the spread) and the amount of credit for losses that a rating agency will give to mortgage insurance. As the spread

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narrows, competition from an execution in which the subordinate tranches bear the first loss increases. The competitiveness of the mortgage insurance execution in the bulk channel may also be impacted by changes in our view of the risk of the business, which is affected by the historical performance of previously insured pools and our expectations for regional and local real estate values. As a result of the sensitivities discussed above, bulk volume can vary materially from period to period.
Pool insurance
     In addition to providing primary insurance coverage, we also insure pools of mortgage loans. New pool risk written during the three months ended September 30, 2006 and 2005 was $43 million and $97 million, respectively. Our direct pool risk in force was $3.1 billion, $2.9 billion and $2.9 billion at September 30, 2006, December 31, 2005 and September 30, 2005, respectively. These risk amounts represent pools of loans with contractual aggregate loss limits and those without such limits. For pools of loans without such limits, risk is estimated based on the amount that would credit enhance the loans in the pool to a ‘AA’ level based on a rating agency model. Under this model, at September 30, 2006 and 2005, for $4.5 billion and $5.1 billion, respectively, of risk without such limits, risk in force was calculated at $472 million and $468 million, respectively. For the three months ended September 30, 2006 and 2005 for $15 million and $98 million, respectively, of risk without contractual aggregate loss limits, new risk written under this model was $1 million and $5 million, respectively.
     New pool risk written during the nine months ended September 30, 2006 and 2005 was $200 million and $203 million, respectively. Under the model described above, for the nine months ended September 30, 2006 and 2005 for $45 million and $900 million, respectively, of risk without contractual aggregate loss limits, new risk written during those periods was calculated at $3 million and $49 million, respectively.
Net premiums written and earned
     Net premiums written and earned during the third quarter of 2006 decreased due to lower average premium rates, offset by a slight increase in the average insurance in force, when compared to the same period in 2005. Net premiums written and earned during the first nine months of 2006 decreased due to lower average premium rates, as well as a decline in the average insurance in force, when compared to the same period in 2005. Average premium rates declined during these periods due to insurance with deductibles written through the bulk channel. We anticipate that net premiums written and earned in the fourth quarter of 2006 will be lower than the comparable period in 2005, due to lower average premium rates, offset by slight growth in the average insurance in force.
Risk sharing arrangements
     For the quarter ended June 30, 2006, approximately 47.4% of our new insurance written on a flow basis was subject to arrangements with reinsurance subsidiaries of certain mortgage lenders or risk sharing arrangements with the GSEs compared to 47.8% for the quarter ended September 30, 2005. The percentage of new insurance

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written during a period covered by such arrangements normally increases after the end of the period because, among other reasons, the transfer of a loan in the secondary market can result in a mortgage insured during a period becoming part of such an arrangement in a subsequent period. Therefore, the percentage of new insurance written covered by such arrangements is not shown for the current quarter. Premiums ceded in such arrangements are reported in the period in which they are ceded regardless of when the mortgage was insured.
     Continuing a program begun in 2005 to reduce exposure to certain geographical areas and categories of risk, during the first nine months of 2006, we entered into an excess of loss reinsurance agreement under which we ceded approximately $45 million of risk in force to a special purpose reinsurance company. The structure of this reinsurance transaction was similar to two reinsurance transactions entered into in 2005. See the 10-K MD&A under “Results of Consolidated Operations – Risk-sharing arrangements.” The total original risk in force ceded under these three transactions was $130 million. Premiums ceded under these three reinsurance agreements have not been material and are included in “ceded premiums.” We may enter into similar transactions in the future.
Investment income
     Investment income for the third quarter of 2006 increased due to an increase in the average investment yield. Investment income for the first nine months of 2006 increased due to an increase in the average investment yield, offset by a slight decrease in the average amortized cost of invested assets. The portfolio’s average pre-tax investment yield was 4.54% at September 30, 2006 and 4.21% at September 30, 2005. The portfolio’s average after-tax investment yield was 4.01% at September 30, 2006 and 3.79% at September 30, 2005. Our net realized gains in the third quarter and net realized losses in the first nine months of 2006 were immaterial. Our net realized gains in the third quarter and first nine months of 2005 resulted primarily from the sale of fixed maturities.
Other revenue
     The decrease in other revenue in the third quarter of 2006 compared to the third quarter of 2005 is primarily the result of decreased revenue from contract underwriting, offset by additional revenue from the operation of Myers Internet. The increase in other revenue for the first nine months of 2006 compared to the same period in 2005 is primarily the result of additional revenue from the operation of Myers Internet, offset by a decrease in revenue from contract underwriting.
Losses
     As discussed in “Critical Accounting Policies” in the 10-K MD&A, consistent with industry practices, loss reserves for future claims are established only for loans that are currently delinquent. (The terms “delinquent” and “default” are used interchangeably by the Company and are defined as an insured loan with a mortgage payment that is 45 days or more past due.) Loss reserves are established by management’s estimating the number of loans in our inventory of delinquent loans that will not cure their delinquency and thus result in a claim (historically, a substantial majority of delinquent loans have

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cured), which is referred to as the claim rate, and further estimating the amount that we will pay in claims on the loans that do not cure, which is referred to as claim severity.
     The estimated claims rates and claims amounts represent what management believes best reflect the estimate of what will actually be paid on the loans in default as of the reserve date. The estimate of claims rates and claims amounts are based on management’s review of recent trends in default inventory. Management reviews recent trends in the rate at which defaults resulted in a claim (i.e. claims rate), the amount of the claim (i.e. severity), the change in the level of defaults by geography and the change in average loan exposure. The process does not encompass management projecting any correlation between claims rate and claims amounts to projected economic conditions such as changes in unemployment rate, interest rate or housing value. As a result, management’s process to determine reserves does not include quantitative ranges of outcomes that are reasonably likely to occur.
     In considering the potential sensitivity of the factors underlying management’s best estimate of loss reserves, it is possible that even a relatively small change in estimated claim rate or a relatively small percentage change in estimated claim amount could have a significant impact on reserves and, correspondingly, on results of operations. For example, as of the reserve date, a $1,000 change in the average severity reserve factor combined with a 1% change in the average claim rate reserve factor could change the reserve amount by approximately $55 million. Historically, it has not been uncommon for us to experience variability in the development of the reserves at this level or higher, as shown by the historical development of our loss reserves in the table below:
                 
    Losses incurred   Reserve at
    related to   end of
    prior years (1)   prior year
2005
  $ 126,167     $ 1,185,594  
2004
    13,451       1,061,788  
2003
    (113,797 )     733,181  
2002
    74,252       613,664  
2001
    212,126       609,546  
 
(1)   A positive number for a prior year indicates a redundancy of loss reserves, and a negative number for a prior year indicates a deficiency of loss reserves.
     The establishment of loss reserves is subject to inherent uncertainty and requires judgment by management. The actual amount of the claim payments may vary significantly from the loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a drop in housing values that could expose the Company to greater loss, including through resale of properties obtained through foreclosure proceedings. Changes to our estimates could result in material changes to our operations, even in a stable economic environment. Adjustments to reserve estimates are reflected in the financial statements in the periods in which the adjustments are made.

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     Net losses incurred increased in the third quarter of 2006 compared to the same period in 2005 due to a smaller decrease in the estimates regarding how many delinquencies will eventually result in a claim, when compared to the same period in 2005. The decrease in estimates regarding how many delinquencies will result in a claim is the result of recent historical improvements in the claim rate in certain geographical regions, with the exception of the Midwest where recent historical claim rates have not improved. The states of Michigan, Ohio and Indiana accounted for approximately 35% of our losses paid for the third quarter. Additionally, news from the auto industry suggests continued cuts in Midwest employment for the next couple of years.
     The average primary claim paid for the three months ended September 30, 2006 was $29,606 compared to $26,735 for the same period in 2005.
     Net losses incurred increased in the first nine months of 2006 compared to the same period in 2005 due to a larger increase in the estimates regarding how much will be paid on claims, as well as a smaller decrease in the estimates regarding how many delinquencies will eventually result in a claim, when both are compared to the same period in 2005. The increase in estimates regarding how much will be paid on claims is primarily the result of the default inventory containing higher loan exposures with expected higher average claim payments as well as a decrease in our ability to mitigate losses through the sale of properties in some geographical areas. The decrease in estimates regarding how many delinquencies will result in a claim is the result of recent historical improvements in the claim rate in certain geographical regions, with the exception of the Midwest where recent historical claim rates have not improved. The states of Michigan, Ohio and Indiana accounted for approximately 35% of our losses paid for the first nine months of 2006. Additionally, news from the auto industry suggests continued cuts in Midwest employment for the next couple of years.
     The average primary claim paid for the nine months ended September 30, 2006 was $27,874 compared to $26,173 for the same period in 2005.
     Information about the composition of the primary insurance default inventory at September 30, 2006, December 31, 2005 and September 30, 2005 appears in the table below.

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    September 30,   December 31,   September 30,
    2006   2005   2005
Total loans delinquent
    76,301       85,788       78,754  
Percentage of loans delinquent (default rate)
    5.98 %     6.58 %     5.95 %
 
                       
Flow loans delinquent
    41,130       47,051       41,742  
Percentage of flow loans delinquent (default rate)
    3.99 %     4.52 %     3.95 %
 
                       
Bulk loans delinquent
    35,171       38,737       37,012  
Percentage of bulk loans delinquent (default rate)
    14.33 %     14.72 %     13.92 %
 
                       
A-minus and subprime credit loans delinquent*
    33,727       36,485       34,265  
Percentage of A-minus and subprime credit loans delinquent (default rate)
    18.70 %     18.30 %     16.66 %
 
*   A portion of A-minus and subprime credit loans is included in flow loans delinquent and the remainder is included in bulk loans delinquent. Most A-minus and subprime credit loans are written through the bulk channel. A-minus loans have FICO credit scores of 575-619, as reported to MGIC at the time a commitment to insure is issued, and subprime loans have FICO credit scores of less than 575.
     The pool notice inventory decreased from 23,772 at December 31, 2005 to 20,244 at September 30, 2006; the pool notice inventory was 23,033 at September 30, 2005.
Information about net losses paid in 2006 and 2005 appears in the table below.
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
Net paid claims ($ millions)
                               
 
                               
Flow
  $ 67     $ 72     $ 201     $ 217  
Bulk
    69       65       187       187  
Other
    21       20       66       60  
 
                       
 
  $ 157     $ 157     $ 454     $ 464  
 
                       
     Net paid claims in 2006 were $135 million in the first quarter, $162 million in the second quarter and $157 million in the third quarter. The sequential increase in paid claims compared to the first quarter was primarily the result of an acceleration in bankruptcy filings in October 2005 prior to the change in the bankruptcy laws. The effect of this acceleration was that we paid claims in the second and third quarters of 2006 that we would otherwise have paid after these quarters. To a lesser extent, the increase was also the result of the GSE’s lifting of the moratorium on pursuing delinquencies in certain areas of the hurricane impacted states and the beginning of the clearance of a foreclosure backlog in Ohio. The effect of these factors was that claims that would otherwise have been paid before the second and third quarter were paid in those quarters.

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     As of September 30, 2006, 67% of our primary insurance in force was written subsequent to December 31, 2003. On our flow 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 low persistency (which can have the effect of accelerating the period in the life of a book during which the highest claim frequency occurs) and deteriorating economic conditions (which can result in increasing claims following a period of declining claims). On our bulk business, the period of highest claims frequency has generally occurred earlier than in the historical pattern on our flow business.
Underwriting and other expenses
     Underwriting and other expenses in the third quarter and first nine months of 2006 were more than the comparable periods in 2005. The increase was primarily due to additional expenses from Myers Internet, equity based compensation and expansion into international operations. (In the first nine months of 2006, $4.0 million of equity based compensation expenses were related to the adoption of FAS 123R.) The effect of these expense increases was partially offset by lower non-insurance expenses.
Consolidated ratios
     The table below presents our consolidated loss, expense and combined ratios for the periods indicated.
                                 
    Three months ended   Nine months ended
    September 30,   September 30,
    2006   2005   2006   2005
Consolidated Insurance Operations:
                               
 
                               
Loss ratio
    55.7 %     47.8 %     47.9 %     40.9 %
Expense ratio
    16.4 %     15.7 %     16.9 %     15.6 %
 
                               
Combined ratio
    72.1 %     63.5 %     64.8 %     56.5 %
 
                               
     The loss ratio (expressed as a percentage) is the ratio of the sum of incurred losses and loss adjustment expenses to net premiums earned. The increase in the loss ratio in 2006, compared to 2005, is due to an increase in losses incurred and a decrease in premiums earned compared to the prior year. The expense ratio (expressed as a percentage) is the ratio of underwriting expenses to net premiums written. The increase in the expense ratio in 2006, compared to 2005, is due to an increase in underwriting expenses and a decrease in premiums written compared to the prior year. The combined ratio is the sum of the loss ratio and the expense ratio.
Income taxes
     The effective tax rate was 24.0% in the third quarter of 2006, compared to 26.1% in the third quarter of 2005. During those periods, the effective tax rate was below the statutory rate of 35%, reflecting the benefits recognized from tax preferenced investments. Our tax preferenced investments include tax-exempt municipal bonds, interests in mortgage related securities with flow through characteristics and investments in real estate ventures which generate low income housing credits. The

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lower effective tax rate in 2006 resulted from a higher percentage of total income before tax being generated from tax preferenced investments, which resulted from lower levels of underwriting income.
     The effective tax rate was 25.6% in the first nine months of 2006, compared to 27.7% in the first nine months of 2005. The lower effective tax rate in 2006 resulted from a higher percentage of total income before tax being generated from tax preferenced investments, which resulted from lower levels of underwriting income.
Joint ventures
     Our equity in the earnings from the C-BASS and Sherman joint ventures with Radian Group Inc. (“Radian”) and certain other joint ventures and investments, accounted for in accordance with the equity method of accounting, is shown separately, net of tax, on our consolidated statement of operations. The increase in income from joint ventures for the third quarter and first nine months of 2006 compared to the third quarter and first nine months of 2005 is primarily the result of increased equity earnings from each of C-BASS and Sherman.
C-BASS
     Summary C-BASS balance sheets and income statements at the dates and for the periods indicated appear below.
Summary Balance Sheet:
(September 30, 2006 — unaudited
December 31, 2005 — audited)
                 
    September 30,     December 31,  
    2006     2005  
    ($ millions)  
Assets
               
Whole loans
  $ 4,655     $ 4,638  
Securities
    1,923       2,054  
Servicing
    569       468  
Other
    1,285       534  
 
           
Total Assets
  $ 8,432     $ 7,694  
 
           
 
               
Total Liabilities
  $ 7,522     $ 6,931  
 
               
Debt*
    5,809       6,434  
 
               
Owners’ Equity
    910       763  
 
*   Most of which is scheduled to mature within one year or less.
     Included in whole loans and total liabilities at September 30, 2006 were approximately $941 million of assets and the same amount of liabilities from 3rd party

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securitizations that did not qualify for off-balance sheet treatment. The liabilities from these securitizations are not included in Debt in the table above. There were no such assets and liabilities at December 31, 2005.
Summary Income Statement
(Unaudited)
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
    ($ millions)  
Portfolio
  $ 71.6     $ 53.6     $ 256.5     $ 220.7  
Servicing
    94.2       73.8       275.8       213.9  
Money management
    8.0       7.2       24.1       21.4  
Other
                0.1       0.1  
 
                       
Total revenue
    173.8       134.6       556.5       456.1  
 
                               
Total expense
    114.1       89.0       333.9       274.8  
 
                       
 
                               
Income before tax
  $ 59.7     $ 45.6     $ 222.6     $ 181.3  
 
                       
 
                               
Company’s share of pretax income
  $ 27.5     $ 21.0     $ 102.7     $ 83.6  
 
                       
     See “Overview—Business and General Environment—Income from Joint Ventures—C-BASS” for a description of the components of the revenue lines.
     The increased contribution for the third quarter of 2006, compared to the same period in 2005, was primarily due to increased net interest income and servicing revenue. Higher net interest income was the result of a higher average investment portfolio and higher earnings on trust deposits for securities serviced by Litton as well as the overall interest rate movement. The increased servicing revenue was due primarily to Litton’s higher average servicing portfolio.
     In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets (“SFAS 156”), an amendment to SFAS No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. SFAS 156 provides standards for the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. It is effective for fiscal years beginning after September 15, 2006. C-BASS is currently evaluating the effect, if any, the new standard will have on its results of operations and financial position.
     Our investment in C-BASS on an equity basis at September 30, 2006 was $430.1 million. We received $35.2 million in distributions from C-BASS during the first nine months of 2006.

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Sherman
     Summary Sherman balance sheets and income statements at the dates and for the periods indicated appear below.
Summary Balance Sheet:
(September 30, 2006 — unaudited
December 31, 2005 — audited)
                 
    September 30,   December 31,
    2006   2005
    ($ millions)
Total Assets
  $ 1,078     $ 979  
 
Total Liabilities
    900       743  
 
Debt
    727       597  
 
Members’ Equity
    178       236  
     During 2006, the changes in debt and members’ equity were primarily related to a capital distribution paid during the year. We received $103.7 million in distributions in the first nine months of 2006. Our investment in Sherman on an equity basis at September 30, 2006 was $124.9 million. See discussion below on the exercise of the restructured call option, as well as our Current Report on Form 8-K filed on September 15, 2006.

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Summary Income Statement
(Unaudited)
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
    ($ millions)  
Revenues from receivable portfolios
  $ 248.7     $ 224.8     $ 809.9     $ 672.0  
Portfolio amortization
    84.6       71.8       289.5       221.2  
 
                       
Revenues, net of amortization
    164.1       153.0       520.4       450.8  
 
                       
 
                               
Credit card interest income and fees
    93.8       59.4       254.7       121.7  
Other revenue
    2.4       7.1       15.3       30.6  
 
                       
Total revenues
    260.3       219.5       790.4       603.1  
 
                               
Expenses
    179.0       147.3       548.6       397.1  
 
                       
 
                               
Income before tax
  $ 81.3     $ 72.2     $ 241.8     $ 206.0  
 
                       
 
                               
Company’s share of pretax income
  $ 26.7     $ 26.4     $ 82.2     $ 82.0  
 
                       
     Sherman experienced increased net revenues in 2006 from portfolios owned and from the operations of the Credit One Bank, acquired in March 2005. The increase in expenses in 2006 relates to the Credit One acquisition.
     In connection with the restructuring of the Sherman option, effective July 1, 2006, 94% of the existing interests in Sherman were recapitalized into Class A Common Units and the remaining 6% were recapitalized into a combination of Preferred Units and Class B Common Units. After exercise of the option we now own 40.96% of the Class A units and 50% of the Preferred Units. Also upon exercise of the option, the option price paid in excess of the book value, $61.5 million was allocated to Sherman’s assets on our financial records, up to the fair market value of those assets. The written up assets will be amortized over their assumed lives, resulting in additional amortization expense for us above Sherman’s actual amortization expense. The “Company’s share of pretax income” line item in the table above includes $6.6 million of this additional amortization expense for both the three and nine months ended September 30, 2006. The difference between the option price paid over book value and the fair value of the assets is recorded in our financial records as goodwill and will be periodically tested for impairment.
Other Matters
     Under the Office of Federal Housing Enterprise Oversight’s (“OFHEO”) risk-based capital stress test for the GSEs, claim payments made by a private mortgage insurer on GSE loans are reduced below the amount provided by the mortgage insurance policy to reflect the risk that the insurer will fail to pay. Claim payments from an insurer whose

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claims-paying ability rating is ‘AAA’ are subject to a 3.5% reduction over the 10-year period of the stress test, while claim payments from a ‘AA’ rated insurer, such as MGIC, are subject to an 8.75% reduction. The effect of the differentiation among insurers is to require the GSEs to have additional capital for coverage on loans provided by a private mortgage insurer whose claims-paying rating is less than ‘AAA.’ As a result, there is an incentive for the GSEs to use private mortgage insurance provided by a ‘AAA’ rated insurer.
Financial Condition
     In September 2006 the Company issued, in a public offering, $200 million, 5.625% Senior Notes due in 2011. Interest on the Senior Notes is payable semiannually in arrears on March 15 and September 15, beginning on March 15, 2007. The Senior Notes were rated “A-1” by Moody’s, “A” by S&P and “A+” by Fitch. In addition to the recent offering, the Company had $300 million, 5.375% Senior Notes due in November 2015 and $200 million, 6% Senior Notes due in March 2007 outstanding at September 30, 2006. At September 30, 2006 and 2005, the market value of the outstanding debt (which also includes commercial paper) was $776.9 million and $603.6 million, respectively.
     See “Results of Operations–Joint ventures” above for information about the financial condition of C-BASS and Sherman.
     As of September 30, 2006, 82% of the investment portfolio was invested in tax-preferenced securities. In addition, at September 30, 2006, based on book value, approximately 98% of our fixed income securities were invested in ‘A’ rated and above, readily marketable securities, concentrated in maturities of less than 15 years.
     At September 30, 2006, our derivative financial instruments in our investment portfolio were immaterial. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer and type of instrument. At September 30, 2006, the effective duration of our fixed income investment portfolio was 4.8 years. This means that for an instantaneous parallel shift in the yield curve of 100 basis points there would be an approximate 4.8% change in the market value of our fixed income portfolio.
Liquidity and Capital Resources
     Our consolidated sources of funds consist primarily of premiums written and investment income. Positive cash flows are invested pending future payments of claims and other expenses. Management believes that future cash inflows from premiums will be sufficient to meet future claim payments. Cash flow shortfalls, if any, could be funded through sales of short-term investments and other investment portfolio securities subject to insurance regulatory requirements regarding the payment of dividends to the extent funds were required by other than the seller. Substantially all of the investment portfolio securities are held by our insurance subsidiaries.

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     We have a $300 million commercial paper program, which is rated “A-1” by S&P and “P-1” by Moody’s. At September 30, 2006 and 2005, we had $84.3 and $100.0 million in commercial paper outstanding with a weighted average interest rate of 5.36% and 3.80%, respectively. We have a $300 million, five year revolving credit facility expiring in 2010 which will continue to be used as a liquidity back up facility for the outstanding commercial paper. The remaining credit available under the facility after reduction for the amount necessary to support the commercial paper was $215.7 million and $200.0 million at September 30, 2006 and 2005, respectively.
     During the first quarter of 2006, an outstanding interest rate swap contract was terminated. This swap was placed into service to coincide with the committed credit facility, used as a backup for the commercial paper program. Under the terms of the swap contract, we paid a fixed rate of 5.07% and received a variable interest rate based on LIBOR. The swap had an expiration date coinciding with the maturity of the credit facility and was designated as a cash flow hedge. At September 30, 2006 we have no interest rate swaps outstanding.
     (Income) expense on the interest rate swaps for the nine months ended September 30, 2006 and 2005 of approximately ($0.1) million and $0.7 million, respectively, was included in interest expense. Gains or losses arising from the amendment or termination of interest rate swaps are deferred and amortized to interest expense over the life of the hedged items.
     The commercial paper, back-up credit facility and the Senior Notes are obligations of the Company and not of its subsidiaries. We are a holding company and the payment of dividends from our insurance subsidiaries is restricted by insurance regulation. MGIC is the principal source of dividend-paying capacity. In the first nine months of 2006, MGIC paid three quarterly dividends of $55 million each, as well as extraordinary dividends totaling $350 million. As a result of the extraordinary dividends, MGIC cannot currently pay any dividends without regulatory approval. In early November 2006 MGIC received regulatory approval to pay a quarterly dividend of $55 million in the fourth quarter of 2006.
     During the first nine months of 2006, we repurchased 5.9 million shares of Common Stock under publicly announced programs at a cost of $373.0 million. At September 30, 2006, we had authority covering the purchase of an additional 4.9 million shares under these programs. For additional information regarding stock repurchases, see Item 2(c) of Part II of this Quarterly Report on Form 10-Q. From mid-1997 through September 30, 2006, we repurchased 41.4 million shares under publicly announced programs at a cost of $2.3 billion. Funds for the shares repurchased by us since mid-1997 have been provided through a combination of debt, including the Senior Notes and the commercial paper, and internally generated funds.
     Our principal exposure to loss is our obligation to pay claims under MGIC’s mortgage guaranty insurance policies. At September 30, 2006, MGIC’s direct (before any reinsurance) primary and pool risk in force (which is the unpaid principal balance of insured loans as reflected in our records multiplied by the coverage percentage, and taking account of any loss limit) was approximately $53.3 billion. In addition, as part of our contract underwriting activities, we are responsible for the quality of our underwriting decisions in accordance with the terms of the contract underwriting agreements with

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customers. Through September 30, 2006, the cost of remedies provided by us to customers for failing to meet the standards of the contracts has not been material. However, the decreasing trend of home mortgage interest rates over the last several years may have mitigated the effect of some of these costs since the general effect of lower interest rates can be to increase the value of certain loans on which remedies are provided. There can be no assurance that contract underwriting remedies will not be material in the future.
     Our consolidated risk-to-capital ratio was 7.4:1 at both September 30, 2006 and December 31, 2005.
     The risk-to-capital ratios set forth above have been computed on a statutory basis. However, the methodology used by the rating agencies to assign claims-paying ability ratings permits less leverage than under statutory requirements. As a result, the amount of capital required under statutory regulations may be lower than the capital required for rating agency purposes. In addition to capital adequacy, the rating agencies consider other factors in determining a mortgage insurer’s claims-paying rating, including its historical and projected operating performance, business outlook, competitive position, management and corporate strategy.

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Forward-Looking Statements and Risk Factors
     General: Our revenues and losses could be affected by the risk factors referred to under “Location of Risk Factors” below that are applicable to the Company, and our income from joint ventures could be affected by the risk factors referred to under “Location of Risk Factors” that are applicable to C-BASS and Sherman. These risk factors are an integral part of Management’s Discussion and Analysis.
     These 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. Among others, statements that include words such as we “believe”, “anticipate” or “expect”, or words of similar import, are forward looking statements. We are not undertaking any obligation to update any forward looking statements we may make even though these statements may be affected by events or circumstances occurring after the forward looking statements were made.
     Location of Risk Factors: The risk factors are in Item 1 A of our Annual Report on Form 10-K for the year ended December 31, 2005, as supplemented by Part II, Item 1 A of our Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2006 and in Part II, Item 1 A of this Quarterly Report on Form 10-Q. The risk factors in the 10-K, as supplemented by those 10-Qs and through updating of various statistical information, are reproduced in Exhibit 99 to this Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     At September 30, 2006, derivative financial instruments in our investment portfolio were immaterial. We primarily place our investments in instruments that meet investment grade credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer and type of instrument. At September 30, 2006, the effective duration of our fixed income investment portfolio was 4.8 years. This means that for each instantaneous parallel shift in the yield curve of 100 basis points there would be an approximate 4.8% change in the market value of our fixed income investment portfolio.
     Our borrowings under our commercial paper program are subject to interest rates that are variable. See the fourth and fifth paragraphs under “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for a discussion of our interest rate swaps.
ITEM 4. CONTROLS AND PROCEDURES
     Our management, with the participation of our principal executive officer and principal financial officer, has evaluated our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the

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period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer concluded that such controls and procedures were effective as of the end of such period. There was no change in our internal control over financial reporting that occurred during the third quarter of 2006 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1 A. Risk Factors
     With the possible exception of the changes set forth below, there have been no material changes in our risk factors from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The principal changes to the risk factors that are set forth below were also included in Exhibit 99 to our Current Report on Form 8-K dated October 12, 2006. Exhibit 99 set forth our risk factors as part of our press release announcing earnings for the third quarter of 2006. Some of the information in the risk factors in the 10-K has been updated by information in the same risk factor included in that Exhibit 99.
Deterioration in the domestic economy or in home prices in the segment of the market the Company serves or changes in the mix of business may result in more homeowners defaulting and the Company’s losses increasing.
     Losses result from events that reduce a borrower’s ability to continue to make mortgage payments, such as unemployment, 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. Favorable economic conditions generally 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 generally increases the likelihood that borrowers will not have sufficient income to pay their mortgages and can also adversely affect housing values.
     The mix of business the Company writes also affects the likelihood of losses occurring. In recent years, the percentage of the Company’s volume written on a flow basis that includes segments the Company views as having a higher probability of claim has continued to increase. These segments include loans with LTV ratios over 95% (including loans with 100% LTV ratios), FICO credit scores below 620, limited underwriting, including limited borrower documentation, or total debt-to-income ratios of 38% or higher, as well as loans having combinations of higher risk factors.
     Approximately 9% of the Company’s primary risk in force written through the flow channel, and 72% of the Company’s primary risk in force written through the bulk channel, consists of adjustable rate mortgages (“ARMs”). The Company believes that during a prolonged period of rising interest rates, claims on ARMs would be substantially higher than for fixed rate loans, although the performance of ARMs has not been tested in such an environment. Moreover, even if interest rates remain unchanged, claims on ARMs with a “teaser rate” (an initial interest rate that does not fully reflect the index which determines subsequent rates) may also be substantially higher because of the increase in the mortgage payment that will occur when the fully indexed rate becomes effective. In addition, the Company believes the volume of “interest-only” loans (which may also be ARMs) and loans with negative amortization features, such as pay option ARMs, increased in 2005 and 2006. Because interest-only loans and pay option ARMs are a relatively recent development, the Company has no data on their historical performance. The Company believes claim rates on certain of these loans will be substantially higher than on loans without scheduled payment increases that are made to borrowers of comparable credit quality.

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The mortgage insurance industry is subject to the risk of private litigation and regulatory proceedings.
     Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. In recent years, seven mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in late December 2004 following denial of class certification in June 2004. There can be no assurance that MGIC will not be subject to future litigation under RESPA or FCRA or that the outcome of any such litigation would not have a material adverse effect on the Company. In August 2005, the United States Court of Appeals for the Ninth Circuit decided a case under FCRA to which the Company was not a party that may make it more likely that the Company will be subject to litigation regarding when notices to borrowers are required by FCRA.
     In June 2005, in response to a letter from the New York Insurance Department (the “NYID”), the Company provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the NYID requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the NYID that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years. In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MDC”), which regulates insurance, the Company provided the MDC with information about captive mortgage reinsurance and certain other matters. The Company subsequently provided additional information to the MDC. Other insurance departments or other officials, including attorneys general, may also seek information about or investigate captive mortgage reinsurance.
     The anti-referral fee provisions of RESPA provide that the Department of Housing and Urban Development (“HUD”) as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions 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 the Company believes its captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on the Company or the mortgage insurance industry.
The Company’s income from joint ventures could be adversely affected by credit losses, insufficient liquidity or competition affecting those businesses.
     C-BASS: Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) is principally engaged in the business of investing in the credit risk of credit sensitive single-family residential mortgages. C-BASS is particularly exposed to funding risk and to credit risk through ownership of the higher risk classes of mortgage backed securities

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from its own securitizations and those of other issuers. In addition, C-BASS’s results are sensitive to its ability to purchase mortgage loans and securities on terms that it projects will meet its return targets. C-BASS’s mortgage purchases in 2005 and 2006 have primarily been of subprime mortgages, which bear a higher risk of default. Further, a higher proportion of subprime mortgage originations in 2005 and in 2006, as compared to 2004, were interest-only loans, which C-BASS views as having greater credit risk. C-BASS has not purchased any pay option ARMs, which are another type of higher risk mortgage. Credit losses are affected by housing prices. A higher house price at default than at loan origination generally mitigates credit losses while a lower house price at default generally increases losses. Over the last several years, in certain regions home prices have experienced rates of increase greater than historical norms and greater than growth in median incomes. During the period 2003 to 2005, according to the Office of Federal Housing Oversight, home prices nationally increased 27%. Recent forecasts predict that home prices will have minimal if any increase over the remainder of 2006, and may decline in certain regions.
     With respect to liquidity, the substantial majority of C-BASS’s on-balance sheet financing for its mortgage and securities portfolio is dependent on the value of the collateral that secures this debt. C-BASS maintains substantial liquidity to cover margin calls in the event of substantial declines in the value of its mortgages and securities. While C-BASS’s policies governing the management of capital at risk are intended to provide sufficient liquidity to cover an instantaneous and substantial decline in value, such policies cannot guaranty that all liquidity required will in fact be available. Further, approximately 43% of C-BASS’s financing has a term of less than one year, and is subject to renewal risk.
     The interest expense on C-BASS’s borrowings is primarily tied to short-term rates such as LIBOR. In a period of rising interest rates, the interest expense could increase in different amounts and at different rates and times than the interest that C-BASS earns on the related assets, which could negatively impact C-BASS’s earnings.
     Although there has been growth in the volume of subprime mortgage originations in recent years, volume is expected to decline in 2006, which may result in C-BASS purchasing fewer mortgages for securitization. Since 2005, there has been an increasing amount of competition to purchase subprime mortgages, from mortgage originators that formed real estate investment trusts and from firms, such as investment banks and commercial banks, that in the past acted as mortgage securities intermediaries but which are now establishing their own captive origination capacity. Many of these competitors are larger and have a lower cost of capital.
     Sherman: The results of Sherman Financial Group LLC (“Sherman”), which is principally engaged in the business of purchasing and servicing delinquent consumer assets, are sensitive to its ability to purchase receivable portfolios on terms that it projects will meet its return targets. While the volume of charged-off consumer receivables and the portion of these receivables that have been sold to third parties such as Sherman has grown in recent years, there is an increasing amount of competition to purchase such portfolios, including from new entrants to the industry, which has resulted in increases in the prices at which portfolios can be purchased.

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ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES & USE OF PROCEEDS
(c) Repurchase of common stock:
Information about shares of Common Stock repurchased during the third quarter of 2006 appears in the table below.
                                 
                            (d)
                    (c)   Maximum
                    Total Number of   Number of
                    Shares   Shares that May
                    Purchased as   Yet Be
    (a)           Part of Publicly   Purchased
    Total Number of   (b)   Announced   Under the Plans
    Shares   Average Price   Plans or   or Programs
Period   Purchased   Paid per Share   Programs   (A)
July 1, 2006 through July 31, 2006
    1,616,140     $ 58.63       1,616,140       6,001,382  
 
                               
August 1, 2006 through August 31,2006
    165,000     $ 55.27       165,000       5,836,382  
 
                               
September 1, 2006 through September 30, 2006
    915,900     $ 59.96       915,900       4,920,482  
 
                               
Total
    2,697,040     $ 58.88       2,697,040       4,920,482  
 
(A)   On January 26, 2006 the Company announced that its Board of Directors authorized the repurchase of up to ten million shares of our Common Stock in the open market or in private transactions.

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ITEM 6. EXHIBITS
     The accompanying Index to Exhibits is incorporated by reference in answer to this portion of this Item, and except as otherwise indicated in the next sentence, the Exhibits listed in such Index are filed as part of this Form 10-Q. Exhibit 32 is not filed as part of this Form 10-Q but accompanies this Form 10-Q.

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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on November 9, 2006.
         
 
  MGIC INVESTMENT CORPORATION    
 
       
 
  \s\ J. Michael Lauer    
 
       
 
  J. Michael Lauer    
 
  Executive Vice President and    
 
  Chief Financial Officer    
 
       
 
  \s\ Joseph J. Komanecki    
 
       
 
  Joseph J. Komanecki    
 
  Senior Vice President, Controller and    
 
  Chief Accounting Officer    

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INDEX TO EXHIBITS
(Part II, Item 6)
     
Exhibit    
Number   Description of Exhibit
2
  Amended and Restated Call Option Agreement, dated as of September 13, 2006, by and among the Company, Radian Guaranty, Inc., and Sherman Capital, L.L.C. (Incorporated by reference to Exhibit 1.2 in the Company’s Current Report on Form 8-K filed on September 15, 2006)
 
   
11
  Statement Re Computation of Net Income Per Share
 
   
31.1
  Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
 
   
31.2
  Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
 
   
32
  Certification of CEO and CFO under Section 906 of Sarbanes-Oxley Act of 2002 (as indicated in Item 6 of Part II, this Exhibit is not being “filed”)
 
   
99
  Risk Factors included in Item 1 A of our Annual Report on Form 10-K for the year ended December 31, 2005, as supplemented by Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006 and September 30, 2006