SECURITIES AND EXCHANGE COMMISSION
OF THE SECURITIES EXCHANGE ACT OF 1934
FORM 10 - Q
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended March 31, 2003 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 0-4625
OLD REPUBLIC INTERNATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
- ------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes _X_ No___
Shares Outstanding
Class March 31, 2003
- --------------------------------- ----------------------------------
Common Stock / $1 par value 120,626,621
There are 20 pages contained in this report.
2
OLD REPUBLIC INTERNATIONAL CORPORATION
Report on Form 10-Q / March 31, 2003
INDEX
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PAGE NO.
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PART I FINANCIAL INFORMATION:
CONSOLIDATED SUMMARY BALANCE SHEETS 3
CONSOLIDATED SUMMARY STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO CONSOLIDATED SUMMARY FINANCIAL STATEMENTS 7 - 10
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND
RESULTS OF OPERATIONS 11 - 15
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 16
CONTROLS AND PROCEDURES 16
PART II OTHER INFORMATION 17
SIGNATURES 18
CERTIFICATIONS 19 & 20
3
OLD REPUBLIC INTERNATIONAL CORPORATION
CONSOLIDATED SUMMARY BALANCE SHEETS (Unaudited)
($ in Millions)
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March 31, December 31,
2003 2002
---------------- ----------------
<s> <c> <c>
Assets
Investments: Available for sale:
Fixed maturity securities (at fair value) (cost: $5,062.3 and $2,989.4) $5,378.4 $3,172.4
Equity securities (at fair value) (cost: $506.8 and $520.3) 454.1 513.5
Short-term investments (at fair value which approximates cost) 389.9 253.8
Other investments 49.3 ---
---------------- ----------------
Total 6,271.7 3,939.9
---------------- ----------------
Held to maturity:
Fixed maturity securities (at amortized cost) (fair value: $-- and $2,171.7) --- 2,054.1
Miscellaneous investments 8.8 57.4
---------------- ----------------
Total 8.8 2,111.6
---------------- ----------------
Total investments 6,280.6 6,051.5
---------------- ----------------
Other Assets: Cash 52.9 37.2
Accrued investment income 75.5 79.4
Accounts and notes receivable 527.0 512.3
Federal income tax recoverable: Current --- 1.0
Reinsurance balances and funds held 59.0 58.1
Reinsurance recoverable: Paid losses 26.9 28.9
Policy and claim reserves 1,526.7 1,500.3
Deferred policy acquisition costs 204.8 197.8
Sundry assets 253.6 248.5
---------------- ----------------
2,726.7 2,663.8
---------------- ----------------
Total Assets $9,007.3 $8,715.4
================ ================
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Liabilities, Preferred Stock and Common Shareholders' Equity
Liabilities: Future policy benefits $99.7 $103.4
Losses, claims and settlement expenses 3,748.1 3,676.8
Unearned premiums 739.9 709.3
Other policyholders' benefits and funds 64.4 62.3
---------------- ----------------
Total policy liabilities and accruals 4,652.2 4,552.0
Commissions, expenses, fees and taxes 175.0 195.2
Reinsurance balances and funds 133.8 133.4
Federal income tax payable: Current 33.1 ---
Deferred 482.4 445.2
Debt 140.5 141.5
Sundry liabilities 86.5 91.9
Commitments and contingent liabilities --- ---
---------------- ----------------
Total liabilities 5,703.8 5,559.5
---------------- ----------------
Preferred
Stock: Convertible preferred stock --- ---
---------------- ----------------
Common Common stock (*) 123.8 123.7
Shareholders' Additional paid-in capital 253.6 253.1
Equity: Retained earnings 2,785.5 2,700.5
Accumulated other comprehensive income 173.0 111.0
Treasury stock (at cost) (*) (32.6) (32.6)
---------------- ----------------
Total Common Shareholders' Equity 3,303.4 3,155.8
---------------- ----------------
Total Liabilities, Preferred Stock and Common Shareholders' Equity $9,007.3 $8,715.4
================ ================
(*) At March 31, 2003 and December 31, 2002 there were 500,000,000 shares of
common stock, $1.00 par value, authorized, of which 123,819,248 at March
31, 2003 and 123,791,366 at December 31, 2002 were issued and outstanding.
As of the same dates, there were 100,000,000 shares of Class B Common
Stock, $1.00 par value, authorized, of which no shares were issued. Common
shares classified as treasury stock were 3,192,627 and 3,192,597 as of
March 31, 2003 and December 31, 2002, respectively.
See accompanying notes.
4
OLD REPUBLIC INTERNATIONAL CORPORATION
CONSOLIDATED SUMMARY STATEMENTS OF INCOME (Unaudited)
($ in Millions, Except Common Share Data)
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Quarters Ended
March 31,
-----------------------------------
2003 2002
----------------- -----------------
<s> <c> <c>
Revenues: Net premiums earned $583.9 $489.0
Title, escrow and other fees 79.6 62.6
----------------- -----------------
Sub-total 663.6 551.6
Net investment income 69.4 67.0
Realized investment gains (losses) (6.7) 9.7
Other income 12.7 10.5
----------------- -----------------
Net revenues 739.0 639.0
----------------- -----------------
Expenses: Benefits, claims and settlement expenses 249.5 224.9
Underwriting, acquisition and
insurance expenses 333.8 271.2
Interest and other expenses 1.8 2.7
----------------- -----------------
Total expenses 585.2 498.9
----------------- -----------------
Income before income taxes and items below 153.8 140.1
----------------- -----------------
Income Taxes: Currently payable 42.9 29.3
Deferred 6.4 15.1
----------------- -----------------
Total income taxes 49.4 44.5
----------------- -----------------
104.4 95.6
Other items - net --- ---
----------------- -----------------
Net Income: $104.3 $95.5
================= =================
Net Income
Per Share: Basic $0.86 $0.79
================= =================
Diluted $0.86 $0.79
================= =================
Dividends Per
Common Share: Cash dividends $0.16 $0.15
================= =================
Average shares outstanding:
Basic 120,621,469 120,226,110
================= =================
Diluted 121,323,860 121,323,388
================= =================
See accompanying notes.
5
OLD REPUBLIC INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
($ in Millions)
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Quarters Ended
March 31,
------------------------------------
2003 2002
----------------- -----------------
<s> <c> <c>
Net income as reported $104.3 $95.5
----------------- -----------------
Other comprehensive income (loss):
Foreign currency translation adjustment 4.4 0.1
----------------- -----------------
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period 81.6 (13.3)
Less: elimination of pretax realized gains (losses)
included in income as reported (6.7) 9.7
----------------- -----------------
Pretax unrealized gains (losses) on securities
carried at market value 88.4 (23.0)
Deferred income taxes (credits) 30.8 (8.3)
----------------- -----------------
Net unrealized gains (losses) on securities 57.5 (14.6)
----------------- -----------------
Net adjustments 61.9 (14.5)
----------------- -----------------
Comprehensive income $166.3 $81.0
================= =================
See accompanying notes.
6
OLD REPUBLIC INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($ in Millions)
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Quarters Ended
March 31,
------------------------------------
2003 2002
----------------- -----------------
<s> <c> <c>
Cash from operating activities:
Net income $104.3 $95.5
Adjustment to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs (5.8) (3.2)
Premiums and other receivables (10.0) (6.3)
Unpaid claims and related items 37.3 25.1
Future policy benefits and policyholders' funds 31.9 16.2
Income taxes 40.3 24.2
Reinsurance balances and funds 1.2 (6.8)
Accounts payable, accrued expenses and other (2.9) 5.0
----------------- -----------------
Total 196.4 149.7
----------------- -----------------
Cash flows from investing activities:
Sales of fixed maturity securities:
Available for sale:
Maturities and early calls 183.2 99.8
Other 27.3 7.9
Held to maturity:
Maturities and early calls --- 53.9
Other --- ---
Sales of equity securities 10.4 41.9
Sales of other investments 0.8 0.3
Sales of fixed assets for company use 0.6 0.1
Cash and short-term investments of subsidiary acquired --- 0.8
Purchases of fixed maturity securities:
Available for sale (227.8) (262.9)
Held to maturity --- (23.2)
Purchases of equity securities (5.2) (44.4)
Purchases of other investments (1.3) (0.7)
Purchases of fixed assets for company use (5.3) (2.8)
Other-net (1.8) 2.2
----------------- -----------------
Total (19.0) (126.9)
----------------- -----------------
Cash flows from financing activities:
Issuance of preferred and common stocks 0.4 16.5
Repayments of term loans --- (5.0)
Redemption of debentures and notes (0.9) (0.2)
Dividends on common shares (19.2) (17.9)
Dividends on preferred shares --- ---
Other-net (5.8) (2.2)
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Total (25.6) (8.7)
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Increase (decrease) in cash and short-term investments 151.7 14.0
Cash and short-term investments, beginning of period 291.1 336.6
----------------- -----------------
Cash and short-term investments, end of period $442.8 $350.6
================= =================
Supplemental disclosure of cash flow information:
Cash paid during the period for: Interest $0.1 $0.3
================= =================
Income taxes $8.6 $13.5
================= =================
See accompanying notes.
7
OLD REPUBLIC INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED SUMMARY FINANCIAL STATEMENTS (Unaudited)
($ in Millions, Except Share Data)
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1. Accounting Policies and Basis of Presentation:
The accompanying consolidated summary financial statements have been
prepared in conformity with generally accepted accounting principles
("GAAP") as described in the Corporation's latest annual report to
shareholders or as disclosed herein. The financial accounting and reporting
process relies on estimates and on the exercise of judgment, but in the
opinion of management all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the accompanying statements
have been reflected therein.
During the first quarter of 2002, the Company adopted Statement of
Financial Accounting Standards No. 142 (FAS 142) " Goodwill and Other
Intangible Assets". Under FAS 142, goodwill and certain intangible assets
will no longer be amortized against operations but must be tested
periodically for possible impairment of their carrying values. The Company
completed the transitional goodwill impairment test required by FAS 142 in
the first quarter of 2002 and determined that there was no indication of
goodwill or intangible asset impairment. During the first quarter of 2003,
the Company tested the carrying value of its goodwill and intangible assets
and determined that there was no indication of impairment of such assets.
Effective January 1, 2003, the Company elected to reclassify its fixed
maturity securities categorized as held to maturity to the available for
sale classification. The securities involved are primarily utility and
tax-exempt bonds that account for approximately 34 percent of Old
Republic's investment portfolio. The decision was prompted by restrictive
accounting rules affecting held to maturity investment securities. The
necessarily mechanical application of these rules can inhibit the
Corporation's ability to optimally manage its investments from a practical
business point of view. As of March 31, 2003, the net impact of this
reclassification on the Corporation's balance sheet is to increase the
carrying value of invested assets by $119.4 million, deferred tax
liabilities by $41.8 million, and shareholders' equity by $77.6 million, or
approximately 64 cents per share. This change has no income statement
impact, no effect on Old Republic's ability or intent to hold individual
securities to maturity as it may deem appropriate, and does not affect the
Company's necessary long-term orientation in the management of its
business. Going forward, Old Republic's shareholders' equity account
determined on the basis of GAAP could, as a result, reflect somewhat
greater period-to-period volatility as the entire bond, note and stock
investment portfolio will be marked to market on a quarterly basis.
8
2. Common Share Data:
(a) Earnings Per Share - Common share data has been retroactively adjusted
to reflect all stock dividends and splits. The following table provides a
reconciliation of the income and number of shares used in basic and diluted
earnings per share calculations.
Quarters Ended March 31,
--------------------------------
2003 2002
--------------- --------------
<s> <c> <c>
Numerator:
Net Income .............................................................. $ 104.3 $ 95.5
Less preferred stock dividends........................................... -- --
--------------- --------------
Numerator for basic earnings per share -
income available to common stockholders............................... 104.3 95.5
Effect of dilutive securities:
Convertible preferred stock dividends.................................... -- --
--------------- --------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions................................................ $ 104.3 $ 95.5
=============== ==============
Denominator:
Denominator for basic earnings per share -
weighted-average shares............................................... 120,621,469 120,226,110
Effect of dilutive securities:
Stock options............................................................ 696,881 1,073,194
Convertible preferred stock.............................................. 5,510 24,084
--------------- --------------
Dilutive potential common shares......................................... 702,391 1,097,278
--------------- --------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions...................................................... 121,323,860 121,323,388
=============== ==============
Basic earnings per share.................................................... $ 0.86 $ 0.79
=============== ==============
Diluted earnings per share.................................................. $ 0.86 $ 0.79
=============== ==============
(b) Stock Options - For financial reporting purposes, Old Republic records
the exercise of stock options directly in its capital accounts as permitted
under existing accounting pronouncements. The following table shows a
comparison of net income and related per share information as reported, and
on a pro-forma basis on the assumption that the estimated value of stock
options was treated as compensation cost. In estimating the compensation
cost of options, the fair value of options at date of grant has been
calculated using the Black-Scholes option pricing model.
Quarters Ended March 31,
--------------------------------
2003 2002
--------------- --------------
<s> <c> <c>
Comparative data:
Net income:
As reported........................................................... $ 104.3 $ 95.5
Deduct: Total stock-based employee compensation
expenses determined under the fair value based.....................
method for all awards, net of related tax effects.................. 3.5 3.0
--------------- --------------
Pro-forma basis....................................................... $ 100.7 $ 92.5
=============== ==============
Basic earnings per share:
As reported........................................................... $ 0.86 $ 0.79
Pro-forma basis....................................................... 0.84 0.77
Diluted earnings per share:
As reported........................................................... 0.86 0.79
Pro-forma basis....................................................... $ 0.83 $ 0.76
=============== ==============
9
Options granted during the first quarters of 2003 and 2002 were 1,235,000
and 1,137,600, respectively. Options outstanding as of March 31, 2003 and
2002 were 5,989,033 and 5,172,282, respectively. The maximum number of
options available for future issuance as of March 31, 2003 is 1,248,564.
3. Unrealized Appreciation of Investments:
Cumulative net unrealized gains on fixed maturity securities available for
sale and equity securities credited to a separate account in common
shareholders' equity amounted to $179.9 at March 31, 2003. Unrealized
appreciation of investments, before applicable deferred income taxes of
$96.9, at March 31, 2003 included gross unrealized gains and (losses) of
$382.9 and ($105.9), respectively.
For the quarters ended March 31, 2003 and 2002, net unrealized appreciation
(depreciation) of investments, net of deferred income taxes (credits),
amounted to $57.5 and ($14.6), respectively.
4. Information About Segments of Business
The Corporation's business segments are organized as the General Insurance
(property and liability insurance), Mortgage Guaranty, Title Insurance and
Life Insurance Groups. The contributions of Old Republic's insurance
industry segments to consolidated revenues and operating results, and
certain balance sheet data pertaining thereto are shown in the following
tables on the basis of GAAP. Each of the Corporation's segments underwrites
and services only those insurance coverages which may be written by it
pursuant to state insurance regulations and corporate charter provisions.
Segment Reporting
---------------------------------------------------------------------------------------------------------------
Quarters Ended March 31,
--------------------------------
2003 2002
-------------- ---------------
<s> <c> <c>
General Insurance Group:
Net premiums earned..................................................... $ 313.9 $ 268.7
Net investment income and other income (a).............................. 47.9 47.6
-------------- ---------------
Total................................................................. $ 361.8 $ 316.4
============== ===============
Income before taxes..................................................... $ 59.4 $ 40.1
============== ===============
Income tax expense...................................................... $ 17.5 $ 10.6
============== ===============
Mortgage Guaranty Group:
Net premiums earned..................................................... $ 100.0 $ 91.6
Net investment income and other income (a).............................. 24.8 21.8
-------------- ---------------
Total................................................................. $ 124.8 $ 113.4
============== ===============
Income before taxes..................................................... $ 75.9 $ 70.3
============== ===============
Income tax expense...................................................... $ 25.7 $ 23.7
============== ===============
Title Insurance Group:
Net premiums earned..................................................... $ 153.9 $ 113.9
Title, escrow and other fees .......................................... 79.6 62.6
-------------- ---------------
Sub-total............................................................. 233.6 176.5
Net investment income and other income (a).............................. 5.9 5.7
-------------- ---------------
Total................................................................. $ 239.6 $ 182.2
============== ===============
Income before taxes..................................................... $ 25.7 $ 20.1
============== ===============
Income tax expense...................................................... $ 8.8 $ 6.7
============== ===============
Life Insurance Group:
Net premiums earned..................................................... $ 16.0 $ 14.8
Net investment income and other income (a).............................. 1.7 1.8
-------------- ---------------
Total................................................................. $ 17.7 $ 16.6
============== ===============
Income before taxes..................................................... $ 1.3 $ 1.6
============== ===============
Income tax expense...................................................... $ 0.4 $ 0.6
============== ===============
10
Reconciliations of Segments to Consolidated
---------------------------------------------------------------------------------------------------------------
Quarters Ended March 31,
--------------------------------
2003 2002
-------------- ---------------
<s> <c> <c>
Revenues:
Total revenues for reportable segments.................................. $ 744.0 $ 628.7
Net realized investment gains (losses).................................. (6.7) 9.7
Other revenues.......................................................... 2.7 1.6
Elimination of intersegment revenues (b)................................ (0.9) (1.0)
-------------- ---------------
Total consolidated revenues........................................... $ 739.0 $ 639.0
============== ===============
Income before taxes:
Total income before taxes of reportable segments........................ $ 162.4 $ 132.3
Net realized investment gains (losses).................................. (6.7) 9.7
Other sources - net..................................................... (1.9) (1.9)
-------------- ---------------
Income before income taxes ............................................. $ 153.8 $ 140.1
============== ===============
----------
In the above tables, net premiums earned on a GAAP basis differ slightly
from statutory amounts due to certain differences in calculations of
unearned premium reserves under each accounting method.
(a) Including unallocated investment income derived from invested capital
and surplus funds.
(b) Represents results of holding company parent, three minor subsidiaries,
consolidation eliminating adjustments, and general corporate expenses, as
applicable.
5. Legal Proceedings
Legal proceedings against the Company arise in the normal course of
business and usually pertain to claim matters related to insurance policies
and contracts issued by the Corporation's insurance subsidiaries. Other
unusual litigation is discussed below.
In December 1999, a class action lawsuit was filed against the Company in
the Federal District Court for the Southern District of Georgia. The suit
alleges that the Company provided pool insurance and other services to
mortgage lenders at preferential, below market prices in return for
mortgage insurance business, and that such practices violated the Real
Estate Settlement Procedures Act. The Court ruled in favor of a summary
judgment motion filed by the Company and dismissed the lawsuit. The class
plaintiffs appealed, and the U.S. Court of Appeals for the Eleventh Circuit
vacated the judgment and remanded the case back to the District Court. The
Company filed a motion seeking a summary judgment on grounds asserted in
its earlier motion but not considered by the District Court. On February 5,
2003, the District Court denied the plaintiffs' motions to certify a class
in both the lawsuit against the Company and a similar lawsuit pending
before the same Court against another mortgage guaranty insurer. The
plaintiffs have asked the Court to reconsider its ruling or, alternatively,
to certify sub-classes. At this time, the ultimate outcome of this
litigation cannot be foreseen. Between 2000 and March 31, 2003, the Company
has paid or otherwise provided cumulatively $17.8 million, the majority of
which was incurred in 2002, to cover legal defense and other costs
associated with this litigation.
The City and County of San Francisco and certain escrow customers of an
underwritten title agency subsidiary headquartered in the State of
California have filed lawsuits alleging that the subsidiary: 1) failed to
escheat unclaimed escrow funds; 2) charged for services not necessarily
provided; and 3) collected illegal interest payments or fees from banks on
the basis of funds held for escrow customers. The subsidiary in turn
conducted an internal review of its records and concluded that it had
certain liabilities for part of the issues denoted at (1) and (2). The
subsidiary defended against the alleged practice denoted at (3) on the
grounds that such practices are common within the industry, are not in
conflict with any laws or regulations, and other meritorious defenses. The
consolidated lawsuits have been tried and a judgment rendered, affirming in
part and denying in part the subsidiary's defenses. In the aggregate, the
judgment, excluding post-judgment interest, amounts to approximately $33.0
million. The subsidiary has appealed the most significant portions of the
judgment, and management believes the judgment will be substantially
reduced on appeal. Through March 31, 2003, the subsidiary has continually
evaluated its exposures since the litigation began and has paid or
otherwise provided cumulatively $50.6 million, including its best estimate
of its remaining liability and costs associated with all these issues.
11
OLD REPUBLIC INTERNATIONAL CORPORATION
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
Quarters Ended March 31, 2003 and 2002
- --------------------------------------------------------------------------------
OVERVIEW
This analysis pertains to the consolidated accounts of Old Republic
International Corporation which are presented on the basis of generally accepted
accounting principles ("GAAP"). The Company conducts its business through four
separate segments, namely its General (property and liability coverages),
Mortgage Guaranty, Title, and Life insurance groups. This information should be
read in conjunction with the consolidated financial statements and related
footnotes thereto included elsewhere in this document.
CHANGE IN ACCOUNTING POLICIES
During the first quarter of 2002, the Company adopted Statement of Financial
Accounting Standards No. 142 (FAS 142) " Goodwill and Other Intangible Assets".
Under FAS 142, goodwill and certain intangible assets will no longer be
amortized against operations but must be tested periodically for possible
impairment of their carrying values. Within six months of application, a
transitional goodwill impairment test needs to be performed and any resulting
charge is to be reported as a change in accounting principle. At March 31, 2003
and December 31, 2002, the Company's consolidated unamortized goodwill asset
balance was $87.5 million, and the average annual charge from goodwill
amortization to operating results for the three calendar years ended 2001 was
approximately $4.0 million (or 3 cents per average diluted share). The Company
completed the transitional goodwill impairment test required by FAS 142 in the
first quarter of 2002 and determined that there was no indication of goodwill or
intangible asset impairment. During the first quarter of 2003, the Company
tested the carrying value of its goodwill and intangible assets and determined
that there was no indication of impairment of such assets.
Effective January 1, 2003, the Company elected to reclassify its fixed maturity
securities categorized as held to maturity to the available for sale
classification. The securities involved are primarily utility and tax-exempt
bonds that account for approximately 34 percent of Old Republic's investment
portfolio. The decision was prompted by restrictive accounting rules affecting
held to maturity investment securities. The necessarily mechanical application
of these rules can inhibit the Corporation's ability to optimally manage its
investments from a practical business point of view. As of March 31, 2003, the
net impact of this reclassification on the Corporation's balance sheet is to
increase the carrying value of invested assets by $119.4 million, deferred tax
liabilities by $41.8 million, and shareholders' equity by $77.6 million, or
approximately 64 cents per share. This change has no income statement impact, no
effect on Old Republic's ability or intent to hold individual securities to
maturity as it may deem appropriate, and does not affect the Company's necessary
long-term orientation in the management of its business. Going forward, Old
Republic's shareholders' equity account determined on the basis of GAAP could,
as a result, reflect somewhat greater period-to-period volatility as the entire
bond, note and stock investment portfolio will be marked to market on a
quarterly basis.
FINANCIAL POSITION
Old Republic's financial position at March 31, 2003 reflected increases in
assets, liabilities and common shareholders' equity when compared to the
immediately preceding year-end of 3.3%, 2.6% and 4.7%, respectively. Cash and
invested assets represented 71.2% and 70.8% of consolidated assets as of March
31, 2003 and December 31, 2002, respectively. Consolidated operating cash flow
was positive at $196.4 million in the latest quarter, compared to $149.7 million
in the same period of 2002. The increase in consolidated operating cash flow was
largely due to contributions by the Company's three largest operating segments,
most notably the General Insurance Group. As of March 31, 2003, the invested
asset base had increased 3.9% to $6.40 billion when compared to the immediately
preceding year-end principally as a result of greater operating cash flow and an
increase in investments carried at fair value following the aforementioned
reclassification of fixed maturity securities.
Relatively high short-term maturity investment positions continued to be
maintained as of March 31, 2003. Short-term investment positions reflect a large
variety of seasonal and intermediate-term factors including current operating
needs, expected operating cash flows, and investment strategy considerations.
Accordingly, the future level of short-term investments will vary and respond to
the interplay of these factors and may, as a result, increase or decrease from
current levels. During the first quarter of 2003, the Corporation committed
substantially all investable funds in short to intermediate-term fixed maturity
securities. Old Republic continues to adhere to its long-term policy of
investing primarily in investment grade, marketable securities; investable funds
have not been directed to so-called "junk bonds" or types of securities
categorized as derivatives. During the first quarter of 2003, Old Republic's
investment in equity securities decreased 11.6% in relation to the related
invested balance at year-end 2002 principally due to net unrealized losses
caused by declining securities markets. At March 31, 2003, the carrying value of
fixed maturity securities in default as to principal and/or interest was
immaterial in relation to consolidated assets or shareholders' equity.
12
The Company does not own or utilize derivative financial instruments for the
purpose of hedging, enhancing the overall return of its investment portfolio, or
reducing the cost of its debt obligations. Traditional investment management
tools and techniques are employed to address the yield and valuation exposures
of its invested assets base. The long-term fixed maturity investment portfolio
is managed so as to limit various risks inherent in the bond market. Credit risk
is addressed through asset diversification and the purchase of investment grade
securities. Reinvestment rate risk is controlled by concentrating on
non-callable issues, and by taking asset-liability matching considerations into
account; purchases of mortgage and asset backed securities, which have variable
principal prepayment options, are generally avoided. Market value risk is
limited through the purchase of bonds of intermediate maturity. The combination
of these investment management practices is expected to produce a more stable
long-term fixed maturity investment portfolio that is not subject to extreme
interest rate sensitivity and principal deterioration. The market value of the
Company's long-term fixed maturity investment portfolio is sensitive, however,
to fluctuations in the level of interest rates, but not materially affected by
changes in anticipated cash flows caused by any prepayments. The impact of
interest rate movements on the long-term fixed maturity investment portfolio
generally affects net unrealized gains or losses as to securities classified as
available for sale. With a market value of approximately $5.37 billion, the
long-term fixed maturity investment portfolio has an average maturity of 4.0
years and an indicated duration of 3.6. With regard to its $454.1 million equity
portfolio, the Company does not own nor engage in any type of option writing.
Possible declines in values for Old Republic's bond and stock portfolios would
affect negatively the level of the common shareholders' equity account at any
point in time, but would not necessarily result in the recognition of realized
investment losses. In such circumstances, the likely combination of positive
operating cash flow and the scheduled emergence of maturities from the Company's
short duration bond portfolio should provide sufficient funds to meet
obligations to policyholders and claimants, as well as debt service and cash
dividend requirements at the holding company level. The Company reviews the
status and market value changes of its securities portfolio on at least a
quarterly basis during the year, and provisions for other than temporary
impairments in the portfolio's value are evaluated and established at each
quarterly balance sheet date. In management's opinion, the Company's high
quality and diversified portfolio, which consists largely of publicly traded
securities, has been a basic reason for the absence of major impairment
provisions in the periods reported upon. The combination of gains and losses on
sales of securities and such provisions or write-downs of securities are
reflected as realized gains and losses in the income statement. In reviewing
investments for other than temporary impairment, the Company, in addition to a
security's market price history, considers the issuer's operating results,
financial condition and liquidity, its ability to access capital markets, credit
rating trends, most current audit opinion, industry and securities markets
conditions, and analyst expectations, in their totality to reach its
conclusions. The Company recognized other than temporary impairments of
investments in the amounts of $9.5 million and $9.0 million for the quarters
ended March 31, 2003 and 2002, respectively. Unrealized gains or losses on
securities classified as available for sale and carried at fair value are
reflected directly in shareholders' equity, net of deferred income taxes
(credits).
Among other major assets, substantially all of the Company's receivables are not
past due, and reinsurance recoverable balances on paid or estimated unpaid
losses are deemed to be fairly stated and recoverable from solvent reinsurers.
Deferred policy acquisition costs are estimated by taking into account the
variable costs of producing specific types of insurance policies, and evaluating
their recoverability on the basis of recent trends in claims costs. The
Company's deferred acquisition cost balances have not fluctuated substantially
from period-to-period and do not represent significant percentages of assets,
shareholders' equity, or premium reserves.
The parent holding company meets its liquidity and capital needs principally
through dividends paid by its subsidiaries. The insurance subsidiaries' ability
to pay cash dividends to the parent company is generally restricted by law or
subject to approval of the insurance regulatory authorities of the states in
which they are domiciled. In contemplation of such restrictions and approvals,
the Company can receive up to $227.4 million in dividends from its subsidiaries
in 2003. The liquidity achievable through such permitted dividend payments is
more than adequate to cover the parent holding company's cash outflow
represented mostly by interest on outstanding debt and quarterly cash dividend
payments to shareholders. In addition, Old Republic can access the commercial
paper market for up to $150.0 million to meet unanticipated liquidity needs.
Old Republic's capitalization of $3.44 billion at March 31, 2003 consisted of
debt of $140.5 million, a minor amount of convertible preferred stock, and
common shareholders' equity of $3.30 billion. The increase in the common
shareholders' equity account during the quarter ended March 31, 2003 reflects
primarily the retention of earnings in excess of dividend requirements and an
increase in the value of investments carried at market values. At its March 21,
2002 meeting, the Company's Board of Directors authorized the reacquisition of
up to $200.0 million of common shares as market conditions warrant during the
two year period from that date; no stock has as yet been acquired through March
31, 2003 pursuant to this authorization.
RESULTS OF OPERATIONS
Revenues:
Pursuant to generally accepted accounting principles applicable to the insurance
industry, benefits, claims, and expenses are associated with the related
revenues by means of the provision for policy benefits, the deferral and
subsequent amortization of acquisition costs, and the recognition of incurred
benefits, claims and operating expenses.
13
General insurance (property and liability) and level-term credit life insurance
premiums are reflected in income on a pro-rata-basis. Earned but unbilled
premiums are generally taken into income on the billing date, and adjustments
for retrospective premiums, commissions and similar charges are accrued on the
basis of periodic evaluations of current underwriting experience and contractual
obligations. First year and renewal mortgage guaranty premiums are recognized as
income on a straight-line basis, except that a portion of first year premiums
received for certain high risk policies is deferred and reported as earned over
the estimated policy life, including renewal periods. Single premiums for
mortgage guaranty policies covering more than one year are earned on an
accelerated basis over the policy term. Title insurance premiums are recognized
as income upon the substantial completion of the policy issuance process. Title
abstract, escrow, service, and other fees are taken into income at the time of
closing of the related escrow. Ordinary life premiums are recognized as revenue
when due. Decreasing term credit life and credit disability/accident & health
insurance premiums are generally earned on a sum-of-the-years-digits or similar
method.
The composition of Old Republic's earned premiums and fees for the periods
reported upon was as follows:
Quarters Ended March 31,
-----------------------------------------
%
2003 2002 Change
------------- ------------ ------------
General........................... $ 313.9 $ 268.7 16.8%
Mortgage Guaranty................. 100.0 91.6 9.2
Title............................. 233.6 176.5 32.4
Life & Health..................... 16.0 14.8 8.1
Consolidated.................. $ 663.6 $ 551.6 20.3%
=========================================
In 2003, general insurance premium growth has resulted principally from the
positive pricing and risk selection changes the Company has effected during the
past three years, as well as additional business produced in an environment
marked by a more restrictive marketing stance on the part of many competitors.
Mortgage guaranty premium income trends reflect greater sales opportunities
arising from strong housing and mortgage lending markets, offset in part by a
high level of mortgage refinancing activity and a greater amount of reinsurance
and similar premium cessions. High loan refinancing activity tends to reduce
mortgage guaranty insurers' policies in force, and thus renewal premium
production, since previously insured mortgages may no longer require coverage or
may become insured by competitors. In both 2003 and 2002 periods, title
insurance premium and fee revenues reflect a continuation of favorable market
conditions for the sale of new and used homes, and most importantly strong
mortgage refinancing activity driven by a fairly consistent drop in mortgage
rates during the recent past. Premium volume in the Company's smallest segment
of life and health insurance has continued to reflect the flattish trends of the
past several years as growth for the Company's limited product offerings has
been contained or inhibited by significant price competition among life and
health insurers.
Consolidated net investment income of $69.4 million in the first quarter of 2003
was up slightly when compared to $67.0 million posted in the same period of 2002
due to the continuation of a lower yield environment which partially offset the
positive effect of growth in the Company's invested asset base. The average
annualized yield on investments was 4.8% and 5.2% for the quarters ended March
31, 2003 and 2002, respectively. Yield trends reflect at once the relatively
short maturity of Old Republic's fixed maturity securities portfolio and a
continuation of a progressively lower yield environment during recent quarterly
periods.
The Company's investment policies have not been designed to maximize realized
investment gains. Net realized losses of $6.7 million in the first quarter of
2003 and net realized gains of $9.7 million in the prior year period result from
dispositions and the aforementioned write-downs of fixed maturity and equity
securities. Dispositions of fixed maturity securities arise mostly from
scheduled maturities and early calls; for the first quarters of 2003 and 2002,
87.0% and 95.1%, respectively, of all such dispositions resulted from these
factors.
Expenses:
The percentage of net benefits, claims, and related settlement expenses measured
against premiums and related fee revenues of the Company's operating segments
were as follows:
Quarters Ended March 31,
------------------------
2003 2002
-------- --------
General......................................... 69.2% 74.5%
Mortgage Guaranty............................... 15.2 12.5
Title........................................... 5.5 4.7
Life & Health................................... 49.2 54.1
Consolidated................................ 37.6% 40.8%
========================
The general insurance portion of the claims ratio improved in 2003. The positive
underwriting trends are attributable to the steadily improving pricing and risk
selection standards that have been applied in the past three years, as well as
reduced claim frequency and severity in the latest quarter in most parts of Old
Republic's business. Despite an increase in the mortgage guaranty claims ratio,
trends
14
in loan default rates and claim severity remained relatively stable during the
first quarter thus reducing pressure on claim cost provisions. The title
insurance ratio remained in the low single digits for each period shown due to a
continuation of favorable trends in claims frequency and severity for business
underwritten since 1992 in particular. Old Republic's life and health benefit
and claims ratio, while reflecting a decrease in the current quarter due to
reduced benefits and claims costs, can vary widely from period-to-period due to
the relatively small size of this segment's book of business and the material
impact that even a slight change in frequency or severity of death and health
claims can have. The consolidated benefit and claim ratio reflects the changing
effect of period-to-period contributions of each segment to consolidated results
and this ratio's variances within each segment.
Consolidated benefit, claim, and related settlement costs for each of the
Company's business segments are affected by the adequacy of reserves established
for current and prior years' claim occurrences. Such reserves are recorded on a
case by case basis and by means of a large number of formulas and calculations
to cover known as well as incurred but not as yet reported claims at each
balance sheet date. In the aggregate, the Company's record in establishing such
reserves has not indicated deficiencies for many years. However, the reserves
posted by insurers such as the Company are necessarily based on a wide variety
of estimates made by a large number of employees and third parties such as
independent claim adjusters and attorneys, can be affected by lagging claim
emergence or reporting delays, and their ultimate disposition is subject to a
multitude of economic, political, judicial and societal factors that cannot be
anticipated or quantified accurately. Accordingly, there can be no guaranty that
such reserves will always be on the mark.
The ratio of consolidated underwriting, acquisition and other operating expenses
to net premiums and fees earned was 48.1% and 47.0% in the first quarter of 2003
and 2002, respectively. Variations in these consolidated ratios reflect a
continually changing mix of coverages sold and attendant costs of producing
business by the Company's four business segments. The following table sets forth
the expense ratios recorded by each business segment for the periods shown:
Quarters Ended March 31,
-------------------------
2003 2002
-------- --------
General......................................... 25.6% 25.6%
Mortgage Guaranty............................... 25.3 28.5
Title........................................... 86.0 86.7
Life & Health................................... 53.0 46.7
Consolidated................................ 48.1% 47.0%
=========================
Expense ratios for the Company as a whole have remained basically stable for the
periods reported upon. The flat 2003 General Insurance Group expense ratio
reflects the benefits of firm expense management in the face of a greater
revenue base. The same factor affects the expense ratios for Old Republic's
mortgage guaranty and title insurance segments. Consolidated interest and other
corporate charges decreased in 2003 due primarily to reduced interest costs on a
declining debt level.
Pretax and Net Income:
Consolidated income before taxes increased by 9.8% in the first quarter of 2003
when compared to the same period one year ago. The following table reflects each
segment's contribution to pretax operating results, excluding the aforementioned
realized investment gains or losses:
Quarters Ended March 31,
-----------------------------------------
%
2003 2002 Change
------------- ------------ ------------
General........................... $ 59.4 $ 40.1 48.0%
Mortgage Guaranty................. 75.9 70.3 7.9
Title............................. 25.7 20.1 28.0
Life & Health..................... 1.3 1.6 -20.1
Consolidated.................. $ 160.5 $ 130.3 23.1%
=========================================
General Insurance Group earnings improved meaningfully in 2003 by virtue of
better underwriting experience. Further growth of Mortgage Guaranty Group income
from underwriting , and accelerated growth in premiums and fees from greater
refinancing activity which benefitted the Title Insurance Group in particular,
also led to greater contributions to consolidated pretax operating earnings in
the current quarter.
The effective consolidated income tax rate was 32.1% and 31.8% in the first
quarters of 2003 and 2002, respectively. The rates for each period reflect
primarily the varying proportions of pretax operating income derived from
partially tax-sheltered investment income (principally tax-exempt interest) on
the one hand, and the combination of fully taxable investment income, realized
investments gains or losses, and underwriting and service income on the other
hand.
15
OTHER INFORMATION
Reference is here made to "Information About Segments of Business" appearing
elsewhere herein.
Historical data pertaining to the operating performance, liquidity, and other
financial matters applicable to an insurance enterprise such as Old Republic are
not necessarily indicative of results to be achieved in succeeding years. In
addition to the factors cited below, the long-term nature of the insurance
business, seasonal and annual patterns in premium production and incidence of
claims, changes in yields obtained on invested assets, changes in government
policies and free markets affecting inflation rates and general economic
conditions, and changes in legal precedents or the application of law affecting
the settlement of disputed claims can have a bearing on period-to-period
comparisons and future operating results.
Some of the statements made in this report, as well as oral statements or
commentaries made by the Company's official in conference calls following
earnings releases, can constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Any
forward-looking statements, commentaries or inferences contained in this report,
of necessity, involve assumptions, uncertainties, and risks that may affect the
Company's future performance. With regard to Old Republic's General Insurance
segment, its results can be affected in particular by the level of market
competition, which is typically a function of available capital and expected
returns on such capital among competitors, the levels of interest and inflation
rates, and periodic changes in claim frequency and severity patterns caused by
natural disasters, weather conditions, accidents, illnesses, work-related
injuries, and unanticipated external events. Mortgage Guaranty and Title
insurance results can be affected by similar factors and most particularly by
changes in national and regional housing demand and values, the availability and
cost of mortgage loans, employment trends, and default rates on mortgage loans;
mortgage guaranty results may also be affected by various risk-sharing
arrangements with business producers as well as the risk management and pricing
policies of government sponsored enterprises. Life and disability insurance
results can be impacted by the levels of employment and consumer spending, as
well as mortality and health trends. At the parent company level, operating
earnings or losses are generally affected by the amount of debt outstanding and
its cost, as well as interest income on temporary holdings of short-term
investments.
Any forward-looking statements or commentaries speak only as of their dates. Old
Republic undertakes no obligation to publicly update or revise all such
comments, whether as a result of new information, future events or otherwise,
and accordingly they may not be unduly relied upon.
16
OLD REPUBLIC INTERNATIONAL CORPORATION
- --------------------------------------------------------------------------------
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
The information called for by Item 3 is found in the third and fourth unnumbered
paragraphs under the heading "Financial Position" in the "Management Analysis of
Financial Position and Results of Operations" section of this report.
Item 4 - Controls and Procedures
Based on their review and evaluation, conducted within ninety days prior to the
filing date of this quarterly report, the Company's Chief Executive Officer and
Chief Financial Officer are of the opinion that the Company's disclosure
controls and procedures are effective, and that there have been no significant
changes in internal controls or other factors that could significantly affect
these disclosure controls and procedures subsequent to the date of their
evaluation. Disclosure controls and procedures means such controls and
procedures as are designed to ensure that information required to be disclosed
by the Company in its reports filed with the Securities and Exchange Commission
is accumulated and communicated to the aforementioned executives to allow timely
decisions regarding required disclosure.
17
OLD REPUBLIC INTERNATIONAL CORPORATION
FORM 10 - Q
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Principal Executive Officer's Signed Certification of Periodic Report
99.2 Principal Financial Officer's Signed Certification of Periodic Report
(b) Reports on Form 8-K
1. On April 24, 2003, the Company furnished a Current Report on Form 8-K
to incorporate its earnings release dated April 24, 2003 announcing
the results of its operations and its financial condition for the
quarter ended March 31, 2003.
2. On May 8, 2003, Old Republic International Corporation submitted to
the U.S. Securities and Exchange Commission the Certifications of its
Chief Executive Officer and its Chief Financial Officer under Section
906 of the Sarbanes-Oxley Act of 2002 with respect to the Company's
periodic report on Form 10-Q for the quarterly period ended March 31,
2003. The full text of their certifications are included as Exhibit
99.1 and Exhibit 99.2 hereto.
Items other than those listed are omitted because they are not required.
18
SIGNATURE
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.
Old Republic International Corporation
--------------------------------------
(Registrant)
Date: May 8, 2003
-----------
/s/ John S. Adams
--------------------------------------
John S. Adams
Senior Vice President &
Chief Financial Officer
19
CERTIFICATION
I, Aldo C. Zucaro, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Old Republic
International Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 8, 2003
/s/ A.C.Zucaro
-----------------------------------
Aldo C. Zucaro
Chairman and Chief Executive Officer
20
CERTIFICATION
I, John S. Adams, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Old Republic
International Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 8, 2003
/s/ John S. Adams
-----------------------------------
John S. Adams
Senior Vice President and
Chief Financial Officer