UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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: September 30, 2004
or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 001-10607
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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
- -------------------------------------------- ---------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
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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 September 30, 2004
- ----------------------------------- ------------------------------------
Common Stock / $1 par value 182,335,518
There are 30 pages in this report
OLD REPUBLIC INTERNATIONAL CORPORATION
Report on Form 10-Q / September 30, 2004
INDEX
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PAGE NO.
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PART I FINANCIAL INFORMATION:
CONSOLIDATED SUMMARY BALANCE SHEETS 3
CONSOLIDATED SUMMARY STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO CONSOLIDATED SUMMARY FINANCIAL STATEMENTS 7 - 12
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND
RESULTS OF OPERATIONS 13 - 26
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 27
CONTROLS AND PROCEDURES 27
PART II OTHER INFORMATION:
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 28
SIGNATURE 29
EXHIBIT INDEX 30
2
Old Republic International Corporation and Subsidiaries
Consolidated Summary Balance Sheets (Unaudited)
($ in Millions)
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
-------------------- -------------------
<s> <c> <c>
Assets
Investments:
Available for sale:
Fixed maturity securities (at fair value)(cost: $5,988.2 and $5,463.9).............. $ 6,206.6 $ 5,741.1
Equity securities (at fair value)(cost: $453.2 and $439.2).......................... 503.7 513.5
Short-term investments (at fair value which approximates cost)...................... 399.9 403.9
Miscellaneous investments........................................................... 48.4 53.2
-------------------- -------------------
Total........................................................................... 7,158.8 6,711.8
Held to maturity: Miscellaneous investments......................................... 13.5 8.5
-------------------- -------------------
Total investments............................................................... 7,172.3 6,720.4
-------------------- -------------------
Other Assets:
Cash................................................................................ 59.3 47.2
Accrued investment income........................................................... 84.2 81.5
Accounts and notes receivable....................................................... 618.8 564.4
Federal income tax recoverable: Current............................................. 9.7 15.9
Reinsurance balances and funds held................................................. 89.9 69.9
Reinsurance recoverable: Paid losses................................................ 48.4 55.9
Policy and claim reserves.................................. 1,786.1 1,667.8
Deferred policy acquisition costs................................................... 241.6 221.9
Sundry assets....................................................................... 275.3 267.0
-------------------- -------------------
3,213.6 2,991.8
-------------------- -------------------
Total Assets.................................................................... $ 10,386.0 $ 9,712.3
==================== ===================
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities, Preferred Stock, and Common Shareholders' Equity
Liabilities:
Future policy benefits.............................................................. $ 101.4 $ 100.9
Losses, claims and settlement expenses.............................................. 4,342.5 4,022.7
Unearned premiums................................................................... 905.0 814.8
Other policyholders' benefits and funds............................................. 73.3 71.3
-------------------- -------------------
Total policy liabilities and accruals........................................... 5,422.3 5,009.8
Commissions, expenses, fees and taxes............................................... 188.0 206.1
Reinsurance balances and funds...................................................... 149.7 147.8
Federal income tax payable: Deferred................................................ 557.1 556.8
Debt................................................................................ 142.7 137.7
Sundry liabilities.................................................................. 134.4 100.2
Commitments and contingent liabilities.............................................. - -
-------------------- -------------------
Total Liabilities............................................................... 6,594.4 6,158.6
-------------------- -------------------
Preferred Stock:
Convertible preferred stock(*)...................................................... - -
-------------------- -------------------
Common Shareholders' Equity:
Common stock(*)..................................................................... 185.2 184.4
Additional paid-in capital.......................................................... 266.2 245.5
Retained earnings................................................................... 3,163.4 2,896.8
Accumulated other comprehensive income ............................................. 186.7 236.8
Treasury stock (at cost) (*)........................................................ (10.0) (10.0)
-------------------- -------------------
Total Common Shareholders' Equity............................................... 3,791.6 3,553.6
-------------------- -------------------
Total Liabilities, Preferred Stock and Common Shareholders' Equity.............. $ 10,386.0 $ 9,712.3
==================== ===================
(*) At September 30, 2004 and December 31, 2003, there were 75,000,000 shares
of $0.01 par value preferred stock authorized, of which no shares were
outstanding. As of the same dates, there were 500,000,000 shares of common
stock, $1.00 par value, authorized, of which 185,201,100 at September 30,
2004 and 184,471,698 at December 31, 2003 were issued and outstanding. At
September 30, 2004 and December 31, 2003, there were 100,000,000 shares of
Class B Common Stock, $1.00 par value, authorized, of which no shares were
issued. Common shares classified as treasury stock were 2,865,582 as of
September 30, 2004 and 2,865,542 as of December 31, 2003.
See accompanying Notes to Consolidated Summary Financial Statements.
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3
Old Republic International Corporation and Subsidiaries
Consolidated Summary Statements of Income (Unaudited)
($ in Millions, Except Share Data)
- ------------------------------------------------------------------------------------------------------------------------------------
Quarters Ended Nine Months Ended
September 30, September 30,
--------------------------------- ----------------------------------
2004 2003 2004 2003
--------------- -------------- --------------- ---------------
<s> <c> <c> <c> <c>
Revenues:
Net premiums earned.................................... $ 717.5 $ 672.8 $ 2,069.4 $ 1,878.1
Title, escrow, and other fees.......................... 78.7 105.2 234.3 280.8
--------------- -------------- --------------- ---------------
Total premiums and fees............................ 796.3 778.1 2,303.7 2,158.9
Net investment income.................................. 72.8 69.1 214.6 208.6
Other income........................................... 8.9 14.5 28.6 42.0
--------------- -------------- --------------- ---------------
Total operating revenues........................... 878.0 861.8 2,547.0 2,409.5
Realized investment gains.............................. 2.2 4.5 22.7 10.5
--------------- -------------- --------------- ---------------
Total revenues..................................... 880.3 866.4 2,569.8 2,420.1
--------------- -------------- --------------- ---------------
Benefits, Losses and Expenses:
Benefits, claims, and settlement expenses.............. 344.5 289.4 962.7 813.4
Underwriting, acquisition, and other expenses.......... 371.2 397.4 1,102.8 1,090.2
Interest and other charges............................. 2.0 1.5 6.2 5.1
--------------- -------------- --------------- ---------------
Total expenses..................................... 717.8 688.4 2,071.8 1,908.7
--------------- -------------- --------------- ---------------
Income before income taxes and other items ............ 162.4 177.9 498.0 511.3
--------------- -------------- --------------- ---------------
Income Taxes: Currently payable........................ 35.6 46.9 134.5 137.5
Deferred................................. 17.6 10.9 28.6 27.7
--------------- -------------- --------------- ---------------
Total.................................... 53.2 57.9 163.1 165.2
--------------- -------------- --------------- ---------------
109.2 120.0 334.8 346.1
Other items - net...................................... - (.1) (.2) (.2)
--------------- -------------- --------------- ---------------
Net Income............................................. $ 109.1 $ 119.9 $ 334.5 $ 345.8
=============== ============== =============== ===============
Net Income Per Share:
Basic:............................................. $ .60 $ .66 $ 1.84 $ 1.91
=============== ============== =============== ===============
Diluted:........................................... $ .59 $ .65 $ 1.81 $ 1.89
=============== ============== =============== ===============
Average shares outstanding: Basic.................. 182,327,380 181,287,134 182,317,511 181,273,961
=============== ============== =============== ===============
Diluted................ 184,417,471 183,452,643 184,474,671 182,867,660
=============== ============== =============== ===============
Dividends Per Common Share:
Cash dividends .................................... $ .130 $ .113 $ .373 $ .333
=============== ============== =============== ===============
See accompanying Notes to Consolidated Summary Financial Statements.
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4
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
($ in Millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Quarters Ended Nine Months Ended
September 30, September 30,
---------------------------------- ----------------------------------
2004 2003 2004 2003
--------------- --------------- -------------- ---------------
<s> <c> <c> <c> <c>
Net income as reported................................... $ 109.1 $ 119.9 $ 334.5 $ 345.8
--------------- --------------- -------------- ---------------
Other comprehensive income (loss):
Foreign currency translation adjustment............... 5.2 (.1) 2.4 10.7
--------------- --------------- -------------- ---------------
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period..... 66.3 (40.9) (58.0) 180.9
Less: elimination of pretax realized gains
included in income as reported.................. 2.2 4.5 22.7 10.5
--------------- --------------- -------------- ---------------
Pretax unrealized gains (losses) on securities
carried at market value......................... 64.1 (45.5) (80.8) 170.3
Deferred income taxes (credits)..................... 22.4 (15.9) (28.3) 59.6
--------------- --------------- -------------- ---------------
Net unrealized gains (losses) on securities......... 41.6 (29.6) (52.4) 110.7
--------------- --------------- -------------- ---------------
Net adjustments....................................... 46.8 (29.7) (50.0) 121.5
--------------- --------------- -------------- ---------------
Comprehensive income..................................... $ 156.0 $ 90.1 $ 284.4 $ 467.4
=============== =============== ============== ===============
See accompanying Notes to Consolidated Summary Financial Statements.
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5
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($ in Millions)
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Nine Months Ended
September 30,
---------------------------------
2004 2003
-------------- --------------
<s> <c> <c>
Cash flows from operating activities:
Net income................................................................................ $ 334.5 $ 345.8
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs....................................................... (19.2) (19.9)
Premiums and other receivables.......................................................... (39.2) (56.0)
Unpaid claims and related items......................................................... 212.2 140.9
Future policy benefits and policyholders' funds......................................... 78.9 86.5
Income taxes............................................................................ 34.4 25.2
Reinsurance balances and funds.......................................................... (10.7) (20.2)
Accounts payable, accrued expenses and other............................................ 36.9 48.9
-------------- --------------
Total..................................................................................... 627.8 551.3
-------------- --------------
Cash flows from investing activities:
Fixed maturity securities:
Maturities and early calls............................................................. 496.3 583.8
Sales.................................................................................. 87.6 164.2
Sales of equity securities................................................................ 23.4 137.6
Sales of other investments................................................................ 9.1 1.5
Sales of fixed assets for company use..................................................... .8 .4
Cash and short-term investments of subsidiary acquired.................................... 2.5 -
Purchases of fixed maturity securities.................................................... (1,129.1) (1,046.1)
Purchases of equity securities............................................................ (37.2) (105.3)
Purchases of other investments............................................................ (1.6) (3.4)
Purchases of fixed assets for company use................................................. (12.8) (15.3)
Purchases of investment in affiliate...................................................... (1.4) -
Other-net................................................................................. 1.4 1.0
-------------- --------------
Total..................................................................................... (560.8) (281.4)
-------------- --------------
Cash flows from financing activities:
Issuance of preferred and common shares................................................... 11.9 5.1
Redemption of debentures and notes........................................................ (.5) (2.5)
Dividends on common shares................................................................ (67.9) (60.3)
Other-net................................................................................. (2.2) (12.3)
-------------- --------------
Total..................................................................................... (58.8) (70.1)
-------------- --------------
Increase (decrease) in cash and short-term investments 8.1 199.7
Cash and short-term investments, beginning of period...................................... 451.2 291.1
-------------- --------------
Cash and short-term investments, end of period............................................ $ 459.3 $ 490.9
============== ==============
Supplemental disclosure of cash flow information:
Cash paid during the period for: Interest ................................................ $ 4.4 $ 4.5
============== ==============
Income Taxes............................................. $ 126.8 $ 138.1
============== ==============
See accompanying Notes to Consolidated Summary Financial Statements.
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6
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
otherwise 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 statement of the results were recorded for the interim
periods.
The Company adopted Statement of Financial Accounting Standards No. 142 ("FAS
142") "Goodwill and Other Intangible Assets". Under FAS 142, which took
effect for fiscal years beginning after December 15, 2001, all goodwill
resulting from business combinations will no longer be amortized against
operations but must be tested at least annually for possible impairment of
its continued value. Such a test was performed in the first quarters of 2004
and 2003 and did not result in impairment charges. At September 30, 2004 and
December 31, 2003, the Company's consolidated unamortized goodwill asset
balance was $92.3 and $87.5, respectively.
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 accounted 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.
This change has no income statement impact, no effect on Old Republic's
ability 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 could reflect somewhat greater period-to-period volatility as
the entire bond, note and stock investment portfolio will now be marked to
market on a quarterly basis. Nevertheless, the Company believes that its
ability to hold securities until they mature or until such other time when
they can be sold opportunistically are much more significant factors than the
balance sheet or income statement effect of changes in market values at any
point in time.
During the second quarter of 2003, the Company adopted Statement of Financial
Accounting Standards No. 148 ("FAS 148") "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS No. 123" as
described more fully in footnote 2(b) herein.
7
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 Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
<s> <c> <c> <c> <c>
Numerator:
Net Income ........................................ $ 109.1 $ 119.9 $ 334.5 $ 345.8
Less convertible preferred stock dividends ........ - - - -
-------------- -------------- -------------- --------------
Numerator for basic earnings per share -
income available to common stockholders.......... 109.1 119.9 334.5 345.8
Effect of dilutive securities:
Convertible preferred stock dividends ............. - - - -
-------------- -------------- -------------- --------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions.......................... $ 109.1 $ 119.9 $ 334.5 $ 345.8
============== ============== ============== ==============
Denominator:
Denominator for basic earnings per share
weighted-average shares......................... 182,327,380 181,287,134 182,317,511 181,273,961
Effect of dilutive securities:
Stock options...................................... 2,090,091 2,164,983 2,157,160 1,588,042
Convertible preferred stock........................ - 526 - 5,657
-------------- -------------- -------------- --------------
Dilutive potential common shares................... 2,090,091 2,165,509 2,157,160 1,593,699
-------------- -------------- -------------- --------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions................................ 184,417,471 183,452,643 184,474,671 182,867,660
============== ============== ============== ==============
Earnings per share: Basic............................. $ .60 $ .66 $ 1.84 $ 1.91
============== ============== ============== ==============
Diluted........................... $ .59 $ .65 $ 1.81 $ 1.89
============== ============== ============== ==============
8
(b) Stock Options - The Financial Accounting Standards Board has issued FAS
148 for periods starting after December 15, 2002. As of April 1, 2003, the
Company adopted the requirements of FAS 148 utilizing the prospective method.
Under this method, stock-based compensation expense is recognized for awards
granted after the beginning of the fiscal year of adoption. For all other
stock option awards outstanding, the Company continues to use the intrinsic
value method 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 has
been calculated using the Black-Scholes option pricing model. Expense
recognition of stock options granted in 2003 and 2004 reduced earnings per
share by less than one cent per share in this year's third quarter and three
cents per share for the first nine months of 2004. Stock option expense
recognition reduced earnings per share by less than one cent per share in the
third quarter and first nine months of 2003.
Quarters Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
<s> <c> <c> <c> <c>
Comparative data:
Net income:
As reported....................................... $ 109.1 $ 119.9 $ 334.5 $ 345.8
Add: Stock-based compensation expense
included in reported income, net of
related tax effects........................... .4 .2 5.1 1.1
Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of related tax effects.... .5 .3 10.5 4.2
-------------- -------------- -------------- --------------
Pro-forma basis................................... $ 109.0 $ 119.8 $ 329.1 $ 342.7
============== ============== ============== ==============
Basic earnings per share:
As reported....................................... $ .60 $ .66 $ 1.84 $ 1.91
Pro-forma basis................................... .60 .66 1.81 1.89
Diluted earnings per share:
As reported....................................... .59 .65 1.81 1.89
Pro-forma basis................................... $ .59 $ .65 $ 1.78 $ 1.87
============== ============== ============== ==============
Options were granted during the first quarter of 2004 and 2003 for 1,990,500
and 1,852,500 shares of common stock, respectively. Options outstanding as of
September 30, 2004 and 2003 were 9,543,336 and 8,655,010, respectively. The
maximum number of options available for future issuance as of September 30,
2004 is 1,396,795.
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 $181.7 at September 30, 2004. Unrealized
appreciation of investments, before applicable deferred income taxes of
$97.9, at September 30, 2004 included gross unrealized gains and (losses) of
$335.5 and ($55.8), respectively.
For the nine months ended September 30, 2004 and 2003, net unrealized
appreciation (depreciation) of investments, net of deferred income taxes
(credits), amounted to ($52.4) and $110.7, respectively.
9
4. Pension Plans:
The Corporation has three defined benefit pension plans covering a portion of
its work force. The three plans are the Old Republic International Salaried
Employees Restated Retirement Plan (the Old Republic Plan), the Bituminous
Casualty Corporation Retirement Income Plan (the Bituminous Plan) and the Old
Republic National Title Group Pension Plan (the Title Plan). The plans are
defined benefit plans pursuant to which pension payments are based primarily
on years of service and employee compensation near retirement. It is the
Corporation's policy to fund the plans' costs as they accrue. Plan assets are
comprised principally of bonds, common stocks and short-term investments.
The measurement dates used to determine pension measurements are December 31
for the Old Republic Plan and the Bituminous Plan and September 30 for the
Title Plan.
The components of estimated net periodic pension cost for the plans consisted
of the following:
Quarters Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- -------------- -------------- ---------------
<s> <c> <c> <c> <c>
Service cost............................. $ 2.0 $ 1.4 $ 5.5 $ 4.3
Interest cost............................ 2.8 2.7 8.6 8.3
Expected return on plan assets........... (3.7) (3.5) (10.8) (10.5)
Recognized loss.......................... .5 .7 1.7 2.2
--------------- -------------- -------------- ---------------
Net cost................................. $ 1.6 $ 1.4 $ 5.1 $ 4.3
=============== ============== ============== ===============
The companies contributed $5.7 and $10.1 in 2004 and 2003, respectively. Such
contributions reflect amounts required by funding regulations or laws.
10
5. Information About Segments of Business:
The Corporation's business segments are organized as the General Insurance
(property and liability insurance), Mortgage Guaranty and Title Insurance
Groups. Due to immateriality, effective in the second quarter of 2004 the
Company included the results of its small life & health insurance business
with those of its corporate and minor service operations. Prior period data
has been reclassified to achieve consistency with current presentation. 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 results exclude realized investment
gains or losses and impairments as these are aggregated in consolidated
totals. The contributions of Old Republic's insurance industry segments to
consolidated totals are shown in the following table.
Quarters Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2004 2003 2004 2003
----------- ---------- ---------- ----------
<s> <c> <c> <c> <c>
General Insurance Group:
Net premiums earned.................................................. $ 421.3 $ 359.0 $ 1,194.2 $ 1,012.0
Net investment income and other income .............................. 49.8 47.9 147.5 145.1
----------- ---------- ---------- ----------
Total revenues before realized gains.............................. $ 471.1 $ 407.0 $ 1,341.7 $ 1,157.1
=========== ========== ========== ==========
Income before taxes and realized investment gains.................... $ 87.3 $ 64.8 $ 245.0 $ 186.7
=========== ========== ========== ==========
Income tax expense on above.......................................... $ 28.0 $ 19.3 $ 77.5 $ 55.3
=========== ========== ========== ==========
Mortgage Insurance Group:
Net premiums earned.................................................. $ 102.3 $ 100.1 $ 301.5 $ 298.9
Net investment income and other income .............................. 21.3 25.6 65.1 76.2
----------- ---------- ---------- ----------
Total revenues before realized gains.............................. $ 123.7 $ 125.8 $ 366.6 $ 375.1
=========== ========== ========== ==========
Income before taxes and realized investment gains.................... $ 53.7 $ 69.1 $ 170.7 $ 214.9
=========== ========== ========== ==========
Income tax expense on above ......................................... $ 18.0 $ 23.3 $ 57.4 $ 72.2
=========== ========== ========== ==========
Title Insurance Group:
Net premiums earned.................................................. $ 178.2 $ 203.2 $ 525.5 $ 528.4
Title, escrow and other fees......................................... 78.7 105.2 234.3 280.8
----------- ---------- ---------- ----------
Sub-total......................................................... 256.9 308.4 759.8 809.3
Net investment income and other income .............................. 6.6 6.1 19.8 18.0
----------- ---------- ---------- ----------
Total revenues before realized gains (losses)..................... $ 263.6 $ 314.5 $ 779.7 $ 827.4
=========== ========== ========== ==========
Income before taxes and realized investment gains (losses)........... $ 21.1 $ 43.0 $ 65.6 $ 105.2
=========== ========== ========== ==========
Income tax expense on above.......................................... $ 7.3 $ 14.9 $ 22.5 $ 36.4
=========== ========== ========== ==========
Consolidated Revenues:
Total revenues of above Company segments............................. $ 858.5 $ 847.3 $ 2,488.2 $ 2,359.7
Other sources (a).................................................... 20.8 16.1 61.8 53.0
Consolidated net realized investment gains........................... 2.2 4.5 22.7 10.5
Elimination of intersegment revenues (b)............................. (1.3) (1.6) (3.0) (3.2)
----------- ---------- ---------- ----------
Consolidated revenues............................................. $ 880.3 $ 866.4 $ 2,569.8 $ 2,420.1
=========== ========== ========== ==========
Consolidated Income Before Taxes:
Total income before taxes and realized investment
gains of above Company segments................................... $ 162.2 $ 177.0 $ 481.4 $ 506.9
Other sources - net (a).............................................. (2.0) (3.6) (6.1) (6.1)
Consolidated net realized investment gains........................... 2.2 4.5 22.7 10.5
----------- ---------- ---------- ----------
Consolidated income before income taxes........................... $ 162.4 $ 177.9 $ 498.0 $ 511.3
=========== ========== ========== ==========
11
September 30, December 31,
2004 2003
------------------ -------------------
<s> <c> <c>
Consolidated Assets:
General.................................................................... $ 7,104.0 $ 6,603.5
Mortgage................................................................... 2,155.9 2,080.1
Title...................................................................... 742.7 720.5
Other - net (a)............................................................ 383.2 308.0
------------------ -------------------
Consolidated .............................................................. $ 10,386.0 $ 9,712.3
================== ===================
- ---------
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)Represents amounts for Old Republic's small life and health insurance
operations, holding company parent and minor internal service subsidiaries.
(b)Represents consolidation eliminating adjustments.
6. Commitments and Contingent Liabilities:
(a) 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 its insurance subsidiaries. Other legal proceedings
are discussed below.
The City and County of San Francisco and certain escrow customers of an
underwritten title agency subsidiary headquartered in the State of California
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 were 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. The subsidiary has appealed the most
significant portions of the judgment, and management believes the judgment
will be substantially reduced on appeal. Through September 30, 2004, the
subsidiary has continually evaluated its exposures since the litigation began
and has paid or otherwise provided cumulatively $54.2, including its best
estimate of its remaining liability, costs associated with all these issues,
and accumulating interest on the aforementioned judgment.
Purported class actions have been filed in state courts in Ohio and Florida
against the Company's principal title insurance subsidiary, Old Republic
National Title Insurance Company ("ORNTIC"). Substantially similar lawsuits
have been filed against other title insurance companies in New York and
Florida. Plaintiffs allege that, pursuant to rate schedules filed by ORNTIC
with insurance regulators, ORNTIC was required to, but failed to give
consumers a reissue credit on the premiums charged for title insurance
covering mortgage refinancing transactions. Both actions seek damages and
declaratory and injunctive relief. ORNTIC intends to defend vigorously
against these actions, but at this early stage in the litigation the Company
cannot estimate the costs it may incur as the actions proceed to their
conclusions. The Ohio case has been stayed, pending an appeal in a similar
action against another title insurer.
An action was filed in the Federal District court for South Carolina against
the Company's wholly-owned mortgage guaranty insurance subsidiary, Republic
Mortgage Insurance Company ("RMIC"). Similar lawsuits have been filed against
the other six private mortgage insurers in different Federal District Courts.
The action against RMIC seeks certification of a nationwide class of
consumers who were allegedly required to pay for private mortgage insurance
at a cost greater than RMIC's "best available rate". The action alleges that
the decision to insure their loans at a higher rate was based on the
consumers' credit scores and constituted an "adverse action" within the
meaning, and in violation of the Fair Credit Reporting Act, that requires
notice, allegedly not given, to the consumers. The action seeks statutory and
punitive damages, as well as other costs. RMIC intends to defend vigorously
against the action, but at this early stage in the litigation the Company
cannot estimate the costs it may incur as the litigation proceeds to its
conclusion. RMIC has filed a motion to compel arbitration of the dispute with
the named plaintiff.
(b) In April, 2004 the Internal Revenue Service ("IRS") provided the Company
a so-called "30 Day Letter" resulting from a recently completed examination
of tax returns for years 1998 to 2000. In substance, the letter alleges that
certain claim reserve deductions taken through year end 2000 were overstated
and thus served to reduce taxable income for those years. The Company has
made a review of the IRS calculations and has concluded that actual loss
settlements and reserve re-estimates in the three years following December
31, 2000 can disprove the most substantial portions of the alleged reserve
overstatements. Accordingly, the Company intends to defend vigorously the
validity of claim reserve deductions taken in its tax returns. In the event
the Company's position is not fully sustained, payments of any additional
taxes owed would be categorized as timing differences, and as such would
likely have little effect on its GAAP financial statements. The matter has
been assigned to an IRS appeals officer.
12
OLD REPUBLIC INTERNATIONAL CORPORATION
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
Nine Months Ended September 30, 2004 and 2003
($ in Millions, Except Share Data)
- --------------------------------------------------------------------------------
OVERVIEW AND EXECUTIVE SUMMARY
This management analysis of financial position and results of operations
pertains to the consolidated accounts of Old Republic International Corporation.
The Company conducts its business through three major segments, namely, its
General (property and liability), Mortgage Guaranty and Title insurance
segments. A small life and health insurance business is included in the
corporate and other caption. The consolidated accounts are presented on the
basis of generally accepted accounting principles ("GAAP"). This analysis should
be read in conjunction with the most recent annual and quarterly consolidated
financial statements and the footnotes appended to them.
The insurance business is distinguished from most others in that the prices
(premiums) charged for various coverages are set without certainty of the
ultimate benefit and claim costs that will emerge or be incurred, often many
years after issuance of a policy. This basic fact casts Old Republic's business
as a long-term undertaking which is managed with a primary focus on the
achievement of favorable underwriting results over time. In addition to
operating income stemming from Old Republic's basic underwriting and related
services functions, significant revenues are obtained from investable funds
generated by those functions as well as from retained shareholders' capital. In
managing investable funds the Company aims to assure stability of income from
interest and dividends, protection of capital, and sufficient liquidity to meet
insurance underwriting and other obligations as they become payable in the
future. Securities trading and the realization of capital gains are not
objectives. The investment philosophy is therefore best categorized as
emphasizing value, credit quality, and relatively long-term holding periods. The
Company's ability to hold both fixed maturity and equity securities for long
periods of time is enabled by the scheduling of maturities in contemplation of
an appropriate matching of assets and liabilities.
In light of the above factors, the Company's affairs are managed for the
long haul, without regard to the arbitrary strictures of quarterly or even
annual reporting periods that American industry must observe. In Old Republic's
view, short reporting time frames do not comport well with the long-term nature
of much of its business, driven as it is by a strong focus on the fundamental
underwriting and related service functions of the Company. Management believes
that Old Republic's operating results and financial condition can best be
evaluated by observing underwriting performance trends over succeeding five to
ten year intervals. Such time intervals are likely to encompass one or two
economic and/or underwriting cycles, and provide appropriate time frames for
such cycles to run their course and for reserved claim costs to be quantified
with greater finality and effect.
* * *
To aid investment analysis of Company results, both net operating income
and net income figures are given as they highlight the impact of certain
accounting rules or securities market-driven considerations that affect the
recording of investment gains or losses and lead to lessened period-to-period
comparability. The realization of investment gains or losses can be highly
discretionary and arbitrary due to such factors as the timing of individual
securities sales, losses from write-downs of impaired securities, tax-planning
considerations, and changes in investment management judgments relative to the
direction of securities markets or the future prospects of individual investees
or industry sectors. In particular, write-downs of securities deemed other than
temporarily impaired are affected by some of these factors as well as industry
or issuer-specific developments that can call for the recognition of a permanent
loss of market value or non-recoverability of asset cost.
Consolidated pretax earnings in this year's first nine months were affected
adversely by the expensing of stock option benefits of $7.8, (or 3 cents per
share after tax) of which $5.6 represented a charge for a non-recurring vesting
acceleration of stock option costs in this year's first quarter. Stock option
expense charges reduced earnings per share by less than 1 cent per share in the
third quarter and first nine months of 2003. The major components of pretax
income and resulting consolidated GAAP net income discussed in this report were
as follows:
13
Quarters Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2004 2003 2004 2003
-------------- ------------ ------------ ------------
<s> <c> <c> <c> <c>
Pretax operating income (loss):
General .............................................. $ 87.3 $ 64.8 $ 245.0 $ 186.7
Mortgage Guaranty .................................... 53.7 69.1 170.7 214.9
Title ................................................ 21.1 43.0 65.6 105.2
Corporate and other................................... (2.0) (3.6) (6.1) (6.1)
-------------- ------------ ------------ ------------
Sub-total.......................................... 160.2 173.3 475.2 500.7
Realized investment gains ............................ 2.2 4.5 22.7 10.5
-------------- ------------ ------------ ------------
Consolidated pretax income ........................... 162.4 177.9 498.0 511.3
Income taxes....................................... 53.2 57.9 163.1 165.2
-------------- ------------ ------------ ------------
Net income............................................ $ 109.1 $ 119.9 $ 334.5 $ 345.8
============== ============ ============ ============
Components of Diluted Earnings Per Share:
Net operating income .............................. $ .58 $ .64 $ 1.73 $ 1.85
Net realized gains ................................ .01 .01 .08 .04
-------------- ------------ ------------ ------------
Net income ........................................ $ .59 $ .65 $ 1.81 $ 1.89
============== ============ ============ ============
Old Republic's General Insurance Group, which underwrites mostly commercial
property and liability insurance coverages, registered pretax operating income
of $87.3 in this year's third quarter, which compares to $64.8 earned in the
same period of 2003. Net premium revenues in the latest quarterly period rose by
17.4 percent to $421.3, compared to $359.0 one year ago. The composite
underwriting ratio for this year's third quarter was 89.7 percent versus 92.9
percent in the same quarter one year ago. For the first nine months of 2004,
pretax operating income rose by 31.3 percent to $245.0 when compared to $186.7
posted in the like period of 2003. Net premiums earned were $1.19 billion versus
$1.01 billion a year ago, for an increase of 18.0 percent. The composite
underwriting ratio was 90.5 percent compared to 93.6 percent in the same period
last year.
Earned premiums in the General Insurance Group increased as a result of
positive pricing and risk selection changes effected during the past few years,
as well as additional business produced in an environment marked by a more
restrictive marketing stance on the part of many competitors. Underwriting
results in the latest quarter and year-to-date period continued to benefit from
lower claims ratios, and from reasonably firm production and administrative
expense control. The composite underwriting ratio represents the most widely
accepted indicator of underwriting performance in the industry, and Old Republic
has now registered a favorable composite ratio below 100 percent for ten
consecutive quarters. The ratio reached a high of 118.8 percent in the third
quarter of 1999 and has dropped fairly consistently to the most recent lower
levels.
Mortgage Guaranty Group pretax operating income dropped 22.2 percent to
$53.7 in this year's third quarter when compared to the $69.1 posted in the same
quarter of last year. Net premiums earned benefited from improved persistency in
the traditional primary business and increased 2.2 percent to $102.3 from $100.1
earned in the same period of 2003. The composite underwriting ratio rose to 64.0
percent compared to 47.2 percent in last year's third quarter, mostly as a
result of an increase in the claims component to 41.4 percent from 23.3 percent
in 2003.
For the nine months ended September 30, 2004, pretax operating income for
this segment reflected a decline of 20.6 percent to $170.7 from the $214.9
reported in the same period of 2003. Year to date, net premiums earned grew by
0.8 percent to $301.5 from $298.9 earned in the first nine months of last year.
The year to date composite ratio was 60.1 percent compared to 44.5 percent in
2003 with the majority of the increase also attributable to the claim ratio
component.
The higher loss ratios for 2004 periods resulted from greater loss
provisions caused by an increase in paid losses and net reserve additions that
reflect moderately higher expectations of estimated claim frequency and
severity. The expense ratio for the third quarter and first nine months of this
year reflects reductions of 2.1 percent and 0.7 percent, respectively, from
recovery of certain prior years' litigation costs.
Comparative operating results for the Company's Title Insurance Group
declined in both the third quarter and year-to-date periods of 2004. Premium and
fee revenues totaled $256.9 in the third quarter of 2004, down 16.7 percent from
$308.4 a year ago. Pretax operating income dropped to $21.1 from $43.0 in last
year's third quarter. Claim costs remained in line with premium and fee revenue
trends, while other expenses were down 10.5 percent. In combination, these
factors produced a composite ratio of 94.3 percent, compared to 90.7 percent in
the second quarter of 2004, and 88.1 percent in last year's third quarter.
For the first nine months of 2004, premium and fee revenues were $759.8,
down 6.1 percent from $809.3 in 2003. Pretax operating income for the first nine
months of 2004 totaled $65.6, a 37.7 percent decline from $105.2 in 2003. A
composite ratio of 93.9 percent was posted for the year-to-date period, compared
to 89.3 percent in 2003.
The decline in 2004 operating results is primarily attributable to a
substantial reduction in mortgage refinancing revenues which reached a peak in
the third quarter of 2003, without a corresponding decline in certain relatively
fixed operating expenses.
14
Aggregate results for Old Republic's small Life & Health insurance business
and its Holding Company activities reflected pretax net operating deficits of
$6.1 and $2.0 in the first nine months and third quarter of 2004, respectively.
For the same periods of 2003, the comparable operating deficits amounted to $6.1
and $3.6, respectively. These results are reflective of holding company expenses
and debt service costs, investment income on temporary investment holdings, and
moderately higher earnings from Old Republic's combined book of term life and
accident and health business.
Consolidated net investment income rose by 5.3 percent to $72.8 and 2.9
percent to $214.6 in this year's third quarter and first nine months,
respectively. While the Company's consolidated invested asset base has continued
to grow as a result of strong operating cash flows, a general downtrend in
interest rates in the past several years has inhibited a corresponding growth in
investment income. Realized investment gains amounted to $2.2 and $22.7 in the
third quarter and first nine months of 2004, respectively, and $4.5 and $10.5 in
the third quarter and first nine months of 2003, respectively.
Cash and invested assets at September 30, 2004, totaled $7.31 billion, or
$40.12 per share, versus $6.84 billion, or $37.71 per share, at December 31,
2003, and $6.79 billion, or $37.47 per share, at September 30, 2003.
Consolidated operating cash flow grew by 13.9 percent to $627.8 for the first
nine months of 2004, with substantially all of this growth stemming from Old
Republic's General Insurance segment. The investment portfolio reflects a
current allocation of approximately 87 percent in fixed-income investments and 7
percent in equities. As has been the case for many years, it contains little or
no exposure to real estate investments, mortgage-backed securities, derivatives,
junk bonds, private placements or mortgage loans.
Common shareholders' equity grew by 6.7 percent to $3.79 billion at
September 30, 2004, compared to the equivalent balance of $3.55 billion at
December 31, 2003, and $3.57 billion at September 30, 2003. Book value per share
was $20.79 at the end of this year's third quarter, versus $19.57 at year-end
2003, and $19.70 at September 30, 2003.
- --------------------------------------------------------------------------------
MANAGEMENT ANALYSIS
- --------------------------------------------------------------------------------
CHANGES 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 at least annually
for possible impairment of their carrying values. At September 30, 2004 and
December 31, 2003, the Company's consolidated unamortized goodwill asset balance
was $92.3 and $87.5. During the first quarters of 2004 and 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 accounted 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. This change has no income
statement impact, no effect on Old Republic's ability 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 could reflect
somewhat greater period-to-period volatility as the entire bond, note and stock
investment portfolio will now be marked to market on a quarterly basis.
Nevertheless, the Company believes that its ability to hold securities until
they mature or until such other time when they can be sold opportunistically are
much more significant and meaningful factors than the balance sheet or income
statement effect of changes in market values at any point in time.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 148 ("FAS 148") "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS No. 123" for
periods starting after December 15, 2002. As of April 1, 2003, the Company
adopted the requirements of FAS 148 utilizing the prospective method. Under this
method, stock-based compensation expense is recognized for awards granted after
the beginning of the fiscal year of adoption. For all other stock option awards
outstanding, the Company continues to use the intrinsic value method permitted
under existing accounting pronouncements. In estimating the compensation cost of
options, the fair value of options has been calculated using the Black-Scholes
option pricing model. Required stock option compensation charges of $.7 and $7.8
for the third quarter and first nine months of 2004, respectively, reduced
earnings per share by less than one cent per share in the third quarter of 2004
and by three cents per share in the first nine months of 2004, of which $5.6
represented the expense of a non-recurring vesting acceleration of such costs in
the first quarter 2004. Third quarter and first nine months 2003 operating
results were reduced by required stock option compensation charges of $.4 and
$1.7, respectively, reducing earnings per share by less than one cent per share
in the third quarter and first nine months of 2003.
15
FINANCIAL POSITION
The Company's financial position at September 30, 2004 reflected increases
in assets, liabilities and common shareholders' equity of 6.9 percent, 7.1
percent and 6.7 percent, respectively, when compared to the immediately
preceding year-end. Cash and invested assets represented 70.4 percent and 70.5
percent of consolidated assets as of September 30, 2004 and December 31, 2003,
respectively. Consolidated operating cash flow was positive at $627.8 in this
year's first nine months, compared to $551.3 in the same period of 2003. As of
September 30, 2004, the invested asset base increased 6.8 percent to $7,315.9
principally as a result of higher operating cash flow offset by a decline in the
fair value of fixed maturity investments.
During the first nine months of 2004, the Corporation invested
substantially all available funds in short to intermediate-term fixed maturity
securities. At both September 30, 2004 and December 31, 2003, approximately 99
percent of the Company's investments consisted of marketable securities,
including $499.3 and $446.5, respectively, of U.S. Treasury tax and loss bonds
held by its mortgage guaranty subsidiaries for deferred tax purposes. Old
Republic continues to adhere to its long held 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. At
September 30, 2004, Old Republic's commitment to equity securities decreased 1.9
percent in relation to the related invested balance at year-end 2003, mostly as
a result of reduced net unrealized gains. At September 30, 2004, the Company had
no fixed maturity investments in default as to principal and/or interest.
Relatively high short-term maturity investment positions continued to be
maintained as of September 30, 2004. Such positions reflect a large variety of
seasonal and intermediate-term factors including current operating needs,
expected operating cash flows, quarter-end cash flow seasonality, 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.
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. With regard to its
equity portfolio, the Company does not own any options nor does it engage in any
type of option writing. Traditional investment management tools and techniques
are employed to address the yield and valuation exposures of the 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 reduced 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 a general rule, rising
interest rates enhance currently available yields but typically lead to a
reduction in the fair value of existing fixed maturity investments. By contrast,
a decline in such rates reduces currently available yields but usually serves to
increase the fair value of the existing fixed maturity investment portfolio. All
such changes in fair value are reflected, net of deferred income taxes, directly
in the shareholders' equity account, and as a separate component of the
statement of comprehensive income. Given the Company's inability to forecast or
control the movement of interest rates, Old Republic sets the maturity spectrum
of its fixed maturity securities portfolio within parameters of estimated
liability payouts, and focuses the overall portfolio on high quality
investments. By so doing, Old Republic believes it is reasonably assured of its
ability to hold securities to maturity as it may deem necessary in changing
environments, and of ultimately recovering their aggregate cost.
Possible future declines in fair values for Old Republic's bond and stock
portfolios would affect negatively the common shareholders' equity account at
any point in time, but would not necessarily result in the recognition of
realized investment losses. The Company reviews the status and market value
changes of each of its investments on at least a quarterly basis during the
year, and estimates of other than temporary impairments in the portfolio's value
are evaluated and established at each quarterly balance sheet date. In reviewing
investments for other than temporary impairment, the Company, in addition to a
security's market price history, considers the totality of such factors as 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 to reach
its conclusions. Sudden market value declines caused by such adverse
developments as newly emerged or imminent bankruptcy filings, issuer default on
significant obligations, or reports of financial accounting developments that
bring into question the validity of previously reported earnings or financial
condition, are recognized as realized losses as soon as credible publicly
available information emerges to confirm such developments. Accordingly, the
recognition of losses from other than temporary value impairments is subject to
a great deal of judgment as well as turns of events over which the Company can
exercise little or no control. In the event the Company's estimate of other than
temporary impairments is insufficient at any point in time, future periods' net
income would be affected adversely by the recognition of additional realized or
impairment losses, but its financial condition would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses.
16
The following tables show certain information relating to the Company's
fixed maturity and equity portfolios as of the dates shown:
- -------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (*)
- -------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
------------------ ------------------
<s> <c> <c>
Aaa............................................................................. 31.8% 29.7%
Aa.............................................................................. 19.1 19.1
A............................................................................... 28.8 32.0
Baa............................................................................. 19.7 18.5
------------------ ------------------
Total investment grade................................................. 99.4 99.3
All other (**).................................................................. .6 .7
------------------ ------------------
Total.................................................................. 100.0% 100.0%
================== ==================
(*) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(**) "All other" includes non-investment or non-rated small issues of tax-exempt
bonds.
- -------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities
as of September 30, 2004
- -------------------------------------------------------------------------------------------------------------------------------
Gross
Amortized Unrealized
Cost Losses
------------ ------------
<s> <c> <c>
Fixed Maturity Securities by Industry Concentration:
Municipals...................................................................... $ 186.1 $ 1.6
Finance......................................................................... 105.3 1.1
Utilities....................................................................... 73.1 1.1
Service......................................................................... 45.4 .8
Other (includes 16 industry groups)............................................. 402.0 4.0
------------ ------------
Total.................................................................. $ 812.2 (a) $ 8.8
============ ============
(a) Represents 13.5 percent of the total fixed maturity securities portfolio.
- -------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities
as of September 30, 2004
- -------------------------------------------------------------------------------------------------------------------------------
Gross
Unrealized
Cost Losses
------------ ------------
<s> <c> <c>
Equity Securities by Industry Concentration:
Healthcare...................................................................... $ 55.9 $ 16.9
Retail.......................................................................... 24.0 7.3
Utilities....................................................................... 33.7 4.6
Technology...................................................................... 12.7 4.3
Other (includes 8 industry groups).............................................. 54.3 5.7
------------ ------------
Total.................................................................. $ 180.7 (b) $ 39.0 (c)
============ ============
(b) Represents 39.9 percent of the total equity securities portfolio.
(c) Represents 8.6 percent of the cost of the total equity securities
portfolio, while gross unrealized gains represent 19.8 percent of the
portfolio.
17
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified For All Fixed Maturity Securities
as of September 30, 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Amortized Cost
of Fixed Maturity Securities Gross Unrealized Losses
---------------------------------- --------------------------------
Non-Investment Non-Investment
All Grade Only All Grade Only
------------- ------------- ------------ ------------
<s> <c> <c> <c> <c>
Maturity Ranges:
Due in one year or less............................. $ 64.3 $ - $ .2 $ -
Due after one year through five years............... 261.1 - 2.3 -
Due after five years through ten years.............. 474.7 - 6.0 -
Due after ten years................................. 11.8 - .1 -
------------- ------------- ------------ ------------
Total...................................... $ 812.2 (d) $ - $ 8.8 $ -
============= ============= ============ ============
(d) Represents 13.5 percent of the total fixed maturity securities portfolio.
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses
as of September 30, 2004
- --------------------------------------------------------------------------------------------------------------------------------
Amount of Gross Unrealized Losses
-----------------------------------------------------------------------
Total Gross
Less than 20% to 50% More than Unrealized
20% of Cost of Cost 50% of Cost Loss
-------------- ------------- ------------ ------------
<s> <c> <c> <c> <c>
Number of Months in Loss Position:
Fixed Maturity Securities:
One to six months.................... $ 6.3 $ - $ - $ 6.3
Seven to twelve months............... 1.2 - - 1.2
More than twelve months.............. 1.2 - - 1.2
-------------- ------------- ------------ ------------
Total....................... $ 8.8 $ - $ - $ 8.8
============== ============= ============ ============
Equity Securities:
One to six months.................... $ .3 $ 1.8 $ - $ 2.1
Seven to twelve months............... 4.3 6.1 - 10.4
More than twelve months.............. 2.7 21.4 2.1 26.3
-------------- ------------- ------------ ------------
Total....................... $ 7.4 $ 29.3 $ 2.1 $ 39.0
============== ============= ============ ============
Number of Issues in Loss Position:
Fixed Maturity Securities:
One to six months.................... 175 - - 175
Seven to twelve months............... 13 - - 13
More than twelve months.............. 16 - - 16
-------------- ------------- ------------ ------------
Total....................... 204 - - 204 (e)
============== ============= ============ ============
Equity Securities:
One to six months.................... 3 1 - 4
Seven to twelve months............... 5 2 - 7
More than twelve months.............. 7 7 1 15
-------------- ------------- ------------ ------------
Total....................... 15 10 1 26 (e)
============== ============= ============ ============
The aging of issues with unrealized losses employs month-end closing market
price comparisons with an issue's original cost. The percentage reduction from
original cost reflects the decline as of a specific point in time (September 30,
2004) in the above table, and accordingly, is not indicative of a security's
value having been consistently below its cost at the aggregate percentages and
throughout the periods shown.
(e) At September 30, 2004, the number of issues in a loss position represent
14.1 percent as to fixed maturities, and 31.7 percent as to equity
securities of the total number of such issues held by the Company.
18
- --------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- --------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
------------------ ------------------
<s> <c> <c>
Maturity Ranges:
Due in one year or less............................................................ 2.1% 11.0%
Due after one year through five years.............................................. 47.1 50.0
Due after five years through ten years............................................. 45.6 37.7
Due after ten years through fifteen years.......................................... 5.2 1.3
Due after fifteen years............................................................ - -
------------------ ------------------
Total..................................................................... 100.0% 100.0%
================== ==================
Average Maturity................................................................... 4.5 Yrs. 4.5 Yrs.
================== ==================
Duration (f)....................................................................... 4.1 4.0
================== ==================
(f) Duration is used as a measure of bond price sensitivity to interest rate
changes. A duration of 4.1 as of September 30, 2004 implies that a 100
basis point parallel increase in interest rates from current levels would
result in a possible decline in the market value of the long-term fixed
maturity investment portfolio of approximately 4.1 percent.
- --------------------------------------------------------------------------------------------------------------------------------
Composition of Unrealized Gains (Losses)
- --------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
------------------ ------------------
<s> <c> <c>
On Fixed Maturity Securities:
Amortized cost..................................................................... $ 5,988.2 $ 5,463.9
Estimated fair value............................................................... 6,206.6 5,741.1
------------------ ------------------
Gross unrealized gains............................................................. 227.3 285.0
Gross unrealized losses............................................................ (8.8) (7.8)
------------------ ------------------
Net unrealized gains ..................................................... $ 218.4 $ 277.1
================== ==================
On Equity Securities:
Cost............................................................................... $ 453.2 $ 439.2
Estimated fair value............................................................... 503.7 513.5
------------------ ------------------
Gross unrealized gains............................................................. 89.5 98.2
Gross unrealized losses............................................................ (39.0) (23.9)
------------------ ------------------
Net unrealized gains ..................................................... $ 50.5 $ 74.2
================== ==================
- --------------------------------------------------------------------------------------------------------------------------------
Among other major assets, substantially all of the Company's receivables
are not past due. Reinsurance recoverable balances on paid or estimated unpaid
losses are deemed recoverable from solvent reinsurers or have otherwise been
reduced by allowances for estimated amounts unrecoverable. 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 policy 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. The Company can receive up to $321.2
in dividends from its subsidiaries in 2004 without the prior approval of
regulatory authorities. The liquidity achievable through such permitted dividend
payments is more than adequate to cover the parent holding company's currently
expected cash outflows represented mostly by interest on outstanding debt and
Board-declared quarterly cash dividend payments to shareholders. In addition,
Old Republic can access the commercial paper market for up to $150.0 to meet
unanticipated liquidity needs.
Old Republic's capitalization of $3,934.3 at September 30, 2004 consisted
of debt of $142.7 and common shareholders' equity of $3,791.6. The increase in
the common shareholders' equity account during the first nine months of 2004
reflects primarily the retention of earnings in excess of dividend requirements
offset by a decrease in the value of investments carried at market values. At
its March, 2004 meeting, the Company's Board of Directors authorized the
reacquisition of up to $250.0 of common shares as market conditions warrant
during the two year period from that date; no stock had as yet been acquired
through September 30, 2004 pursuant to this authorization.
19
RESULTS OF OPERATIONS
Revenues/ Premiums & Fees:
Pursuant to GAAP applicable to the insurance industry, revenues are
associated with the related benefits, claims, and expenses by means of the
provision for policy benefits, the deferral and subsequent amortization of
applicable acquisition costs, and the recognition of incurred benefits, claims
and operating expenses.
Substantially all general insurance premiums are reflected in income on a
pro-rata basis. Earned but unbilled premiums are generally taken into income on
the billing date, while adjustments for retrospective premiums, commissions and
similar charges or credits are accrued on the basis of periodic evaluations of
current underwriting experience and contractual obligations. Nearly all of the
Company's mortgage guaranty premiums stem from monthly installment policies.
Accordingly, such premiums are fully earned in the month they are reported and
received. With respect to minor numbers of annual or single premium policies,
earned premiums are largely recognized on a pro-rata basis over the terms of the
policies. Title premium and fee revenues stemming from the Company's direct
operations represent approximately 39 percent of such consolidated title
business revenues. Such premiums are generally recognized as income at the
escrow closing date which approximates the policy effective date. Fee income
related to escrow and other closing services is recognized when the related
services have been performed and completed. The remaining 61 percent of
consolidated title premium and fee revenues is produced by independent title
agents and other service providers. Rather than making estimates that could be
subject to significant variance from actual premium and fee production, the
Company recognizes revenues from those sources upon receipt. Such receipts can
reflect a three to four month lag relative to the effective date of the
underlying title policy, and are offset concurrently by production expenses and
claim reserve provisions which, during the past five years, have accounted for
approximately 93 percent of such revenues.
The major sources of Old Republic's earned premiums and fees for the
periods shown were as follows:
% Change
over prior
General Mortgage Title Other Total year period
---------- ---------- ---------- ---------- ---------- -----------
<s> <c> <c> <c> <c> <c> <c>
Years Ended December 31:
1999................................... $ 853.4 $ 300.3 $ 573.8 $ 54.0 $ 1,781.7 -1.6%
2000................................... 857.8 331.4 494.0 53.4 1,736.8 -2.5
2001................................... 1,000.2 353.1 625.3 50.6 2,029.5 16.9
2002................................... 1,184.1 376.2 813.4 50.1 2,423.9 19.4
2003................................... 1,379.5 400.9 1,103.8 51.6 2,936.0 21.1
Quarters Ended September 30:
2003................................... 359.0 100.1 308.4 10.4 778.1 24.8
2004................................... 421.3 102.3 256.9 15.6 796.3 2.3
Nine Months Ended September 30:
2003................................... 1,012.0 298.9 809.3 38.6 2,158.9 23.3
2004................................... $ 1,194.2 $ 301.5 $ 759.8 $ 48.1 $ 2,303.7 6.7%
========== ========== ========== ========== ========== ===========
Earned premiums in the General Insurance Group increased as a result of
positive pricing and risk selection changes the Company has effected during the
past four 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 premiums were up slightly in the current quarter and nearly
flat for the year-to-date period, mostly reflecting rising persistency trends
offset by greater reinsurance cessions. The decline in title premium and fee
revenues in 2004 is primarily attributable to a substantial reduction in
mortgage refinancing revenues.
Revenues/ Net Investment Income:
Net investment income is affected by trends in interest and dividend yields
for the types of securities in which the Company's funds are invested during
individual reporting periods. The following tables reflect the segmented and
consolidated invested asset bases as of the indicated dates, and the investment
income earned and resulting yields on such assets. In calculating yields,
non-interest bearing U.S. Treasury tax and loss bonds, held by the Company's
mortgage guaranty subsidiaries for deferred tax purposes, are necessarily
excluded from the invested asset base. Since the Company can exercise little
control over market values, yields are evaluated on the basis of investment
income earned in relation to the amortized cost of the underlying invested
assets, though yields based on the market values of such assets are also shown
in the statistics below.
20
Market Invested
Invested Assets at Cost Value Assets at
------------------------------------------------------------------- Adjust- Market
General Mortgage Title Other Total ment Value
----------- ----------- --------- --------- ----------- ---------- -----------
<s> <c> <c> <c> <c> <c> <c> <c>
As of December 31:
1999.................. $ 3,116.5 $ 1,131.2 $ 353.3 $ 153.5 $ 4,754.5 $ (34.0) $ 4,720.4
2000.................. 3,112.3 1,333.6 373.7 149.5 4,969.2 98.0 5,067.2
2001.................. 3,198.8 1,542.3 423.9 150.1 5,315.0 219.7 5,534.8
2002.................. 3,446.0 1,700.9 489.6 226.9 5,863.4 305.5 6,169.0
2003.................. 3,798.2 1,827.9 556.9 177.1 6,360.1 360.3 6,720.4
As of September 30:
2003.................. 3,692.2 1,802.4 542.1 270.2 6,307.0 358.6 6,665.6
2004.................. $ 4,092.6 $ 1,937.4 $ 574.7 $ 288.2 $ 6,893.0 $ 279.3 $ 7,172.3
=========== =========== ========= ========= =========== ========== ===========
Net Investment Income Yield at
------------------------------------------------------------------- ------------------------
General Mortgage Title Other Total Cost Market
--------- --------- --------- ---------- ----------- ---------- ----------
<s> <c> <c> <c> <c> <c> <c> <c>
Years Ended
December 31:
1999.................. $ 182.5 $ 45.0 $ 22.3 $ 13.3 $ 263.2 5.8% 5.7%
2000.................. 179.8 56.8 24.0 13.3 273.9 6.0 5.9
2001.................. 175.7 63.3 22.7 12.8 274.7 5.7 5.5
2002.................. 172.5 65.8 22.5 11.7 272.6 5.2 5.0
2003.................. 175.0 65.7 23.5 14.9 279.2 4.9 4.6
Quarters Ended
September 30:
2003.................. 43.1 16.2 5.9 3.8 69.1 4.9 4.6
2004.................. 45.7 16.9 6.4 3.7 72.8 4.7 4.5
Nine Months Ended
September 30:
2003.................. 131.0 49.0 17.6 10.9 208.6 4.9 4.6
2004.................. $ 135.2 $ 50.2 $ 18.9 $ 10.1 $ 214.6 4.7% 4.4%
========= ========= ========= ========== =========== ========== ==========
Consolidated net investment income of $214.6 in the first nine months of
2004 and $72.8 in the third quarter of 2004 was up slightly when compared to
$208.6 and $69.1, respectively, posted in the same periods of 2003 due to a
continuing low yield environment which diluted the benefit of the Company's
growing invested asset base. The average annual yield based on costs of
investments was 4.7 percent and 4.9 percent for the first nine months ended
September 30, 2004 and 2003, 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
periods.
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Rather, these policies aim to
assure a stable source of income from interest and dividends, protection of
capital, and provision of sufficient liquidity to meet insurance underwriting
and other obligations as they become payable in the future. Dispositions of
fixed maturity securities arise mostly from scheduled maturities and early
calls; for the first nine months of 2004 and 2003, 85.0 percent and 78.0
percent, respectively, of all such dispositions resulted from these occurrences.
Dispositions of equity securities at a realized gain or loss reflect such
factors as ongoing assessments of issuers' business prospects, rotation among
industry sectors, and tax planning considerations. Additionally, the amount of
net realized gains and losses registered in any one accounting period is
affected by the aforementioned assessments of securities' values for other than
temporary impairment. As a result of the interaction of all these factors and
considerations, net realized investment gains or losses can vary significantly
from period-to-period, and, in the Company's view, are not indicative of any
particular trend or result in regard to its basic insurance underwriting
business. The following table reflects the composition of net realized gains or
losses for the periods shown:
Quarters Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2004 2003 2004 2003
------------- ------------ ------------ ------------
<s> <c> <c> <c> <c>
Realized Gains (Losses) on Disposition of:
Fixed maturity securities............................... $ 1.3 $ 1.5 $ 3.2 $ 4.8
Equity securities and miscellaneous investments......... .9 10.0 19.4 22.1
------------- ------------ ------------ ------------
Total...................................... 2.2 11.5 22.7 27.0
------------- ------------ ------------ ------------
Impairment losses on:
Fixed maturity securities............................... - - - -
Equity securities and miscellaneous investments......... - (6.9) - (16.4)
------------- ------------ ------------ ------------
Total...................................... - (6.9) - (16.4)
------------- ------------ ------------ ------------
Net realized gains........................................... $ 2.2 $ 4.5 $ 22.7 $ 10.5
============= ============ ============ ============
21
Expenses:
In order to achieve a necessary matching of revenues and expenses, the
Company records the benefits, claims and related settlement costs that have been
incurred during each accounting period. Such costs are affected by the adequacy
of reserve estimates established for current and prior years' claim occurrences.
The establishment of claim reserves by the Company's insurance subsidiaries is a
reasonably complex and dynamic process influenced by a large variety of factors.
These factors include past experience applicable to the anticipated costs of
various types of claims, continually evolving and changing legal theories
emanating from the judicial system, recurring accounting, statistical, and
actuarial studies, the professional experience and expertise of the Company's
claim departments' personnel or attorneys and independent claim adjusters,
ongoing changes in claim frequency or severity patterns such as those caused by
natural disasters, illnesses, accidents, work-related injuries, and changes in
general and industry-specific economic conditions. Consequently, the
reserve-setting process relies on the opinions of a large number of persons, on
the application and interpretation of historical precedent and trends, on
expectations as to future developments, and on management's judgment in
interpreting all such factors. At any point in time, the Company is exposed to
possibly higher than anticipated claim costs due to all of these factors, and to
the evolution, interpretation, and expansion of tort law, as well as the effects
of unexpected jury verdicts.
All reserves are thus based on a large number of assumptions and resulting
estimates which are periodically reviewed and evaluated in the light of emerging
claim experience and changing circumstances. The resulting changes in estimates
are recorded in operations of the periods during which they are made. The
Company believes that its overall reserving practices have been consistently
applied over many years. For at least the past ten years, previously established
reserves have produced reasonable estimates of the cumulative ultimate net costs
of claims incurred. However, no representation is made that ultimate net claim
and related costs will not develop in future years to be greater or lower than
currently established reserve estimates.
In addition to the factors cited in the two preceding paragraphs, certain
events could impact adversely the Company's reserve adequacy and its future
operating results and financial condition. With respect to Old Republic's
General insurance business, such events or exposures would include catastrophic
workers' compensation claims caused by a terrorist attack or a natural disaster
such as an earthquake, legislated retroactive incurrence of previously denied or
settled claims, the levying of major guaranty fund assessments by various states
based on the costs of insurance company failures apportioned against remaining
and financially secure insurers, the future failure of one or more significant
assuming reinsurers that would void or reduce the Company's reinsurance
recoverable for losses paid or in reserve, and greater than expected involuntary
market assessments, such as those caused by forced participation in assigned
risk and similar involuntary market plans, all of which cannot be reasonably
estimated prior to their emergence.
Mortgage guaranty claim reserves could develop deficiently as a result of
an unexpected rise in unemployment which might hinder borrowers' ability to cure
mortgage payment defaults. Significant declines in home prices could also have
similarly adverse effects since salvage recoveries from the sale of properties
obtained through foreclosures could be reduced. Title segment loss reserve
levels could be impacted adversely by such developments as reduced loan
refinancing activity, the effect of which could be to lengthen the period during
which title policies remain exposed to loss emergence, or reductions in either
property values or the volume of transactions which, by virtue of the
speculative nature of some real estate developments, could lead to increased
occurrences of fraud, defalcations or mechanics' liens. As to Old Republic's
small life and health insurance operations, reserve adequacy may be affected
adversely by greater than anticipated medical care cost inflation as well as
greater than expected frequency and severity of claims.
In management's opinion, geographic concentrations of assureds' employees
in the path of an earthquake or acts of terrorism represent the most significant
catastrophic risks to Old Republic's General insurance segment. These risks
would largely impact the workers' compensation line since primary insurers such
as the Company must, by regulation, issue unlimited liability policies. While
Old Republic obtains a degree of protection through its reinsurance program as
to earthquake exposures, and, until 2005 through the Terrorism Risk Insurance
Act of 2002, there is no assurance that recoveries thereunder would be
sufficient to offset the costs of a major calamity nor eliminate its possible
major impact on operating results and financial condition. Old Republic has
availed itself of modeling techniques to evaluate the possible magnitude of
earthquake or terrorist induced claim costs for its most exposed coverage of
workers' compensation. Such models, however, have not been sufficiently
validated by past occurrences, and rely on a large variety and number of
assumptions. As a result, they may not be predictive of possible claims from
future events. With respect to the Company's Mortgage Guaranty business, the
most significant risk lies in the possibility of prolonged economic dislocations
that would result in high unemployment levels and depressed property values
conspiring to magnify loan default rates and resulting claim costs. In Title
insurance, the Company's biggest exposure likely relates to defalcations and
fraud which can result in significant aggregations of claims or non-collection
of insurance premiums. In Life insurance, as in General insurance,
concentrations of insured lives coupled with a catastrophic event would
represent the Company's largest exposure. In all of these regards, current GAAP
accounting does not permit the Company's reserving practices to anticipate and
provide for these exposures before they occur.
22
Most of Old Republic's consolidated claim and related expense reserves stem
from its General insurance business. At September 30, 2004, such reserves
accounted for 88.6 percent and 82.1 percent of consolidated gross and net of
reinsurance reserves, respectively. The following table shows a breakdown of
gross and net of reinsurance claim reserve estimates for major types of
insurance coverages as of that date:
Gross Net
----------- ------------
<s> <c> <c>
Claim and Loss Adjustment Expense Reserves:
Commercial automobile (mostly trucking)........................................................... $ 786.0 $ 638.5
Workers' compensation............................................................................. 1,602.2 799.8
General liability................................................................................. 810.7 332.5
Other coverages................................................................................... 563.0 369.1
Unallocated loss adjustment expense reserves...................................................... 87.2 87.1
----------- ------------
Total general insurance segment reserves 3,849.3 2,227.2
Mortgage guaranty................................................................................. 194.3 192.9
Title............................................................................................. 252.6 252.6
Life and health................................................................................... 21.4 15.4
Unallocated loss adjustment expense reserves - other coverages................................... 24.6 24.6
----------- ------------
Total claim and loss adjustment expense reserves............................................. $ 4,342.5 $ 2,712.9
=========== ============
Asbestosis and environmental claim reserves included in the above
General insurance reserves: Amount...................................................... $ 120.6 $ 99.8
=========== ============
% of total general insurance segment reserves............... 3.1% 4.5%
=========== ============
Old Republic's General insurance business is composed of a large variety of
lines or classes of commercial insurance; it has negligible exposure to personal
lines such as homeowners or private passenger automobile insurance that exhibit
wide diversification of risks, significant frequency of claim occurrences, and
high degrees of statistical credibility. Most of the General Insurance segment's
claim reserves stem from liability insurance coverages for commercial customers.
Liability claims typically require more extended periods of investigation and at
times protracted litigation before they are finally settled, and thus tend to
exhibit loss development and payment patterns that stretch over relatively long
periods of time.
The Company establishes point estimates for most reserves on an insurance
coverage line-by-line basis for individual subsidiaries, sub-classes, or
individual blocks of business that have similar attributes. Actuarially or
otherwise derived ranges of reserve levels are not utilized in setting such
reserves. The reserves listed in the above table represent such point estimates.
Accordingly, the overall reserve level at any point in time represents the
compilation of a very large number of reported ("case") reserve estimates and
the results of a variety of formula calculations intended to cover claims and
related costs not as yet reported or emerged ("IBNR"). Case reserves are based
on continually evolving assessments of the facts available to the Company during
the claim settlement process. Long-term, disability-type workers' compensation
reserves are discounted to present value based on interest rates that range from
3.5 percent to 4.0 percent. Formula calculations are utilized and are intended
to cover IBNR claim costs as well as additional costs that can arise from such
factors as monetary and social inflation, changes in claims administration
processes, changes in reinsurance ceded and recoverability levels, and expected
trends in claim costs and related ratios. Typically, such formulas take into
account so-called link ratios that represent prior years' patterns of incurred
or paid loss trends between succeeding years, or past experience relative to
progressions of the number of claims reported over time and ultimate average
costs per claim. Reserves pertaining to large individual commercial insurance
accounts that exhibit sufficient statistical credibility, and that may be
subject to retrospective premium rating plans or the utilization of varying
levels or types of self-insured retentions are established on an account by
account basis using case reserves and applicable formula-driven methods. For
certain so-called long-tail categories of insurance such as excess liability or
excess workers' compensation, officers and directors' liability, and commercial
umbrella liability relative to which claim development patterns are particularly
long, more volatile, and immature in their early stages of development, the
Company judgmentally establishes the most current accident years' loss reserves
on the basis of expected loss ratios. As actual claims data emerges in
succeeding years, the original accident year loss ratio assumptions are
validated or otherwise adjusted sequentially through the application of
statistical or actuarial projection techniques such as the Bornhuetter/Ferguson
method which utilizes data from the more mature experience of prior years.
Except for a small portion that emanates from ongoing primary insurance
operations, a large majority of the asbestosis and environmental ("A&E") claim
reserves posted by Old Republic stem mainly from its participations in assumed
reinsurance treaties and insurance pools. Substantially all such participations
were discontinued fifteen or more years ago and have since been in run-off
status. With respect to the primary portion of gross A&E reserves, Old Republic
administers the related claims through its claims personnel as well as outside
attorneys, and posted reserves reflect its best estimates of ultimate claim
costs. Claims administration for the assumed portion of the Company's A&E
exposures is handled by the claims departments of unrelated primary or ceding
reinsurance companies. While the Company performs periodic reviews of a portion
of claim files so managed, the overall A&E reserves it establishes respond to
the paid claim and case reserve activity reported to the Company as well as
available industry statistical data such as so-called survival ratios. Such
ratios represent the number of years' average paid losses for the three or five
most recent calendar years that are encompassed by an insurer's A&E reserve
level at any point in time. According to this simplistic appraisal of an
insurer's A&E loss reserve level, Old Republic's average five year survival
ratios stood at 7.0 years (gross) and 12.0 years (net of reinsurance) as of
September 30, 2004. Incurred net losses for asbestosis and environmental claims
have averaged 1.2 percent of General Insurance Group incurred losses for the
five years ended December 31, 2003.
23
Mortgage guaranty loss reserves are based on calculations that take into
account the number of reported insured mortgage loan defaults as of each balance
sheet date, as well as experience-based estimates of loan defaults that have
occurred but have not as yet been reported. Further, the resulting loss reserve
estimates take into account a large number of variables including trends in
claim severity, potential salvage recoveries, expected cure rates for reported
loan defaults at various stages of default, and judgments relative to future
employment levels, housing market activity, and mortgage loan demand and
extensions.
Title insurance and related escrow service loss and loss adjustment expense
reserves are established to cover the estimated settlement costs of known as
well as claims incurred but not reported, concurrently with the recognition of
premium and escrow service revenues. Reserves for known claims are based on an
assessment of the facts available to the Company during the settlement process.
Reserves for claims incurred but not reported are established on the basis of
past experience and evaluations of such variables as changes and trends in the
types of policies issued, changes in real estate markets and interest rate
environments, and changed levels of loan refinancings, all of which can have a
bearing on the emergence, number, and ultimate cost of claims.
In addition to the above reserve elements, the Company establishes reserves
for loss settlement costs that are not directly related to individual claims.
Such reserves are based on prior years' cost experience and trends, and are
intended to cover the unallocated costs of claim departments' administration of
known and IBNR claims.
Substantially all of the Company's reserves for IBNR claims relate to its
general insurance business. As of September 30, 2004, the Company's general
insurance segment carried reserves of $715.3 to cover claims incurred but not as
yet reported as well as for the possible adverse development of known case
reserves. As noted above, the aggregate of these provisions, known collectively
as IBNR reserves, results from the application of many formulas and
reserve-setting approaches that are sensitive to the wide variety of already
enumerated factors. Should these reserves for IBNR claims be understated by 10
percent for a deficiency of $71.5, or 3.2 percent of the Company's net general
insurance reserves as of the most recent balance sheet date, the impact on the
Company's income statement would be to reduce pretax income by that amount.
While the Company has not incurred such a deficiency level on reserves posted as
of the 10 most recent year ends, there can be no assurance that this positive
experience will continue in the future.
The percentage of net benefits, claims, and related settlement expenses
measured against premiums and related fee revenues of the Company's three major
operating segments and in consolidation were as follows:
General Mortgage Title Consolidated
-------------- ------------- ----------- --------------
<s> <c> <c> <c> <c>
Years Ended December 31:
1999............................................. 83.4% 22.3% 4.9% 46.8%
2000............................................. 77.9 15.0 3.6 43.9
2001............................................. 75.3 16.1 4.0 42.4
2002............................................. 72.6 14.1 5.0 40.2
2003............................................. 67.8 22.7 5.8 37.9
Quarters Ended September 30:
2003............................................. 67.1 23.3 5.6 37.2
2004............................................. 66.0 41.4 5.8 43.3
Nine Months Ended September 30:
2003............................................. 68.4 19.5 5.6 37.7
2004............................................. 66.1% 34.4% 5.8% 41.8%
============== ============= =========== ==============
The general insurance portion of the claims ratios has reflected a
reasonably consistent downtrend since 1999. The reduction in this major cost
factor reflects largely the aforementioned pricing and risk selection
improvements that have been applied since 2001, together with elements of
reduced loss severity and frequency. The mortgage guaranty claims ratio has
trended higher since the second quarter of 2003. These trends mostly reflect
increases in claim provisions principally due to such factors as higher loss
payments and expectations of loan default rates, as well as slightly higher
severity and frequency of claims. Title insurance loss ratios have been in the
low single digits in each of the past six years due to a continuation of
favorable trends in claims frequency and severity for business underwritten
since 1992 in particular. The moderate uptrend in title insurance loss ratios
since 2002 stems from a rise in the net provision for ultimate claim costs from
the historically low level achieved in 2001 and 2000. The consolidated benefits
and claims ratios reflect the changing effects of period-to-period contributions
of each segment to consolidated results, and this ratio's variances within each
segment.
The ratio of consolidated underwriting, acquisition, and insurance expenses
to net premiums and fees earned was 45.1 percent and 48.8 percent in the third
quarters of 2004 and 2003, respectively, and 46.2 percent and 48.1 percent for
the first nine months of 2004 and 2003, respectively. Variations in these
consolidated ratios reflect a continually changing mix of coverages sold and
attendant costs of producing business in each of the Company's business
segments. The following table sets forth the expense ratios registered by each
major business segment and in consolidation for the periods shown:
24
General Mortgage Title Consolidated
-------------- ------------- ----------- --------------
<s> <c> <c> <c> <c>
Years Ended December 31:
1999............................................ 28.8% 33.5% 90.9% 50.7%
2000............................................ 28.1 29.6 92.4 47.7
2001............................................ 26.7 27.5 87.2 46.5
2002............................................ 25.8 32.3 85.6 47.9
2003............................................ 25.5 24.8 84.6 48.5
Quarters Ended September 30:
2003............................................ 25.8 23.9 82.5 48.8
2004............................................ 23.7 22.6 88.5 45.1
Nine Months Ended September 30:
2003............................................ 25.2 25.0 83.7 48.1
2004............................................ 24.4% 25.7% 88.1% 46.2%
============== ============= =========== ==============
Consolidated expense ratios have reflected a moderate downtrend since 1999
due to a similar pattern for Old Republic's major operating segments. To a
significant degree, expense ratios for both the general and title insurance
segments are mostly reflective of variable costs, such as commissions or similar
charges, that rise or decline along with corresponding changes in premium and
fee income, as well as changes in general operating expenses which can contract
or expand in differing proportions due to varying levels of operating
efficiencies and expense management opportunities. Mortgage guaranty expense
ratios have displayed a basic downtrend since 1999 mostly due to greater
operating efficiencies. Departures from this downtrend have been due mostly to
higher litigation and product termination costs (2002), reduction in such costs
(2003), and higher stock option compensation expenses in the first quarter of
2004 offset by recovery of certain prior years' litigation costs in the third
quarter of 2004.
The composite ratios of the above net benefits and claims costs and
underwriting and other expenses reflecting the sum total of all the factors
enumerated above have been as follows:
General Mortgage Title Consolidated
-------------- ------------- ----------- --------------
<s> <c> <c> <c> <c>
Years Ended December 31:
1999............................................. 112.2% 55.8% 95.8% 97.5%
2000............................................. 106.0 44.6 96.0 91.6
2001............................................. 102.0 43.6 91.2 88.9
2002............................................. 98.4 46.4 90.6 88.1
2003............................................. 93.3 47.5 90.4 86.4
Quarters Ended September 30:
2003............................................. 92.9 47.2 88.1 86.0
2004............................................. 89.7 64.0 94.3 88.4
Nine Months Ended September 30:
2003............................................. 93.6 44.5 89.3 85.8
2004............................................. 90.5% 60.1% 93.9% 88.0%
============== ============= =========== ==============
The effective consolidated income tax rate was 32.8 percent for both the
third quarter and first nine months of 2004, and 32.5 percent and 32.3 percent
for the same periods of 2003, respectively. The rates for each year reflect
primarily the varying proportions of pretax operating income derived from
partially tax-sheltered investment income (principally state and municipal
tax-exempt interest) on the one hand, and the combination of fully taxable
investment income, realized investment gains or losses, and underwriting and
service income, on the other hand.
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 indicators 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 management in conference calls following
earnings releases, can constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Any such
forward-looking statements, commentaries, or inferences, 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
25
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 impacted 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; additionally,
mortgage guaranty results, may also be impacted by various risk-sharing
arrangements with business producers as well as the risk management and pricing
policies of government sponsored enterprises. Life and health insurance earnings
can be affected by the levels of employment and consumer spending, variations in
mortality and health trends, and changes in policy lapsation rates. At the
parent company level, operating earnings or losses are generally reflective of
the amount of debt outstanding and its cost, interest income on temporary
holdings of short-term investments, and period-to-period variations in the costs
of administering the Company's widespread operations.
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.
26
OLD REPUBLIC INTERNATIONAL CORPORATION
- --------------------------------------------------------------------------------
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
The information called for by Item 3 is found in the fourth and fifth unnumbered
paragraphs, as well as in the table entitled "Age Distribution of Fixed Maturity
Securities" 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
As of the end of the period covered by this quarterly report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Chairman and Chief Executive Officer
(CEO) and Senior Vice President and Chief Financial Officer (CFO), of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Securities Exchange Act Rule 13a-15 (Disclosure
Controls).
The Company's management, including the CEO and CFO, does not expect that its
Disclosure Controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions.
Based upon the Company's controls evaluation, the CEO and CFO have concluded
that the Company's Disclosure Controls provide reasonable assurance that the
information required to be disclosed by the Company in its periodic reports is
accumulated and communicated to management, including the CEO and CFO, as
appropriate to allow timely decisions regarding disclosure and is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms.
There were no changes in the Company's internal control over financial reporting
during the Company's most recent fiscal quarter that materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
27
OLD REPUBLIC INTERNATIONAL CORPORATION
FORM 10-Q
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 6 - Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
31.1 Certification by Aldo C. Zucaro, Chief Executive Officer and the
Interim Principal Financial Officer, pursuant to Rule 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification by Aldo C. Zucaro, Chief Executive Officer and the
Interim Principal Financial Officer, pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
1. On August 16, 2004, the Company furnished a Current Report on Form
8-K to incorporate its press release dated August 12, 2004
announcing the creation of two new directorship positions and the
appointments of Charles F. Titterton and Dennis P. Van Mieghem to
those positions.
2. On October 26, 2004, the Company furnished a Current Report on Form
8-K to incorporate its earnings release dated October 26, 2004
announcing the results of its operations and its financial
condition for the quarter ended September 30, 2004.
28
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: November 8, 2004
------------------------
/s/ Aldo C. Zucaro
--------------------------------------------
Aldo C. Zucaro
Chairman, Chief Executive Officer
and Interim Principal Financial Officer
29
EXHIBIT INDEX
Exhibit
No. Description
- -------------- --------------------------------------------------------------
31.1 Certification by Aldo C. Zucaro, Chief Executive Officer and
the Interim Principal Financial Officer, pursuant to Rule
13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification by Aldo C. Zucaro, Chief Executive Officer and
the Interim Principal Financial Officer, pursuant to Section
1350, Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
30