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: March 31, 2005 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number: 001-10607 --------- OLD REPUBLIC INTERNATIONAL CORPORATION ------------------------------------------------------ (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 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes: _X_/ No:___ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes: _X_/ No:___ Shares Outstanding Class March 31, 2005 - --------------------------------- ---------------------------------- Common Stock / $1 par value 182,700,939 There are 32 pages in this report OLD REPUBLIC INTERNATIONAL CORPORATION Report on Form 10-Q / March 31, 2005 INDEX - -------------------------------------------------------------------------------- PAGE NO. ---------- PART I FINANCIAL INFORMATION: CONSOLIDATED BALANCE SHEETS 3 CONSOLIDATED STATEMENTS OF INCOME 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5 CONSOLIDATED STATEMENTS OF CASH FLOWS 6 NOTES TO CONSOLIDATED SUMMARY FINANCIAL STATEMENTS 7 - 11 MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS 12 - 28 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 29 CONTROLS AND PROCEDURES 29 PART II OTHER INFORMATION: ITEM 5 - OTHER INFORMATION 30 ITEM 6 - EXHIBITS 30 SIGNATURE 31 EXHIBIT INDEX 32 2 Old Republic International Corporation and Subsidiaries Consolidated Balance Sheets (Unaudited) ($ in Millions) - ------------------------------------------------------------------------------------------------------------------------------------ March 31, December 31, 2005 2004 -------------------- ------------------- <s> <c> <c> Assets Investments: Available for sale: Fixed maturity securities (at fair value)(cost: $6,346.4 and $6,273.2).............. $ 6,420.1 $ 6,455.9 Equity securities (at fair value)(cost: $361.3 and $396.8).......................... 413.6 459.0 Short-term investments (at fair value which approximates cost)...................... 509.0 388.6 Miscellaneous investments........................................................... 54.6 54.4 -------------------- ------------------- Total........................................................................... 7,397.5 7,358.1 Other investments................................................................... 13.2 13.4 -------------------- ------------------- Total investments............................................................... 7,410.7 7,371.6 -------------------- ------------------- Other Assets: Cash................................................................................ 64.9 60.5 Securities and indebtedness of related parties...................................... 66.8 60.2 Accrued investment income........................................................... 86.8 87.3 Accounts and notes receivable....................................................... 544.1 543.9 Reinsurance balances and funds held................................................. 79.4 92.5 Reinsurance recoverable: Paid losses................................................ 55.5 53.3 Policy and claim reserves.................................. 1,868.7 1,793.2 Deferred policy acquisition costs................................................... 229.7 232.3 Sundry assets....................................................................... 272.4 275.6 -------------------- ------------------- 3,268.8 3,199.2 -------------------- ------------------- Total Assets.................................................................... $ 10,679.5 $ 10,570.8 ==================== =================== - ------------------------------------------------------------------------------------------------------------------------------------ Liabilities, Preferred Stock, and Common Shareholders' Equity Liabilities: Losses, claims and settlement expenses.............................................. $ 4,544.4 $ 4,403.5 Unearned premiums................................................................... 913.8 903.1 Other policyholders' benefits and funds............................................. 174.2 175.9 -------------------- ------------------- Total policy liabilities and accruals........................................... 5,632.5 5,482.6 Commissions, expenses, fees and taxes............................................... 187.4 235.9 Reinsurance balances and funds...................................................... 149.7 157.8 Federal income tax payable: Current................................................. 42.1 8.4 Deferred................................................ 522.9 554.5 Debt................................................................................ 143.2 143.0 Sundry liabilities.................................................................. 120.5 122.7 Commitments and contingent liabilities.............................................. - - -------------------- ------------------- Total Liabilities............................................................... 6,798.6 6,705.1 -------------------- ------------------- Preferred Stock: Convertible preferred stock (1)..................................................... - - -------------------- ------------------- Common Shareholders' Equity: Common stock (1).................................................................... 185.5 185.4 Additional paid-in capital.......................................................... 273.7 270.4 Retained earnings................................................................... 3,330.7 3,240.1 Accumulated other comprehensive income ............................................. 100.8 179.5 Treasury stock (at cost) (1)........................................................ (10.0) (10.0) -------------------- ------------------- Total Common Shareholders' Equity............................................... 3,880.9 3,865.6 -------------------- ------------------- Total Liabilities, Preferred Stock and Common Shareholders' Equity.............. $ 10,679.5 $ 10,570.8 ==================== =================== (1) At March 31, 2005 and December 31, 2004, 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 185,566,521 at March 31, 2005 and 185,429,127 at December 31, 2004 were issued and outstanding. At March 31, 2005 and December 31, 2004, there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. Common shares classified as treasury stock were 2,865,582 as of both March 31, 2005 and December 31, 2004. See accompanying Notes to Consolidated Summary Financial Statements. - -------------------------------------------------------------------------------- 3 Old Republic International Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) ($ in Millions, Except Share Data) - ------------------------------------------------------------------------------------------------------------------------------------ Quarters Ended March 31, --------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Revenues: Net premiums earned........................................................................ $ 717.1 $ 660.7 Title, escrow, and other fees.............................................................. 71.7 65.8 -------------- -------------- Total premiums and fees................................................................ 788.8 726.6 Net investment income...................................................................... 75.7 70.5 Other income............................................................................... 8.0 9.6 -------------- -------------- Total operating revenues............................................................... 872.6 806.8 Realized investment gains.................................................................. 7.9 15.6 -------------- -------------- Total revenues......................................................................... 880.6 822.4 -------------- -------------- Benefits, Claims and Expenses: Benefits, claims, and settlement expenses.................................................. 345.7 301.9 Dividends to policyholders................................................................. .6 .2 Underwriting, acquisition, and other expenses.............................................. 363.6 360.0 Interest and other charges................................................................. 2.0 2.1 -------------- -------------- Total expenses......................................................................... 712.0 664.2 -------------- -------------- Income before income taxes ................................................................ 168.5 158.1 -------------- -------------- Income Taxes: Currently payable............................................................ 44.3 45.6 Deferred..................................................................... 9.9 6.1 -------------- -------------- Total........................................................................ 54.2 51.7 -------------- -------------- Net Income................................................................................. $ 114.3 $ 106.4 ============== ============== Net Income Per Share: Basic.................................................................................. $ .63 $ .58 ============== ============== Diluted................................................................................ $ .62 $ .57 ============== ============== Average shares outstanding: Basic...................................................... 182,681,195 181,962,757 ============== ============== Diluted.................................................... 184,688,964 184,504,465 ============== ============== Dividends Per Common Share: Cash .................................................................................. $ .130 $ .113 ============== ============== See accompanying Notes to Consolidated Summary Financial Statements. - -------------------------------------------------------------------------------- 4 Old Republic International Corporation and Subsidiaries Consolidated Statements of Comprehensive Income (Unaudited) ($ in Millions) - ------------------------------------------------------------------------------------------------------------------------------------ Quarters Ended March 31, --------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Net income as reported..................................................................... $ 114.3 $ 106.4 -------------- -------------- Other comprehensive income (loss): Foreign currency translation adjustment................................................. (1.4) (1.3) -------------- -------------- Unrealized gains (losses) on securities: Unrealized gains (losses) arising during period....................................... (111.0) 41.2 Less: elimination of pretax realized gains included in income as reported.................................................... 7.9 15.6 -------------- -------------- Pretax unrealized gains (losses) on securities carried at market value........................................................... (118.9) 25.6 Deferred income taxes (credits)....................................................... (41.6) 8.9 -------------- -------------- Net unrealized gains (losses) on securities........................................... (77.3) 16.7 -------------- -------------- Net adjustments......................................................................... (78.7) 15.3 -------------- -------------- Comprehensive income....................................................................... $ 35.5 $ 121.7 ============== ============== See accompanying Notes to Consolidated Summary Financial Statements. - -------------------------------------------------------------------------------- 5 Old Republic International Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) ($ in Millions) - ------------------------------------------------------------------------------------------------------------------------------------ Quarters Ended March 31, --------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Cash flows from operating activities: Net income................................................................................ $ 114.3 $ 106.4 Adjustments to reconcile net income to net cash provided by operating activities: Deferred policy acquisition costs....................................................... 2.5 (2.7) Premiums and other receivables.......................................................... (.1) 11.1 Unpaid claims and related items......................................................... 78.7 67.8 Other policyholders' benefits and funds................................................. (4.6) 1.7 Income taxes............................................................................ 43.7 50.7 Reinsurance balances and funds.......................................................... 2.6 5.5 Realized investment gains............................................................... (7.9) (15.6) Accounts payable, accrued expenses and other............................................ (33.7) (6.0) -------------- -------------- Total..................................................................................... 195.6 219.0 -------------- -------------- Cash flows from investing activities: Fixed maturity securities: Maturities and early calls............................................................. 185.7 187.4 Sales.................................................................................. 47.0 23.8 Sales of: Equity securities...................................................................... 45.5 28.8 Other investments...................................................................... .7 .6 Fixed assets for company use........................................................... 4.4 .1 Cash and short-term investments of subsidiary acquired.................................... 1.2 - Purchases of: Fixed maturity securities.............................................................. (315.5) (388.9) Equity securities...................................................................... (5.2) - Other investments...................................................................... (.7) (.7) Fixed assets for company use........................................................... (5.4) (3.2) Investment in affiliates............................................................... (9.7) (1.4) Other-net................................................................................. .4 1.3 -------------- -------------- Total..................................................................................... (51.7) (152.0) -------------- -------------- Cash flows from financing activities: Issuance of debentures and notes.......................................................... 1.0 - Issuance of common shares................................................................. 2.0 6.3 Redemption of debentures and notes........................................................ (.6) (.3) Dividends on common shares................................................................ (23.7) (20.6) Other-net................................................................................. 2.1 (4.7) -------------- -------------- Total..................................................................................... (19.1) (19.3) -------------- -------------- Increase (decrease) in cash and short-term investments 124.7 47.6 Cash and short-term investments, beginning of period...................................... 449.2 451.2 -------------- -------------- Cash and short-term investments, end of period............................................ $ 574.0 $ 498.8 ============== ============== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest ................................................ $ .3 $ .1 ============== ============== Income Taxes............................................. $ 10.2 $ .3 ============== ============== See accompanying Notes to Consolidated Summary Financial Statements. - -------------------------------------------------------------------------------- 6 OLD REPUBLIC INTERNATIONAL CORPORATION NOTES TO CONSOLIDATED SUMMARY FINANCIAL STATEMENTS (Unaudited) ($ in Millions, Except Share Data) - -------------------------------------------------------------------------------- 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. 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, 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 2005 and 2004 and did not result in impairment charges. At March 31, 2005 and December 31, 2004, the Company's consolidated unamortized goodwill asset balance was $92.8 and $92.2, respectively. 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". During December, 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R") "Share-Based Payment". FAS 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The effective date of this pronouncement is the beginning of the first interim or annual reporting periods that begins after June 15, 2005. In April, 2005, the U.S. Securities and Exchange Commission approved a new rule that, for public companies, delays the effective date of FAS 123R to the first annual, rather than interim, reporting period that begins after June 15, 2005. Except for the change in effective date, the guidance of FAS 123R is unchanged. See footnote 2(b) herein for further discussion. 2. Common Share Data: (a) Earnings Per Share - Common share data has been retroactively adjusted to reflect all stock dividends and splits. The following table provides a reconciliation of the income and number of shares used in basic and diluted earnings per share calculations. Quarters Ended March 31, -------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Numerator: Net Income .......................................................................... $ 114.3 $ 106.4 -------------- -------------- Numerator for basic earnings per share - income available to common stockholders............................................ 114.3 106.4 -------------- -------------- Numerator for diluted earnings per share - income available to common stockholders after assumed conversions.......................................................... $ 114.3 $ 106.4 ============== ============== Denominator: Denominator for basic earnings per share weighted-average shares............................................................ 182,681,195 181,962,757 Effect of dilutive securities: Stock options...................................................................... 2,007,769 2,541,708 -------------- -------------- Dilutive potential common shares................................................... 2,007,769 2,541,708 -------------- -------------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions................................................................ 184,688,964 184,504,465 ============== ============== Earnings per share: Basic............................................................... $ 0.63 $ 0.58 ============== ============== Diluted............................................................. $ 0.62 $ 0.57 ============== ============== 7 (b) Stock Options Compensation - The Financial Accounting Standards Board 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, as such awards become vested. 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 for all periods shown. In estimating the compensation cost of options, the fair value of options has been calculated using the Black-Scholes option pricing model. Quarters Ended March 31, -------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Comparative data: Net income: As reported........................................................................... $ 114.3 $ 106.4 Add: Stock-based compensation expense included in reported income, net of related tax effects............................................................... .4 4.1 Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects........................................ 3.9 9.5 -------------- -------------- Pro forma basis....................................................................... $ 110.8 $ 101.0 ============== ============== Basic earnings per share: As reported........................................................................... $ 0.63 $ 0.58 Pro forma basis....................................................................... 0.61 0.56 Diluted earnings per share: As reported........................................................................... 0.62 0.57 Pro forma basis....................................................................... $ 0.60 $ 0.55 ============== ============== Expense recognition of stock options granted in 2003 and 2004 (no options were granted in the first quarter of 2005) reduced earnings per share by less than one cent per share in the first quarter 2005 and by two cents per share in the first quarter 2004. Options were granted during the first quarter of 2004 for 1,990,500 shares of common stock. Options outstanding as of March 31, 2005 and 2004 were 9,164,519 and 9,895,529, respectively. The maximum number of options available for future issuance as of March 31, 2005 is 1,797,537. During December, 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R") "Share-Based Payment". FAS 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The effective date of this pronouncement is the beginning of the first interim or annual reporting periods that begins after June 15, 2005. In April, 2005, the U.S. Securities and Exchange Commission approved a new rule that, for public companies, delays the effective date of FAS 123R to the first annual, rather than interim, reporting period that begins after June 15, 2005. Except for the change in effective date, the guidance of FAS 123R is unchanged. The statement allows for three transition methods of implementation: the modified prospective application and two versions of the modified retrospective application. The modified prospective application requires entities to expense share-based payments for new awards and awards modified, repurchased, or cancelled after the required effective date. Additionally, it requires entities to record as an expense, the cost attributable to the unvested options outstanding as of the required effective date. Modified retrospective application may be applied either (a) to all prior years for which Statement 123 was effective (fiscal years beginning after December 15, 1994) or (b) only to prior interim periods in the year of initial adoption if the required effective date of this statement does not coincide with the beginning of the entity's fiscal year. The Company believes that the approximate reduction to fully diluted earnings per share will be less than one cent per share cumulatively for all years from 2006 through 2009 calculated by using the modified prospective transition method. 8 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 $93.3 at March 31, 2005. Unrealized appreciation of investments, before applicable deferred income taxes of $50.2, at March 31, 2005 included gross unrealized gains and (losses) of $204.8 and ($61.1), respectively. For the quarters ended March 31, 2005 and 2004, net unrealized appreciation (depreciation) of investments, net of deferred income taxes (credits), amounted to ($77.3) and $16.7, respectively. 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 March 31, --------------------------------- 2005 2004 -------------- -------------- <s> <c> <c> Service cost..................................................................... $ 2.1 $ 1.9 Interest cost.................................................................... 3.0 2.8 Expected return on plan assets................................................... (3.6) (3.5) Recognized loss.................................................................. 0.5 0.6 -------------- -------------- Net cost $ 2.0 $ 1.9 ============== ============== The companies are not expecting to make cash or non-cash contributions to their pension plans in calendar year 2005. Effective January 1, 2005, both the Old Republic Plan and the Bitco Plan were closed to new employees hired after December 31, 2004. The Title Plan was already closed to new employees. There were no changes to the benefits for employees/beneficiaries already in the Plans. Also effective January 1, 2005, the Old Republic International Employees Savings and Stock Ownership Plan ("ESSOP") became a 401K. All aspects of the ESSOP remained unchanged, except that employee contributions are now made on a pretax rather than post-tax basis. 9 5. Information About Segments of Business: The Corporation's major business segments are organized as the General Insurance (property and liability insurance), Mortgage Guaranty and Title Insurance Groups. Effective with the second quarter of 2004, the Company has 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 accordingly. 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 net realized investment gains or losses 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 March 31, ------------------------- 2005 2004 ---------- ---------- <s> <c> <c> General Insurance Group: Net premiums earned............................................................................ $ 431.1 $ 376.5 Net investment income and other income ........................................................ 51.4 48.8 ---------- ---------- Total revenues before realized gains........................................................ $ 482.5 $ 425.4 ========== ========== Income before taxes and realized investment gains.............................................. $ 84.8 $ 74.3 ========== ========== Income tax expense on above.................................................................... $ 26.8 $ 23.1 ========== ========== Mortgage Insurance Group: Net premiums earned............................................................................ $ 105.4 $ 98.7 Net investment income and other income ........................................................ 21.5 21.4 ---------- ---------- Total revenues before realized gains........................................................ $ 127.0 $ 120.2 ========== ========== Income before taxes and realized investment gains.............................................. $ 64.6 $ 57.4 ========== ========== Income tax expense on above ................................................................... $ 21.6 $ 19.3 ========== ========== Title Insurance Group: Net premiums earned............................................................................ $ 159.9 $ 168.3 Title, escrow and other fees................................................................... 71.7 65.8 ---------- ---------- Sub-total................................................................................... 231.7 234.1 Net investment income and other income ........................................................ 6.6 6.5 ---------- ---------- Total revenues before realized gains........................................................ $ 238.4 $ 240.7 ========== ========== Income before taxes and realized investment gains.............................................. $ 12.8 $ 13.2 ========== ========== Income tax expense on above.................................................................... $ 4.2 $ 4.4 ========== ========== Consolidated Revenues: Total revenues of above Company segments....................................................... $ 848.0 $ 786.3 Other sources (1).............................................................................. 26.1 21.3 Consolidated net realized investment gains..................................................... 7.9 15.6 Elimination of intersegment revenues (2)....................................................... (1.5) (.9) ---------- ---------- Consolidated revenues....................................................................... $ 880.6 $ 822.4 ========== ========== Consolidated Income Before Taxes: Total income before taxes and realized investment gains of above Company segments............................................................. $ 162.3 $ 145.0 Other sources - net (1)........................................................................ (1.7) (2.5) Consolidated net realized investment gains..................................................... 7.9 15.6 ---------- ---------- Consolidated income before income taxes..................................................... $ 168.5 $ 158.1 ========== ========== Consolidated Income Tax Expense: Total income tax expense of above Company segments............................................. $ 52.6 $ 46.8 Other sources - net (1)........................................................................ (1.2) (1.0) Income tax expense on consolidated net realized investment gains............................... 2.7 5.8 ---------- ---------- Consolidated income tax expense............................................................. $ 54.2 $ 51.7 ========== ========== 10 March 31, December 31, 2005 2004 ------------------- ------------------ <s> <c> <c> Consolidated Assets: General................................................................. $ 7,369.5 $ 7,222.8 Mortgage................................................................ 2,229.8 2,205.9 Title................................................................... 717.2 753.0 Other - net (1)......................................................... 362.9 388.9 ------------------- ------------------ Consolidated ........................................................... $ 10,679.5 $ 10,570.8 =================== ================== - ---------- 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. (1) Represents amounts for Old Republic's holding company parent, minor internal service subsidiaries, and a small life and health insurance operation. (2) 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. 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 filed a motion to compel arbitration of the dispute with the named plaintiff. The motion was denied and RMIC has filed an appeal. (b) In April, 2004 the Internal Revenue Service ("IRS") issued a so-called "30 Day Letter" to the Company as a result of 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 its loss reserves were calculated consistently and provide a fair and reasonable estimate of its unpaid losses. 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 temporary differences, and as such would likely have little effect on its GAAP financial statements. The matter has been assigned to an IRS appeals officer. 11 OLD REPUBLIC INTERNATIONAL CORPORATION MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS Quarters Ended March 31, 2005 and 2004 ($ in Millions, Except Share Data) - -------------------------------------------------------------------------------- OVERVIEW - -------------------------------------------------------------------------------- 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, accounting for 2.5% of consolidated revenues and 2.2% of consolidated assets, is included within 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 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 run, 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. - -------------------------------------------------------------------------------- EXECUTIVE SUMMARY - -------------------------------------------------------------------------------- To aid investment analysis of Company results, both net operating income and net income figures per share are provided to 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 loss of market value or non-recoverability of asset cost. Old Republic's consolidated net operating earnings before net realized investment gains, amounted to $109.1, or 59 cents per share, for the first quarter of 2005, up 12.9 percent from $96.6, or 52 cents per share in the same period of 2004. The increase stemmed largely from improved performance by the Company's General and Mortgage Guaranty insurance segments. Year-over-year these two segments generated greater underwriting income as well as moderate growth of investment income. Inclusive of net realized investment gains, net income for this year's first quarter amounted to $114.3, or 62 cents per share, versus $106.4, or 57 cents per share in the year-ago period. Pretax earnings in last year's first quarter were affected adversely by required non-recurring stock option compensation charges of $5.6 (or 2 cents per share after tax), representing the expense of a non-recurring vesting acceleration of stock option compensation costs. The major components of pretax income and resulting consolidated GAAP net income discussed in this report were as follows: 12 Quarters Ended March 31, ------------------------------------------------ % 2005 2004 Change ------------ ------------ ------------ <s> <c> <c> <c> Pretax operating income (loss): General ................................................................... $ 84.8 $ 74.3 14.2% Mortgage Guaranty ......................................................... 64.6 57.4 12.5 Title ..................................................................... 12.8 13.2 -3.3 Corporate and other........................................................ (1.7) (2.5) Realized investment gains..................................................... 7.9 15.6 ------------ ------------ Consolidated pretax income ................................................... 168.5 158.1 6.6 Income taxes............................................................... 54.2 51.7 4.8 ------------ ------------ ------------ Net income.................................................................... $ 114.3 $ 106.4 7.4% ============ ============ ============ Components of Diluted Earnings Per Share: Net operating income ...................................................... $ .59 $ .52 13.5% Net realized gains ........................................................ .03 .05 ------------ ------------ Net income ................................................................ $ .62 $ .57 8.8% ============ ============ ============ Consolidated revenues in the first quarter totaled $880.6, up 7.1 percent from $822.4 in the same period of 2004. Net premiums and fees earned were $788.8 in this year's first quarter versus $726.6 in the year-ago period. Old Republic's General Insurance Group, which underwrites principally commercial property and liability insurance coverages, reported a 14.2 percent increase in pretax operating income to $84.8 for this year's first quarter. This compares to $74.3 earned during the same period of 2004. Net premiums earned in this year's first quarter were $431.1, up 14.5 percent from $376.5 a year ago. The composite underwriting ratio for the first three months of 2005 reflected a slight decline to 92.1 percent when compared to 93.0 percent registered in the first quarter of 2004, and a modest increase from the very low 90.7 percent posted for all of 2004. The positive underwriting results are attributable to a reasonably stable pricing environment and well-controlled production and administrative expenses for substantially all of the Company's general insurance coverages. Mortgage Guaranty Group operations posted a double digit rise of 12.5 percent in pretax operating earnings to $64.6 in this year's first quarter. Net premium revenues in the most recent quarter were $105.4, up 6.8 percent from the year-ago level of $98.7. Persistency for the traditional primary book of business continued to improve, rising to 65.2 percent from 50.2 percent in the first quarter of 2004 and 64.5 percent in the fourth quarter of 2004. The composite underwriting ratio in the first three months of 2005 was 55.3 percent compared to 58.6 percent posted in the same quarter of 2004, and 61.1 percent for all of last year. Traditional primary business claim severity, measured in terms of average claim reserves and payments, remained relatively stable in this year's first quarter, as did claim frequency by comparison to the fourth quarter of 2004. The loss ratio of 32.2 percent, while moderately higher than the 29.5 percent loss ratio posted in the first three months of 2004, was nonetheless lower than the 38.9 percent posted in last year's final quarter and 35.5 percent for all of 2004. Most of the quarter-over-quarter decline in the expense ratio reflected this segment's share of the aforementioned 2004 stock option costs, as well as a further reduction in compensation costs in the latest quarter. Old Republic's Title Insurance Group reflected slight variations in the key components of its pretax bottom line, which dropped slightly to $12.8 in this year's first quarter. Premiums were down 5.0 percent quarter-over-quarter, while escrow and other fee revenues grew by 9.0 percent. In combination, premium and fee revenues were basically flat at $231.7 in this year's first quarter. Claim costs, which are influenced principally by premium revenues, were stable for both quarterly periods, while other costs, inclusive of commissions paid on agency-derived premium production, were similarly even year-over-year. In combination, these factors produced a slightly higher composite ratio of 97.2 percent in this year's first quarter, compared to 97.0 percent and 96.3 percent in the first quarter and full year of 2004, respectively. While net investment income grew by 2.0 percent in the first three months of 2005, the gain was not sufficient to offset the current downward bias of the Company's results from its basic underwriting/service functions. Aggregate results for Old Republic's small Life & Health business and the corporate service operations of its parent Holding Company produced combined pretax losses of $1.7 and $2.5 in the first quarters of 2005 and 2004, respectively. Higher life and health pretax income was largely driven by a lower claim ratio and slightly greater investment income, which were partially offset by higher operating expenses. Corporate service operations were generally flat year-over-year. Consolidated net investment income of $75.7 for the first three months of 2005 was up by 7.4 percent when compared to the preceding year due primarily to the benefits of the Company's growing invested asset base. Realized investment gains amounted to $7.9 and $15.6 in the first quarter of 2005 and 2004, respectively. 13 Cash and invested assets at March 31, 2005, totaled $7.56 billion, or $41.39 per share, compared to $7.51 billion, or $41.19 per share, at December 31, 2004, and $7.08 billion, or $38.92 per share, at March 31, 2004. The investment portfolio reflects a current allocation of approximately 87 percent in fixed-maturity securities and 6 percent in equities. As in the past, it contains little or no exposure to real estate investments, mortgage-backed securities, derivatives, junk bonds, private placements or mortgage loans. Consolidated operating cash flow of $195.6 was slightly below the first quarter 2004 level due primarily to the timing of payments for income taxes, claims, and the previously announced settlement of the Title Insurance Group California litigation. Common shareholders' equity was $3.88 billion at March 31, 2005, compared to $3.86 billion at December 31, 2004, and $3.66 billion at March 31, 2004. Book value per share was $21.24 at the end of March 2005, versus $21.17 at year-end 2004 and $20.16 at March 31, 2004. The latest quarter's change in book value reflects principally additions from earnings in excess of dividend requirements, offset by a decline in the value of investment securities carried at market values. - -------------------------------------------------------------------------------- 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 March 31, 2005 and December 31, 2004, the Company's consolidated unamortized goodwill asset balance was $92.8 and $92.2, respectively. During the first quarters of 2005 and 2004, the Company evaluated the carrying value of its goodwill and intangible assets and determined that there was no indication of impairment of such assets. The Financial Accounting Standards Board ("FASB") 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 reduced earnings per share after-tax by less than one cent per share in the first quarter of 2005. In the first quarter of 2004, expense recognition of stock option compensation charges of $6.4 reduced earnings per share by 2 cents per share after-tax, of which $5.6 represented a charge for a non-recurring vesting acceleration of such costs. During December, 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R") "Share-Based Payment". FAS 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The effective date of this pronouncement is the beginning of the first interim or annual reporting period that begins after June 15, 2005. In April, 2005, the U.S. Securities and Exchange Commission ("SEC") approved a new rule that, for public companies, delays the effective date of FAS 123R to the first annual, rather than interim, reporting period that begins after June 15, 2005. Except for the change in the effective date, the guidance of FAS 123R is unchanged. The statement allows for three transition methods of implementation: the modified prospective application and two versions of the modified retrospective application. The modified prospective application requires entities to expense share-based payments for new awards and awards modified, repurchased, or cancelled after the required effective date. Additionally, it requires entities to record as an expense, the cost attributable to the unvested options outstanding as of the required effective date. Modified retrospective application may be applied either (a) to all prior years for which Statement 123 was effective (fiscal years beginning after December 15, 1994) or (b) only to prior interim periods in the year of initial adoption if the required effective date of this statement does not coincide with the beginning of the entity's fiscal year. The Company believes that the approximate reduction to fully diluted earnings per share will be as follows: less than one cent per share cumulatively for all years from 2006 through 2009 calculated by using the modified prospective transition method. FINANCIAL POSITION The Company's financial position at March 31, 2005 reflected increases in assets, liabilities and common shareholders' equity of 1.0%, 1.4% and 0.4%, respectively, when compared to the immediately preceding year-end. Cash and invested assets represented 70.8% and 71.1% of consolidated assets as of March 31, 2005 and December 31, 2004, respectively. Consolidated operating cash flow was positive at $195.6 in this year's first quarter, slightly below the first quarter 2004 level of $219.0 due primarily to the timing of payments for income taxes, claims, and the settlement of the Title Insurance Group California litigation. As of March 31, 2005, the invested asset base increased 0.6% to $7,562.5 principally as a result of positive operating cash flow offset by a decline in the fair value of fixed maturity and equity investments. 14 During the first three months of 2005 and 2004, the Corporation committed substantially all investable funds to short to intermediate-term fixed maturity securities. At both March 31, 2005 and December 31, 2004, approximately 99% of the Company's investments consisted of marketable securities, including $545.7 and $499.3, 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-term policy of investing primarily in investment grade, marketable securities. Investable funds have not been directed to so-called "junk bonds" or types of securities categorized as derivatives. At March 31, 2005, Old Republic's commitment to equity securities decreased 9.9% in relation to the related invested balance at year-end 2004, mostly due to the sales of equity securities and a reduction in net unrealized gains. At March 31, 2005, 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 March 31, 2005. 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. 15 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 (1) - ------------------------------------------------------------------------------------------------------------------------------------ March 31, December 31, 2005 2004 ----------------- ---------------- <s> <c> <c> Aaa............................................................................. 33.3% 32.6% Aa.............................................................................. 19.5 19.5 A............................................................................... 27.6 27.5 Baa............................................................................. 19.1 19.8 ----------------- ----------------- Total investment grade................................................. 99.5 99.4 All other (2)................................................................... .5 .6 ----------------- ----------------- Total.................................................................. 100.0% 100.0% ================= ================= (1) 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. (2) "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 - ------------------------------------------------------------------------------------------------------------------------------------ March 31, 2005 ------------------------------- Gross Amortized Unrealized Cost Losses ------------ ------------- <s> <c> <c> Fixed Maturity Securities by Industry Concentration: Municipals................................................................. $ 850.2 $ 15.0 Utilities.................................................................. 286.2 5.6 Finance.................................................................... 175.9 4.7 Service.................................................................... 133.6 2.4 Other (includes 16 industry groups)........................................ 1,320.2 22.0 ------------ ------------- Total.................................................................. $ 2,766.4 (3) $ 49.9 ============ ============= (3) Represents 43.6 percent of the total fixed maturity securities portfolio. - ------------------------------------------------------------------------------------------------------------------------------------ Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities - ------------------------------------------------------------------------------------------------------------------------------------ March 31, 2005 ------------------------------- Gross Amortized Unrealized Cost Losses ------------ ------------- <s> <c> <c> Equity Securities by Industry Concentration: Insurance.................................................................. $ 28.4 $ 1.3 Health Care................................................................ 22.5 1.0 Service.................................................................... 7.2 .9 Mutual Funds............................................................... 54.3 .7 ------------ ------------- Total.................................................................. $ 112.5 (4) $ 4.0 (5) ============ ============= (4) Represents 31.2 percent of the total equity securities portfolio. (5) Represents 1.1 percent of the cost of the total equity securities portfolio, while gross unrealized gains represent 15.6 percent of the portfolio. 16 - ------------------------------------------------------------------------------------------------------------------------------------ Gross Unrealized Losses Stratified For All Fixed Maturity Securities - ------------------------------------------------------------------------------------------------------------------------------------ March 31, 2005 ------------------------------------------------------------------------ Amortized Cost of Fixed Maturity Securities Gross Unrealized Losses --------------------------------- -------------------------------- Non- Non- Investment Investment All Grade Only All Grade Only ------------- ------------- ------------ ------------- <s> <c> <c> <c> <c> Maturity Ranges: Due in one year or less........................ $ 133.0 $ - $ .4 $ - Due after one year through five years.......... 867.9 - 15.3 - Due after five years through ten years......... 1,735.8 - 33.5 - Due after ten years............................ 29.5 - .6 - ------------- ------------- ------------ ------------- Total....................................... $ 2,766.4 $ - $ 49.9 $ - ============= ============= ============ ============= - ------------------------------------------------------------------------------------------------------------------------------------ Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses - ------------------------------------------------------------------------------------------------------------------------------------ March 31, 2005 ----------------------------------------------------------------------- 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.................... $ 32.1 $ - $ - $ 32.1 Seven to twelve months............... 13.2 - - 13.2 More than twelve months.............. 4.5 - - 4.5 ------------- ------------- ------------ ------------- Total....................... $ 49.9 $ - $ - $ 49.9 ============= ============= ============ ============= Equity Securities: One to six months.................... $ 3.0 $ - $ - $ 3.0 Seven to twelve months............... .9 - - .9 More than twelve months.............. - - - - ------------- ------------- ------------ ------------- Total....................... $ 4.0 $ - $ - $ 4.0 ============= ============= ============ ============= Number of Issues in Loss Position: Fixed Maturity Securities: One to six months.................... 553 - - 553 Seven to twelve months............... 100 - - 100 More than twelve months.............. 28 - - 28 ------------- ------------- ------------ ------------ Total....................... 681 - - 681 (6) ============= ============= ============ ============= Equity Securities: One to six months.................... 3 - - 3 Seven to twelve months............... 1 - - 1 More than twelve months.............. - 1 - 1 ------------- ------------- ------------ ------------ Total....................... 4 1 - 5 (6) ============= ============= ============ ============ The aging of issues with unrealized losses employs 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 (March 31, 2005 in the above table) and, accordingly, is not indicative of a security's value having been consistently below its cost at the percentages and throughout the periods shown. (6) At March 31, 2005 the number of issues in a loss position represent 40.2 percent as to fixed maturities, and 15.6 percent as to equity securities of the total number of such issues held by the Company. 17 - ------------------------------------------------------------------------------------------------------------------------------------ Age Distribution of Fixed Maturity Securities - ------------------------------------------------------------------------------------------------------------------------------------ March 31, December 31, 2005 2004 ------------------ ----------------- <s> <c> <c> Maturity Ranges: Due in one year or less........................................................ 9.0% 12.5% Due after one year through five years.......................................... 43.0 42.9 Due after five years through ten years......................................... 45.3 43.5 Due after ten years through fifteen years...................................... 2.7 1.1 Due after fifteen years........................................................ - - ================== ================= Total...................................................................... 100.0% 100.0% ================== ================= Average Maturity.................................................................... 4.7 Years 4.7 Years ================== ================= Duration (7)........................................................................ 4.2 4.1 ================== ================= (7) Duration is used as a measure of bond price sensitivity to interest rate changes. A duration of 4.2 as of March 31, 2005 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 4.2 percent. - ------------------------------------------------------------------------------------------------------------------------------------ Composition of Unrealized Gains (Losses) - ------------------------------------------------------------------------------------------------------------------------------------ March 31, December 31, 2005 2004 ------------------ ----------------- <s> <c> <c> Fixed Maturity Securities: Amortized cost................................................................ $ 6,346.4 $ 6,273.2 Estimated fair value.......................................................... 6,420.1 6,455.9 ------------------ ----------------- Gross unrealized gains........................................................ 123.6 194.5 Gross unrealized losses....................................................... (49.9) (11.8) ------------------ ----------------- Net unrealized gains ..................................................... $ 73.6 $ 182.7 ================== ================= Equity Securities: Cost.......................................................................... $ 361.3 $ 396.8 Estimated fair value.......................................................... 413.6 459.0 ------------------ ----------------- Gross unrealized gains........................................................ 56.2 68.6 Gross unrealized losses....................................................... (4.0) (6.4) ------------------ ----------------- Net unrealized gains...................................................... $ 52.2 $ 62.2 ================== ================= 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 or shareholders' equity. 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 $341.5 in dividends from its subsidiaries in 2005 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 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 $4,024.1 at March 31, 2005 consisted of debt of $143.2 and common shareholders' equity of $3,880.9. The increase in the common shareholders' equity account during the first quarter of 2005 reflects primarily the retention of earnings in excess of dividends requirements offset by a decrease in the value of investments carried at market values. Old Republic has paid cash dividends to its shareholders without interruption since 1942, and has increased the annual rate in each of the past 23 years. The annual dividend rate is typically reviewed and approved by the Board of Directors in the first quarter of each year. In establishing each year's cash dividend rate the Corporation does not follow a strict formulaic approach and favors a gradual rise in the annual dividend rate that is largely reflective of long-term consolidated operating earnings trends. Accordingly, each year's dividend rate is set judgmentally in consideration of such key factors as the dividend paying capacity of the Corporation's insurance subsidiaries, the trends in average annual statutory and GAAP earnings for the six most recent calendar years, and the long-term expectations for the Corporation's consolidated business. At its March, 2005 meeting the Board of Directors approved a quarterly cash dividend rate of 17 cents per share, up from 13 cents per share, subject to the usual quarterly authorizations. 18 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 March 31, 2005 pursuant to this authorization. RESULTS OF OPERATIONS Revenues: Premiums & Fees Pursuant to GAAP applicable to the insurance industry, revenues are associated with the related benefits, claims, and 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 written and earned in the month coverage is effective. 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 (which includes branch offices of its title insurers and wholly owned subsidiaries of the Company) represent approximately 38 percent of 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 62 percent of consolidated title premium and fee revenues is produced by independent title agents and underwritten title companies. 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. The major sources of Old Republic's earned premiums and fees for the periods shown were as follows: % Change from prior General Mortgage Title Other Total period ---------- ---------- --------- ---------- ---------- ------------ <s> <c> <c> <c> <c> <c> <c> Years Ended December 31: 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 2004............................ 1,623.0 403.2 1,025.2 64.6 3,116.1 6.1 Quarters Ended March 31: 2004............................ 376.5 98.7 234.1 17.1 726.6 9.5 2005............................ $ 431.1 $ 105.4 $ 231.7 $ 20.6 $ 788.8 8.6% ========== ========== ========= ========== ========== ============ 19 The percentage allocation of net premiums earned for major insurance coverage in the General Insurance Group was as follows: Quarters Ended March 31, Years Ended December 31, ----------------------- ---------------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 ---------- ---------- ---------- --------- --------- ---------- ---------- <s> <c> <c> <c> <c> <c> <c> <c> Type of Coverage: Commercial Automobile (mostly trucking)............. 38.8% 38.3% 37.9% 39.5% 43.0% 45.7% 49.7% Workers' Compensation............ 22.4 23.4 21.8 20.0 19.1 17.4 16.6 Financial Indemnity.............. 10.9 12.4 11.8 11.7 8.7 7.2 7.9 Property......................... 11.0 11.7 11.3 12.2 12.9 12.8 13.7 General Liability................ 5.9 4.4 5.8 5.3 4.7 5.4 5.1 Other............................ 11.0 9.8 11.4 11.3 11.6 11.5 7.0 ---------- ---------- ---------- --------- --------- ---------- ---------- Total............................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ========== ========== ========== ========= ========= ========== ========== The following tables provide information on risk exposure trends for Old Republic's Mortgage Guaranty Group. Quarters Ended March 31, Years Ended December 31, -------------------------- ------------------------------------------------------------------------ 2005 2004 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ------------ ----------- ----------- <s> <c> <c> <c> <c> <c> <c> <c> New Insurance Written: Traditional Primary.... $ 4,705.6 $ 5,899.5 $ 24,749.4 $ 37,255.8 $ 30,809.6 $ 25,085.4 $ 14,929.7 Bulk................... 3,299.5 41.1 4,487.8 6,806.6 5,130.0 2,614.4 35.3 Other.................. 39.8 1,165.0 7,324.7 5,802.8 7,555.5 3,675.3 1,594.8 ----------- ----------- ----------- ----------- ------------ ----------- ----------- Total.................. $ 8,045.0 $ 7,105.7 $ 36,562.0 $ 49,865.2 $ 43,495.1 $ 31,375.1 $ 16,559.8 =========== =========== =========== =========== ============ =========== =========== Net Risk In Force: Traditional Primary.... $ 15,274.2 $ 15,289.7 $ 15,452.2 $ 15,329.5 $ 15,367.6 $ 15,043.5 $ 14,840.7 Bulk................... 1,094.5 783.3 834.8 802.2 513.0 167.0 8.7 Other.................. 580.4 509.2 580.9 493.4 450.7 336.9 271.5 ----------- ----------- ----------- ----------- ------------ ----------- ----------- Total.................. $ 16,949.2 $ 16,582.2 $ 16,868.0 $ 16,625.1 $ 16,331.3 $ 15,547.4 $ 15,120.9 =========== =========== =========== =========== ============ =========== =========== Quarter Ended March 31, Years Ended December 31, -------------------- --------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- -------- --------- <s> <c> <c> <c> <c> <c> <c> <c> Analysis of Traditional Primary Risk in Force: By Fair Isaac & Company ("FICO") Scores (1): FICO less than 620......................... 8.6% 8.5% 8.6% 8.5% -% -% -% FICO 620 to 680............................ 31.4 29.8 31.1 29.2 - - - FICO greater than 680...................... 51.8 49.6 51.4 48.8 - - - Unscored/Unavailable....................... 8.2% 12.1% 8.9% 13.5% -% -% -% -------------------- (1) Scores were unavailable for a substantial number of policies in force prior to 2003. By Loan to Value ("LTV") Ratio: LTV less than 85........................... 5.6% 6.2% 5.7% 6.4% 6.0% 5.7% 5.4% LTV 85 to 90............................... 36.9 37.2 36.8 37.3 37.3 37.6 38.2 LTV 90 to 95............................... 41.4 43.5 42.0 43.8 47.0 48.8 50.3 LTV greater than 95........................ 16.1% 13.1% 15.5% 12.5% 9.7% 7.9% 6.1% By Type of Loan Documentation: Full Documentation......................... 92.6% 94.2% 93.2% 94.4% 96.7% 99.4% 100.0% Reduced Documentation...................... 7.4% 5.8% 6.8% 5.6% 3.3% .6% -% 20 Quarters Ended March 31, Years Ended December 31, ---------------------- -------------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 --------- --------- --------- --------- ---------- --------- --------- <s> <c> <c> <c> <c> <c> <c> <c> Earned Premiums: Direct........................... $ 124.6 $ 118.5 $ 483.6 $ 467.3 $ 432.4 $ 390.9 $ 359.0 ========= ========= ========= ========= ========== ========= ========= Net.............................. $ 105.4 $ 98.7 $ 403.2 $ 400.9 $ 376.2 $ 353.1 $ 331.4 ========= ========= ========= ========= ========== ========= ========= Persistency / Traditional Primary... 65.2% 50.2% 64.5% 46.0% 59.1% 65.3% 82.1% Persistency / Bulk (2).............. 49.7% 41.0% 55.7% 31.8% 71.7% -% -% - ---------------- (2) Due to the relative immaturity of the bulk business, the above trend may prove to be highly volatile. The following table indicates the percentage allocation of Title Group premium and fee revenues by production sources: Quarters Ended March 31, Years Ended December 31, ------------------------ -------------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 ---------- --------- ---------- --------- --------- --------- --------- <s> <c> <c> <c> <c> <c> <c> <c> Direct operations..................... 38.5% 35.7% 38.1% 40.0% 43.7% 47.4% 45.8% Independent title agents & other...... 61.5 64.3 61.9 60.0 56.3 52.6 54.2 ---------- --------- ---------- --------- --------- --------- --------- Total................................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ========== ========= ========== ========= ========= ========= ========= Consolidated net premiums and fees earned increased by 8.6% and 9.5% in the first quarters of 2005 and 2004, respectively. Earned premiums in the General Insurance Group grew by 14.5% and 20.0% in the first quarters of 2005 and 2004, respectively, as a result of positive pricing and risk selection changes the Company effected during the 2001 to 2003 period in particular, as well as additional business produced in a reasonably stable underwriting environment. Mortgage guaranty premium income trends reflect improved persistency trends for traditional primary mortgage insurance. Title Group premium and fee revenues were basically flat in the first quarters of both 2005 and 2004 and are reflective of a reduction in mortgage refinancing activity which reached a peak in the third quarter of 2003. 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. 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: 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 2004.................. 4,217.8 2,001.2 595.2 295.0 7,109.4 262.2 7,371.6 As of March 31: 2004.................. 3,911.2 1,906.9 547.9 191.4 6,557.6 385.7 6,943.3 2005.................. $ 4,347.7 $ 2,062.7 $ 559.2 $ 297.9 $ 7,267.5 $ 143.1 $ 7,410.7 =========== ========== ========== ========= =========== ========== =========== 21 Net Investment Income Yield at ------------------------------------------------------------------- ------------------------ General Mortgage Title Other Total Cost Market ---------- ---------- ---------- ---------- ---------- --------- ---------- <s> <c> <c> <c> <c> <c> <c> <c> Years Ended December 31: 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 2004.................. 183.4 67.7 25.5 14.0 290.8 4.6 4.4 Quarters Ended March 31: 2004.................. 44.4 16.6 6.2 3.1 70.5 4.5 4.4 2005.................. $ 47.8 $ 17.5 $ 6.3 $ 3.9 $ 75.7 4.5% 4.4% ========== ========== ========== ========== ========== ========= ========== Consolidated net investment income grew by 7.4% when compared to the same period of 2004 primarily due to the benefits of a rising invested asset base. Yield trends reflect at once the relatively short maturity of Old Republic's fixed maturity securities portfolio as well as continuation of a lower yield environment during the past several years. Revenues: Net Realized Gains 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 quarters of 2005 and 2004, 79.8% and 88.7%, 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 are 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 its basic insurance underwriting business. The following table reflects the composition of net realized gains or losses for the periods shown: Quarters Ended March 31, Years Ended December 31, ---------------------- ---------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 --------- --------- -------- --------- --------- -------- -------- <s> <c> <c> <c> <c> <c> <c> <c> Realized Gains (Losses) on Disposition of: Fixed maturity securities................. $ .3 $ .7 $ 4.6 $ 4.6 $ 3.8 $ (2.9) $ .8 Equity securities and miscellaneous investments........................... 12.7 14.8 48.5 31.1 29.1 39.4 32.9 --------- --------- -------- --------- --------- -------- -------- Total 13.0 15.6 53.2 35.7 33.0 36.5 33.6 --------- --------- -------- --------- --------- -------- -------- Impairment losses on: Fixed maturity securities................. - - - - (5.0) (1.2) - Equity securities and miscellaneous investments........................... (5.1) - (5.2) (16.4) (14.0) (5.5) - --------- --------- -------- --------- --------- -------- -------- Total (5.1) - (5.2) (16.4) (19.0) (6.7) - --------- --------- -------- --------- --------- -------- -------- Net realized gains............................ $ 7.9 $ 15.6 $ 47.9 $ 19.3 $ 13.9 $ 29.7 $ 33.6 ========= ========= ======== ========= ========= ======== ======== Expenses: Benefits and Claims 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 principally 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 unexpectedly adverse jury verdicts. 22 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 but not be limited to 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 insurance claim reserves are determined on the basis of the carried risk on reported loan defaults and on an estimate of defaulted loans that have yet to be reported. In establishing its reserve position, the Company establishes estimates of average claim frequency (the number of reported defaults which will ultimately result in a claim payment) and average claim severity (the amount of claim ultimately to be paid). The majority of defaults reported to the Company are cured by the borrower either by making the necessary number of mortgage payments to bring the loan current, by refinancing the mortgage loan, or by selling the property in an amount sufficient to cover the outstanding mortgage debt. Estimates of claim frequency, which are based on historical trends and on judgments as to current and future economic conditions, are applied according to the level of the reported default. Claim severity is estimated based on historical claim payments including the impact of loss mitigation strategies and potential salvage recoveries. Once reported, the time required to cure a default or settle a claim can be significant, often running years from the date of original default. As such, ultimate cure and claim rates develop over long periods of time, often through changing economic conditions. Higher mortgage guaranty loss ratios for 2004 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. 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 December 31, 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. 23 Most of Old Republic's consolidated claim and related expense reserves stem from its general insurance business. At March 31, 2005, such reserves accounted for 88.9% and 82.5% of consolidated gross and net of reinsurance reserves, respectively, while similar reserves at December 31, 2004 accounted for 88.6% and 82.1% of the respective consolidated amounts. The following table shows a breakdown of gross and net of reinsurance claim reserve estimates for major types of insurance coverages as of those dates: March 31, 2005 December 31, 2004 ------------------------- -------------------------- Gross Net Gross Net ---------- ---------- ----------- ----------- <s> <c> <c> <c> <c> Claim and Loss Adjustment Expense Reserves: Commercial automobile (mostly trucking).............................. $ 807.1 $ 653.4 $ 788.6 $ 635.9 Workers' compensation................................................ 1,639.7 833.3 1,607.0 814.0 General liability.................................................... 865.2 371.8 808.7 350.5 Other coverages...................................................... 595.6 397.0 576.0 382.1 Unallocated loss adjustment expense reserves......................... 131.8 88.0 122.0 87.2 ---------- ---------- ----------- ----------- Total general insurance reserves 4,039.7 2,343.8 3,902.4 2,269.7 Other coverages: Mortgage guaranty.................................................... 201.1 199.8 200.5 199.1 Title................................................................ 254.2 254.2 252.5 252.5 Life and health...................................................... 23.2 18.3 22.6 16.9 Unallocated loss adjustment expense reserves - other coverages................................................... 26.0 26.0 25.4 25.4 ---------- ---------- ----------- ----------- Total claim and loss adjustment expense reserves............... $ 4,544.4 $ 2,842.3 $ 4,403.5 $ 2,763.8 ========== ========== =========== =========== Asbestosis and environmental claim reserves included in the above general insurance reserves: Amount........................................................ $ 124.7 $ 99.2 $ 118.9 $ 97.1 ========== ========== =========== =========== % of total general insurance reserves......................... 3.1% 4.2% 3.0% 4.3% ========== ========== =========== =========== 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 Group'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 accounts and blocks of business that have similar attributes. Actuarially or otherwise derived ranges of reserve levels are not utilized as such in setting these reserves, and, accordingly, the reserves listed in the above table represent the Company's point estimates at each reporting date. The overall reserve level at any point in time therefore 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 to provide for 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 24 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 5.5 years (gross) and 8.9 years (net of reinsurance) as of March 31, 2005 and 6.2 years (gross) and 9.6 years (net of reinsurance) as of December 31, 2004. Fluctuations in this ratio between years can be caused by the inconsistent pay out patterns associated with these types of claims. Incurred net losses for asbestosis and environmental claims have averaged 2.6 percent of General Insurance Group net incurred losses for the five years ended December 31, 2004. 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 March 31, 2005 and December 31, 2004, the Company's general insurance segment carried reserves of $812.2 and $735.2, respectively, 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 $81.2, or 3.5 percent of the Company's net general insurance reserves as of March 31, 2005 and $73.5, or 3.2 percent as of the prior year end balance sheet date, the impact on the Company's income statement would be to reduce pretax income by such amounts. While Old Republic has not incurred such a deficiency level on total reserves posted as of the 10 most recent year ends, there can be no assurance that this favorable experience will continue in the future. The percentage of net claims, benefits and related settlement expenses measured against premiums and related fee revenues of the Company's three major operating segments and its consolidated results were as follows: General Mortgage Title Consolidated -------------- ------------- ----------- ------------- <s> <c> <c> <c> <c> Years Ended December 31: 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 2004............................................. 66.1 35.5 5.8 42.0 Quarters Ended March 31: 2004............................................. 67.0 29.5 6.0 41.6 2005............................................. 67.4% 32.2% 6.0% 43.9% ============== ============= =========== ============= The percentage of net claims, benefits and related settlement expenses measured against premiums by major insurance coverage in the General Insurance Group were as follows: Quarter Ended March 31, Years Ended December 31, ----------------------- ------------------------------------------------------------ 2005 2004 2004 2003 2002 2001 2000 --------- ---------- --------- --------- --------- --------- -------- <s> <c> <c> <c> <c> <c> <c> <c> Type of Coverage: Commercial Automobile (Trucking)......... 70.7% 70.2% 66.5% 70.4% 78.4% 82.5% 91.4% Workers' Compensation.................... 70.8 69.4 72.4 81.2 93.2 89.0 90.3 Financial Indemnity...................... 51.7 44.5 47.6 51.0 41.1 39.0 33.6 Property................................. 53.6 51.4 56.2 59.1 51.5 59.5 54.1 General Liability........................ 98.5 141.7 108.6 89.5 67.6 71.0 64.7 Other.................................... 61.6% 62.6% 59.3% 52.2% 66.9% 68.5% 58.4% ========= ========== ========= ========= ========= ========= ======== 25 Average Mortgage Guaranty paid claims, and certain delinquency ratio data are shown below: Quarters Ended March 31, Years Ended December 31, ---------------------- --------------------------------------------------------------- 2005 2004 2004 2003 2002 2001 2000 --------- --------- ---------- ---------- --------- ---------- --------- <s> <c> <c> <c> <c> <c> <c> <c> Average Paid Claim Amount: (1) Traditional Primary............. $ 24,384 $ 22,786 $ 23,920 $ 22,339 $ 20,693 $ 19,221 $ 21,551 Bulk (2)........................ $ 20,561 $ 18,762 $ 19,885 $ 29,293 $ - $ - $ - --------------- (1) Amounts are in whole dollars. (2) Due to the relative immaturity of the bulk business, the above trend may prove to be highly volatile. Delinquency Ratio: Traditional Primary............. 3.75% 3.67% 4.11% 3.95% 3.43% 2.84% 2.50% Bulk 3.79% 5.62% 4.59% 4.76% 3.28% .33% -% Traditional Primary Delinquency Ratios for Top Ten States (3): Florida......................... 2.5% 3.1% 3.2% 3.5% 3.6% 3.4% 3.4% Texas........................... 4.5 4.3 5.0 4.6 3.9 3.2 2.7 Georgia......................... 5.1 4.6 5.6 4.9 3.9 2.9 2.9 Illinois........................ 3.5 3.6 3.8 4.0 3.3 2.9 2.6 North Carolina.................. 4.4 4.5 4.9 4.7 4.0 3.0 2.4 California...................... 1.7 2.3 2.1 2.8 2.9 3.1 2.9 Ohio............................ 7.2 6.6 7.6 6.9 4.9 3.8 3.2 Pennsylvania.................... 4.0 3.8 4.4 3.8 3.3 2.5 2.3 Minnesota....................... 3.4 2.5 3.5 2.5 2.1 1.9 1.1 Arizona......................... 2.4% 3.1% 2.8% 3.4% 3.3% 2.7% 1.8% - --------------- (3) As determined by risk in force as of December 31, 2004. These 10 states represent approximately 50% of risk in force as of that date. The general insurance portion of the claims ratio 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 reflecting increases in claim provisions principally due to such factors as higher loss payments and expectations of higher severity and frequency of claims. The lower 2002 mortgage guaranty claims ratio resulted from a decline in claim provisions driven principally by a drop in expected claim severity and a small increase in 2001 was largely the result of a moderately higher loan default rate factor. The title insurance loss ratios have been in the low single digits in each of the past five 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 ratio reflects the changing effects of period-to-period contributions of each segment to consolidated results, and this ratio's variances within each segment. Expenses: Underwriting, Acquisition and Other Expenses The ratio of consolidated underwriting, acquisition, and other expenses to net premiums and fees earned was 44.6% and 47.7% in the first quarters of 2005 and 2004, respectively. Variations in these consolidated ratios reflect a continually changing mix of coverages sold and attendant costs of producing business in the Company's three business segments. The following table sets forth the expense ratios registered by each major business segment and in consolidation for the periods shown: General Mortgage Title Consolidated -------------- ------------- ----------- ------------- <s> <c> <c> <c> <c> Years Ended December 31: 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 2004............................................. 24.6 25.6 90.5 47.3 Quarters Ended March 31: 2004............................................. 26.0 29.1 91.0 47.7 2005............................................. 24.7% 23.1% 91.2% 44.6% ============== ============= =========== ============= Expense ratios for the Company as a whole have remained basically stable for the periods reported upon. To a significant degree, expense ratios for both the general and title insurance segments are mostly reflective of variable costs, 26 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. The slight downtrend in the General Insurance Group's expense ratio reflects the benefits of well-controlled production and administrative expense management in the face of a greater revenue base. The mortgage guaranty segment's expense ratio decreased in 2003 and 2001 due to greater efficiencies gained in the distribution and servicing of its products; the increase in this ratio for 2002 was due to the posting of special operating charges aggregating $20.5. These charges stemmed from the cessation of the development and marketing of a loan portfolio evaluation service aimed at existing and potential mortgage guaranty insurance customers, and a reassessment of certain class action litigation exposures. The 2003 ratio also benefited from the resolution of the aforementioned class action litigation at a cost approximately $5.0 less than the related reserves recorded in 2002. The increase in 2004 resulted from higher stock option compensation expenses offset by recovery of certain prior years' litigation costs. The decline in the first quarter 2005 ratio reflects this segments' share of the aforementioned 2004 stock option costs, as well as further reduction in compensation costs in the latest quarter. Decreased title sales volume led to a higher expense ratio in the first quarter 2005 despite a decrease in underwriting costs, while increased title sales volume in 2003 and 2002 led to a lower expense ratio for those years. The increase in the 2004 ratio results from the final settlement of consumer and regulatory litigation costs affecting Old Republic's California title insurance subsidiary. Expenses: Total The composite ratios of the above net claims, benefits and underwriting expenses that reflect 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: 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 2004............................................. 90.7 61.1 96.3 89.3 Quarters Ended March 31: 2004............................................. 93.0 58.6 97.0 89.3 2005............................................. 92.1% 55.3% 97.2% 88.5% ============== ============= =========== ============= Expenses: Income Taxes The effective consolidated income tax rates were 32.2% and 32.7% in the first quarter of 2005 and 2004, 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 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 27 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. 28 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 Evaluation of Disclosure Controls and Procedures The Company's principal executive officer and its principal financial officer have evaluated the Company's disclosure controls and procedures as of the end of the period covered by this quarterly report. Based upon their evaluation, the principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective for the above referenced evaluation period. Changes in Internal Control Over Financial Reporting During the three month period ended March 31, 2005, there were no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Management's Report on Internal Control Over Financial Reporting The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 29 OLD REPUBLIC INTERNATIONAL CORPORATION FORM 10-Q PART II - OTHER INFORMATION - -------------------------------------------------------------------------------- Item 5 - Other Information - -------------------------- On February 16, 2005, Kurt W. Kreyling, a director of the Company since 1974, informed the Company that he was retiring from the Board of Directors effective February 28, 2005. Mr. Kreyling is 83 and was one of the Company's longest serving directors. On March 2, 2005, Anthony F. Colao, a director of the Company since 1987, indicated that he was retiring from the Board of Directors effective as of that date. Mr. Colao is 77 and will continue to serve as a consultant to the Company. Following their retirements, the Board of Directors moved to reduce the size of the Board from fifteen to thirteen directors. Item 6 - Exhibits - ----------------- (a) Exhibits 31.1 Certification by Aldo C. Zucaro, Chief Executive Officer, pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by Karl W. Mueller, Chief 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, 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. 32.2 Certification by Karl W. Mueller, Chief 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 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Old Republic International Corporation ---------------------------------------- (Registrant) Date: May 10, 2005 ---------------- /s/ Karl W. Mueller ---------------------------------------- Karl W. Mueller Senior Vice President and Chief Financial Officer 31 EXHIBIT INDEX Exhibit No. Description - -------------- -------------------------------------------------------------- 31.1 Certification by Aldo C. Zucaro, Chief Executive Officer, pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by Karl W. Mueller, Chief 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, 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. 32.2 Certification by Karl W. Mueller, Chief 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. 32