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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (FEE REQUIRED)
For the fiscal year ended: December 31, 2003
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OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ______________________ to____________________
Commission File Number: 001-10607
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OLD REPUBLIC INTERNATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of each class on Which Registered
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7% Subordinated Debentures Due June 15, 2007 New York Stock Exchange
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Common Stock/$1 par value New York Stock Exchange
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes: _X_/ No:___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. 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:___
The aggregate market value of the Company's voting Common Stock held by
non-affiliates of the registrant (assuming, for purposes of this calculation
only, that the registrant's directors and executive officers, the registrant's
various employee benefit plans and American Business & Personal Insurance
Mutual, Inc. and its subsidiaries are all affiliates of the registrant), based
on the closing sale price of the registrant's common stock on June 30, 2003, the
last day of the registrant's most recently completed second fiscal quarter, was
$3,794,654,577.
The Company had 181,721,548 shares of Common Stock outstanding as of February
16, 2004.
Documents incorporated by reference:
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The following documents are incorporated by reference into that part of this
Form 10-K designated to the right of the document title.
Title Part
Proxy statement for the 2004 Annual
Meeting of Shareholders III, Items 10, 11, 12, 13 and 14
Exhibits as specified in
exhibit index (page 59) IV, Item 15
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There are 60 pages in this report
PART I
Item 1-Business
(a) General Description of Business. Old Republic International Corporation is a
Chicago-based insurance holding company with subsidiaries engaged in the general
(property and liability), mortgage guaranty, title, and life (life and
disability) insurance businesses. In this report, "Old Republic", "the
Corporation", or "the Company" refers to Old Republic International Corporation
and its subsidiaries as the context requires. The aforementioned insurance
segments are organized as the Old Republic General Insurance, Mortgage Guaranty,
Title Insurance, and Life Insurance Groups, and references herein to such groups
apply to the Company's subsidiaries engaged in the respective segments of
business.
Financial Information Relating to Segments of Business (a)
The contributions to net revenues and income (loss) before taxes of each
Old Republic segment are set forth below for the years shown, together with
their respective assets at the end of each year. The information below should be
read in conjunction with the consolidated financial statements, the notes
thereto, and the "Management Analysis of Financial Position and Results of
Operations" appearing elsewhere herein.
($ in Millions)
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Years Ended December 31,
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Net Revenues (b) Income (Loss) Before Taxes
------------------------------------------ ------------------------------------------
2003 2002 2001 2003 2002 2001
------------ ----------- ----------- ----------- ------------ -----------
General....................... $ 1,572.7 $ 1,376.7 $ 1,195.0 $ 259.0 $ 182.1 $ 141.4
Mortgage Guaranty............. 498.6 467.1 436.0 276.4 267.7 261.9
Title......................... 1,128.0 836.5 648.9 129.8 97.8 74.6
Life.......................... 58.4 57.0 58.4 4.3 6.4 4.9
Other Operations - Net........ 8.5 5.0 5.2 (8.8) (7.1) (8.8)
------------ ----------- ----------- ----------- ------------ -----------
Subtotal.................... 3,266.5 2,742.4 2,343.7 660.7 546.9 474.2
Consolidated Realized
Investment Gains............. 19.3 13.9 29.7 19.3 13.9 29.7
------------ ----------- ----------- ----------- ------------ -----------
Consolidated................ $ 3,285.8 $ 2,756.4 $ 2,373.4 $ 680.0 $ 560.9 $ 503.9
============ =========== =========== =========== ============ ===========
Assets at December 31,
------------------------------------------
2003 2002 2001
----------- ----------- -----------
General..................................................................... $ 6,603.5 $ 5,876.5 $ 5,451.9
Mortgage Guaranty........................................................... 2,080.1 1,921.2 1,731.6
Title....................................................................... 720.5 619.9 536.0
Life........................................................................ 244.6 233.3 236.3
Consolidated.............................................................. $ 9,712.3 $ 8,715.4 $ 7,920.2
=========== =========== ===========
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(a) Reference is made to the table in Note 6 of the Notes to Consolidated
Financial Statements, incorporated herein by reference, which shows the
contribution of each subcategory to consolidated net revenues and income or
loss before income taxes of Old Republic's insurance industry segments.
(b) Revenues consist of net premiums, fees, net investment and other income
earned; realized investment gains are shown in total for all groups
combined.
General Insurance Group
Through its General Insurance Group subsidiaries, the Corporation assumes
risks and provides related risk management and marketing services pertaining to
a large variety of property and liability commercial insurance coverages. Old
Republic does not have a meaningful exposure to personal lines of insurance such
as homeowners and private automobile coverages. Similarly, the Corporation does
not provide meaningful amounts of property insurance coverages for commercial
building and related contents.
Liability Coverages: Commercial automobile (mostly trucks) full coverage
protection, workers' compensation and general liability (including the general
liability portion of commercial package policies) are the major classes of
insurance underwritten for businesses and public entities such as
municipalities. Within these classes of insurance, Old Republic specializes in a
number of industries, most prominently the transportation (trucking and general
aviation), construction, forest products and energy industries. Most such
business is produced through independent agency and brokerage channels.
The basic rates charged for workers' compensation insurance are generally
regulated by the various states. It is therefore possible that the rate
increases necessary to cover any expansion of benefits under state laws, or
increases in claim frequency or severity, or inflation-driven cost increases for
such exposures as medical costs related to bodily injuries may not always be
granted soon enough to enable insurers to fully recover the amount of the
benefits they must pay.
2
Over the years, Old Republic has diversified its General Insurance Group
business. This diversification has been achieved through a combination of
internal growth, the establishment of new subsidiaries, and through selective
mergers with other companies. For 2003, production of commercial automobile
direct insurance premiums accounted for approximately 33.7% of consolidated
direct premiums written by the General Insurance Group, while workers'
compensation and general liability direct insurance premiums amounted to 21.8%
and 16.5%, respectively, of such consolidated totals.
Among other liability coverages, Old Republic indemnifies corporations'
financial exposures to directors' and officers' liability as well as those
stemming from errors and omissions liability. In the past twenty years, the
Corporation has developed a presence in the general aviation insurance industry,
providing coverage for hull and liability exposures as well as such additional
areas as airport facilities and flying schools. All of these coverages are
produced through independent insurance agency and brokerage channels.
In the recent past, the Corporation has terminated its involvement with
certain smaller parts of its business, including a reinsurance assumed line and
coverages for propane and petroleum distribution, natural gas utilities, and
grain elevators. The run off of these terminated portions of Old Republic's
business is not expected to affect meaningfully its future operating results or
financial condition. The Company believes it has made adequate provisions for
the ultimate claim costs pertaining to those businesses.
Property and Other Coverages: Old Republic's property insurance business
incorporates mostly commercial physical damage insurance on trucking risks. A
small volume of business is represented by fire and other physical perils for
commercial properties. Such insurance is produced principally through
independent agencies or brokers.
Fidelity and surety coverages are underwritten through some 8,800
independent agents by the Old Republic Surety Group. Surety bonds, such as those
aimed at public officials, license and permit authorizations, and contract bonds
covering both public and private works, are typically written for exposures of
less than $500,000. Fidelity bonds are also extended to small to medium-sized
risks.
Old Republic Insured Credit Services, Inc. has marketed loan and retail
installment sales credit indemnity insurance since 1955 through commercial
banks, thrifts and other lending institutions. This coverage provides a limited
indemnity to lenders on home equity and home improvement loans as well as
installment sales contracts.
Automobile extended warranty and home warranty coverages are marketed by
Old Republic through its own employees and selected independent agents.
Travel insurance is produced through independent travel agents in the
United States and Canada. The coverages provided under these policies, some of
which are also underwritten by the Company's Life Insurance Group, include trip
delay and trip cancellation protection for insureds.
Mortgage Guaranty Group
Private mortgage insurance protects mortgage lenders and investors from
default related losses on residential mortgage loans made primarily to
homebuyers who make down payments of less than 20% of the home's purchase price.
The Corporation insures only first mortgage loans, primarily on residential
properties having one-to-four family dwelling units.
There are two principal types of private mortgage insurance coverage:
"primary" and "pool". Primary mortgage insurance provides mortgage default
protection on individual loans and covers a stated percentage of the unpaid loan
principal, delinquent interest, and certain expenses associated with the default
and subsequent foreclosure. In lieu of paying the stated coverage percentage,
the Corporation may pay the entire claim amount and take title to the mortgaged
property. Pool insurance is generally used as an additional credit enhancement
for certain secondary market mortgage transactions and provides coverage ranging
up to 100% of the net loss on each individual loan included in the pool, subject
to provisions regarding deductibles, caps on individual exposures, and aggregate
stop loss provisions which limit aggregate losses to a specified percentage of
the total original balances of all loans in the pool.
Traditional primary insurance is issued on an individual loan basis to
mortgage bankers, brokers, commercial banks and savings institutions through a
network of underwriting sites located throughout the country. Traditional
primary loans are individually reviewed (except for loans insured under
delegated approval programs) and priced according to filed premium rates. In
underwriting traditional primary business, the Corporation generally adheres to
the underwriting guidelines published by the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"),
purchasers of many of the loans the Corporation insures. Delegated underwriting
programs allow approved lenders to commit the Corporation to insure loans
provided they adhere to predetermined underwriting guidelines. In 2003,
delegated underwriting approvals accounted for 46.9% of the Corporation's new
traditional primary insurance written.
Bulk and other insurance is issued on groups of loans to mortgage banking
customers through a centralized risk assessment and underwriting process. These
groups of loans are priced in the aggregate, on a bid or negotiated basis.
3
Coverage for insurance issued in this manner can be issued under primary
insurance policies (loan level coverage) or pool insurance policies (aggregate
coverage). The Corporation considers transactions designated as bulk insurance
to be higher risk (as determined by characteristics such as loan amount, credit
quality, and loan documentation) than those designated as other insurance.
Before insuring any loans, the Corporation issues to each approved customer
a master policy outlining the terms and conditions under which coverage will be
provided. Primary business is then executed via the issuance of a
commitment/certificate for each loan submitted and approved for insurance. In
the case of business issued as pool coverage, a separate pool insurance policy
is issued covering the loans applicable to the transaction.
The amount of premium charge depends on loan-to-value ratios, the level of
coverage being provided, the type of loan instrument (whether fixed rate/fixed
payment or an adjustable rate/adjustable payment), documentation type, and
whether or not the insured property is to be an investment property or owner
occupied. Coverage is non-cancelable by the Company (except in the case of
non-payment of premium or certain master policy violations) and premiums are
paid under single, annual, or monthly payment plans. Single premiums are paid at
loan closing and provide coverage for the entire coverage term. Annual and
monthly premiums are renewable on their anniversary dates with the premium
charge determined on the basis of original or outstanding loan amount.
Substantially all of the Corporation's insurance in force as of December 31,
2003 has been written under monthly premium plans.
Title Insurance Group
The title insurance business consists primarily of the issuance of policies
to real estate purchasers and investors based upon searches of the public
records, which contain information concerning interests in real property. The
policy insures against losses arising out of defects, liens and encumbrances
affecting the insured title and not excluded or excepted from the coverage of
the policy. For the year ended December 31, 2003, approximately 40% of the
Company's consolidated title premium and related fee income stemmed from direct
operations through its marketing and underwriting staffs, while the remaining
60% emanated from independent title agents and service intermediaries such as
real estate attorneys and realtors.
There are two basic types of title insurance policies: lenders' policies
and owners' policies. Both are issued for a onetime premium. Most mortgages made
in the United States are extended by mortgage bankers, savings and commercial
banks, state and federal agencies, and life insurance companies. The financial
institutions secure title insurance policies to protect their mortgagees'
interest in the real property. This protection remains in effect for as long as
the mortgagee has an interest in the property. A separate title insurance policy
may be issued to the owner of the real estate. An owner's policy of title
insurance protects an owner's interest in the title to the property.
The premiums charged for the issuance of title insurance policies vary with
the policy amount and the type of policy issued. The premium is collected in
full when the real estate transaction is closed, there being no recurring fee
thereafter. In many areas, premiums charged on subsequent policies on the same
property may be reduced, depending generally upon the time elapsed between
issuance of the previous policies and the nature of the transactions for which
the policies are issued. Most of the charge to the customer relates to title
services rendered in conjunction with the issuance of a policy rather than to
the possibility of loss due to risks insured against. Accordingly, the cost of
service performed by a title insurer relates for the most part to the prevention
of loss rather than to the assumption of the risk of loss. Claim losses that do
occur result primarily from title search and examination mistakes, fraud,
forgery, incapacity, missing heirs and escrow processing errors.
In connection with its title insurance operations, Old Republic also
provides escrow closing and construction disbursement services, as well as real
estate information products and services pertaining to real estate transfers and
loan transactions.
Life Insurance Group
Old Republic markets and writes consumer credit life and disability
insurance primarily through automobile dealers. Borrowers insured under consumer
credit life insurance are also generally covered by consumer credit disability
protection. Credit life insurance provides for the repayment of a loan,
installment purchase, or other debt obligation in the event of the death of the
borrower, while credit disability insurance provides for the payment of
installments due on such debt while the borrower is disabled.
Old Republic also writes various conventional life, disability/accident and
health insurance coverages, principally through banks and other financial
services institutions. Ordinary term life insurance is sold through independent
agents and brokers in both the United States and Canada. Marketing of term life
insurance products is aimed principally toward self-employed individuals,
professionals, home owners and small business owners.
4
Consolidated Underwriting Statistics
The following table reflects underwriting statistics covering: 1) premiums
and related loss, expense, and policyholders' dividend ratios for the major
coverages underwritten in the General, Mortgage Guaranty, Title, and Life
insurance groups; and 2) the net retained life insurance in force at the end of
the years shown:
($ in Millions)
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Years Ended December 31,
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2003 2002 2001
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General Insurance Group:
Overall Experience: Net Premiums Written............... $ 1,460.3 $ 1,268.7 $ 1,078.5
Net Premiums Earned ............... $ 1,382.7 $ 1,182.3 $ 1,000.7
Loss Ratio......................... 66.7% 72.7% 75.4%
Policyholders' Dividend Ratio...... 1.1 (.1) (.1)
Expense Ratio ..................... 25.5 25.8 26.7
------------- ------------- -------------
Composite Ratio.................... 93.3% 98.4% 102.0%
============= ============= =============
Experience By Major Coverages:
Commercial Automobile: Net Premiums Earned ............... $ 545.6 $ 508.0 $ 457.7
(Principally Trucking) Loss Ratio......................... 70.4% 78.4% 82.4%
============= ============= =============
Workers' Compensation: Net Premiums Earned ............... $ 277.2 $ 226.2 $ 173.9
Loss Ratio......................... 75.9% 93.7% 90.0%
Policyholders' Dividend Ratio...... 5.3% (.5%) (1.0%)
============= ============= =============
General Liability: Net Premiums Earned ............... $ 72.6 $ 55.3 $ 53.7
Loss Ratio......................... 89.3% 67.5% 70.8%
============= ============= =============
Financial Indemnity: (a) Net Premiums Earned ............... $ 161.8 $ 104.1 $ 72.3
Loss Ratio......................... 50.9% 40.9% 38.8%
============= ============= =============
Property: (b) Net Premiums Earned ............... $ 169.0 $ 151.9 $ 128.1
Loss Ratio......................... 58.9% 51.4% 59.1%
============= ============= =============
Other Coverages: (c) Net Premiums Earned ............... $ 156.4 $ 136.6 $ 114.8
Loss Ratio......................... 52.2% 66.9% 68.5%
============= ============= =============
Mortgage Guaranty Group: Net Premiums Earned................ $ 400.9 $ 376.2 $ 353.1
Loss Ratio......................... 22.7% 14.1% 16.1%
Expense Ratio...................... 24.8 32.3 27.5
------------- ------------- -------------
Composite Ratio.................... 47.5% 46.4% 43.6%
============= ============= =============
Title Insurance Group: (d) Net Premiums Earned................ $ 749.9 $ 524.8 $ 382.7
Combined Net Premiums
& Fees Earned.................... $ 1,103.8 $ 813.4 $ 625.3
Loss Ratio......................... 5.8% 5.0% 4.0%
Expense Ratio...................... 84.6 85.6 87.2
------------- ------------- -------------
Composite Ratio.................... 90.4% 90.6% 91.2%
============= ============= =============
Life Insurance Group: (e) Net Premiums Earned................ $ 51.6 $ 50.1 $ 50.6
Benefits & Claims Ratio............ 48.8% 58.0% 59.7%
Expense Ratio...................... 55.2 42.5 45.4
------------- ------------- -------------
Composite Ratio.................... 104.0% 100.5% 105.1%
============= ============= =============
Net Retained Life
Insurance in Force................ $ 7,431.2 $ 7,383.6 $ 7,500.4
============= ============= =============
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Certain minor reclassifications of prior year data have been reflected in the
above table to conform to current presentation.
(a) Consists principally of fidelity, surety, consumer credit indemnity, and
executive indemnity (directors & officers and errors & omissions) coverages.
(b) Consists principally of fire, allied lines, commercial multi-peril and
inland marine coverages.
(c) Consists principally of home and auto warranty, aviation and travel accident
coverages.
(d) Title loss, expense, and composite ratios are calculated on the basis of
combined net premiums and fees earned.
(e) Life Group benefits and claims ratios take into account combined actuarial
future benefit and claims reserves.
5
Variations in the loss (including related claim settlement expense) ratios
are typically caused by changes in the frequency and severity of claims
incurred, changes in premium rates and the level of premium refunds, and
periodic changes in claim and claim expense reserve estimates resulting from
ongoing reevaluations of reported and incurred but not reported claims and claim
expenses. The Company, therefore, can experience volatility in the underwriting
results of individual lines of coverage as demonstrated in the table on the
previous page. As a result of the Company's strong underwriting focus in the
management of its business, it has attempted to dampen this volatility and thus
ensure a higher degree of underwriting stability by diversifying the coverages
it offers and industries it serves. The loss ratios include loss adjustment
expenses where appropriate. Policyholders' dividends, which apply principally to
workers' compensation insurance, are a reflection of changes in loss experience
for individual or groups of policies, rather than overall results, and should be
viewed in conjunction with loss ratio trends.
General Insurance Group loss ratios for workers' compensation and liability
insurance coverages in particular may reflect greater variability due to a
number of factors. Such variability is due in part to chance events in any one
year, changes in loss costs emanating from participation in involuntary markets
(i.e. industry-wide insurance pools and associations in which participation is
basically mandatory), and added provisions for loss costs not recoverable from
assuming reinsurers which may experience financial difficulties from time to
time. The Company generally underwrites concurrently workers' compensation,
commercial automobile (liability and physical damage), and general liability
insurance coverages for a large number of customers. Accordingly, an evaluation
of trends in premiums, loss and dividend ratios for these individual coverages
should be considered in the light of such a concurrent underwriting approach.
The general insurance portion of the claims ratio improved in 2003 compared to
2002 which also reflected an improvement over 2001. The downtrend in this major
cost factor reflects largely the pricing and risk selection improvements
effected in the past thirty-six months or so. With respect to commercial
automobile coverages, the decline in the loss ratio in 2003 stems primarily from
the pricing and risk selection improvements made in recent years. In workers'
compensation, the decrease in the loss ratio in 2003 stems from improved pricing
in general as well as stronger growth of business subject to captive
reinsurance, retrospective premium, or high deductible programs that tend to
produce lower loss ratios. The 2003 dividend ratio rose primarily due to the
conversion of a large account to self-insured status which served to increase
policyholder dividend costs that were offset by a reduction in incurred losses.
The loss ratio for general liability coverages rose, exhibiting the impact of
higher claims emergence on a relatively small book of business. The increase in
the financial indemnity loss ratio for 2003 reflects higher loss costs for the
Company's consumer credit indemnity and executive indemnity coverages. The
decline in the 2003 loss ratios for other coverages reflects greater production
of aviation coverages and lower loss costs thereon, as well as improved home
warranty claims experience.
The lower 2002 mortgage guaranty claims ratio results from a decline in
claim provisions driven principally by a drop in expected claim severity, while
the increase in 2003 was driven mostly by higher claim frequencies. A small
increase in 2001 was largely the result of a moderately higher loan default rate
factor.
The title insurance loss ratio has been in the low single digits in each of
the past three years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. The
uptrend in the 2003 and 2002 title insurance loss ratios stems from a rise in
the net provision for ultimate claim costs from the historically low levels
achieved in 2001.
General Insurance Claim Reserves
The Corporation's property and liability insurance subsidiaries establish
claim reserves which consist of estimates to settle: a) reported claims; b)
claims which have been incurred as of each balance sheet date but have not as
yet been reported ("IBNR") to the insurance subsidiaries; and c) the direct
costs, (fees and costs which are allocable to individual claims) and indirect
costs (such as salaries and rent applicable to the overall management of claim
departments) to administer known and IBNR claims. Such claim reserves, except as
to classification in the Consolidated Balance Sheets in terms of gross and
reinsured portions, are reported for financial and regulatory reporting purposes
at amounts that are substantially the same.
The establishment of claim reserves by the Corporation's insurance
subsidiaries is a reasonably complex and dynamic process influenced by a large
variety of factors. These factors include past experience applicable to the
anticipated costs of various types of claims, continually evolving and changing
legal theories emanating from the judicial system, recurring accounting,
statistical, and actuarial studies, the professional experience and expertise of
the Company's claim departments' personnel or attorneys and independent claims
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 management's judgments and the opinions of a
large number of persons, on the application and interpretation of historical
precedent and trends, and on expectations as to future developments. At any
point in time, the Company is exposed to possibly higher than anticipated claim
costs due to the aforementioned factors, and to the evolution, interpretation,
and expansion of tort law, as well as the effects of unexpected jury verdicts.
In establishing claim reserves, the possible increase in future loss
settlement costs caused by inflation is considered implicitly, along with the
many other factors cited above. Reserves are generally set to provide for the
ultimate cost of all claims. With regard to workers' compensation reserves,
however, the ultimate cost of long-term disability or pension-type claims is
discounted to present value based on interest rates ranging from 3.5% to 4.0%.
6
The Company, where applicable, uses only such discounted reserves in evaluating
the results of its operations, in pricing its products and settling
retrospective and reinsured accounts, in evaluating policy terms and experience,
and for other general business purposes. Solely to comply with reporting rules
mandated by the Securities and Exchange Commission, however, Old Republic has
made statistical studies of applicable workers' compensation reserves to obtain
estimates of the amounts by which claim and claim adjustment expense reserves,
net of reinsurance, have been discounted. These studies have resulted in
estimates of such amounts at approximately $142.9 million, $145.7 million and
$151.3 million, as of December 31, 2003, 2002 and 2001, respectively. It should
be noted, however, that these differences between discounted and non-discounted
(terminal) reserves are, fundamentally, of an informational nature, and are not
indicative of an effect on operating results for any one or series of years for
the above-noted reasons.
Early in 2001, the Federal Department of Labor revised the Federal Black
Lung Program regulations. The revisions basically require a reevaluation of
previously settled, denied, or new occupational disease claims in the context of
newly devised, more lenient standards when such claims are resubmitted.
Following a number of challenges and appeals by the insurance and coal mining
industries, the revised regulations were, for the most part, upheld in June,
2002 and are to be applied prospectively. Since the final quarter of 2001, black
lung claims filed or refiled pursuant to these anticipated and now final
regulations have increased, though the 2003 volume of new claim reports abated.
The vast majority of claims filed to date against Old Republic pertain to
business underwritten through loss sensitive programs that permit the charge of
additional or refund of return premiums to wholly or partially offset changes in
estimated claim costs, or to business underwritten as a service carrier on
behalf of various industry-wide involuntary market (i.e. assigned risk) pools. A
much smaller portion pertains to business produced on a traditional risk
transfer basis. The Company has established applicable reserves for claims as
they have been reported and for claims not as yet reported on the basis of its
historical experience and assumptions as to the effect of the revised
regulations. Inasmuch as a variety of challenges are likely as the revised
regulations are implemented in the actual claim settlement process, the
potential impact on reserves, gross and net of reinsurance or retrospective
premium adjustments, resulting from such regulations cannot as yet be estimated
with reasonable certainty.
Old Republic's reserve estimates also include provisions for indemnity and
settlement costs for various asbestosis and environmental impairment ("A&E")
claims that have been filed in the normal course of business against a number of
its insurance subsidiaries. Many such claims relate to policies issued prior to
1985, including many issued during a short period between 1981 and 1982 pursuant
to an agency agreement canceled in 1982. Over the years, the Corporation's
property and liability insurance subsidiaries have typically issued general
liability insurance policies with face amounts ranging between $1.0 million and
$2.0 million and rarely exceeding $10.0 million. Such policies have, in turn,
been subject to reinsurance cessions which have typically reduced the
Corporation's retentions to $.5 million or less as to each claim. At December
31, 2003, the Corporation's aggregate indemnity and loss adjustment expense
reserves specifically identified with A&E exposures amounted to approximately
$91.0 million gross, and $56.6 million net of reinsurance. Based on average
annual claims payments during the five most recent calendar years, such reserves
represented 6.3 years (gross) and 9.8 years (net) of average annual claims
payments. Old Republic's exposure to A&E claims cannot, however, be calculated
by conventional insurance reserving methods for a variety of reasons, including:
a) the absence of statistically valid data inasmuch as such claims typically
involve long reporting delays and very often uncertainty as to the number and
identity of insureds against whom such claims have arisen or will arise; and b)
the litigation history of such or similar claims for insurance industry members
that has produced court decisions that have been inconsistent with regard to
such questions as when an alleged loss occurred, which policies provide
coverage, how a loss is to be allocated among potentially responsible insureds
and/or their insurance carriers, how policy coverage exclusions are to be
interpreted, what types of environmental impairment or toxic tort claims are
covered, when the insurer's duty to defend is triggered, how policy limits are
to be calculated, and whether clean-up costs constitute property damage. In
recent times, the Executive Branch and/or the Congress of the United States have
proposed or considered changes in the legislation and rules affecting the
determination of liability for environmental and asbestosis claims. As of
December 31, 2003, however, there is no solid evidence to suggest that possible
future changes might mitigate or reduce some or all of these claim exposures.
Because of the above issues and uncertainties, estimation of reserves for losses
and allocated loss adjustment expenses for A&E claims in particular is much more
difficult or impossible. Accordingly, no representation can be made that the
Corporation's reserves for such claims and related costs will not prove to be
overstated or understated in the future. For the five years ended December 31,
2003, incurred A&E claim and related loss settlement costs have averaged $9.4
million, net of reinsurance, per annum or 1.2% of such average annual General
Insurance Group costs.
The subject of property and liability insurance claim reserves has been
written about and analyzed extensively by a large number of professionals and
regulators. Accordingly, the above discussion summary should, of necessity, be
regarded as a basic outline of the subject and not as a definitive presentation.
The Company believes that its overall reserving practices have been consistently
applied over many years, and that its aggregate reserves have generally resulted
in reasonable approximations of the ultimate net costs of claims incurred.
However, no representation is made that ultimate net claim and related costs
will not develop in future years to be greater or lower than currently
established reserve estimates.
The following table shows the evolving redundancies or deficiencies for
reserves established as of December 31, of each of the years 1993 through 2003.
In reviewing this tabular data, it should be noted that prior periods' loss
payment and development trends may not be repeated in the future due to the
large variety of factors influencing the reserving process outlined herein
above. The reserve redundancies or deficiencies shown for all years are not
necessarily indicative of the effect on reported results of any one or series of
years since retrospective premium and commission adjustments employed in various
parts of the Company's business may partially offset such effects. (See
7
"Consolidated Underwriting Statistics" above, and "Reserves, Reinsurance, and
Retrospective Adjustments" elsewhere herein).
($ in Millions/Percentages to Nearest Whole Point)
- ------------ ----------------------------------------------------------------------------------------------------------------------
(a) As of December 31: 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(b) Liability(1) for unpaid
claims and claim adjustment
Expenses(2): $1,700 $1,768 $1,821 $1,829 $1,846 $1,742 $1,699 $1,661 $1,678 $1,802 $1,964
=================================================================================================
(c) Paid (cumulative) as of (3):
----------------------------
One year later 20% 21% 22% 20% 23% 25% 24% 25% 25% 24% -%
Two years later 33 35 33 34 38 39 40 40 40 - -
Three years later 42 42 42 44 47 49 50 50 - - -
Four years later 46 48 49 49 54 56 57 - - - -
Five years later 51 52 52 55 59 61 - - - - -
Six years later 55 55 57 59 63 - - - - - -
Seven years later 57 59 61 63 - - - - - - -
Eight years later 60 63 64 - - - - - - - -
Nine years later 64 66 - - - - - - - - -
Ten years later 67% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(d) Liability reestimated (i.e.,
cumulative payments plus
reestimated ending liability)
As of (4):
-----------------------------
One year later 95% 95% 96% 94% 93% 96% 96% 97% 100% 99% -%
Two years later 91 93 92 88 89 93 95 98 101 - -
Three years later 93 90 87 84 87 93 97 100 - - -
Four years later 91 87 83 82 87 95 98 - - - -
Five years later 89 84 82 83 89 97 - - - - -
Six years later 86 84 82 85 91 - - - - - -
Seven years later 86 85 85 86 - - - - - - -
Eight years later 88 88 86 - - - - - - - -
Nine years later 91 89 - - - - - - - - -
Ten years later 92% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(e) Redundancy (deficiency)(5)
for each year-end at (a): 8% 11% 14% 14% 9% 3% 2% -% -1% 1% -%
=================================================================================================
Average for all year-ends
at (a): 6.3%
====
- ----------
(1) Amounts are reported net of reinsurance. (2) Excluding unallocated loss
adjustment expense reserves. (3) Percent of most recent reestimated liability
(line d). Decreases in paid loss percentages may at times reflect the
reassumption by the Company of certain previously ceded loss reserves from
assuming reinsurers through commutations of then existing reserves. (4) Percent
of beginning liability (line b) for unpaid claims and claim adjustment expenses.
(5) Beginning liability less the most current liability reestimated (line d) as
a percent of beginning liability (line b).
The following table shows an analysis of changes in aggregate reserves for
the Company's property and liability insurance claims and allocated claim
adjustment expenses for each of the years shown:
($ in Millions)
-------------------------------------------
Years Ended December 31,
-------------------------------------------
2003 2002 2001
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the beginning of each year, net of reinsurance losses recoverable..... $ 1,802.5 $ 1,678.9 $ 1,661.5
----------- ------------ ------------
Incurred claims and claim adjustment expenses:
Provisions for insured events of the current year........................ 893.9 814.6 749.1
Change in provision for insured events of prior years.................... (25.8) (7.1) (44.5)
----------- ------------ ------------
Total incurred claims and claim adjustment expenses................. 868.1 807.5 704.6
----------- ------------ ------------
Payments:
Claims and claim adjustment expenses attributable to insured
events of the current year.......................................... 277.9 260.7 269.0
Claims and claim adjustment expenses attributable to insured
events of prior years................................................ 428.6 423.1 418.2
----------- ------------ ------------
Total payments...................................................... 706.6 683.8 687.2
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the end of each year (a), net of reinsurance losses recoverable....... 1,964.1 1,802.5 1,678.9
Unallocated loss adjustment expense reserves................................ 83.6 78.5 76.6
Reinsurance losses recoverable.............................................. 1,515.0 1,363.0 1,261.2
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses.......... $ 3,562.8 $ 3,244.1 $ 3,016.8
=========== ============ ============
- ----------
(a) Reserves for incurred but not reported losses amounted to approximately
30.3%, 25.3%, and 24.3% of the totals shown as of December 31, 2003, 2002
and 2001, respectively.
8
(b) Investments. In common with other insurance organizations, Old Republic
invests most funds provided by operations in income-producing investment
securities.
All investments must comply with applicable insurance laws and regulations
which prescribe the nature, form, quality, and relative amounts of investments
which may be made by insurance companies. Generally, these laws and regulations
permit insurance companies to invest within varying limitations in state,
municipal and federal government obligations, corporate obligations, preferred
and common stocks, certain types of real estate, and first mortgage loans. Old
Republic's investment policies are also influenced by the terms of the insurance
coverages written, by its expectations as to the timing of claim and benefit
payments, and by income tax considerations. The following tables show invested
assets at the end of the last three years, together with investment income for
such years:
Consolidated Investments
($ in Millions)
December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ------------ ------------
Available for Sale
Fixed Maturity Securities:
U.S. & Canadian Governments............................................ $ 993.4 $ 976.2 $ 869.0
Tax-Exempt............................................................. 1,277.2 - -
Utilities.............................................................. 828.5 - -
Corporate.............................................................. 2,641.8 2,196.2 1,741.2
----------- ------------ ------------
5,741.1 3,172.4 2,610.2
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................. 2.0 2.2 1.7
Common Stocks.......................................................... 511.4 511.2 389.8
----------- ------------ ------------
513.5 513.5 391.6
----------- ------------ ------------
Short-term Investments.................................................... 403.9 253.8 298.5
Miscellaneous Investments................................................. 53.2 - -
----------- ------------ ------------
Total available for sale............................................... 6,711.8 3,939.9 3,300.4
----------- ------------ ------------
Held to Maturity
Fixed Maturity Securities:
Utilities.............................................................. - 754.4 777.6
Tax-Exempt............................................................. - 1,299.7 1,333.4
Redeemable Preferred Stocks............................................ - - .7
----------- ----------- ------------
- 2,054.1 2,111.8
----------- ------------ ------------
Miscellaneous Investments................................................. 8.5 57.4 60.8
----------- ------------ ------------
Total held to maturity................................................. 8.5 2,111.6 2,172.7
----------- ------------ ------------
Total Investments......................................................... $ 6,720.4 $ 6,051.5 $ 5,473.1
=========== ============ ============
Sources of Consolidated Investment Income
($ in Millions)
Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ------------ ------------
Fixed Maturity Securities:
Taxable............................................................... $ 202.7 $ 193.5 $ 189.5
Tax-Exempt............................................................ 53.7 59.5 61.7
Redeemable Preferred Stocks........................................... - - -
----------- ------------ ------------
256.4 253.1 251.3
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................ .1 .1 .1
Common Stocks......................................................... 14.4 12.3 7.8
----------- ------------ ------------
14.6 12.4 7.9
----------- ------------ ------------
Other Investment Income:
Interest on Short-term Investments.................................... 4.5 6.0 15.8
Sundry................................................................ 6.8 5.2 6.1
----------- ------------ ------------
11.4 11.3 22.0
----------- ------------ ------------
Gross Investment Income.................................................. 282.5 276.9 281.3
Less: Investment Expenses (a)......................................... 3.2 4.2 6.5
----------- ------------ ------------
Net Investment Income.................................................... $ 279.2 $ 272.6 $ 274.7
=========== ============ ============
- ----------
(a) Investment expenses consist primarily of personnel costs, investment
management and custody service fees and includes interest incurred on funds
held of $.1, $.3 and $1.4 for the years ended December 31, 2003, 2002 and
2001, respectively.
9
For many years, Old Republic's investment policy has been to acquire and
retain primarily investment grade, publicly traded, fixed maturity securities.
Accordingly, the Corporation's exposure to so-called "junk bonds", private
placements, real estate, mortgage loans, and derivatives is immaterial or
non-existent. Management considers investment-grade securities to be those rated
by Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors
Service, Inc. ("Moody's") that fall within the top four rating categories, or
securities which are not rated but have characteristics similar to securities so
rated. The Company had no bond or note investments in default as to principal
and/or interest at December 31, 2003, and $1.6 million of bond or note
investments in default as to principal and/or interest as of December 31, 2002.
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. 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 management's opinion, the Company's high quality and diversified
portfolio, which consists largely of publicly traded securities, has been a
basic reason for the absence of major impairment provisions in the periods
reported upon. The combination of gains and losses on sales of securities and
such provisions or write-downs of securities are reflected as realized gains and
losses in the income statement. Dispositions of securities result principally
from scheduled maturities of bonds and notes and sales of fixed income and
equity securities available for sale. The Company's invested assets as of
December 31, 2003 have been classified largely as "available for sale" pursuant
to the existing investment policy. (See Item 7 - "Management Analysis of
Financial Position and Results of Operations" for a more thorough discussion on
the transfer of fixed maturity securities from "held to maturity" to "available
for sale".)
The independent credit quality ratings and maturity distribution for Old
Republic's consolidated fixed maturity investments, excluding short-term
investments, at December 31, 2003 and 2002, are shown in the following tables.
These investments, $5.7 billion and $5.2 billion at December 31, 2003 and 2002,
respectively, represented approximately 59% and 60%, respectively, of
consolidated assets as of such dates, and 93% and 94%, respectively, of
consolidated liabilities as of such dates.
- -------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (a)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
---------- ----------
(% of total portfolio)
Aaa.............................................................................. 29.7% 30.9%
Aa............................................................................... 19.1 24.3
A................................................................................ 32.0 31.4
Baa.............................................................................. 18.5 10.8
---------- ----------
Total investment grade....................................................... 99.3 97.4
All others (b)................................................................... .7 2.6
---------- ----------
Total........................................................................ 100.0% 100.0%
========== ==========
- ----------
(a) 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.
(b) "All others" includes non-investment grade or non-rated small issues of tax
exempt bonds.
- -------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
---------- ----------
(% of total portfolio)
Maturity Ranges:
Due in one year or less.......................................................... 11.0% 13.4%
Due after one year through five years............................................ 50.0 55.9
Due after five years through ten years........................................... 37.7 29.9
Due after ten years through fifteen years........................................ 1.3 .8
Due after fifteen years.......................................................... - -
---------- ----------
100.0% 100.0%
========== ==========
Average Maturity................................................................. 4.5 Yrs. 3.9 Yrs.
========== ==========
- -------------------------------------------------------------------------------------------------------------------------------
(c) Marketing. Commercial automobile (trucking), workers' compensation and
general liability insurance underwritten for business enterprises and public
entities is marketed primarily through independent insurance agents and brokers
with the assistance of Old Republic's trained sales, underwriting, actuarial,
and loss control personnel. The remaining property and liability commercial
insurance written by Old Republic is obtained through insurance agents or
brokers who are independent contractors and generally represent other insurance
companies, and by direct sales. No single source accounted for over 10% of Old
Republic's premium volume in 2003.
10
Traditional primary mortgage insurance is marketed primarily through a
direct sales force which calls on mortgage bankers, brokers, commercial banks,
savings institutions and other mortgage originators. No sales commissions or
other forms of remuneration are paid to the lending institutions or others for
the procurement or development of business.
The Mortgage Guaranty segment's ten largest customers were responsible for
approximately 37.3%, 38.3% and 40.7% of traditional primary new insurance
written in 2003, 2002 and 2001, respectively. The largest single customer
accounted for 7.2% of traditional primary new insurance written in 2003 compared
to 10.6% and 8.2% in 2002 and 2001, respectively.
A substantial portion of the Company's title insurance business is referred
to it by title insurance agents, builders, lending institutions, real estate
developers, realtors, and lawyers. Title insurance is sold through 256 Company
offices located in 34 states and through agencies and underwritten title
companies in Guam, Puerto Rico, the District of Columbia and all states except
Iowa. The issuing agents are authorized to issue binders and title insurance
policies based on their own search and examination, or on the basis of abstracts
and opinions of approved attorneys. Policies are also issued through independent
abstract companies (not themselves title insurers) pursuant to underwriting
agreements. These agreements generally provide that the underwritten company may
cause title policies of the Company to be issued, and the latter is responsible
under such policies for any payments to the insured. Typically, the agency or
underwritten title company deducts the major portion of the title insurance
charge to the customer as its commission for services. During 2003,
approximately 60% of title insurance premiums and fees were accounted for by
policies issued by agents and underwritten title companies.
Title insurance premium and fee revenue is closely related to the level of
activity in the real estate market. The volume of real estate activity is
affected by the availability and cost of financing, population growth, family
movements and other factors. Also, the title insurance business is seasonal.
During the winter months, new building activity is reduced and, accordingly, the
Company does less title insurance business relative to new construction during
such months than during the rest of the year. The most important factor, insofar
as Old Republic's title business is concerned, however, is the rate of activity
in the resale market for residential properties.
The personal contacts, relationships, and reputations of Old Republic's key
executives are a vital element in obtaining and retaining much of its business.
Many of the Company's customers produce large amounts of premiums and therefore
warrant substantial levels of top executive attention and involvement. In this
respect, Old Republic's mode of operation is similar to that of professional
reinsurers and commercial insurance brokers, and relies on the marketing,
underwriting, and management skills of relatively few key people for large parts
of its business.
Several types of insurance coverages underwritten by Old Republic, such as
credit life and disability, consumer credit indemnity, title, and mortgage
guaranty insurance, are affected in varying degrees by changes in national
economic conditions. During periods of economic recession or rising interest
rates, operating and/or claim costs pertaining to such coverages tend to rise
disproportionately to revenues and generally result in reduced levels of
profitability.
At least one Old Republic insurance subsidiary is licensed to do business
in each of the 50 states, the District of Columbia, Puerto Rico, Virgin Islands,
Guam, Saipan, and each of the Canadian provinces; mortgage insurance
subsidiaries are licensed in 50 states and the District of Columbia; title
insurance operations are licensed to do business in 49 states, the District of
Columbia, Puerto Rico and Guam. Consolidated direct premium volume distributed
among the various geographical regions shown was as follows for the past three
years:
- -------------------------------------------------------------------------------------------------------------------------------
Geographical Distribution of Direct Premiums Written
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ----------- -----------
United States:
Northeast................................................................ 9.3% 8.4% 7.4%
Mid-Atlantic............................................................. 9.7 8.3 7.9
Southeast................................................................ 17.6 17.7 17.9
Southwest................................................................ 12.1 12.8 13.7
East North Central....................................................... 14.9 14.8 14.6
West North Central....................................................... 12.2 13.0 13.8
Mountain................................................................. 7.5 7.9 8.5
Western.................................................................. 14.6 14.9 14.0
Foreign (Principally Canada)............................................... 2.1 2.2 2.2
----------- ----------- -----------
Total............................................................. 100.0% 100.0% 100.0%
=========== =========== ===========
(d) Reserves, Reinsurance, and Retrospective Adjustments. Old Republic's
insurance subsidiaries establish reserves for future policy benefits, unearned
premiums, reported claims, claims incurred but not reported, and claim
adjustment expenses, as required in the circumstances. Such reserves are based
on regulatory accounting requirements and generally accepted accounting
principles. In accordance with insurance industry practices, claim reserves are
based on estimates of the amounts that will be paid over a period of time and
changes in such estimates are reflected in the financial statements of the
periods when they occur. See "General Insurance Claim Reserves" herein.
11
To maintain premium production within its capacity and limit maximum losses
and risks for which it might become liable under its policies, Old Republic, as
is the practice in the insurance industry, may cede a portion or all of its
premiums and liabilities on certain classes of insurance, individual policies,
or blocks of business to other insurers and reinsurers. Although the ceding of
insurance does not generally discharge an insurer from its direct liability to a
policyholder, it is industry practice to establish the reinsured part of risks
as the liability of the reinsurer. Old Republic also employs retrospective
premium adjustments, contingent commissions, and agency profit and risk-sharing
arrangements, for parts of its business in order to minimize losses for which it
might become liable under its insurance policies, and to afford its customers or
producers a degree of participation in the risks and rewards associated with
such business. Under retrospective arrangements, Old Republic collects
additional premiums if losses are greater than originally anticipated and
refunds a portion of original premiums if loss costs are lower. Pursuant to
contingent commission, agency profit and other risk-sharing arrangements, the
Company adjusts commissions or premiums retroactively to likewise reflect
deviations from originally expected loss costs. The amount of premium,
commission, or other retrospective adjustments which may be made is either
limited or unlimited depending on the Company's evaluation of risks and related
contractual arrangements. To the extent that any reinsurance companies,
retrospectively rated risks, or producers might be unable to meet their
obligations under existing reinsurance or retrospective insurance and commission
agreements, Old Republic would be liable for the defaulted amounts. In these
regards, however, the Company generally protects itself by withholding funds, by
securing indemnity agreements, by obtaining surety bonds, or by otherwise
collateralizing such obligations through irrevocable letters of credit, cash, or
securities.
Reinsurance recoverable asset balances represent amounts due from or
credited by assuming reinsurers for paid and unpaid claims and policy reserves.
Such reinsurance balances as are recoverable from non-admitted foreign and
certain other reinsurers such as captive insurance companies owned by assureds
or business producers, as well as similar balances or credits arising from
policies that are retrospectively rated or subject to assureds' high deductible
retentions are substantially collateralized by letters of credit, securities,
and other financial instruments. Old Republic evaluates on a regular basis the
financial condition of its assuming reinsurers and assureds who purchase its
retrospectively rated or high deductible policies. Estimates of unrecoverable
amounts are included in the Company's net claim and claim expense reserves since
reinsurance, retrospective rating, and high deductible policies and contracts do
not relieve Old Republic from its direct obligations to assureds or their
beneficiaries. Historically, the Company has not incurred material charges from
the non-recoverability of such balances and credits.
Old Republic's reinsurance practices with respect to portions of its
business also result from its desire to bring its sponsoring organizations and
customers into some degree of joint venture or risk sharing relationship. The
Corporation may, in exchange for a ceding commission, reinsure up to 100% of the
underwriting risk, and the premium applicable to such risk, to insurers owned by
or affiliated with lending institutions, financial and other intermediaries
whose customers are insured by Old Republic, or individual customers who have
formed captive (self-owned) insurance companies. The ceding commissions received
compensate Old Republic for performing the direct insurer's functions of
underwriting, actuarial, claim settlement, loss control, legal, reinsurance, and
administrative services to comply with local and federal regulations, and for
providing appropriate risk management services.
Remaining portions of Old Republic's business are reinsured with
independent insurance or reinsurance companies mostly under various quota share
and excess of loss agreements. Except as noted in the following paragraph,
reinsurance protection on property and liability operations generally limits the
net loss on most individual claims to a maximum of (in whole dollars):
$1,000,000 for workers' compensation; $1,000,000 for commercial auto liability;
$1,000,000 for general liability; $3,800,000 for executive protection (directors
& officers and errors & omissions); $1,000,000 for aviation; and $500,000 for
property coverages. Substantially all the mortgage guaranty insurance risk is
retained, with the exposure on any one risk currently averaging approximately
$22,200. Title insurance risk assumptions are limited to a maximum of $100.0
million as to any one policy beginning in 2003, and for amounts of up to $25.0
million in 2002 and prior years. The vast majority of title policies issued,
however, carry exposures of $500,000 or less. The maximum amount of ordinary
life insurance retained on any one life by the Life Insurance Group is $300,000.
Due to worldwide reinsurance capacity and related cost constraints,
effective January 1, 2002, the Corporation began retaining exposures for all,
but most predominantly workers' compensation liability insurance coverages in
excess of $40.0 million that were previously assumed by unaffiliated reinsurers
for up to $100.0 million. Effective January 1, 2003, reinsurance ceded limits
were once again raised to the $100.0 million level. Pursuant to regulatory
requirements, however, all workers' compensation primary insurers such as the
Company remain liable for unlimited amounts in excess of reinsured limits. Other
than the substantial concentration of workers' compensation losses caused by the
September 11, 2001 terrorist attack on America, to the best of the Company's
knowledge there had not been a similar accumulation of claims in a single
location from a single occurrence prior to that event. Nevertheless, the
possibility continues to exist that non-reinsured losses could, depending on a
wide range of severity and frequency assumptions, aggregate several hundred
million dollars to an insurer such as the Company in the event a catastrophe,
such as caused by an earthquake, lead to the death or injury of a large number
of employees concentrated in a single facility such as a high rise building.
As a result of the September 11, 2001 terrorist attack on America, the
reinsurance industry eliminated coverage from substantially all contracts for
claims arising from acts of terrorism. Primary insurers such as the Company
thereby became fully exposed to such claims. Late in 2002, the Terrorism Risk
Insurance Act of 2002 (the "TRIA") was signed into law, immediately establishing
12
a temporary federal reinsurance program administered by the Secretary of
Treasury. The TRIA defines what constitutes an "act of terrorism" and
establishes a formula based on primary insurers' premium volume to reimburse
such insurers for 93% of any terrorism losses suffered between November 26, 2002
and December 31, 2003, 90% of any losses suffered in 2004, and 85% of any losses
suffered in 2005. Further, pursuant to the TRIA, losses are capped for each year
at $100.0 billion. The TRIA will sunset on December 31, 2005 if not extended or
replaced by similar legislation. The TRIA automatically voided all policy
exclusions which were in effect for terrorism related losses. Under the TRIA,
insurers must offer terrorism coverage with most commercial property and
casualty insurance lines and are permitted to establish an additional premium
charge for their share of such risks, but insureds may elect to reject the
coverage. Insurers are permitted to reinsure that portion of the risk which they
retain under the TRIA, but the reinsurance market has not yet responded with a
widespread willingness to reinsure such risks. As of this date, coverage for
acts of terrorism are excluded from substantially all the Corporation's
reinsurance treaties, and are effectively retained by it subject to any recovery
that would be collected under the TRIA.
(e) Competition. The insurance business is highly competitive and Old Republic
competes with many stock and mutual insurance companies. Many of these
competitors offer more insurance coverages and have substantially greater
financial resources than the Corporation. The rates charged for many of the
insurance coverages in which the Corporation specializes, such as workers'
compensation insurance, other property and liability insurance, title insurance,
and credit life and disability insurance, are primarily regulated by the states
and are also subject to extensive competition among major insurance
organizations. The basic methods of competition available to Old Republic, aside
from rates, are service to customers, expertise in tailoring insurance programs
to the specific needs of its clients, efficiency and flexibility of operations,
personal involvement by its key executives, and, as to title insurance, accuracy
and timely delivery of evidences of title issued. Mortgage insurance companies
also compete by providing contract underwriting services to lenders, enabling
the latter to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting processes. For certain types of
coverages, including loan credit indemnity and mortgage guaranty insurance, the
Company also competes in varying degrees with the Federal Housing Administration
("FHA") and the Veterans Administration ("VA"). In these regards, the
Corporation's insurance subsidiaries compete with the FHA and VA by offering
different coverages and by establishing different requirements relative to such
factors as interest rates, closing costs, and loan processing charges. The
Corporation believes its experience and expertise have enabled it to develop a
variety of specialized insurance programs and related services for its
customers, and to secure state insurance departments' approval of these
programs.
(f) Government Regulation. In common with all insurance companies, the
Corporation's insurance subsidiaries are subject to the regulation and
supervision of the jurisdictions in which they do business. The method of such
regulation varies, but, generally, regulation has been delegated to state
insurance commissioners who are granted broad administrative powers relating to:
the licensing of insurers and their agents; the nature of and limitations on
investments; approval of policy forms; reserve requirements; and trade
practices. In addition to these types of regulation, many classes of insurance,
including most of the Corporation's insurance coverages, are subject to rate
regulations which require that rates be reasonable, adequate, and not unfairly
discriminatory.
The Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation have various qualifying requirements for private mortgage
guaranty insurers which write mortgage insurance on loans acquired by the FNMA
and FHLMC from mortgage lenders. These requirements call for compliance with the
applicable laws and regulations of the insurer's domiciliary state and those
states in which it conducts business, maintenance of minimum total
policyholders' surplus of $5.0 million, and maintenance of contingency reserves
in accordance with applicable state laws. The requirements also contain
guidelines pertaining to captive reinsurance transactions.
The financial institutions whose customers are insured by Old Republic are
also regulated by federal and state authorities whose regulations have a direct
effect on certain forms of credit life and disability insurance. There have been
various proposals from time to time with respect to additional regulation of
credit life and disability insurance which could have an adverse effect on the
Company's small consumer credit life and disability insurance business.
The majority of states have also enacted insurance holding company laws
which require registration and periodic reporting by insurance companies
controlled by other corporations licensed to transact business within their
respective jurisdictions. Old Republic's insurance subsidiaries are subject to
such legislation and are registered as controlled insurers in those
jurisdictions in which such registration is required. Such legislation varies
from state to state but typically requires periodic disclosure concerning the
corporation which controls the registered insurers, or ultimate holding company,
and all subsidiaries of the ultimate holding company, and prior approval of
certain intercorporate transfers of assets (including payments of dividends in
excess of specified amounts by the insurance subsidiary) within the holding
company system. Each state has established minimum capital and surplus
requirements to conduct an insurance business. All of the Company's subsidiaries
meet or exceed these requirements, which vary from state to state.
(g) Employees. As of December 31, 2003, Old Republic employed approximately
6,645 persons on a full time basis. A majority of eligible full time employees
participate in various pension plans which provide annuity benefits payable upon
retirement. Eligible employees are also covered by hospitalization and major
medical insurance, group life insurance, and various savings, profit sharing,
and deferred compensation plans. The Company considers its employee relations to
be good.
13
(h) Website access. The Company files various reports with the U.S. Securities
and Exchange Commission ("SEC"), including its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements,
and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act. The Company's filings are available for viewing
and/or copying at the SEC's Public Reference Room located at 450 Fifth Street,
NW., Washington, DC 20549. Information regarding the operation of the Public
Reference Room can be obtained by calling 1-800-SEC-0330. The Company's reports
are also available by visiting the SEC's Internet website (http://www.sec.gov)
and accessing its EDGAR database to view or print copies of the electronic
versions of the Company's reports. Additionally, the Company's reports can be
obtained, free of charge, by visiting its Internet website
(http://www.oldrepublic.com), selecting Financial Data and the EDGAR Filings
hyperlink to access the SEC's EDGAR database to view or print copies of the
electronic versions of the Company's reports. The contents of the Company's
Internet website are not intended to be, nor shall they be considered
incorporated by reference into any of the reports the Company files with the
SEC.
Item 2-Properties
The principal executive offices of the Company are located in the Old
Republic Building in Chicago, Illinois. This Company owned building contains
151,000 square feet of floor space of which approximately 54% is occupied by Old
Republic, and the remainder is leased to others. In addition to the
Company-owned principal executive offices, a subsidiary of the Title Insurance
Group partially occupies its headquarters building. This building contains
110,000 square feet of floor space of which approximately 79% is occupied by the
Old Republic National Title Insurance Company. The remainder of the building is
leased to others. Ten smaller buildings are owned by Old Republic and its
subsidiaries in various parts of the country and are primarily used for its
business. The carrying value of all owned buildings and related land at December
31, 2003 was approximately $21.6 million.
Certain other operations of the Company and its subsidiaries are directed
from leased premises. See Note 4(b) of the Notes to Consolidated Financial
Statements for a summary of all material lease obligations.
Item 3-Legal Proceedings
Legal proceedings against the Company arise in the normal course of
business and usually pertain to claim matters related to insurance policies and
contracts issued by its insurance subsidiaries. Other legal proceedings are
discussed below.
The City and County of San Francisco and certain escrow customers of an
underwritten title agency subsidiary headquartered in the State of California
have filed lawsuits alleging that the subsidiary: 1) failed to escheat unclaimed
escrow funds; 2) charged for services not necessarily provided; and 3) collected
illegal interest payments or fees from banks on the basis of funds held for
escrow customers. The subsidiary in turn conducted an internal review of its
records and concluded that it had certain liabilities for part of the issues
denoted at (1) and (2). The subsidiary defended against the alleged practice
denoted at (3) on the grounds that such practices are common within the
industry, are not in conflict with any laws or regulations, and other
meritorious defenses. The consolidated lawsuits have been tried and a judgment
rendered, affirming in part and denying in part the subsidiary's defenses. In
the aggregate, the judgment, excluding post-judgment interest, amounts to
approximately $33.0 million. The subsidiary has appealed the most significant
portions of the judgment, and management believes the judgment will be
substantially reduced on appeal. Through December 31, 2003, the subsidiary has
continually evaluated its exposures since the litigation began and has paid or
otherwise provided cumulatively $52.4 million, including its best estimate of
its remaining liability, costs associated with all these issues, and
accumulating interest on the aforementioned judgment.
In December 1999, a class action lawsuit was filed against the Company's
principal mortgage guaranty insurance subsidiary in the Federal District Court
for the Southern District of Georgia. The suit alleged that the subsidiary
provided pool insurance and other services to mortgage lenders at preferential,
below market prices in return for mortgage insurance business, and that the
practices violated the Real Estate Settlement Procedures Act. Substantially
identical lawsuits were also filed against all of the other mortgage guaranty
insurers. The Company's subsidiary filed a summary judgment motion which the
Court ruled on favorably, dismissing the lawsuit. The class plaintiffs appealed,
and the U.S. Court of Appeals for the Eleventh Circuit vacated the judgment and
remanded the case back to the District Court. The subsidiary again filed motions
seeking summary judgment on grounds it had asserted earlier but which were not
considered by the District Court and opposing certification of the class. On
February 5, 2003, the District Court denied class certification. The plaintiffs
petitioned the Court to reconsider its ruling or, alternatively, to certify
sub-classes. In order to bring the matter to a conclusion and avoid the
uncertainties and expenses of further litigation, the subsidiary entered into
settlement negotiations with the plaintiffs and reached a settlement agreement
calling for the payment of $10.0 million, including attorneys' fees. The
Agreement received final approval at a hearing set for that purpose on October
24, 2003. Between 2000 and 2003, the Company paid or otherwise provided
cumulatively $12.8 million, the majority of which was incurred in 2002 to cover
legal defenses and other costs associated with this litigation, including the
costs anticipated under the settlement. The full amount of the settlement was
paid on December 23, 2003.
14
Item 4-Submission of Matters to a Vote of Security Holders
None.
Executive Officers of the Registrant
The following table sets forth certain information as of December 31, 2003,
regarding the senior executive officers of the Company:
Name Age Position
- --------------------------- --- ------------------------------------------------------------------------------
John S. Adams 46 Senior Vice President and Chief Financial Officer since August, 2001.
Charles S. Boone 50 Senior Vice President, Chief Investment Officer and Treasurer since August,
2001.
James A. Kellogg 52 Senior Vice President/General Insurance and President of Old Republic
Insurance Company since October, 2002.
Spencer LeRoy, III 57 Senior Vice President, General Counsel and Secretary since 1992.
William A. Simpson 62 Senior Vice President/Mortgage Guaranty, and Director since 1980. President
since 1972 of Republic Mortgage Insurance Company, a wholly-owned subsidiary.
Rande K. Yeager 55 Senior Vice President/Title Insurance since March, 2003. President since
March, 2002 of Old Republic National Title Insurance Company.
A. C. Zucaro 64 Chief Executive Officer, President, Director and Chairman of the Board since
1990, 1981, 1976 and 1993, respectively.
The term of office of each officer of the Company expires on the date of
the annual meeting of the board of directors, which is generally held in May of
each year. There is no family relationship between any of the executive officers
named above. Each of these named officers has been employed in executive
capacities with the Company and/or its subsidiaries for the past five years.
PART II
Item 5- Market for the Registrant's Common Stock and Related Security Holder
Matters
The Company's common stock is traded on the New York Stock Exchange under
the symbol "ORI". The high and low closing prices as reported on the New York
Stock Exchange, and cash dividends declared for each quarterly period during the
past two years were as follows:
Closing Price
---------------------------- Cash
High Low Dividends
----------- ---------- ----------
1st quarter 2002......................................................... $ 21.63 $ 18.10 $ .100
2nd quarter 2002......................................................... 23.15 20.34 .107
3rd quarter 2002......................................................... 21.76 16.85 .107
4th quarter 2002......................................................... $ 21.47 $ 17.37 $ .107
=========== ========== ==========
1st quarter 2003......................................................... $ 20.18 $ 16.53 $ .107
2nd quarter 2003......................................................... 23.43 18.31 .113
3rd quarter 2003......................................................... 23.76 21.78 .113
4th quarter 2003......................................................... 25.79 22.83 .113
Special Dec. 2003......................................................... $ - $ - $ .667 (a)
=========== ========== ==========
- ----------
(a) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
As of January 30, 2004, there were 3,009 registered holders of the
Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial
Statements for a description of certain regulatory restrictions on the payment
of dividends by Old Republic's insurance subsidiaries. Closing prices have been
restated, as necessary, to reflect all stock dividends and splits declared
through December 31, 2003.
15
Item 6-Selected Financial Data
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
FINANCIAL POSITION ($ millions):
Cash and Invested Assets (a)........... $ 6,849.2 $ 6,168.2 $ 5,586.7 $ 5,144.3 $ 4,828.5
Other Assets........................... 2,863.0 2,547.1 2,333.4 2,137.1 2,109.8
Total Assets.................... 9,712.3 8,715.4 7,920.2 7,281.4 6,938.4
Liabilities, Other than Debt........... 6,020.9 5,417.9 4,977.1 4,604.0 4,530.8
Debt................................... 137.7 141.5 159.0 238.0 208.3
Total Liabilities............... 6,158.6 5,559.5 5,136.1 4,842.0 4,739.2
Preferred Stock........................ - - .3 .7 .7
Common Shareholders' Equity............ 3,553.6 3,155.8 2,783.7 2,438.7 2,198.4
Total Capitalization (b)........ $ 3,691.3 $ 3,297.4 $ 2,943.1 $ 2,677.4 $ 2,407.5
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS ($ millions):
Net Premiums and Fees Earned........... $ 2,936.0 $ 2,423.9 $ 2,029.5 $ 1,736.8 $ 1,781.7
Net Investment and Other Income........ 330.5 318.5 314.1 300.1 290.8
Realized Investment Gains.............. 19.3 13.9 29.7 33.6 29.5
Net Revenues................... 3,285.8 2,756.4 2,373.4 2,070.6 2,102.1
Benefits, Claims, Settlement
Expenses and Dividends............... 1,112.8 974.8 860.5 761.2 833.0
Underwriting and Other Expenses........ 1,492.9 1,220.6 1,008.9 882.9 952.0
Pretax Income..................... 680.0 560.9 503.9 426.4 317.0
Income Taxes.......................... 219.9 167.7 159.7 131.0 92.9
Net Income........................ $ 459.8 $ 392.9 $ 346.9 $ 297.5 $ 226.8
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA:(d)
Net Income:
Basic (c)............................. $ 2.53 $ 2.17 $ 1.94 $ 1.66 $ 1.17
============ ============ ============ ============ ============
Diluted .............................. $ 2.51 $ 2.16 $ 1.92 $ 1.65 $ 1.17
============ ============ ============ ============ ============
Dividends: Cash - Regular............... $ .446 $ .420 $ .393 $ .367 $ .327
- Special (e)........... .667 - - - -
------------ ------------ ------------ ------------ ------------
- Total................. $ 1.113 $ .420 $ .393 $ .367 $ .327
============ ============ ============ ============ ============
Stock........................ 50% -% -% -% -%
============ ============ ============ ============ ============
Book Value.............................. $ 19.57 $ 17.45 $ 15.60 $ 13.75 $ 11.99
============ ============ ============ ============ ============
Common Shares (thousands):
Outstanding........................... 181,606 180,898 178,465 177,380 183,299
============ ============ ============ ============ ============
Average: Basic...................... 181,549 180,863 178,436 178,977 193,438
============ ============ ============ ============ ============
Diluted.................... 183,302 182,323 180,491 180,295 194,680
============ ============ ============ ============ ============
- ----------
(a) Consists of cash, investments and investment income due and accrued.
(b) Total capitalization consists of debt, preferred stock, and common
shareholders' equity.
(c) Calculated after deduction of minor amounts of preferred stock cash
dividends.
(d) All per share statistics herein have been restated to reflect all stock
dividends or splits declared through December 31, 2003.
(e) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
16
Item 7-Management Analysis of Financial Position and Results of Operations
($ in Millions, Except Share Data)
- -------------------------------------------------------------------------------
OVERVIEW
This analysis pertains to the consolidated accounts of Old Republic
International Corporation which are presented on the basis of generally accepted
accounting principles ("GAAP"). The Company conducts its business through four
separate segments, namely its General (property and liability coverages),
Mortgage Guaranty, Title, and Life insurance groups. This information should be
read in conjunction with the consolidated financial statements and related
footnotes thereto included elsewhere in this document.
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 December 31, 2003 and 2002,
the Company's consolidated unamortized goodwill asset balance was $87.5, and the
average annual charge from goodwill amortization to operating results for the
three calendar years ended 2001 was approximately $4.0 (or 2 cents per average
diluted share). The Company completed the transitional goodwill impairment test
required by FAS 142 in the first quarter of 2002 and determined that there was
no indication of goodwill or intangible asset impairment. During the first
quarter of 2003, the Company tested the carrying value of its goodwill and
intangible assets and determined that there was no indication of impairment of
such assets.
Effective January 1, 2003, the Company elected to reclassify its fixed
maturity securities categorized as held to maturity to the available for sale
classification. The securities involved are primarily utility and tax-exempt
bonds that accounted for approximately 34 percent of Old Republic's investment
portfolio. The decision was prompted by restrictive accounting rules affecting
held to maturity investment securities. The necessarily mechanical application
of these rules can inhibit the Corporation's ability to optimally manage its
investments from a practical business point of view. As of January 1, 2003, the
net impact of this reclassification on the Corporation's balance sheet was to
increase the carrying value of invested assets by $117.5, deferred tax
liabilities by $41.1, and shareholders' equity by $76.4, or approximately 42
cents per share. As of December 31, 2003, the net impact of this
reclassification on the Corporation's balance sheet is to increase the carrying
value of invested assets by $99.2, deferred tax liabilities by $34.7 and
shareholders' equity by $64.5, or approximately 36 cents per share. This change
has no income statement impact, no effect on Old Republic's ability to hold
individual securities to maturity as it may deem appropriate, and does not
affect the Company's necessary long-term orientation in the management of its
business. Going forward, Old Republic's shareholders' equity account could
reflect somewhat greater period-to-period volatility as the entire bond, note
and stock investment portfolio will now be marked to market on a quarterly
basis. Nevertheless, the Company believes that its ability to hold securities
until they mature or until such other time when they can be sold
opportunistically are much more significant and meaningful factors than the
balance sheet or income statement effect of changes in market values at any
point in time.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 148 ("FAS 148") "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS No. 123" for
periods starting after December 15, 2002. As of April 1, 2003, the Company
adopted the requirements of FAS 148 utilizing the prospective method. Under this
method, stock-based compensation expense is recognized for awards granted after
the beginning of the fiscal year of adoption. For all other stock option awards
outstanding, the Company continues to use the intrinsic value method permitted
under existing accounting pronouncements. In estimating the compensation cost of
options, the fair value of options has been calculated using the Black-Scholes
option pricing model. Expense recognition of stock options granted in 2003
reduced earnings per share by less than 1 cent per share.
FINANCIAL POSITION
The Company's financial position at December 31, 2003 reflected increases
in assets, liabilities and common shareholders' equity of 11.4%, 10.8% and
12.6%, respectively, when compared to the immediately preceding year-end. Cash
and invested assets represented 70.5% and 70.8% of consolidated assets as of
December 31, 2003 and 2002, respectively. Consolidated results produced positive
and growing consolidated operating cash flows for the latest three years, with
the Company's three largest operating segments providing substantially all such
funds from operations. In 2003, the invested asset base increased 11.0% to
$6,849.2 principally as a result of such higher operating cash flow and the
greater increase in fair value of investments resulting from the aforementioned
reclassification of fixed maturity securities.
During 2003 and 2002, the Corporation committed substantially all
investable funds to short to intermediate-term fixed maturity securities. At
both December 31, 2003 and 2002, approximately 99% of the Company's investments
consisted of marketable securities, including tax and loss bonds held by its
mortgage guaranty subsidiaries, which are redeemable by the U.S. Treasury for
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. Old Republic's commitment to equity securities
during 2003 remained stable in relation to the related invested balance at
17
year-end 2002; this resulted mostly from sales of equity securities, which were
essentially offset by purchases and net unrealized gains on the remaining
holdings. At December 31, 2003, the Company had no fixed maturity investments in
default as to principal and/or interest.
Relatively high short-term maturity investment positions were maintained as
of December 31, 2003 and 2002. Such investment positions reflect a large variety
of seasonal and intermediate-term factors including current operating needs,
expected operating cash flows, and investment strategy considerations.
Accordingly, the future level of short-term investments will vary and respond to
the interplay of these factors and may, as a result, increase or decrease from
current levels.
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 component of the separate
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 adversely affected by the recognition of additional realized or
impairment losses, but its financial position would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses.
18
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 (*)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
--------------- --------------
Aaa................................................................................... 29.7% 30.9%
Aa.................................................................................... 19.1 24.3
A..................................................................................... 32.0 31.4
Baa................................................................................... 18.5 10.8
--------------- --------------
Total investment grade....................................................... 99.3 97.4
All other (**)........................................................................ .7 2.6
--------------- --------------
Total........................................................................ 100.0% 100.0%
=============== ==============
(*) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(**) "All other" includes non-investment or non-rated small issues of tax-exempt
bonds.
The Company had no gross unrealized losses on non-investment grade fixed
maturity securities as of December 31, 2003.
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities
as of December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------------
Gross
Amortized Unrealized
Cost Losses
------------ ------------
Fixed Maturity Securities by Industry Concentration:
Energy................................................................................ $ 58.5 $ 1.4
Municipals............................................................................ 49.5 .5
Industrials........................................................................... 48.8 .7
Telecom............................................................................... 44.6 .7
Other ................................................................................ 289.3 4.3
------------ ------------
Total........................................................................ $ 490.9 (a) $ 7.8
============ ============
(a) Represents 9.0 percent of the total fixed maturity securities portfolio.
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities
as of December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------------
Gross
Unrealized
Cost Losses
------------ ------------
Equity Securities by Industry Concentration:
Health care........................................................................... $ 39.7 $ 7.3
Utilities............................................................................. 28.7 4.1
Retail................................................................................ 24.0 4.6
Telecom............................................................................... 19.4 1.0
Other ................................................................................ 49.2 6.8
------------ ------------
Total........................................................................ $ 161.1 (b) $ 23.9 (c)
============ ============
(b) Represents 36.7 percent of the total equity securities portfolio.
(c) Represents 5.5 percent of the cost of the total equity securities portfolio,
while gross unrealized gains represent 22.4 percent of the portfolio.
19
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified For All Fixed Maturity Securities
as of December 31, 2003
- --------------------------------------------------------------------------------------------------------------------------------
Amortized Cost
of Fixed Maturity Securities Gross Unrealized Losses
--------------------------------- -------------------------------
Non- Non-
Investment Investment
All Grade Only All Grade Only
------------- ------------- ------------ ------------
Maturity Ranges:
Due in one year or less............................... $ 1.7 $ - $ - $ -
Due after one year through five years................. 119.8 - 1.5 -
Due after five years through ten years................ 347.9 - 5.5 -
Due after ten years................................... 21.3 - .7 -
------------- ------------- ------------ ------------
Total........................................ $ 490.9 (d) $ - $ 7.8 $ -
============= ============= ============ ============
(d) Represents 9.0 percent of the total fixed maturity securities portfolio.
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses
as of December 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Amount of Gross Unrealized Losses
-----------------------------------------------------------------------
Total Gross
Less than 20% 20% to 50% More than 50% Unrealized
of Cost of Cost of Cost Loss
------------- ------------- ------------- -------------
Number of Months in Loss Position:
Fixed Maturity Securities:
One to six months.................... $ 7.6 $ - $ - $ 7.6
Seven to twelve months............... - - - -
More than twelve months.............. .2 - - .2
------------- ------------- ------------- -------------
Total....................... $ 7.8 $ - $ - $ 7.8
============= ============= ============= =============
Equity Securities:
One to six months.................... $ 2.2 $ - $ - $ 2.2
Seven to twelve months............... - - - -
More than twelve months.............. 9.7 11.9 - 21.6
------------- ------------- ------------- -------------
Total....................... $ 12.0 $ 11.9 $ - $ 23.9
============= ============= ============= =============
Number of Issues in Loss Position:
Fixed Maturity Securities:
One to six months.................... 106 - - 106
Seven to twelve months............... 1 - - 1
More than twelve months.............. 3 - - 3
------------- ------------- ------------- -------------
Total....................... 110 - - 110 (e)
============= ============= ============= =============
Equity Securities:
One to six months.................... 8 - - 8
Seven to twelve months............... - - - -
More than twelve months.............. 13 5 - 18
------------- ------------- ------------- -------------
Total....................... 21 5 - 26 (e)
============= ============= ============= =============
The aging of issues with unrealized losses employs month-end closing market
price comparisons with an issue's original cost. The percentage reduction from
original cost reflects the decline as of a specific point in time, December 31,
2003 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.
(e) At December 31, 2003 the number of issues in a loss position represent 6.9
percent as to fixed maturities, and 27.7 percent as to equity securities of
the total number of such issues held by the Company.
20
- --------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- --------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
--------------- --------------
Maturity Ranges:
Due in one year or less............................................................. 11.0% 13.4%
Due after one year through five years............................................... 50.0 55.9
Due after five years through ten years.............................................. 37.7 29.9
Due after ten years through fifteen years........................................... 1.3 .8
Due after fifteen years............................................................. - -
--------------- --------------
Total...................................................................... 100.0% 100.0%
=============== ==============
Average Maturity.................................................................... 4.5 Yrs. 3.9 Yrs.
=============== ==============
Duration (f)........................................................................ 4.0 3.5
=============== ==============
(f) Duration is used as a measure of bond price sensitivity to interest rate
changes. A duration of 4.0 as of December 31, 2003 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 4.0 percent.
- -------------------------------------------------------------------------------------------------------------------------------
Composition of Unrealized Gains (Losses)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
--------------- --------------
On Fixed Maturity Securities:
Amortized cost.................................................................. $ 5,463.9 $ 5,043.6
Estimated fair value............................................................ 5,741.1 5,344.2
--------------- --------------
Gross unrealized gains.......................................................... 285.0 318.6
Gross unrealized losses......................................................... (7.8) (18.0)
--------------- --------------
Net unrealized gains .................................................. $ 277.1 $ 300.5
=============== ==============
On Equity Securities:
Cost............................................................................ $ 439.2 $ 520.3
Estimated fair value............................................................ 513.5 513.5
--------------- --------------
Gross unrealized gains.......................................................... 98.2 63.1
Gross unrealized losses......................................................... (23.9) (69.9)
--------------- --------------
Net unrealized gains (losses).......................................... $ 74.2 $ (6.7)
=============== ==============
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 reduced by allowances
for estimated amounts unrecoverable which allowances are reflected in the
Company's net reserve liabilities. Deferred policy acquisition costs are
estimated by taking into account the variable costs of producing specific types
of insurance policies, and evaluating their recoverability on the basis of
recent trends in claims costs. The Company's deferred policy acquisition cost
balances have not fluctuated substantially from period-to-period and do not
represent significant percentages of assets, shareholders' equity, or premium
reserves.
The parent holding company meets its liquidity and capital needs
principally through dividends paid by its subsidiaries. The insurance
subsidiaries' ability to pay cash dividends to the parent company is generally
restricted by law or subject to approval of the insurance regulatory authorities
of the states in which they are domiciled. The Company can receive up to $321.2
in dividends from its subsidiaries in 2004 without the prior approval of
regulatory authorities. The liquidity achievable through such permitted dividend
payments is more than adequate to cover the parent holding company's currently
expected cash outflows represented mostly by interest on outstanding debt and
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. During 2003 and 2002, the Company used a part of available cash
flow to redeem a portion of its commercial paper outstanding, thereby reducing
consolidated debt by approximately $1.0 and $15.0, respectively.
Old Republic's capitalization of $3,691.3 at December 31, 2003 consisted of
debt of $137.7 and common shareholders' equity of $3,553.6. Changes in the
common shareholders' equity account for the three most recent years reflect
primarily the retention of earnings in excess of dividends declared on
outstanding preferred and common shares and an increase in the value of
investments carried at market values. In May 2003, the Company canceled 1.9
million common shares previously reported as treasury stock, and restored them
to unissued status; this had no effect on total shareholders' equity or the
financial condition of the Company. At its March, 2002 meeting, the Company's
Board of Directors authorized the reacquisition of up to $200.0 of common shares
as market conditions warrant during the two year period from that date; no stock
had as yet been acquired through December 31, 2003 pursuant to this
authorization.
21
The following table shows certain information relating to the Company's
contractual obligations as of December 31, 2003:
Payments Due by Period
---------------------------------------------------------------------------------
Less than 1 - 3 3 - 5 More than 5
Total 1 Year Years Years Years
------------ ------------- ------------- ------------- ------------
Contractual Obligations:
Debt.................................. $ 137.7 $ 19.5 $ 1.0 $ 115.5 $ 1.5
Operating Leases...................... 128.6 33.7 43.6 24.6 26.5
------------ ------------- ------------- ------------- ------------
Total............................. $ 266.3 $ 53.2 $ 44.7 $ 140.2 $ 28.1
============ ============= ============= ============= ============
In December, 2003, the Company's Board of Directors declared a 50 percent
stock dividend on the Company's outstanding common shares. At the same time, the
Board of Directors also declared a special year-end cash dividend of $.667 per
common share ($1.00 per common share before adjustment for the 50 percent stock
dividend).
RESULTS OF OPERATIONS
Revenues:
Pursuant to GAAP applicable to the insurance industry, revenues are
associated with the related benefits, claims, and expenses by means of the
provision for policy benefits, the deferral and subsequent amortization of
applicable acquisition costs, and the recognition of incurred benefits, claims
and operating expenses. Substantially all general insurance premiums are
reflected in income on a pro-rata basis. Earned but unbilled premiums are
generally taken into income on the billing date, while adjustments for
retrospective premiums, commissions and similar charges or credits are accrued
on the basis of periodic evaluations of current underwriting experience and
contractual obligations.
Nearly all of the Company's mortgage guaranty premiums stem from monthly
installment policies. Accordingly, such premiums are fully earned in the month
they are reported and received. With respect to minor numbers of annual or
single premium policies, earned premiums are largely recognized on a pro-rata
basis over the terms of the policies.
Title premium and fee revenues stemming from the Company's direct
operations represent approximately 40% of such consolidated title business
revenues. Such premiums are generally recognized as income at the escrow closing
date which approximates the policy effective date. Fee income related to escrow
and other closing services is recognized when the related services have been
performed and completed. The remaining 60% of consolidated title premium and fee
revenues is produced by independent title agents and other service providers.
Rather than making estimates that could be subject to significant variance from
actual premium and fee production, the Company recognizes revenues from those
sources upon receipt. Such receipts can reflect a three to four month lag
relative to the effective date of the underlying title policy, and are offset
concurrently by production expenses and claim reserve provisions.
Ordinary life insurance premiums are recognized as revenues when due,
whereas premiums for other coverages such as credit life, credit disability, and
health insurance are recognized as income on a pro-rata, sum of the years'
digits, or combination of such methods as are deemed most applicable in the
circumstances.
The composition of Old Republic's earned premiums and fees for the periods
reported upon was as follows:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- -------------- -------------
General Insurance premiums........................................ $ 1,379.5 $ 1,184.1 $ 1,000.2
Mortgage Guaranty premiums........................................ 400.9 376.2 353.1
Title Insurance premiums and fees................................. 1,103.8 813.4 625.3
Life Insurance premiums........................................... 51.6 50.1 50.6
------------- -------------- -------------
Consolidated premiums and fees............................... $ 2,936.0 $ 2,423.9 $ 2,029.5
============= ============== =============
Consolidated net premiums and fees earned increased by 21.1%, 19.4% and
16.9% in 2003, 2002 and 2001, respectively. Earned premiums in the General
Insurance Group increased 16.5%, 18.4% and 16.6% in 2003, 2002 and 2001,
respectively, as a result of positive pricing and risk selection changes the
Company has effected during the past four years, as well as additional business
produced in an environment marked by a more restrictive marketing stance on the
part of many competitors. During 2002 and 2001 in particular, Old Republic
experienced greater success in retaining existing accounts and obtaining new
accounts at generally rising prices. Mortgage guaranty premium income trends
reflect greater sales opportunities arising from strong housing and mortgage
lending markets, offset in part by a high level of mortgage refinancing activity
and a greater amount of reinsurance cessions. High loan refinancing activity
tends to reduce mortgage guaranty insurers' policies in force, and thus renewal
premium production, since previously insured mortgages may no longer require
coverage or may become insured by competitors. Title Group premium and fee
revenues increased by 35.7%, 30.1% and 26.6% in 2003, 2002 and 2001,
respectively. These results reflect a continuation of favorable market
conditions for the sale of new and used homes, and most importantly strong
22
mortgage refinancing activity driven by a fairly consistent drop in mortgage
rates during the recent past. Life and disability premiums volume has continued
to reflect the flattish trends of the past several years as growth for the
Company's limited product offerings has been inhibited by significant price
competition among life and health insurers.
Consolidated net investment income grew by 2.4% in 2003, was down 0.8% in
2002 and grew by 0.3% in 2001. For each of the past three years, this revenue
source was affected by a rising invested asset base caused by positive
consolidated operating cash flows, by a concentration of investable assets in
interest-bearing fixed maturity securities, and by changes in market yields. The
average annual yield on investments was 4.7%, 5.1% and 5.6% for the years ended
December 31, 2003, 2002 and 2001, respectively. Yield trends reflect at once the
relatively short maturity of Old Republic's fixed maturity securities portfolio,
a continuation of a progressively lower yield environment during the past three
years, and a moderate increase in equity investments which typically produce
lower current yields in the form of cash dividends.
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, protect capital,
and provide 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; in 2003, 2002
and 2001, 70.2%, 74.9% 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:
Years Ended December 31,
------------------------------------------
2003 2002 2001
---------- ---------- ----------
Realized Gains (Losses) on Disposition of:
Fixed maturity securities.............................................. $ 4.6 $ 3.8 $ (2.9)
Equity securities and miscellaneous investments........................ 31.1 29.1 39.4
---------- ---------- ----------
Total..................................................... 35.7 33.0 36.5
---------- ---------- ----------
Impairment losses on:
Fixed maturity securities.............................................. - (5.0) (1.2)
Equity securities and miscellaneous investments........................ (16.4) (14.0) (5.5)
---------- ---------- ----------
Total..................................................... (16.4) (19.0) (6.7)
---------- ---------- ----------
Net realized gains.......................................................... $ 19.3 $ 13.9 $ 29.7
========== ========== ==========
Expenses:
The insurance business is distinguished from most others in that the prices
(premiums) charged for insurance coverages are set without clear knowledge of
the claim costs that will ultimately emerge and be incurred, often many years
after issuance of a policy. In order to achieve a necessary matching of revenues
and expenses, the Company records in each accounting period the benefits, claims
and related settlement costs that have been incurred during the period. Such
costs are affected by the adequacy of reserve estimates established for current
and prior years' claim occurrences. The establishment of claim reserves by the
Company's insurance subsidiaries is a reasonably complex and dynamic process
influenced by a large variety of factors. These factors include past experience
applicable to the anticipated costs of various types of claims, continually
evolving and changing legal theories emanating from the judicial system,
recurring accounting, statistical, and actuarial studies, the professional
experience and expertise of the Company's claim departments' personnel or
attorneys and independent claim adjusters, ongoing changes in claim frequency or
severity patterns such as those caused by natural disasters, illnesses,
accidents, work-related injuries, and changes in general and industry-specific
economic conditions. Consequently, the reserve-setting process relies on
management's judgments and the opinions of a large number of persons, on the
application and interpretation of historical precedent and trends, and on
expectations as to future developments. At any point in time, the Company is
exposed to possibly higher than anticipated claim costs due to all of these
factors, and to the evolution, interpretation, and expansion of tort law, as
well as the effects of unexpected jury verdicts.
All reserves are thus based on a large number of assumptions and resulting
estimates which are periodically reviewed and evaluated in the light of emerging
claim experience and changing circumstances. The resulting changes in estimates
are recorded in operations of the periods during which they are made. The
Company believes that its overall reserving practices have been consistently
applied over many years. For at least the past ten years, previously established
reserves have produced reasonable estimates of the 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
23
General insurance business, such events or exposures would include catastrophic
workers' compensation claims caused by a terrorist attack or a natural disaster
such as an earthquake, legislated retroactive incurrence of previously denied or
settled claims, the levying of major guaranty fund assessments by various states
based on the costs of insurance company failures apportioned against remaining
and financially secure insurers, the future failure of one or more significant
assuming reinsurers that would void or reduce the Company's reinsurance
recoverable for losses paid or in reserve, and greater than expected involuntary
market assessments, such as those caused by forced participation in assigned
risk and similar state plans, all of which cannot be reasonably estimated prior
to their emergence.
Mortgage guaranty claim reserves could develop deficiently as a result of
an unexpected rise in unemployment which might hinder borrowers' ability to cure
mortgage payment defaults. Significant declines in home prices could also have
similarly adverse effects since salvage recoveries from the sale of properties
obtained through foreclosures could be reduced. Title segment loss reserve
levels could be impacted adversely by such developments as reduced loan
refinancing activity whose effect 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
life and health segment, reserve adequacy may be affected adversely by greater
than anticipated medical care cost inflation as well as greater than expected
frequency and severity of claims.
In management's opinion, geographic concentrations of assureds' employees
in the path of an earthquake or acts of terrorism represent the most significant
catastrophic risks to Old Republic's General insurance segment. These risks
would largely impact the workers' compensation line since primary insurers such
as the Company must, by regulation, issue unlimited liability policies. While
Old Republic obtains a degree of protection through its reinsurance program as
to earthquake exposures, and until 2005, through the Terrorism Risk Insurance
Act of 2002, there is no assurance that recoveries thereunder would be
sufficient to offset the costs of a major calamity nor eliminate its possible
major impact on operating results and financial condition. Old Republic has
availed itself of modeling techniques to evaluate the possible magnitude of
earthquake or terrorist induced claim costs for its most exposed coverage of
workers' compensation. Such models, however, have not been sufficiently
validated by past occurrences, and rely on a large variety and number of
assumptions. As a result, they may not be predictive of possible claims from
future events. With respect to the Company's Mortgage Guaranty business, the
most significant risk lies in the possibility of prolonged economic dislocations
that would result in high unemployment levels and depressed property values
conspiring to magnify loan default rates and resulting claim costs. In Title
insurance, the Company's biggest exposure likely relates to defalcations and
fraud which can result in significant aggregations of claims or non-collection
of insurance premiums. In Life insurance, as in General insurance,
concentrations of insured lives coupled with a catastrophic event would
represent the Company's largest exposure. In all of these regards, current GAAP
accounting does not permit the Company's reserving practices to anticipate and
provide for these exposures before they occur.
Most of Old Republic's consolidated claim and related expense reserves stem
from its General insurance business. At December 31, 2003, such reserves
accounted for 88.6% and 81.9% of consolidated gross and net of reinsurance
reserves, respectively. The following table shows a breakdown of gross and net
of reinsurance claim reserve estimates for major types of insurance coverages as
of that date:
Gross Net
---------- -----------
Claim and Loss Adjustment Expense Reserves:
Commercial automobile (mostly trucking)........................................................... $ 764.5 $ 616.6
Workers' compensation............................................................................. 1,482.6 743.4
General liability................................................................................. 733.8 270.7
Other coverages................................................................................... 498.0 333.2
Unallocated loss adjustment expense reserves...................................................... 83.7 83.6
---------- -----------
Total general insurance segment reserves................................................. 3,562.8 2,047.7
Mortgage guaranty................................................................................. 181.5 179.7
Title............................................................................................. 237.1 237.1
Life.............................................................................................. 18.2 12.6
Unallocated loss adjustment expense reserves - other segments..................................... 22.7 22.7
---------- -----------
Total claim and loss adjustment expense reserves......................................... $ 4,022.7 $ 2,500.1
========== ===========
Asbestosis and environmental claim reserves included in the above
general insurance reserves: Amount......................................................... $ 91.0 $ 56.6
========== ===========
% of total general insurance segment reserves.................. 2.6% 2.8%
========== ===========
Old Republic's General insurance business is composed of a large variety of
lines or classes of commercial insurance; it has negligible exposure to personal
lines such as homeowners or private passenger automobile insurance that exhibit
wide diversification of risks, significant frequency of claim occurrences, and
high degrees of statistical credibility. Most of the General Insurance segment's
claim reserves stem from liability insurance coverages for commercial customers.
Liability claims typically require more extended periods of investigation and at
times protracted litigation before they are finally settled, and thus tend to
exhibit loss development and payment patterns that stretch over relatively long
periods of time.
The Company establishes point estimates for most reserves on an insurance
24
coverage line-by-line basis for individual subsidiaries, sub-classes, or
individual blocks of business that have similar attributes. Actuarially or
otherwise derived ranges of reserve levels are not utilized in setting such
reserves. The reserves listed in the table above represent such point estimates.
Accordingly, the overall reserve level at any point in time represents the
compilation of a very large number of reported ("case") reserve estimates and
the results of a variety of formula calculations intended to cover claims and
related costs not as yet reported or emerged ("IBNR"). Case reserves are based
on continually evolving assessments of the facts available to the Company during
the claim settlement process. Long-term, disability-type workers' compensation
reserves are discounted to present value based on interest rates ranging from
3.5% to 4.0%. Formula calculations are utilized and are intended to cover IBNR
claim costs as well as additional costs that can arise from such factors as
monetary and social inflation, changes in claims administration processes,
changes in reinsurance ceded 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 substantial majority of the asbestosis and environmental ("A&E")
claim reserves posted by Old Republic stem mainly from its participations in
assumed reinsurance treaties and insurance pools. Substantially all such
participations were discontinued fifteen or more years ago and have since been
in run-off status. With respect to the primary portion of gross A&E reserves,
Old Republic administers the related claims through its claims personnel as well
as outside attorneys, and posted reserves reflect its best estimates of ultimate
claim costs. Claims administration for the assumed portion of the Company's A&E
exposures is handled by the claims departments of unrelated primary or ceding
reinsurance companies. While the Company performs periodic reviews of a portion
of claim files so managed, the overall A&E reserves it establishes respond to
the paid claim and case reserve activity reported to the Company as well as
available industry statistical data such as so-called survival ratios. Such
ratios represent the number of years' average paid losses for the three or five
most recent calendar years that are encompassed by an insurer's A&E reserve
level at any point in time. According to this simplistic appraisal of an
insurer's A&E loss reserve level, Old Republic's average five year survival
ratios stood at 6.3 years (gross) and 9.8 years (net of reinsurance) as of
December 31, 2003. Incurred net losses for asbestosis and environmental claims
have averaged 1.2% of General Insurance Group incurred losses over the past five
years.
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.
Life and health insurance claim reserves also take into account estimates
of the costs of settling known as well as incurred but not reported claims. Such
estimates are based on an assessment of the facts available during the
settlement process and past experience as to the emergence and severity of
unreported 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' experience 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 December 31, 2003, the Company's general
insurance segment carried reserves of $595.1 to cover claims incurred but not as
yet reported as well as possible adverse development of known cases. As noted
above, the aggregate of these provisions, known collectively as IBNR reserves,
25
results from the application of many formulas and reserve-setting approaches
that are sensitive to the wide variety of already enumerated factors. Should the
reserves for IBNR claims be understated by 10% for a deficiency of $59.5, or
2.9% of the Company's net general insurance reserves as of the most current year
end, the impact on the Company's income statement would be to reduce pretax
income by that amount. While the Company has not incurred such deficiency levels
on reserves posted as of the 10 most recent year ends, there can be no assurance
that this experience will continue in the future.
The percentage of net benefits, claims, and related settlement expenses
measured against premiums and related fee revenues of the Company's operating
segments were as follows:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- -------------- -------------
General Insurance Group........................................... 67.8% 72.6% 75.3%
Mortgage Guaranty Group........................................... 22.7% 14.1% 16.1%
Title Insurance Group............................................. 5.8% 5.0% 4.0%
Life Insurance Group.............................................. 48.8% 58.0% 59.7%
Consolidated................................................. 37.9% 40.2% 42.4%
============= ============== =============
The general insurance portion of the claims ratio improved in 2003 compared
to 2002 which also reflected an improvement over 2001. The downtrend in this
major cost factor reflects largely the aforementioned pricing and risk selection
improvements effected in the past thirty-six months or so. The lower 2002
mortgage guaranty claims ratio results from a decline in claim provisions driven
principally by a drop in expected claim severity, while the increase in 2003 was
driven mostly by higher claim frequencies. A small increase in 2001 was largely
the result of a moderately higher loan default rate factor. The title insurance
loss ratio has been in the low single digits in each of the past three years due
to a continuation of favorable trends in claims frequency and severity for
business underwritten since 1992 in particular. The uptrend in the 2003 and 2002
title insurance loss ratios stem from a rise in the net provision for ultimate
claim costs from the historically low level achieved in 2001. Old Republic's
life and health benefit and claims ratio, though reasonably stable in the
periods reported upon, can vary widely from period to period due to the
relatively small size of this segment's book of business and the material impact
that even a slight change in frequency or severity of death and health claims
can have. The consolidated benefit and claim ratio reflects the changing effect
of period to period contributions of each segment to consolidated results and
this ratio's variances within each segment.
The Company's mix of coverages, industries served, and long-standing
objective of assuring wide dispersion of risks in selected geographical areas
minimized claim exposures related to the September 11, 2001 terrorist attack on
America. The income statement for the year ended December 31, 2001 nonetheless
included charges aggregating approximately $4.0 to cover isolated property,
workers' compensation, trip delay and life insurance claims; the resulting
aggregate post tax charge of $2.6 reduced consolidated net income 1 cent per
share.
The ratio of consolidated underwriting, acquisition, and insurance expenses
to net premiums and fees earned was 48.5% in 2003, 47.9% in 2002 and 46.5% in
2001. Variations in these consolidated ratios reflect a continually changing mix
of coverages sold and attendant costs of producing business in the Company's
four business segments. The following table sets forth the expense ratios
registered by each business segment for the periods shown:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- -------------- -------------
General Insurance Group........................................... 25.5% 25.8% 26.7%
Mortgage Guaranty Group........................................... 24.8% 32.3% 27.5%
Title Insurance Group............................................. 84.6% 85.6% 87.2%
Life Insurance Group.............................................. 55.2% 42.5% 45.4%
Consolidated................................................. 48.5% 47.9% 46.5%
============= ============== =============
Expense ratios for the Company as a whole have remained basically stable
for the periods reported upon. The slight downtrend in the General Insurance
Group's expense ratio reflects the benefits of firm general 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. Increased title sales volume in 2003,
2002 and 2001 led to a lower expense ratio for those years. Consumer and
regulatory litigation affecting Old Republic's California title insurance
subsidiary was responsible for expenses of $2.4, $3.4 and $6.8 charged to 2003,
2002 and 2001 operations, respectively. Consolidated interest and other
corporate charges decreased in 2003 due primarily to reduced interest costs on a
slightly lower debt level.
Pretax and Net Income:
Consolidated pretax income increased by 21.2%, 11.3% and 18.2% in 2003,
2002 and 2001, respectively. The following table shows the components of pretax
income reconciled to consolidated net income:
26
Years Ended December 31,
------------------------------------------
2003 2002 2001
----------- ---------- ----------
Pretax income (loss):
General Insurance Group........................................................... $ 259.0 $ 182.1 $ 141.4
Mortgage Guaranty Group........................................................... 276.4 267.7 261.9
Title Insurance Group............................................................. 129.8 97.8 74.6
Life Insurance Group.............................................................. 4.3 6.4 4.9
Other............................................................................. (8.8) (7.1) (8.8)
Consolidated pretax net realized gains............................................ 19.3 13.9 29.7
----------- ---------- ----------
Consolidated pretax income........................................................ 680.0 560.9 503.9
Income taxes................................................................... 219.9 167.7 159.7
----------- ---------- ----------
Consolidated net income........................................................... $ 459.8 $ 392.9 $ 346.9
=========== ========== ==========
General insurance results improved meaningfully in 2003, 2002 and 2001 by
virtue of the better underwriting experience produced by the above noted factors
that affected loss and expense ratios. Further growth of mortgage guaranty
income from underwriting and investments, and accelerated growth in premiums and
fees from greater refinancing activity which benefited the Title Insurance Group
in particular, also led to greater contributions to consolidated pretax earnings
by these segments. Life and disability operations registered increased earnings
in 2002 and decreased earnings in 2003 and 2001 as a result of varying benefit
and claims costs, and in particular during 2003, a greater than average
lapsation of certain term life policies issued in prior years and higher expense
levels in travel related product areas.
The effective consolidated income tax rates were 32.3% in 2003, 29.9% in
2002, and 31.7% in 2001. The effective tax rate was reduced and net earnings
were enhanced by tax and related interest recoveries of $10.9, or 6 cents per
share in 2002 from the favorable resolution of tax issues dating back to the
Company's 1987 tax return. Otherwise, the rates for each year reflect primarily
the varying proportions of pretax operating income derived from partially
tax-sheltered investment income (principally tax-exempt interest) on the one
hand, and the combination of fully taxable investment income, realized
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 contained in this report,
of necessity, involve assumptions, uncertainties, and risks that may affect the
Company's future performance. With regard to Old Republic's General insurance
segment, its results can be affected in particular by the level of market
competition, which is typically a function of available capital and expected
returns on such capital among competitors, the levels of interest and inflation
rates, and periodic changes in claim frequency and severity patterns caused by
natural disasters, weather conditions, accidents, illnesses, work-related
injuries, and unanticipated external events. Mortgage Guaranty and Title
insurance results can be 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;
mortgage guaranty results, in particular, 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 disability
insurance results can be affected by the levels of employment and consumer
spending, as well as mortality and health trends, and changes in policy
lapsation rates. At the parent company level, operating earnings or losses are
generally reflective of the amount of debt outstanding and its cost, as well as
interest income on temporary holdings of short-term investments.
Any forward-looking statements or commentaries speak only as of their
dates. Old Republic undertakes no obligation to publicly update or revise all
such comments, whether as a result of new information, future events or
otherwise, and accordingly they may not be unduly relied upon.
Item 7A-Quantitative and Qualitative Disclosure About Market Risk
The information called for by Item 7A is found in the fourth and fifth
unnumbered paragraphs, as well as various tables following those paragraphs
under the heading "Financial Position" in Part II, Item 7 of this report.
27
Item 8-Financial Statements
Listed below are the financial statements included herein:
OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES
Page No.
-------
Consolidated Balance Sheets ....................................... 29 & 30
Consolidated Statements of Income.................................. 31
Consolidated Statements of Comprehensive Income.................... 32
Consolidated Statements of Preferred Stock and
Common Shareholders' Equity..................................... 33
Consolidated Statements of Cash Flows.............................. 34
Notes to Consolidated Financial Statements......................... 35 - 54
Report of Independent Auditors..................................... 55
28
Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets ($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
------------- -------------
Assets
Investments:
Available for sale:
Fixed maturity securities (at fair value) (cost: $5,463.9 and $2,989.4)............ $ 5,741.1 $ 3,172.4
Equity securities (at fair value) (cost: $439.2 and $520.3)......................... 513.5 513.5
Short-term investments (at fair value which approximates cost)...................... 403.9
253.8
Miscellaneous investments........................................................... 53.2 -
------------- -------------
Total........................................................................... 6,711.8 3,939.9
------------- -------------
Held to maturity:
Fixed maturity securities (at amortized cost) (fair value: $ - and $2,171.7)........ - 2,054.1
Miscellaneous investments........................................................... 8.5 57.4
------------- -------------
Total........................................................................... 8.5 2,111.6
------------- -------------
Total investments............................................................... 6,720.4 6,051.5
------------- -------------
Other Assets:
Cash................................................................................ 47.2 37.2
Securities and indebtedness of related parties...................................... 54.9 37.7
Accrued investment income........................................................... 81.5 79.4
Accounts and notes receivable....................................................... 509.5 474.6
Federal income tax recoverable: Current............................................. 15.9 1.0
Reinsurance balances and funds held................................................. 69.9 58.1
Reinsurance recoverable: Paid losses................................................ 55.9 28.9
Policy and claim reserves.................................. 1,667.8 1,500.3
Deferred policy acquisition costs................................................... 221.9 197.8
Sundry assets....................................................................... 267.0 248.5
------------- -------------
2,991.8 2,663.8
------------- -------------
Total Assets.................................................................... $ 9,712.3 $ 8,715.4
============= =============
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
29
Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets ($ in Millions) (Continued)
- ---------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
-------------- -------------
Liabilities, Preferred Stock, and Common Shareholders' Equity
Liabilities:
Future policy benefits.............................................................. $ 100.9 $ 103.4
Losses, claims and settlement expenses.............................................. 4,022.7 3,676.8
Unearned premiums................................................................... 814.8 709.3
Other policyholders' benefits and funds............................................. 71.3 62.3
-------------- -------------
Total policy liabilities and accruals........................................... 5,009.8 4,552.0
Commissions, expenses, fees and taxes............................................... 206.1 195.2
Reinsurance balances and funds...................................................... 147.8 133.4
Federal income tax: Deferred........................................................ 556.8 445.2
Debt................................................................................ 137.7 141.5
Sundry liabilities.................................................................. 100.2 91.9
Commitments and contingent liabilities.............................................. - -
-------------- -------------
Total Liabilities............................................................... 6,158.6 5,559.5
-------------- -------------
Preferred Stock:
Convertible preferred stock (*)..................................................... - -
-------------- -------------
Common Shareholders' Equity:
Common stock(*)..................................................................... 184.4 123.7
Additional paid-in capital.......................................................... 245.5 253.1
Retained earnings................................................................... 2,896.8 2,700.5
Accumulated other comprehensive income ............................................. 236.8 111.0
Treasury stock (at cost) (*)........................................................ (10.0) (32.6)
-------------- -------------
Total Common Shareholders' Equity............................................... 3,553.6 3,155.8
-------------- -------------
Total Liabilities, Preferred Stock and Common Shareholders' Equity.............. $ 9,712.3 $ 8,715.4
============== =============
- ----------
(*) At December 31, 2003 and 2002, there were 75,000,000 shares of $0.01 par
value preferred stock authorized, of which 0 in 2003 and 8,700 in 2002 were
convertible preferred shares issued and outstanding. As of the same dates,
there were 500,000,000 shares of common stock, $1.00 par value, authorized,
of which 184,471,698 in 2003 and 185,687,049 in 2002 were issued and
outstanding. At December 31, 2003 and 2002, there were 100,000,000 shares
of Class B Common Stock, $1.00 par value, authorized, of which no shares
were issued. Common shares classified as treasury stock were 2,865,542 and
4,788,896 as of December 31, 2003 and 2002, respectively.
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
30
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Income ($ in Millions, Except Share Data)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------
2003 2002 2001
---------------- ---------------- ----------------
Revenues:
Net premiums earned.......................................... $ 2,582.1 $ 2,135.4 $ 1,786.8
Title, escrow, and other fees................................ 353.9 288.5 242.6
---------------- ---------------- ----------------
Total premiums and fees.................................. 2,936.0 2,423.9 2,029.5
Net investment income........................................ 279.2 272.6 274.7
Other income................................................. 51.2 45.8 39.4
---------------- ---------------- ----------------
Total operating revenues................................. 3,266.5 2,742.4 2,343.7
Realized investment gains.................................... 19.3 13.9 29.7
---------------- ---------------- ----------------
Total revenues........................................... 3,285.8 2,756.4 2,373.4
---------------- ---------------- ----------------
Benefits, Losses and Expenses:
Benefits, claims, and settlement expenses.................... 1,097.6 975.3 861.0
Dividends to policyholders................................... 15.1 (.4) (.4)
Underwriting, acquisition, and insurance expenses............ 1,484.9 1,212.0 989.9
Interest and other charges................................... 7.9 8.5 18.9
---------------- ---------------- ----------------
Total expenses........................................... 2,605.7 2,195.4 1,869.5
---------------- ---------------- ----------------
Income before income taxes and items below................... 680.0 560.9 503.9
---------------- ---------------- ----------------
Income Taxes: Currently payable.............................. 168.0 109.1 104.4
Deferred....................................... 51.9 58.5 55.2
---------------- ---------------- ----------------
Total.......................................... 219.9 167.7 159.7
---------------- ---------------- ----------------
Income before items below.................................... 460.0 393.2 344.2
Equity in earnings of unconsolidated subsidiaries
and minority interests..................................... (.2) (.2) 2.7
---------------- ---------------- ----------------
Net Income................................................... $ 459.8 $ 392.9 $ 346.9
================ ================ ================
Net Income Per Share:
Basic:................................................... $ 2.53 $ 2.17 $ 1.94
================ ================ ================
Diluted:................................................. $ 2.51 $ 2.16 $ 1.92
================ ================ ================
Average shares outstanding: Basic........................ 181,549,485 180,863,325 178,436,267
================ ================ ================
Diluted...................... 183,302,935 182,323,316 180,491,859
================ ================ ================
Dividends Per Common Share:
Cash: Regular............................................ $ .446 $ .420 $ .393
Special............................................ .667 - -
---------------- ---------------- ----------------
Total.............................................. $ 1.113 $ .420 $ .393
================ ================ ================
Stock.................................................... 50% -% -%
================ ================ ================
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
31
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income ($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------
2003 2002 2001
---------------- ---------------- ----------------
Net income as reported....................................... $ 459.8 $ 392.9 $ 346.9
---------------- ---------------- ----------------
Other comprehensive income (loss):
Foreign currency translation adjustment................... 13.9 .6 (2.4)
---------------- ---------------- ----------------
Unrealized gains on securities:
Unrealized gains arising during period.................. 191.2 43.6 118.8
Less: elimination of pretax realized gains
included in income as reported...................... 19.3 13.9 29.7
---------------- ---------------- ----------------
Pretax unrealized gains on securities
carried at market value............................. 171.9 29.6 89.1
Deferred income taxes .................................. 60.1 10.3 31.2
---------------- ---------------- ----------------
Net unrealized gains on securities...................... 111.7 19.2 57.9
---------------- ---------------- ----------------
Net adjustments.............................................. 125.7 19.9 55.4
---------------- ---------------- ----------------
Comprehensive income......................................... $ 585.5 $ 412.9 $ 402.4
================ ================ ================
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
32
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Preferred Stock
and Common Shareholders' Equity ($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Convertible Preferred Stock:
Balance, beginning of year.................................... $ - $ .3 $ .7
Converted into common stock................................ - (.2) (.4)
-------------- -------------- --------------
Balance, end of year.......................................... $ - $ - $ .3
============== ============== ==============
Common Stock:
Balance, beginning of year.................................... $ 123.7 $ 122.1 $ 121.4
Stock dividend............................................. 61.4 - -
Dividend reinvestment plan................................. - - -
Exercise of stock options.................................. .4 1.3 .6
Conversion of convertible preferred stock.................. - - -
Acquisition of subsidiary.................................. - .1 -
Treasury stock restored to unissued status................. (1.2) - -
-------------- -------------- --------------
Balance, end of year.......................................... $ 184.4 $ 123.7 $ 122.1
============== ============== ==============
Additional Paid-in Capital:
Balance, beginning of year.................................... $ 253.1 $ 219.8 $ 207.8
Dividend reinvestment plan................................. 1.5 .6 .6
Exercise of stock options.................................. 9.9 27.9 11.0
Stock option compensation.................................. 2.2 - -
Conversion of convertible preferred stock.................. - .2 .3
Acquisition of subsidiary.................................. - 4.4 -
Treasury stock restored to unissued status................. (21.4) - -
-------------- -------------- --------------
Balance, end of year.......................................... $ 245.5 $ 253.1 $ 219.8
============== ============== ==============
Retained Earnings:
Balance, beginning of year.................................... $ 2,700.5 $ 2,383.2 $ 2,106.4
Net income................................................. 459.8 392.9 346.9
Dividends on common stock: cash ........................... (201.9) (75.7) (70.0)
stock........................... (61.4) - -
Cash dividends on preferred stock.......................... - - -
-------------- -------------- --------------
Balance, end of year.......................................... $ 2,896.8 $ 2,700.5 $ 2,383.2
============== ============== ==============
Accumulated Other Comprehensive Income:
Balance, beginning of year.................................... $ 111.0 $ 91.1 $ 35.6
Foreign currency translation adjustments................... 13.9 .6 (2.4)
Net unrealized gains on securities......................... 111.7 19.2 57.9
-------------- -------------- --------------
Balance, end of year.......................................... $ 236.8 $ 111.0 $ 91.1
============== ============== ==============
Treasury Stock:
Balance, beginning of year.................................... $ (32.6) $ (32.6) $ (32.6)
Acquired during the year................................... - - -
Restored to unissued status................................ 22.6 - -
-------------- -------------- --------------
Balance, end of year.......................................... $ (10.0) $ (32.6) $ (32.6)
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
33
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows ($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Cash flows from operating activities:
Net income....................................................... $ 459.8 $ 392.9 $ 346.9
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs.............................. (21.6) (18.6) (32.8)
Premiums and other receivables................................. (34.6) (54.4) (146.2)
Unpaid claims and related items................................ 192.1 128.6 31.7
Future policy benefits and policyholders' funds................ 84.0 85.7 188.6
Income taxes................................................... 36.4 50.0 57.4
Reinsurance balances and funds................................. (24.9) 10.7 26.8
Accounts payable, accrued expenses and other................... 64.9 76.2 54.1
-------------- -------------- --------------
Total............................................................ 756.0 671.2 526.7
-------------- -------------- --------------
Cash flows from investing activities:
Sales of fixed maturity securities:
Available for sale:
Maturities and early calls.................................... 703.4 258.1 240.8
Other......................................................... 298.3 195.9 59.9
Held to maturity:
Maturities and early calls.................................... - 328.9 254.1
Other......................................................... - 1.0 2.9
Sales of equity securities....................................... 185.7 96.7 67.4
Sales of other investments....................................... 1.7 2.0 2.9
Sales of fixed assets for company use............................ 1.0 1.3 1.8
Cash and short-term investments of subsidiary acquired........... - 1.7 -
Purchases of fixed maturity securities:
Available for sale............................................. (1,428.9) (915.6) (629.4)
Held to maturity............................................... - (279.1) (293.7)
Purchases of equity securities................................... (119.0) (305.7) (146.8)
Purchases of other investments................................... (4.0) (2.6) (3.7)
Purchases of fixed assets for company use........................ (22.1) (16.3) (14.6)
Other-net........................................................ 1.3 (3.5) (3.3)
-------------- -------------- --------------
Total............................................................ (382.3) (637.1) (461.6)
-------------- -------------- --------------
Cash flows from financing activities:
Increase in term loans........................................... - - 30.0
Issuance of preferred and common shares.......................... 9.7 22.0 9.3
Repayments of term loans......................................... (1.0) (15.0) (109.0)
Redemption of debentures and notes............................... (2.8) (2.8) (1.0)
Dividends on common shares....................................... (201.9) (75.7) (70.0)
Dividends on preferred shares.................................... - - -
Other-net........................................................ (17.5) (7.9) 1.2
-------------- -------------- --------------
Total............................................................ (213.6) (79.5) (139.4)
-------------- -------------- --------------
Increase (decrease) in cash and short-term investments............. 160.0 (45.5) (74.4)
Cash and short-term investments, beginning of year............... 291.1 336.6 411.0
-------------- -------------- --------------
Cash and short-term investments, end of year..................... $ 451.2 $ 291.1 $ 336.6
============== ============== ==============
Supplemental cash flow information:
Cash paid during the year for: Interest ......................... $ 8.7 $ 9.2 $ 13.0
============== ============== ==============
Income Taxes...................... $ 180.6 $ 109.4 $ 97.8
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
34
Old Republic International Corporation and Subsidiaries
Notes to Consolidated Financial Statements
($ in Millions, Except as Otherwise Indicated)
- --------------------------------------------------------------------------------
Old Republic International Corporation is a Chicago-based insurance holding
company with subsidiaries engaged in the general (property and liability),
mortgage guaranty, title, and life (life and disability) insurance businesses.
In this report, "Old Republic", "the Corporation", or "the Company" refers to
Old Republic International Corporation and its subsidiaries as the context
requires. The aforementioned insurance segments are organized as the Old
Republic General Insurance, Mortgage Guaranty, Title Insurance, and Life
Insurance Groups, and references herein to such groups apply to the Company's
subsidiaries engaged in the respective segments of business. See Note 6 for a
discussion of the Company's business segments.
Note 1-Summary of Significant Accounting Policies-The significant accounting
policies employed by Old Republic International Corporation and its subsidiaries
are set forth in the following summary.
(a) Consolidation Practices-The consolidated financial statements include the
accounts of the Corporation and those of its major insurance underwriting and
service subsidiaries. Non-consolidated insurance marketing and service
subsidiaries are insignificant and are reflected on the equity basis of
accounting. All significant intercompany accounts and transactions have been
eliminated in consolidation.
(b) Accounting Principles-The Corporation's insurance underwriting subsidiaries
maintain their records in conformity with accounting practices prescribed or
permitted by state insurance regulatory authorities. In consolidating such
subsidiaries, adjustments have been made to conform their accounts with
generally accepted accounting principles. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(c) Investments-The Company may classify its invested assets in terms of those
assets relative to which it either (1) has the positive intent and ability to
hold until maturity, (2) has available for sale or (3) has the intention of
trading. As of December 31, 2003, the Company's invested assets were largely
classified "available for sale."
Effective January 1, 2003, the Company elected to reclassify its fixed
maturity securities categorized as held to maturity to the available for sale
classification. The securities involved are primarily utility and tax-exempt
bonds that accounted for approximately 34 percent of Old Republic's investment
portfolio. The decision was prompted by restrictive accounting rules affecting
held to maturity investment securities. The necessarily mechanical application
of these rules can inhibit the Corporation's ability to optimally manage its
investments from a practical business point of view. As of January 1, 2003, the
net impact of this reclassification on the Corporation's balance sheet was to
increase the carrying value of invested assets by $117.5, deferred tax
liabilities by $41.1, and shareholders' equity by $76.4, or approximately 42
cents per share. This change has no income statement impact, no effect on Old
Republic's ability to hold individual securities to maturity as it may deem
appropriate, and does not affect the Company's necessary long-term orientation
in the management of its business. Going forward, Old Republic's shareholders'
equity account could reflect somewhat greater period-to-period volatility as the
entire bond, note and stock investment portfolio will now be marked to market on
a quarterly basis. Nevertheless, the Company believes that its ability to hold
securities until they mature or until such other time when they can be sold
opportunistically are much more significant and meaningful factors than the
balance sheet or income statement effect of changes in market values at any
point in time.
Fixed maturity securities classified as "held to maturity" are generally
carried at amortized costs while fixed maturity securities classified as
"available for sale" and other preferred and common stocks (equity securities)
are included at fair value with changes in such values, net of deferred income
taxes, reflected directly in shareholders' equity. Fair values for fixed
maturity securities and equity securities are based on quoted market prices or
estimates using values obtained from independent pricing services as applicable.
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 adversely affected by the recognition of additional realized or
impairment losses, but its financial position would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
35
recognized previously as unrealized losses. The Company recognized other than
temporary impairments of investments in the amounts of $16.4, $19.0 and $6.7 for
the years ended December 31, 2003, 2002 and 2001, respectively.
The amortized cost and estimated fair values of fixed maturity securities are as
follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------- ------------ -------------
Fixed Maturity Securities:
December 31, 2003:
Available for sale:
U.S. & Canadian Governments.............. $ 956.3 $ 37.2 $ .1 $ 993.4
Tax-exempt............................... 1,215.1 62.6 .5 1,277.2
Utilities................................ 791.4 39.5 2.3 828.5
Corporate................................ 2,501.0 145.6 4.8 2,641.8
------------ ------------- ------------ -------------
$ 5,463.9 $ 285.0 $ 7.8 $ 5,741.1
============ ============= ============ =============
Fixed Maturity Securities:
December 31, 2002:
Held to maturity:
Utilities................................ $ 754.4 $ 43.8 $ 2.4 $ 795.8
Tax-exempt............................... 1,299.7 76.1 - 1,375.9
------------ ------------- ------------ -------------
$ 2,054.1 $ 120.0 $ 2.5 $ 2,171.7
============ ============= ============ =============
Available for sale:
U.S. & Canadian Governments.............. $ 929.1 $ 47.1 $ - $ 976.2
Corporate................................ 2,060.2 151.4 15.4 2,196.2
------------ ------------- ------------ -------------
$ 2,989.4 $ 198.5 $ 15.5 $ 3,172.4
============ ============= ============ =============
The amortized cost and estimated fair value at December 31, 2003, by
contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Estimated
Amortized Fair
Cost Value
--------------- --------------
Fixed Maturity Securities:
Available for Sale:
Due in one year or less.................................................... $ 599.2 $ 610.0
Due after one year through five years...................................... 2,733.4 2,888.3
Due after five years through ten years..................................... 2,057.9 2,159.5
Due after ten years........................................................ 73.4 83.2
--------------- --------------
$ 5,463.9 $ 5,741.1
=============== ==============
Bonds and other investments carried at $146.0 as of December 31, 2003 were
on deposit with governmental authorities by the Corporation's insurance
subsidiaries to comply with insurance laws.
A summary of the Company's equity securities follows:
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- ------------- ------------- --------------
Equity Securities:
December 31, 2003:
Common stocks.............................. $ 437.2 $ 98.1 $ 23.9 $ 511.4
Perpetual preferred stocks................. 1.9 .1 - 2.0
-------------- ------------- ------------- --------------
$ 439.2 $ 98.2 $ 23.9 $ 513.5
============== ============= ============= ==============
December 31, 2002:
Common stocks.............................. $ 518.0 $ 63.0 $ 69.8 $ 511.2
Perpetual preferred stocks................. 2.2 - .1 2.2
-------------- ------------- ------------- --------------
$ 520.3 $ 63.1 $ 69.9 $ 513.5
============== ============= ============= ==============
Investment income is reported net of allocated expenses and includes
appropriate adjustments for amortization of premium and accretion of discount on
fixed maturity securities acquired at other than par value. Dividends on equity
securities are credited to income on the ex-dividend date. Realized investment
gains and losses, which are comprised of sales of securities and provisions or
write-downs of securities, are reflected as revenues in the income statement and
are determined on the basis of amortized value at date of sale for fixed
maturity securities, and cost in regard to equity securities; such bases apply
to the specific securities sold. Unrealized investment gains and losses, net of
36
any deferred income taxes, are recorded directly as a component of accumulated
other comprehensive income.
The following table reflects the Company's gross unrealized losses and fair
value, aggregated by category and length of time that individual securities have
been in a continuous unrealized loss position at December 31, 2003:
12 Months or Less Greater than 12 Months Total
------------------------- ------------------------- ---------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ----------- ----------- ---------- ----------- ------------
Fixed Maturity Securities:
U.S & Canadian Governments......... $ 14.9 $ .1 $ - $ - $ 14.9 $ .1
Tax-exempt......................... 48.9 .5 - - 48.9 .5
Corporates......................... 416.3 6.9 2.8 .2 419.1 7.2
---------- ----------- ----------- ---------- ----------- ------------
480.2 7.6 2.8 .2 483.0 7.8
Equity Securities.................... 36.5 2.2 100.5 21.6 137.1 23.9
---------- ----------- ----------- ---------- ----------- ------------
Total................................ $ 516.7 $ 9.9 $ 103.4 $ 21.9 $ 620.1 $ 31.8
========== =========== =========== ========== =========== ============
At December 31, 2003, the Corporation and its subsidiaries had no
non-income producing fixed maturity securities except for U.S. Treasury Tax and
Loss Bonds in the amount of $446.5 held as required by its mortgage insurance
subsidiaries for the payment of deferred income taxes.
The following table reflects the composition of net investment income, net
realized gains or losses, and the net change in unrealized investment gains or
losses for each of the years shown:
Years Ended December 31,
--------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Investment income from:
Fixed maturity securities.................................... $ 256.4 $ 253.1 $ 251.3
Equity securities............................................ 14.6 12.4 7.9
Short-term investments....................................... 4.5 6.0 15.8
Other sources................................................ 6.8 5.2 6.1
-------------- -------------- --------------
Gross investment income................................... 282.5 276.9 281.3
Investment expenses (1)...................................... 3.2 4.2 6.5
-------------- -------------- --------------
Net investment income..................................... $ 279.2 $ 272.6 $ 274.7
============== ============== ==============
Realized gains (losses) on:
Fixed maturity securities:
Held to maturity.......................................... $ - $ (2.4) $ (2.2)
-------------- -------------- --------------
Available for sale:
Gains................................................... 9.0 4.0 3.1
Losses.................................................. (4.4) (2.7) (5.1)
-------------- -------------- --------------
Net..................................................... 4.6 1.3 (1.9)
-------------- -------------- --------------
Total..................................................... 4.6 (1.1) (4.1)
Equity securities & other long-term investments.............. 14.6 15.0 33.9
-------------- -------------- --------------
Total..................................................... 19.3 13.9 29.7
Income taxes................................................. 6.7 4.8 13.5
-------------- -------------- --------------
Net realized gains........................................ $ 12.5 $ 9.0 $ 16.1
============== ============== ==============
Changes in unrealized investment gains (losses) on:
Fixed maturity securities:
Held to maturity (2)...................................... $ (117.5) $ 55.7 $ 33.6
============== ============== ==============
Available for sale........................................ $ 94.0 $ 109.1 $ 60.8
Less: Deferred income taxes ............................. 32.9 38.1 21.3
-------------- -------------- --------------
Net changes in unrealized investment gains ............... $ 61.1 $ 71.0 $ 39.5
============== ============== ==============
Equity securities & other long-term investments.............. $ 77.8 $ (79.4) $ 28.2
Less: Deferred income taxes (credits)........................ 27.2 (27.7) 9.9
-------------- -------------- --------------
Net changes in unrealized investment gains (losses)....... $ 50.6 $ (51.7) $ 18.3
============== ============== ==============
- ---------
(1) Investment expenses consist of personnel costs and investment management
and custody service fees, and includes interest incurred on funds held of
$.1, $.3 and $1.4 for the years ended December 31, 2003, 2002 and 2001,
respectively.
(2) Deferred income taxes do not apply since these securities are carried at
amortized cost. During the first quarter of 2003, the Company reclassified
its fixed maturity securities categorized as held to maturity to the
available for sale classification, which resulted in recognizing the $117.5
of unrealized investment gains imbedded in such securities at December 31,
2002.
37
(d) Revenue Recognition -Pursuant to GAAP applicable to the insurance industry,
revenues are associated with the related benefits, claims, and expenses by means
of the provision for policy benefits, the deferral and subsequent amortization
of applicable acquisition costs, and the recognition of incurred benefits,
claims and operating expenses. Substantially all general insurance premiums are
reflected in income on a pro-rata basis. Earned but unbilled premiums are
generally taken into income on the billing date, while adjustments for
retrospective premiums, commissions and similar charges or credits are accrued
on the basis of periodic evaluations of current underwriting experience and
contractual obligations.
Nearly all of the Company's mortgage guaranty premiums stem from monthly
installment policies. Accordingly, such premiums are fully earned in the month
they are reported and received. With respect to minor numbers of annual or
single premium policies, earned premiums are largely recognized on a pro-rata
basis over the terms of the policies.
Title premium and fee revenues stemming from the Company's direct
operations represent approximately 40% of such consolidated title business
revenues. Such premiums are generally recognized as income at the escrow closing
date which approximates the policy effective date. Fee income related to escrow
and other closing services is recognized when the related services have been
performed and completed. The remaining 60% of consolidated title premium and fee
revenues is produced by independent title agents and other service providers.
Rather than making estimates that could be subject to significant variance from
actual premium and fee production, the Company recognizes revenues from those
sources upon receipt. Such receipts can reflect a three to four month lag
relative to the effective date of the underlying title policy, and are offset
concurrently by production expenses and claim reserve provisions.
Ordinary life insurance premiums are recognized as revenues when due,
whereas premiums for other coverages such as credit life, credit disability, and
health insurance are recognized as income on a pro-rata, sum of the years'
digits, or combination of such methods as are deemed most applicable in the
circumstances.
(e) Deferred Policy Acquisition Costs-The Corporation's insurance subsidiaries,
other than title companies, defer certain costs which vary with and are
primarily related to the production of business. Deferred costs consist
principally of commissions, premium taxes, marketing, and policy issuance
expenses. With respect to most coverages, deferred acquisition costs are
amortized on the same basis as the related premiums are earned or,
alternatively, over the periods during which premiums will be paid or
underwriting and claim services performed. The following table summarizes
deferred policy acquisition costs and related data for the years shown:
Years Ended December 31,
--------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Deferred, beginning of year.................................... $ 197.8 $ 179.8 $ 148.1
-------------- -------------- --------------
Acquisition costs deferred:
Commissions - net of reinsurance........................... 178.6 159.3 151.0
Premium taxes.............................................. 58.2 45.5 40.0
Salaries and other marketing expenses...................... 102.5 92.1 84.1
-------------- -------------- --------------
Sub-total.............................................. 339.3 297.0 275.1
Amortization charged to income................................. (315.2) (279.1) (243.3)
-------------- -------------- --------------
Change for the year.................................... 24.0 17.9 31.8
-------------- -------------- --------------
Deferred, end of year.......................................... $ 221.9 $ 197.8 $ 179.8
============== ============== ==============
(f) Future Policy Benefits/Unearned Premiums-General insurance and level term
credit life insurance policy liabilities represent unearned premium reserves
developed by application of monthly pro-rata factors to premiums in force.
Disability/accident & health and decreasing term credit life insurance policy
liabilities are calculated primarily on a sum-of-the-years-digits method.
Mortgage guaranty unearned premium reserves are calculated primarily on a
pro-rata basis. Ordinary life policy liabilities are determined on a level
premium method and take into account mortality and withdrawal rates based
principally on anticipated company experience; assumed interest rates range from
3.0% to 6.0%.
At December 31, 2003 and 2002, the Life Insurance Group had $7,431.2 and
$7,383.6, respectively, of net life insurance in force. Future policy benefits
and unearned premiums, consisted of the following:
December 31,
---------------------------------------
2003 2002
-------------- --------------
Future Policy Benefits:
Life Insurance Group:
Life insurance................................................. $ 70.9 $ 69.3
Disability/accident & health................................... 30.0 34.0
-------------- --------------
Total...................................................... $ 100.9 $ 103.4
============== ==============
Unearned Premium:
General Insurance Group ....................................... $ 766.8 $ 666.4
Mortgage Guaranty Group........................................ 47.9 42.9
-------------- --------------
Total...................................................... $ 814.8 $ 709.3
============== ==============
38
The Company has previously issued directly or assumed as a reinsurer
certain insurance policies generally categorized as financial guarantees. All
such business has been in run off mode for several years. The major types of
guarantees pertain to state, municipal and other general or special revenue
bonds. The types of risks involved include failure by the bond issuer to make
timely payment of principal and interest. The degree of risk pertaining to these
insurance products is largely dependent on the effects of general economic
cycles and changes in the credit worthiness of issuers whose obligations have
been guaranteed. Premiums received for financial guarantee policies are
generally earned over the terms of the contract (which may range between 5 and
30 years) or on the basis of current exposure relative to maximum exposure in
force. Since losses on financial guarantee insurance products cannot be
predicted reliably, the Company's unearned premium reserves serve as the primary
income recognition and loss reserving mechanism. When losses become known and
determinable, they are paid or placed in reserve and the remaining
directly-related unearned premiums are taken into income. No assurance can be
given that unearned premiums will be greater or less than ultimate incurred
losses on these policies.
The following table reflects certain data pertaining to net insurance in
force for the Company's financial guarantee business at the dates shown:
Years Ended December 31,
---------------------------------------
2003 2002
-------------- --------------
Bond Insurance:
Insurance in force................................................. $ 1,118.9 $ 1,405.8
Unearned Premiums.................................................. $ 6.0 $ 7.8
============== ==============
With respect to mortgage guaranty insurance (net insurance in force of
$112,882.4 and $112,916.4, at December 31, 2003 and 2002, respectively) the
Company's reserving policies are set forth below in Note 1(g).
(g) Losses, Claims and Settlement Expenses-The establishment of claim reserves
by the Company's insurance subsidiaries is a reasonably complex and dynamic
process influenced by a large variety of factors. These factors include past
experience applicable to the anticipated costs of various types of claims,
continually evolving and changing legal theories emanating from the judicial
system, recurring accounting, statistical, and actuarial studies, the
professional experience and expertise of the Company's claim departments'
personnel or attorneys and independent adjusters retained to handle individual
claims, the effect of inflationary trends on future claim settlement costs, and
ongoing changes in claim frequency or severity patterns such as those caused by
natural disasters, illnesses, accidents, work-related injuries, or changes in
economic conditions. Consequently, the reserve-setting process relies on the
judgments and opinions of a large number of persons, on the application and
interpretation of historical precedent and trends, and on expectations as to
future developments. At any point in time, the Company and the insurance
industry are exposed to possibly higher than anticipated claim costs due to the
aforementioned factors, and to the evolution, interpretation, and expansion of
tort law, as well as the effects of unexpected jury verdicts.
All reserves are necessarily based on 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. Return and additional premiums and
policyholders' dividends, all of which tend to be affected by development of
claims in future years, may offset, in whole or in part, developed claim
redundancies or deficiencies for certain coverages such as workers'
compensation, a portion of which are written under loss sensitive programs that
provide for such adjustments. The Company believes that its overall reserving
practices have been consistently applied over many years, and that its aggregate
net reserves have produced reasonable estimates of the ultimate net costs of
claims incurred. However, no representation is made that ultimate net claim and
related costs will not be greater or lower than previously established reserves.
General Insurance Group reserves are established to provide for the
ultimate expected cost of settling unpaid losses and claims reported at each
balance sheet date. Such reserves are based on continually evolving assessments
of the facts available to the Company during the settlement process which may
stretch over long periods of time. Long-term disability-type workers'
compensation reserves are discounted to present value based on interest rates
ranging from 3.5% to 4.0%. Losses and claims incurred but not reported, as well
as expenses required to settle losses and claims are established on the basis of
various criteria, including historical cost experience and anticipated costs of
servicing reinsured and other risks. Estimates of possible recoveries from
salvage or subrogation rights are considered in the establishment of such
reserves as applicable.
Early in 2001, the Federal Department of Labor revised the Federal Black
Lung Program regulations. The revisions basically require a re-evaluation of
previously settled, denied, or new occupational disease claims in the context of
newly devised, more lenient standards when such claims are resubmitted.
Following a number of challenges and appeals by the insurance and coal mining
industries, the revised regulations were, for the most part, upheld in June,
2002 and are to be applied prospectively. Since the final quarter of 2001 black
lung claims filed or refiled pursuant to these anticipated and now final
regulations have increased, though the 2003 volume of new claim reports abated.
The vast majority of claims filed to date against Old Republic pertain to
business underwritten through loss sensitive programs that permit the charge of
additional or refund of return premiums to wholly or partially offset changes in
estimated claim costs, or to business underwritten as a service carrier on
behalf of various industry-wide involuntary market (i.e. assigned risk) pools. A
much smaller portion pertains to business produced on a traditional risk
transfer basis. The Company has established applicable reserves for claims as
they have been reported and for claims not as yet reported on the basis of its
historical experience and assumptions as to the effect of the revised
regulations. Inasmuch as a variety of challenges are likely as the revised
regulations are implemented in the actual claim settlement process, the
39
potential impact on reserves, gross and net of reinsurance or retrospective
premium adjustments, resulting from such regulations cannot as yet be estimated
with reasonable certainty.
Old Republic's reserve estimates also include provisions for indemnity and
settlement costs for various asbestosis and environmental impairment ("A&E")
claims that have been filed in the normal course of business against a number of
its insurance subsidiaries. Many such claims relate to policies issued prior to
1985, including many issued during a short period between 1981 and 1982 pursuant
to an agency agreement canceled in 1982. Over the years, the Corporation's
property and liability insurance subsidiaries have typically issued general
liability insurance policies with face amounts ranging between $1.0 and $2.0 and
rarely exceeding $10.0. Such policies have, in turn, been subject to reinsurance
cessions which have typically reduced the Corporation's retentions to $.5 or
less as to each claim. At December 31, 2003, the Corporation's aggregate
indemnity and loss adjustment expense reserves specifically identified with A&E
exposures amounted to approximately $91.0 gross, and $56.6 net of reinsurance.
Based on average annual claims payments during the five most recent calendar
years, such reserves represented 6.3 years (gross) and 9.8 years (net) of
average annual claims payments. Old Republic's exposure to A&E claims cannot,
however, be calculated by conventional insurance reserving methods for a variety
of reasons, including: a) the absence of statistically valid data inasmuch as
such claims typically involve long reporting delays and very often uncertainty
as to the number and identity of insureds against whom such claims have arisen
or will arise; and b) the litigation history of such or similar claims for
insurance industry members that has produced court decisions that have been
inconsistent with regard to such questions as when an alleged loss occurred,
which policies provide coverage, how a loss is to be allocated among potentially
responsible insureds and/or their insurance carriers, how policy coverage
exclusions are to be interpreted, what types of environmental impairment or
toxic tort claims are covered, when the insurer's duty to defend is triggered,
how policy limits are to be calculated, and whether clean-up costs constitute
property damage. In recent times, the Executive Branch and/or the Congress of
the United States have proposed or considered changes in the legislation and
rules affecting the determination of liability for environmental and asbestosis
claims. As of December 31, 2003, however, there is no solid evidence to suggest
that possible future changes might mitigate or reduce some or all of these claim
exposures. Because of the above issues and uncertainties, estimation of reserves
for losses and allocated loss adjustment expenses for A&E claims in particular
is much more difficult or impossible. Accordingly, no representation can be made
that the Corporation's reserves for such claims and related costs will not prove
to be overstated or understated in the future.
Mortgage guaranty loss and loss adjustment expense reserve estimates are
based on reported insured mortgage loan defaults, as well as experience-based
estimates of loan defaults that have occurred but have not as yet been reported
as of each balance sheet date. In making all these estimates, such variables as
trends in net claim severity, salvage and cure rates for mortgages at varying
stages of default, and trends in employment levels and housing market activity
are considered.
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. 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
concurrently with the recognition of premium and escrow service revenues based
on past experience and an evaluation of such variables as changes and trends in
the types of policies issued, and changes in real estate market and interest
rate environments that can have a bearing on the emergence, number, and ultimate
cost of claims.
Life and health insurance claim reserves also take into account estimates
of the costs of settling known as well as incurred but not reported claims. Such
estimates are based on an assessment of the facts available during the
settlement process and past experience as to the emergence and severity of
unreported claims.
40
The following table shows an analysis of changes in aggregate reserves for
the Company's losses, claims and settlement expenses for each of the years
shown:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
Gross reserves at beginning of year................................ $ 3,676.8 $ 3,451.0 $ 3,389.5
Less: reinsurance losses recoverable .............................. 1,370.7 1,273.3 1,243.9
------------- ------------- -------------
Net reserves at beginning of year ........................ 2,306.0 2,177.6 2,145.6
------------- ------------- -------------
Incurred claims and claim adjustment expenses:
Provisions for insured events of the current year................ 1,159.2 1,049.4 983.6
Change in provision for insured events of prior years............ (60.8) (76.5) (126.6)
------------- ------------- -------------
Total incurred claims and claim adjustment expenses....... 1,098.4 972.9 857.0
------------- ------------- -------------
Payments:
Claims and claim adjustment expenses attributable to
insured events of the current year............................. 337.4 312.9 319.8
Claims and claim adjustment expenses attributable to
insured events of prior years.................................. 566.9 531.5 505.0
------------- ------------- -------------
Total payments............................................ 904.3 844.5 824.9
------------- ------------- -------------
Amount of reserves for unpaid claims and claim adjustment
expenses at the end of each year, net of reinsurance
losses recoverable............................................... 2,500.1 2,306.0 2,177.6
Reinsurance losses recoverable..................................... 1,522.5 1,370.7 1,273.3
------------- ------------- -------------
Gross reserves at end of year...................................... $ 4,022.7 $ 3,676.8 $ 3,451.0
============= ============= =============
For the three most recent calendar years, the above table indicates, on
line (5), that the one-year development of consolidated reserves at the
beginning of each year produced average annual redundancies of about 4.0%. The
Company believes that the factors most responsible, in varying and continually
changing degrees, for such redundancies included greater than originally
estimated salvage and subrogation recoveries, better than expected employment
levels that can reduce the number of insured mortgage loans that actually
default, greater than anticipated sales and rising prices of homes that can
reduce claim costs upon the sale of foreclosed properties, higher levels of loan
refinancing activity that can reduce the period of time over which a policy
remains at risk, and lower than expected frequencies of claims incurred but not
reported. The factors most responsible for producing varying offsetting levels
of reserve deficiencies include the effect of reserve discounts applicable to
workers' compensation claims, higher than expected severity of litigated claims
in particular, governmental or judicially imposed retroactive conditions in the
settlement of claims such as noted above in regard to black lung disease claims,
greater than anticipated inflation rates applicable to repairs and the medical
portion of claims in particular, and higher than expected claims incurred but
not reported due to the slower emergence patterns applicable to certain types of
claims such as those stemming from litigated, assumed reinsurance, or the A&E
types of claims noted above.
(h) Income Taxes-The Corporation and most of its subsidiaries file a
consolidated tax return and provide for income taxes payable currently. Deferred
income taxes included in the accompanying consolidated financial statements will
not necessarily become payable/recoverable in the future. The Company uses the
asset and liability method of calculating deferred income taxes. This method
calls for the establishment of a deferred tax, calculated at currently enacted
tax rates that are applied to the cumulative temporary differences between
financial statement and tax bases of assets and liabilities.
The provision for combined current and deferred income taxes reflected in
the consolidated statements of income does not bear the usual relationship to
operating income before taxes as the result of permanent and other differences
between pretax income and taxable income determined under existing tax
regulations. The more significant differences, their effect on the statutory
income tax rate, and the resulting effective income tax rates are summarized
below:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- -------------- -------------
Statutory tax rate................................................ 35.0% 35.0% 35.0%
Tax rate increases (decreases):
Tax-exempt interest ........................................ (2.3) (3.1) (3.5)
Dividends received exclusion................................ (.5) (.4) (.3)
Other items - net (*) ...................................... .1 (1.6) .5
------------- -------------- -------------
Effective tax rate................................................ 32.3% 29.9% 31.7%
============= ============== =============
(*) Tax and related interest recoveries of $10.9 were recorded in the
second quarter of 2002 as a result of the favorable resolution of tax issues
dating back to the Company's 1987 tax return. This adjustment reduced the
effective tax rate by approximately 1.9 percentage points.
41
The tax effects of temporary differences that give rise to significant
portions of the Company's net deferred tax recoverable (payable) are as follows
at the dates shown:
December 31,
------------------------------------------------
2003 2002 2001
------------- -------------- -------------
Deferred Tax Assets:
Future policy benefits....................................... $ 4.1 $ 4.8 $ 5.9
Losses, claims, and settlement expenses...................... 161.5 148.5 140.4
Other........................................................ 21.4 19.4 19.4
------------- -------------- -------------
Total deferred tax assets................................ 187.1 172.8 165.9
------------- -------------- -------------
Deferred Tax Liabilities:
Unearned premium reserves.................................... 33.2 26.5 25.9
Deferred policy acquisition costs............................ 72.3 65.0 55.4
Mortgage guaranty insurers' contingency reserves............. 499.4 446.5 391.9
Fixed maturity securities adjusted to cost................... 8.2 9.5 8.9
Net unrealized investment gains.............................. 126.2 66.0 55.5
Title plants and records..................................... 4.4 4.4 4.4
------------- -------------- -------------
Total deferred tax liabilities........................... 743.9 618.1 542.4
------------- -------------- -------------
Net deferred tax liabilities............................. $ 556.8 $ 445.2 $ 376.5
============= ============== =============
Pursuant to special provisions of the Internal Revenue Code pertaining to
mortgage guaranty insurers, a contingency reserve (established in accordance
with insurance regulations designed to protect policyholders against
extraordinary volumes of claims) is deductible from gross income. The tax
benefits obtained from such deductions must, however, be invested in a special
type of non-interest bearing U.S. Treasury Tax and Loss Bonds which aggregated
$446.5 at December 31, 2003. For Federal income tax purposes, the amounts
deducted for the contingency reserve are taken into gross statutory taxable
income (a) when the contingency reserve is permitted to be charged for losses
under state law or regulation, (b) in the event operating losses are incurred,
or (c) in any event upon the expiration of ten years.
Life insurance companies domiciled in the United States and qualifying as
life insurers for tax purposes are taxed under special provisions of the
Internal Revenue Code. As a result of legislation, 1983 and prior years' tax
deferred earnings (cumulatively $13.3 at December 31, 2003) credited to the
former memorandum "policyholders' surplus account" will generally not be taxed
unless they are subsequently distributed to shareholders. The Company does not
presently anticipate any distribution or payment of taxes on such earnings in
the future.
During 2002, the Corporation and its subsidiaries settled tax years
1991-1995 with the Internal Revenue Service ("IRS") for a net immaterial amount
which had no significant effect on the Corporation's financial condition or
results of operations. The IRS is currently examining the 1998-2000 tax years.
The Company does not believe that any potential adjustments will have a material
impact on its financial position or results of operations.
(i) Property and Equipment-Property and equipment is generally depreciated or
amortized over the estimated useful lives of the assets, (2 to 27 years),
substantially by the straight-line method. Expenditures for maintenance and
repairs are charged to income as incurred, and expenditures for major renewals
and additions are capitalized.
(j) Title Plants and Records-Title plants and records are carried at original
cost or appraised value at date of purchase. Such values represent the cost of
producing or acquiring interests in title records and indexes and the appraised
value of purchased subsidiaries' title records and indexes at dates of
acquisition. The cost of maintaining, updating, and operating title records is
charged to income as incurred. Title records and indexes are ordinarily not
amortized unless events or circumstances indicate that the carrying amount of
the capitalized costs may not be recoverable.
(k) Goodwill-Through December 31, 2001, the costs of certain purchased
subsidiaries in excess of related book values (goodwill) at date of acquisition
had been amortized against operations principally over 40 years using the
straight-line method. Amortization of goodwill amounted to $4.2 in 2001.
Under Statement of Financial Accounting Standards No. 142 (FAS-142)
"Goodwill and Other Intangible Assets", 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
periodically for possible impairment of its continued value. Such a test was
performed early in 2003 and 2002 and did not result in impairment charges. At
both December 31, 2003 and 2002, the Company's consolidated unamortized goodwill
asset balance was $87.5.
(l) Employee Benefit Plans- The Corporation has three 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.
42
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 changes in the projected benefit obligation, for the plan years ended
relative to the above measurement dates, are as follows:
2003 2002 2001
------------- -------------- -------------
Projected benefit obligation at beginning of year................ $ 161.6 $ 144.2 $ 127.7
------------- -------------- -------------
Increases (decreases) during the year attributable to:
Service cost.................................................. 5.8 4.9 4.3
Interest cost................................................. 11.0 10.2 9.5
Actuarial (gains) losses...................................... 26.4 9.8 6.7
Benefits paid................................................. (9.1) (7.7) (7.3)
Plan merger................................................... - - 3.1
------------- -------------- -------------
Net increase for year............................................ 34.2 17.3 16.5
------------- -------------- -------------
Projected benefit obligation at end of year...................... $ 195.8 $ 161.6 $ 144.2
============= ============== =============
The changes in the fair value of net assets available for plan benefits,
for the plan years ended relative to the above measurement dates, are as
follows:
2003 2002 2001
------------- -------------- -------------
Fair value of net assets available for plan benefits
at beginning of the year....................................... $ 156.6 $ 158.2 $ 143.8
------------- -------------- -------------
Increases (decreases) during the year attributable to:
Actual return on plan assets................................... 17.4 (1.2) 13.7
Sponsor contributions.......................................... 10.1 8.1 5.1
Benefits paid.................................................. (9.1) (7.7) (7.3)
Administrative expenses........................................ (.1) (.3) (.1)
Plan merger.................................................... - (.3) 3.1
------------- -------------- -------------
Net increase (decrease) for year................................. 18.3 (1.6) 14.4
------------- -------------- -------------
Fair value of net assets available for plan benefits
at the end of the year......................................... $ 175.0 $ 156.6 $ 158.2
============= ============== =============
A reconciliation of the funded status of the plans, for the plan years ended
relative to the above measurement dates, is as follows:
2003 2002
------------- -------------
Plan assets less than projected benefit obligations.............................. $ (20.8) $ (4.9)
Prior service cost not yet recognized in net periodic
pension cost.................................................................. .1 .2
Unrecognized net loss............................................................ 40.8 20.4
------------- -------------
Pension asset recognized in the consolidated balance sheet....................... $ 20.1 $ 15.7
============= =============
Amounts recognized in the statement of financial position, for the plan
years ended relative to the above measurement dates, consist of:
Pension Benefits
------------------------------
2003 2002
------------- -------------
Prepaid benefit cost............................................................. $ 31.4 $ 25.1
Accrued benefit cost............................................................. (11.3) (9.4)
------------- -------------
Net amount recognized............................................................ $ 20.1 $ 15.7
============= =============
The Old Republic Plan and the Title Plan have accumulated benefit
obligations in excess of plan assets, for the plan years ended relative to the
above measurement dates, as follows:
2003 2002
------------- -------------
Projected benefit obligation..................................................... $ 119.6 $ 97.5
Accumulated benefit obligation................................................... 105.0 87.2
Fair value of plan assets........................................................ 95.0 80.3
43
The weighted-average asset allocations of the Plans, for the plan years
ended relative to the above measurement dates, are as follows:
Plan Assets
------------------------------- Investment Policy Asset
2003 2002 Allocation % Range Target
------------- ------------- -------------------------------------
Equity securities: 30% to 70%
Common shares of Company stock........... 1.2% 3.9%
Other.................................... 44.2 42.1
Debt securities............................... 47.6 47.2 30% to 70%
Other (including short-term and
accrued interest and dividends)............. 7.0 6.8 1% to 20%
------------- -------------
Total............................... 100.0% 100.0%
============= =============
The Corporation's three plans adhere to the same investment policy under
which the Corporation's general assets are managed. Asset/liability matching
techniques, diversification, and high quality investments are stressed. Lower
quality issuers and derivatives are avoided. Non-callable, U.S. government and
investment grade corporate fixed income securities of intermediate maturities
are purchased to meet the plans' obligations out to ten years. Purchases of
value oriented equity securities exhibiting dividend growth characteristics are
preferred investment vehicles to meet the longer term obligations of the plans.
Some funds are employed for diversification purposes. Short-term securities are
held to cover current plan obligations and anticipated expenses. Investment
policy asset allocation range targets, listed above, are applicable to each
plan, and allow for modest changes in investment strategy as financial market
conditions warrant.
The Old Republic Plan used 8.75% as the expected long-term rate of return
for its 2003 and 2002 pension cost. The Plan selected this rate based on the
time weighted yield of historical asset returns for the five year period
beginning with 1995, without adjustment for expectations of future returns.
The Bituminous and Title Plans used 8.25% as the expected long-term rate of
return for their 2003 and 2002 pension cost. To develop the expected long-term
rate of return on assets assumption, the Plans considered the historical returns
and the future expectations for returns for each asset class, as well as the
target asset allocation of the pension portfolios.
The components of annual net periodic pension cost (credit) for the plans,
for the plan years ended relative to the above measurement dates, consisted of
the following:
2003 2002 2001
------------- ------------- -------------
Service cost........................................................ $ 5.8 $ 4.9 $ 4.3
Interest cost....................................................... 11.0 10.2 9.5
Expected return on plan assets...................................... (14.1) (7.5) (13.2)
Recognized (gain) loss.............................................. 2.9 (5.2) 1.4
------------- ------------- -------------
Net cost............................................................ $ 5.7 $ 2.4 $ 2.2
============= ============= =============
The projected benefit obligations for the plans were determined using the
following weighted-average assumptions, for the plan years ended relative to the
above measurement dates:
2003 2002
------------- -------------
Settlement discount rates........................................................ 6.00% 7.00%
Rates of compensation increase................................................... 3.38% 3.37%
Long-term rates of return on plans' assets....................................... 8.37% 8.37%
The net periodic benefit cost for the Plans were determined using the
following weighted-average assumptions, for the plan years ended relative to the
above measurement dates:
2003 2002
------------- -------------
Settlement discount rates........................................................ 6.61% 6.75%
Rates of compensation increase................................................... 3.38% 3.37%
Long-term rates of return on plans' assets....................................... 8.37% 8.37%
The accumulated benefit obligation for the Plans was $172.2 and $144.1 for
the 2003 and 2002 plan years ended relative to the above measurement dates,
respectively.
The companies expect to contribute $.4 to their pension plans in calendar
year 2004. Such contributions reflect amounts required by funding regulations or
laws. There are no discretionary contributions anticipated nor are any non-cash
contributions expected.
44
The Corporation has a number of profit sharing and other incentive
compensation programs for the benefit of a substantial number of its employees.
The costs related to such programs are summarized below:
Years Ended December 31,
------------------------------------------------
2003 2002 2001
------------- ------------- -------------
Employees Savings and Stock Ownership Plan.......................... $ 5.3 $ 5.0 $ 4.7
Other profit sharing plans.......................................... 7.2 6.7 6.0
Deferred and incentive compensation................................. $ 31.2 $ 24.3 $ 15.0
============= ============= =============
The Company sponsors an Employees Savings and Stock Ownership Plan (ESSOP)
in which a majority of its employees participate. The ESSOP initially acquired
its stock of the Company in 1987 and prior years. All such shares have been
released over the years, and current Company contributions are directed to the
open market purchase of its shares. Dividends on released shares are allocated
to participants as earnings. The Company's annual contributions are based on a
formula that takes growth in net income per share over consecutive five year
periods into account. As of December 31, 2003, there were 9,711,635 Common
Shares owned by the ESSOP all of which were released and allocated to employees'
account balances. There are no repurchase obligations in existence.
(m) Escrow Funds-Segregated cash deposit accounts and the offsetting liabilities
for escrow deposits in connection with Title Insurance Group real estate
transactions in the same amounts ($763.5 and $942.8 at December 31, 2003 and
2002, respectively) are not included as assets or liabilities in the
accompanying consolidated balance sheets as the escrow funds are not available
for regular operations.
(n) Earnings Per Share-Consolidated basic earnings per share excludes the
dilutive effect of common stock equivalents and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
actually outstanding for the year. Diluted earnings per share are similarly
calculated with the inclusion of common stock equivalents. The following tables
provide a reconciliation of net income and number of shares used in basic and
diluted earnings per share calculations.
Years Ended December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- --------------
Numerator:
Net Income ........................................... $ 459.8 $ 392.9 $ 346.9
Less: Preferred stock dividends....................... - - -
--------------- --------------- --------------
Numerator for basic earnings per share -
income available to common stockholders........... 459.8 392.9 346.9
Effect of dilutive securities:
Convertible preferred stock dividends............. - - -
--------------- --------------- --------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions........................ $ 459.8 $ 392.9 $ 346.9
=============== =============== ==============
Denominator:
Denominator for basic earnings per share -
weighted-average shares.......................... 181,549,485 180,863,325 178,436,267
Effect of dilutive securities:
Stock options..................................... 1,749,219 1,444,856 1,988,122
Convertible preferred stock....................... 4,231 15,135 67,470
--------------- --------------- --------------
Dilutive potential common shares.................. 1,753,450 1,459,991 2,055,592
--------------- --------------- --------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions.............................. 183,302,935 182,323,316 180,491,859
=============== =============== ==============
Basic earnings per share (*).......................... $ 2.53 $ 2.17 $ 1.94
=============== =============== ==============
Diluted earnings per share (*)........................ $ 2.51 $ 2.16 $ 1.92
=============== =============== ==============
- ----------
(*) All per share statistics have been restated to reflect all stock dividends
or splits declared through December 31, 2003.
(o) Cash Flows-For purposes of the Consolidated Statements of Cash Flows, the
Company considers short-term investments, consisting of money market funds,
certificates of deposit, and commercial paper with original maturities of less
than 90 days to be cash equivalents. These securities are carried at cost which
approximates fair value.
45
(p) Concentration of Credit Risk-Excluding U.S. government fixed maturity
securities, the Company is not exposed to material concentration of credit risks
as to any one issuer.
(q) Stock Option 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. In
estimating the compensation cost of options, the fair value of options has been
calculated using the Black-Scholes option pricing model. Expense recognition of
stock options granted in 2003 reduced earnings by $1.4 or less than 1 cent per
share.
Years Ended December 31,
--------------------------------------------------
2003 2002 2001
-------------- -------------- --------------
Option pricing/weighted average assumptions:
Risk-free interest rates...................................... 4.36% 5.41% 4.79%
Dividend yield................................................ 3.12% 2.53% 2.82%
Common stock market
price volatility factors................................... .26 .27 .27
Expected option life.......................................... 10 years 10 years 10 years
Comparative data:
Net income:
As reported................................................ $ 459.8 $ 392.9 $ 346.9
Add: Stock based compensation expense included
in reported income, net of related tax effects......... 1.4 - -
Deduct: Total stock-based employee compensation
expenses determined under the fair value based
method for all awards, net of related tax effects...... 4.6 3.0 1.8
-------------- -------------- --------------
Pro forma basis............................................ $ 456.5 $ 389.9 $ 345.1
============== ============== ==============
Basic earnings per share:
As reported................................................ $ 2.53 $ 2.17 $ 1.94
Pro forma basis............................................ 2.51 2.16 1.93
Diluted earnings per share:
As reported................................................ 2.51 2.16 1.92
Pro forma basis............................................ $ 2.49 $ 2.14 $ 1.91
============== ============== ==============
A summary of the status of the Corporation's stock options as of December
31, 2003, 2002 and 2001, and changes in outstanding options during the years
then ended follows:
As of and for the Years Ended December 31,
----------------------------------------------------------------------------
2003 2002 2001
----------------------- ---------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- --------- --------- ---------- ----------
Outstanding at beginning of year ...... 7,193,060 $ 16.46 7,694,534 $ 13.73 6,935,250 $ 12.15
Granted................................ 1,851,000 17.96 1,706,400 21.07 1,722,000 17.97
Exercised.............................. 632,430 12.88 2,092,974 10.19 914,463 9.54
Forfeited and canceled ................ 37,153 18.47 114,900 16.77 48,253 16.83
---------- --------- ----------
Outstanding at end of year............. 8,374,477 17.05 7,193,060 16.46 7,694,534 13.73
========== ========= ==========
Exercisable at end of year............. 3,780,166 $ 14.98 3,286,983 $ 13.76 4,305,795 $ 11.78
========== ========= ========= ========= ========== ==========
Weighted average fair value of
options granted during the year (1) $ 4.76 per share $ 6.92 per share $ 5.41 per share
========== ========= ==========
(1) Based on the Black-Scholes option pricing model and the assumptions
outlined in the table above.
46
A summary of stock options outstanding and exercisable at December 31, 2003
follows:
Options Outstanding Options Exercisable
-------------------------------------- -------------------------
Weighted - Average
------------------------ Weighted
Year(s) Number Remaining Average
Of Out- Contractual Exercise Number Exercise
Ranges of Exercise Prices Grant Standing Life Price Exercisable Price
-------------------------------- -------- ---------- ----------- --------- ----------- ----------
$ 7.22 to $ 7.89............ 1995 175,446 1.00 $ 7.24 172,802 $ 7.24
$ 9.83 to $ 11.89............ 1996-97 790,473 3.00 11.88 764,976 11.89
$ 19.36 to $ 19.39............ 1998 1,184,782 4.00 19.36 695,442 19.36
$ 11.71 to $ 13.00............ 1999 645,886 5.00 13.00 624,139 13.00
$ 8.00 to $ 9.04............ 2000 461,517 6.00 8.00 405,990 8.00
$ 17.95 to $ 18.91............ 2001 1,612,827 7.00 17.97 501,120 17.97
$ 21.07 to $ 21.07............ 2002 1,667,709 8.00 21.07 442,961 21.07
$ 17.96 to $ 17.96............ 2003 1,835,837 9.00 $ 17.96 172,736 $ 17.96
---------- ========= ----------- ==========
Total...................... 8,374,477 3,780,166
========== ===========
The maximum number of options available for future issuance as of December
31, 2003, is 2,521,892.
(r) Statement Presentation-Amounts shown in the consolidated financial
statements and applicable notes are stated (except as otherwise indicated and as
to share data) in millions, which amounts may not add to totals shown due to
rounding. Necessary reclassifications are made in prior periods' financial
statements whenever appropriate to conform to the most current presentation.
Note 2-Debt-Consolidated debt of Old Republic and its subsidiaries is summarized
below:
December 31,
-------------------------------------------------------
2003 2002
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ----------- -----------
Commercial paper due within 180 days with an
average yield of 1.23% and 1.48%, respectively....... $ 18.9 $ 18.9 $ 19.9 $ 19.9
Debentures maturing in 2007 at 7.0%...................... 114.9 128.7 114.9 124.2
Other miscellaneous debt................................. 3.7 3.7 6.6 6.6
---------- ----------- ----------- -----------
Total Debt...................................... $ 137.7 $ 151.4 $ 141.5 $ 150.7
========== =========== =========== ===========
The carrying amount of the Company's commercial paper borrowings
approximates its fair value. The fair value of publicly traded debt is based on
its quoted market price.
Scheduled maturities of the above debt at December 31, 2003 are as follows:
2004: $19.5; 2005: $.7; 2006: $.2; 2007: $115.2; 2008: $.3; 2009 and after:
$1.5. During 2003, 2002 and 2001, $8.8, $9.3 and $13.1, respectively, of
interest expense on debt was charged to consolidated operations.
47
Note 3-Shareholders' Equity - All common and preferred share data herein has
been retroactively adjusted as applicable for stock dividends or splits declared
through December 31, 2003.
(a) Preferred Stock-The following table shows certain information pertaining to
the Corporation's preferred shares issued and outstanding:
Convertible
-------------
Preferred Stock Series: G(1)
-------------
Annual cumulative dividend rate per share.............................................. $ (1)
Conversion ratio of preferred into common shares ...................................... 1 for .95
Conversion right begins................................................................ Anytime
Redemption and liquidation value per share............................................. (1)
Redemption beginning in year........................................................... (1)
Total redemption value (millions)...................................................... (1)
Vote per share......................................................................... one
Shares outstanding:
December 31, 2002.................................................................... 8,700
December 31, 2003.................................................................... 0
=============
- ----------
(1) The Corporation has authorized up to 1,000,000 shares of Series G
Convertible Preferred Stock for issuance pursuant to the Corporation's
Stock Option Plan. Series G had been issued under the designation "G-2". As
of December 31, 2003, all Series "G-2" have been converted into shares of
common stock. In 2001, the Corporation created a new designation, "G-3",
from which no shares have been issued as of December 31, 2003. Management
believes this designation will be the source of possible future issuances
of Series G stock. Except as otherwise stated, Series "G-2" and Series
"G-3" are collectively referred to as Series "G". Each share of Series G
pays a floating rate dividend based on the prime rate of interest. At
December 31, 2003, the annual dividend rate for Series G-2 was $.27 per
share. Each share of Series G is convertible at any time, after being held
six months, into 0.95 shares of Common Stock (See Note 3(c)). Unless
previously converted, Series G shares may be redeemed at the Corporation's
sole option five years after their issuance.
(b) Cash Dividend Restrictions-The payment of cash dividends by the Corporation
is principally dependent upon the amount of its insurance subsidiaries'
statutory policyholders' surplus available for dividend distribution. The
insurance subsidiaries' ability to pay cash dividends to the Corporation is in
turn generally restricted by law or subject to approval of the insurance
regulatory authorities of the states in which they are domiciled. These
authorities recognize only statutory accounting practices for determining
financial position, results of operations, and the ability of an insurer to pay
dividends to its shareholders. Based on 2003 data, the maximum amount of
dividends payable to the Corporation by its insurance and a small number of
non-insurance company subsidiaries during 2004 without the prior approval of
appropriate regulatory authorities is approximately $321.2.
(c) Stock Option Plan-The Corporation has stock option plans for certain
eligible key employees. The plan in effect since 1992 was amended in 2002 for
grants made in 2002, prior to the plan's expiration, as to the granting of new
shares in May, 2002. A new plan was adopted and approved by the shareholders in
May, 2002 to cover grants in 2003 and after. The combination of options awarded
at the date of grant and previously issued options still outstanding at such
date, may not exceed 6% of the Old Republic common stock then issued and
outstanding. The exercise price of options is equal to the market price of the
Corporation's stock at the date of grant, and the term of the options is
generally ten years from such date. Options granted in 2001 and prior years
under the 1992 plan may be exercised to the extent of 10% of the number of
options covered thereby on and after the date of grant, and cumulatively to the
extent of an additional 10% on and after each of the first through ninth
subsequent calendar years. Options granted in 2002 and 2003 may be exercised to
the extent of 10% of the number of options covered thereby on and after the date
of grant, and cumulatively to the extent of an additional 15%, 20%, 25% and 30%
on and after the second through fifth calendar years, respectively.
In the event the closing market price of Old Republic's common stock
reaches a pre-established value ("the vesting acceleration price"), options
granted in 2001 and prior years may be exercised cumulatively to the extent of
10% of the number of shares covered by the grant for each year of employment by
the optionee. For grants in 2002 and 2003, optionees become vested on an
accelerated basis to the extent of the greater of 10% of the options granted
times the number of years of employment, or the sum of the optionee's already
vested grant plus 50% of the remaining unvested grant.
The option plans enable optionees to, alternatively, exercise their options
into Series "G" Convertible Preferred Stock. The exercise of options into such
Preferred Stock reduces by 5% the number of equivalent common shares which would
otherwise be obtained from the exercise of options into common shares.
(d) Common Stock-There were 500,000,000 shares of common stock authorized at
December 31, 2003. At the same date, there were 100,000,000 shares of Class "B"
common stock authorized, but none were issued or outstanding. Class "B" common
shares have the same rights as common shares except for being entitled to 1/10th
of a vote per share. In May 2003, the Company canceled 1,923,710 common shares
previously reported as treasury stock and restored them to unissued status; this
had no effect on total shareholders' equity or the financial position of the
Company.
48
(e) Undistributed Earnings-At December 31, 2003, the equity of the Corporation
in the undistributed earnings, determined in accordance with generally accepted
accounting principles, and in the net unrealized investment gains (losses) of
its subsidiaries amounted to $2,522.1 and $234.6, respectively. Dividends
declared during 2003, 2002 and 2001, to the Corporation by its subsidiaries
amounted to $174.6, $139.1 and $120.3, respectively.
(f) Statutory Data-The policyholders' surplus and net income (loss), determined
in accordance with statutory accounting practices, of the Corporation's
insurance subsidiaries was as follows at the dates and for the periods shown:
Policyholders' Surplus Net Income (Loss)
-------------------------- -----------------------------------------
December 31, Years Ended December 31,
-------------------------- -----------------------------------------
2003 2002 2003 2002 2001
----------- ----------- ----------- ----------- -----------