Disclosure Items Omitted:
-------------------------
Item 8, Report of Independent
Registered Public Accounting Firm
Item 9A, Controls and Procedures
Exhibits 23, 31.1 - 32.2
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, 2004 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
---------
OLD REPUBLIC INTERNATIONAL CORPORATION
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
- -------------------------------------------- -----------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
- -------------------------------------------- -----------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
------------
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of each class on Which Registered
------------------- -----------------------
7% Subordinated Debentures Due June 15, 2007 New York Stock Exchange
- -------------------------------------------- -----------------------
Common Stock/$1 par value New York Stock Exchange
------------------------- -----------------------
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 registrant'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, 2004, the
last day of the registrant's most recently completed second fiscal quarter, was
$3,971,217,178.
The registrant had 182,614,298 shares of Common Stock outstanding as of February
16, 2005.
Documents incorporated by reference:
- -----------------------------------
The following documents are incorporated by reference into that part of this
Form 10-K designated to the right of the document title.
Title Part
Proxy statement for the 2005 Annual
Meeting of Shareholders III, Items 10, 11, 12, 13 and 14
Exhibits as specified in
exhibit index (page 65) IV, Item 15
----------------
There are 66 pages in this report
PART I
Item 1-Business
(a) General Description of Business. Old Republic International Corporation is a
Chicago-based insurance holding company with subsidiaries that conduct business
through three major segments, namely, its general (property and liability),
mortgage guaranty, and title insurance businesses. A small life and health
insurance business is included under the corporate and other caption. In this
report, "Old Republic", "the Corporation", or "the Company" refers to Old
Republic International Corporation and its subsidiaries as the context requires.
The aforementioned insurance segments are organized as the Old Republic General
Insurance, Mortgage Guaranty, and Title Insurance Groups and references herein
to such groups apply to the Company's subsidiaries engaged in the respective
segments of business.
Financial Information Relating to Segments of Business (1)
The contributions to net revenues and income (loss) before taxes of each Old
Republic segment are set forth below for the years shown, together with their
respective assets at the end of each year. The information below should be read
in conjunction with the consolidated financial statements, the notes thereto,
and the "Management Analysis of Financial Position and Results of Operations"
appearing elsewhere herein.
($ in Millions)
----------------------------------------------------------------------------------------
Years Ended December 31,
----------------------------------------------------------------------------------------
Net Revenues (2) Income (Loss) Before Taxes
------------------------------------------ -------------------------------------------
2004 2003 2002 2004 2003 2002
----------- ----------- ------------ ------------ ----------- -----------
General........................ $ 1,822.5 $ 1,572.7 $ 1,376.7 $ 333.0 $ 258.9 $ 182.1
Mortgage Guaranty.............. 489.9 498.6 467.1 224.5 276.4 267.7
Title.......................... 1,051.8 1,128.0 836.5 62.5 129.6 97.6
Corporate & Other - Net (3).... 79.3 66.9 62.0 (17.2) (4.5) (.7)
Consolidated Realized
Investment Gains.............. 47.9 19.3 13.9 47.9 19.3 13.9
----------- ----------- ------------ ------------ ----------- -----------
Consolidated................. $ 3,491.6 $ 3,285.8 $ 2,756.4 $ 650.9 $ 679.7 $ 560.7
=========== =========== ============ ============ =========== ===========
Assets at December 31,
------------------------------------------
2004 2003 2002
----------- ----------- -----------
General..................................................................... $ 7,222.8 $ 6,603.5 $ 5,876.5
Mortgage Guaranty........................................................... 2,205.9 2,080.1 1,921.2
Title....................................................................... 753.0 720.5 619.9
Corporate & Other - Net (3)................................................. 388.9 308.0 297.6
----------- ----------- -----------
Consolidated.............................................................. $10,570.8 $ 9,712.3 $ 8,715.4
=========== =========== ===========
- -----------------------
(1) 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.
(2) Revenues consist of net premiums, fees, net investment and other income
earned; realized investment gains are shown in total for all groups
combined.
(3) Represents amounts for Old Republic's holding company parent, minor
internal service subsidiaries, and a small life and health insurance
operation.
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 2004, production of commercial automobile
direct insurance premiums accounted for approximately 33.0% of consolidated
direct premiums written by the General Insurance Group, while workers'
compensation and general liability direct insurance premiums amounted to 23.2%
and 15.2%, respectively, of such consolidated totals.
Among other liability coverages, Old Republic indemnifies corporations'
financial exposures to directors' and officers' ("D&O") liability as well as
those stemming from errors and omissions ("E&O") 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.
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.
In addition to the aforementioned D&O and E&O financial indemnity
exposures, the Corporation also provides coverage for fidelity, surety and
credit exposures for a wide range of business enterprises. Fidelity and surety
coverages are underwritten through some 9,000 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 a variety of consumer loans and installment sales
contracts.
Extended warranty coverages for new and used automobiles, as well as home
warranty policies covering appliances and other mechanical systems in used homes
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 one of the Company's life insurance subsidiaries,
include trip delay and trip cancellation protection for insureds.
In recent years, 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 terminated coverages.
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 Mortgage Guaranty Group 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 2004,
delegated underwriting approvals accounted for 53.8% of the Corporation's new
traditional primary insurance written.
3
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.
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,
2004 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, 2004, approximately 38% of the
Company's consolidated title premium and related fee income stemmed from direct
operations (which include branch offices of its title insurers and wholly owned
subsidiaries of the Company), while the remaining 62% emanated from independent
title agents and underwritten title companies.
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.
Corporate and Other Operations
Corporate and other operations include the accounts of a small life and
health insurance business as well as those of the parent holding company and
several internal service subsidiaries that perform investment management,
payroll, administrative and minor marketing services.
The Corporation's small life and health business registered 2004 and 2003
net premium revenues of $64.6 million and $51.6 million, respectively. This
business is conducted in both the United States and Canada and consists mostly
of limited product offerings sold through financial intermediaries such as
finance companies, automobile dealers, and travel agents, marketing channels
that are also utilized in some of Old Republic's general insurance operations.
Production of term life insurance, as to which new and renewal business
accounted for net premiums earned of approximately $18.9 million in 2004, has
been terminated and placed in run off mode as of year end 2004. As a result of
the changed circumstances, it was concluded that previously deferred acquisition
costs could no longer be amortized for their full amount of the product's
expected run-off years. Accordingly, 2004 operations were charged in the sum of
$10.5 million to reflect revised estimates of deferrable costs.
4
Consolidated Underwriting Statistics
The following table reflects underwriting statistics covering: 1) premiums
and related loss, expense, and policyholders' dividend ratios for the major
coverages underwritten in the General, Mortgage Guaranty and Title insurance
groups:
($ in Millions)
-------------------------------------------------
Years Ended December 31,
-------------------------------------------------
2004 2003 2002
------------- ------------- -------------
General Insurance Group (Statutory Basis):
Overall Experience: Net Premiums Written............... $ 1,701.1 $ 1,460.3 $ 1,268.7
Net Premiums Earned ............... $ 1,626.0 $ 1,382.7 $ 1,182.3
Claim Ratio........................ 65.9% 66.7% 72.7%
Policyholders' Dividend Benefit.... .2 1.1 (.1)
Expense Ratio ..................... 24.6 25.5 25.8
------------- ------------- -------------
Composite Ratio.................... 90.7% 93.3% 98.4%
============= ============= =============
Experience By Major Coverages:
Commercial Automobile: Net Premiums Earned ............... $ 616.3 $ 545.6 $ 508.0
(Principally Trucking) Claim Ratio........................ 66.5% 70.4% 78.4%
============= ============= =============
Workers' Compensation: Net Premiums Earned ............... $ 353.9 $ 277.2 $ 226.2
Claim Ratio........................ 71.9% 75.9% 93.7%
Policyholders' Dividend Benefit.... .5% 5.3% (.5%)
============= ============= =============
Financial Indemnity: (1) Net Premiums Earned ............... $ 191.4 $ 161.8 $ 104.1
Claim Ratio........................ 47.5% 50.9% 40.9%
============= ============= =============
Property: (2) Net Premiums Earned ............... $ 184.5 $ 169.0 $ 151.9
Claim Ratio........................ 56.0% 58.9% 51.4%
============= ============= =============
General Liability: Net Premiums Earned ............... $ 94.4 $ 72.6 $ 55.3
Claim Ratio........................ 108.6% 89.3% 67.5%
============= ============= =============
Other Coverages: (3) Net Premiums Earned ............... $ 185.2 $ 156.4 $ 136.6
Claim Ratio........................ 59.3% 52.2% 66.9%
============= ============= =============
Mortgage Guaranty Group: Net Premiums Earned................ $ 403.2 $ 400.9 $ 376.2
Claim Ratio........................ 35.5% 22.7% 14.1%
Expense Ratio...................... 25.6 24.8 32.3
------------- ------------- -------------
Composite Ratio.................... 61.1% 47.5% 46.4%
============= ============= =============
Title Insurance Group: (4) Net Premiums Earned................ $ 714.0 $ 749.9 $ 524.8
Combined Net Premiums
& Fees Earned.................... $ 1,025.2 $ 1,103.8 $ 813.4
Claim Ratio........................ 5.8% 5.8% 5.0%
Expense Ratio...................... 90.5 84.6 85.6
------------- ------------- -------------
Composite Ratio.................... 96.3% 90.4% 90.6%
============= ============= =============
Consolidated: Net Premiums & Fees Earned......... $ 3,116.1 $ 2,936.0 $ 2,423.9
Claim and Benefit Ratio............ 42.0% 37.9% 40.2%
Expense Ratio...................... 47.3 48.5 47.9
------------- ------------- -------------
Composite Ratio.................... 89.3% 86.4% 88.1%
============= ============= =============
- ---------------
Certain minor reclassifications of prior year data have been reflected in the
above table to conform to current presentation.
(1) Consists principally of fidelity, surety, consumer credit indemnity, and
executive indemnity (directors & officers and errors & omissions)
coverages.
(2) Consists principally of commercial fire, allied lines, multi-peril and
inland marine coverages.
(3) Consists principally of home and auto warranty, aviation and travel
accident coverages.
(4) Title claim, expense, and composite ratios are calculated on the basis of
combined net premiums and fees earned.
Variations in the claim (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
5
ongoing reevaluations of reported and incurred but not reported claims and claim
expenses. The Company can therefore experience period-to-period volatility in
the underwriting results for individual coverages as demonstrated in the above
table. As a result of the Company's fundamental underwriting focus in the
management of its business, it has attempted to dampen this volatility and thus
ensure a higher degree of overall underwriting stability by diversifying the
coverages it offers and industries it serves.
The claim 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.
The general insurance claims ratio has reflected favorable trends since
reaching a peak in 1999. The downtrend in this major cost factor reflects
largely the pricing and risk selection improvements effected in the past
forty-eight months. General Insurance Group loss ratios for workers'
compensation and liability insurance coverages in particular may reflect greater
variability due to chance events in any one year, changes in loss costs
emanating from participation in involuntary markets (i.e. insurance assigned
risk 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, claims
and dividend ratios for these individual coverages should be considered in the
light of such a concurrent underwriting approach. With respect to commercial
automobile coverages, the declining claims ratio stems primarily from the
pricing and risk selection improvements made in recent years, while better
results in workers' compensation are due to improved pricing in general as well
as stronger growth of business subject to captive reinsurance, retrospective
premium, or self-insured deductible programs that are expected to produce lower
net loss ratios. The 2003 workers' compensation dividend benefit rose primarily
due to the conversion of a large account to self-insured status which led to an
increase in policyholder dividend costs and a contra-reduction in incurred
losses. The claims ratio for general liability coverages has tended to be highly
volatile, usually rising due to the impact of higher claims emergence and
greater than anticipated severity on a relatively small book of business.
Mortgage guaranty claim ratios rose in both 2004 and 2003 from historically
low levels posted in 2002 and several prior years. The recent higher loss ratios
have resulted from greater loss provisions caused by higher paid losses and
expectations of moderately higher estimates of claim severity.
The title insurance claim ratio has been in the low single digits in each
of the past several years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. A
moderate uptrend in the three years ended December 31, 2004 stems from a rise in
the net provision for ultimate claim costs from the historically low levels
achieved in 2001 and 2000.
The consolidated claims, expense, and composite ratios reflect the changing
period-to-period contributions of each segment to consolidated results, and the
variances within each segment.
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%.
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
6
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 $139.3 million, $142.9 million and
$145.7 million, as of December 31, 2004, 2003 and 2002, 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 volume of new claim reports has abated in
2003 and 2004. 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 as well as assumptions relative to the effect
of the revised regulations. Inasmuch as a variety of challenges are likely as
the revised regulations are implemented through 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. 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 to 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, 2004, 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 to quantify with a high degree of precision.
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. At December 31, 2004, Old Republic's aggregate indemnity and loss
adjustment expense reserves specifically identified with A&E exposures amounted
to approximately $118.9 million gross, and $97.1 million net of reinsurance.
Based on average annual claims payments during the five most recent calendar
years, such reserves represented 6.2 years (gross) and 9.6 years (net) of
average annual claims payments. Fluctuations in this ratio between years can be
caused by the inconsistent pay out patterns associated with these types of
claims. For the five years ended December 31, 2004, incurred A&E claim and
related loss settlement costs have averaged 2.6% of average annual General
Insurance Group claims and related settlement costs.
Over the years, 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 1994 through 2004.
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 and settlement processes
outlined herein above. The reserve redundancies or deficiencies shown for all
years are not necessarily indicative of the effect on reported results of any
7
one or series of years since cumulative retrospective premium and commission
adjustments employed in various parts of the Company's business may partially
offset such effects. (See "Consolidated Underwriting Statistics" above, and
"Reserves, Reinsurance, and Retrospective Adjustments" elsewhere herein).
($ in Millions/Percentages to Nearest Whole Point)
- ------------------------------------------------------------------------------------------------------------------------------------
(a) As of December 31: 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(b) Liability(1) for unpaid claims
and claim adjustment
expenses(2): $2,182 $1,964 $1,802 $1,678 $1,661 $1,699 $1,742 $1,846 $1,829 $1,821 $1,768
=================================================================================================
(c) Paid (cumulative) as of (3):
----------------------------
One year later -% 24% 24% 25% 25% 24% 24% 22% 19% 21% 20%
Two years later - - 40 39 39 39 38 37 33 32 33
Three years later - - - 50 49 49 48 45 42 41 40
Four years later - - - - 56 55 54 52 48 47 46
Five years later - - - - - 60 59 57 53 50 50
Six years later - - - - - - 63 61 57 54 53
Seven years later - - - - - - - 65 60 58 56
Eight years later - - - - - - - - 64 62 60
Nine years later - - - - - - - - - 65 63
Ten years later -% -% -% -% -% -% -% -% -% -% 67%
=================================================================================================
(d) Liability reestimated (i.e.,
cumulative payments plus
reestimated ending liability)
As of (4):
-----------------------------
One year later -% 97% 99% 100% 97% 96% 96% 93% 94% 96% 95%
Two years later - - 98 101 98 95 93 89 88 92 93
Three years later - - - 103 100 97 93 87 84 87 90
Four years later - - - - 102 98 95 87 82 83 87
Five years later - - - - - 101 97 89 83 82 84
Six years later - - - - - - 99 91 85 82 84
Seven years later - - - - - - - 94 86 85 85
Eight years later - - - - - - - - 89 86 88
Nine years later - - - - - - - - - 90 89
Ten years later -% -% -% -% -% -% -% -% -% -% 93%
==================================================================================================
(e) Redundancy (deficiency)(5)
for each year-end at (a): -% 3% 2% -3% -2% -1% 1% 6% 11% 10% 7%
==================================================================================================
Average for all year-ends
at (a): 3.6%
========
- ---------------
(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,
-----------------------------------------------------------------------------------------
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994
------- ------- ------- ------- -------- ------- ------- ------- ------- ------- --------
(a) Beginning net reserves.......... $1,964 $1,802 $1,678 $1,661 $1,699 $1,742 $1,846 $1,829 $1,821 $1,768 $1,700
-----------------------------------------------------------------------------------------
Incurred claims and claim expenses:
-----------------------------------
(b) Current year provision.......... 1,070 893 814 749 690 734 728 713 668 684 705
(c) Change in prior years' provision (55) (25) (7) (44) (66) (66) (123) (105) (74) (92) (89)
-----------------------------------------------------------------------------------------
(d) Total incurred.................. 1,014 868 807 704 623 668 604 608 593 592 616
-----------------------------------------------------------------------------------------
Claim payments on:
------------------
(e) Current year events............. 332 277 260 269 258 298 322 275 243 207 236
(f) Prior years' events............. 463 428 423 418 402 412 385 316 342 332 312
-----------------------------------------------------------------------------------------
(g) Total payments.................. 796 706 683 687 661 710 708 591 585 539 549
-----------------------------------------------------------------------------------------
(h) Ending net reserves (a+d-g)..... 2,182 1,964 1,802 1,678 1,661 1,699 1,742 1,846 1,829 1,821 1,768
(i) Unallocated loss adjustment
expense reserves............. 87 83 78 76 73 71 73 73 71 69 55
(j) Reinsurance recoverable on
claim reserves............... 1,632 1,515 1,363 1,261 1,235 1,238 1,190 1,232 1,296 1,311 1,407
-----------------------------------------------------------------------------------------
(k) Gross claim reserves (h+i+j).... $3,902 $3,562 $3,244 $3,016 $2,969 $3,009 $3,005 $3,151 $3,197 $3,202 $3,231
=========================================================================================
8
(b) Investments. In common with other insurance organizations, Old Republic
invests most funds provided by operations in income-producing investment
securities. All investments must comply with applicable insurance laws and
regulations which prescribe the nature, form, quality, and relative amounts of
investments which may be made by insurance companies. Generally, these laws and
regulations permit insurance companies to invest within varying limitations in
state, municipal and federal government obligations, corporate obligations,
preferred and common stocks, certain types of real estate, and first mortgage
loans. Old Republic's investment policies are also influenced by the terms of
the insurance coverages written, by its expectations as to the timing of claim
and benefit payments, and by income tax considerations. The following tables
show invested assets at the end of the last three years, together with
investment income for such years:
Consolidated Investments
($ in Millions)
December 31,
-----------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
----------- ------------ ------------
Available for Sale
Fixed Maturity Securities:
U.S. & Canadian Governments............................................ $ 1,135.3 $ 993.4 $ 976.2
Tax-Exempt............................................................. 1,574.0 1,277.2 -
Utilities.............................................................. 876.4 828.5 -
Corporate.............................................................. 2,870.0 2,641.8 2,196.2
----------- ------------ ------------
6,455.9 5,741.1 3,172.4
Equity Securities......................................................... 459.0 513.5 513.5
Short-term Investments.................................................... 388.6 403.9 253.8
Miscellaneous Investments................................................. 54.4 53.2 -
----------- ------------ ------------
Total available for sale............................................... 7,358.1 6,711.8 3,939.9
----------- ------------ ------------
Held to Maturity
Fixed Maturity Securities:
Utilities.............................................................. - - 754.4
Tax-Exempt............................................................. - - 1,299.7
----------- ------------ ------------
- - 2,054.1
----------- ------------ ------------
Other Investments......................................................... 13.4 8.5 57.4
----------- ------------ ------------
Total held to maturity................................................. 13.4 8.5 2,111.6
----------- ------------ ------------
Total Investments......................................................... $ 7,371.6 $ 6,720.4 $ 6,051.5
=========== ============ ============
Sources of Consolidated Investment Income
($ in Millions)
Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
------------ ------------ ------------
Fixed Maturity Securities:
Taxable................................................................ $ 214.0 $ 202.7 $ 193.5
Tax-Exempt............................................................. 53.1 53.7 59.5
------------ ------------ ------------
267.2 256.4 253.1
------------ ------------ ------------
Equity Securities......................................................... 14.3 14.6 12.4
------------ ------------ ------------
Other Investment Income:
Interest on Short-term Investments..................................... 5.7 4.5 6.0
Sundry................................................................. 6.8 6.8 5.2
------------ ------------ ------------
12.5 11.4 11.3
------------ ------------ ------------
Gross Investment Income................................................... 294.1 282.5 276.9
Less: Investment Expenses (1).......................................... 3.2 3.2 4.2
------------ ------------ ------------
Net Investment Income..................................................... $ 290.8 $ 279.2 $ 272.6
============ ============ ============
- ---------------
(1) Investment expenses consist primarily of personnel costs, investment
management and custody service fees and includes interest incurred on funds
held of $.3, $.1 and $.3 for the years ended December 31, 2004, 2003 and
2002, 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, 2004 and 2003.
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Old Republic 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, 2004 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 detailed 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, 2004 and 2003, are shown in the following tables.
These investments, $6.4 billion and $5.7 billion at December 31, 2004 and 2003,
respectively, represented approximately 61% and 59%, respectively, of
consolidated assets, and 96% and 93%, respectively, of consolidated liabilities
as of such dates.
- -------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (1)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
---------- ----------
(% of total portfolio)
Aaa.............................................................................. 32.6% 29.7%
Aa............................................................................... 19.5 19.1
A................................................................................ 27.5 32.0
Baa.............................................................................. 19.8 18.5
---------- ----------
Total investment grade....................................................... 99.4 99.3
All others (2)................................................................... .6 .7
---------- ----------
Total........................................................................ 100.0% 100.0%
========== ==========
- ---------------
(1) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(2) "All others" includes non-investment grade or non-rated small issues of
tax-exempt bonds.
- -------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
---------- ----------
(% of total portfolio)
Maturity Ranges:
Due in one year or less.......................................................... 12.5% 11.0%
Due after one year through five years............................................ 42.9 50.0
Due after five years through ten years........................................... 43.5 37.7
Due after ten years through fifteen years........................................ 1.1 1.3
Due after fifteen years.......................................................... - -
---------- ----------
100.0% 100.0%
========== ==========
Average Maturity................................................................. 4.7 Years 4.5 Years
========== ==========
- -------------------------------------------------------------------------------------------------------------------------------
(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 2004.
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 41.8%, 37.3% and 38.3% of traditional primary new insurance
written in 2004, 2003 and 2002, respectively. The largest single customer
accounted for 11.7% of traditional primary new insurance written in 2004
compared to 7.2% and 10.6% in 2003 and 2002, 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 260 Company
offices located in 33 states and through agencies and underwritten title
companies in Puerto Rico, the District of Columbia and all states except Iowa.
The issuing agents are authorized to issue commitments 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 2004,
approximately 62% 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 produces less title insurance business relative to new construction
during such months than during the rest of the year. The most important factors,
insofar as Old Republic's title business is concerned, however, are the rates of
activity in the resale and refinance markets 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
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
- -------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
----------- ----------- -----------
United States:
Northeast................................................................ 8.9% 9.3% 8.4%
Mid-Atlantic............................................................. 9.6 9.7 8.3
Southeast................................................................ 18.6 17.6 17.7
Southwest................................................................ 11.8 12.1 12.8
East North Central....................................................... 14.6 14.9 14.8
West North Central....................................................... 12.7 12.2 13.0
Mountain................................................................. 7.5 7.5 7.9
Western.................................................................. 14.0 14.6 14.9
Foreign (Principally Canada)............................................... 2.3 2.1 2.2
----------- ----------- -----------
Total............................................................. 100.0% 100.0% 100.0%
=========== =========== ===========
(d) Reserves, Reinsurance, and Retrospective Adjustments. Old Republic's
insurance subsidiaries establish reserves for 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 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 risk-sharing arrangements, the Company adjusts
production costs or premiums retroactively to likewise reflect deviations from
originally expected loss costs. The amount of premium, production and 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, retrospective insurance and production 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, retrospectively rated and self-insured deductible policies and
contracts do not relieve Old Republic from its direct obligations to assureds or
their beneficiaries.
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 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 in most
instances with independent insurance or reinsurance companies pursuant to 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 $21,700,
though portions of the business are also ceded to captive reinsurers on an
excess of loss basis in most instances. Title insurance risk assumptions are
currently limited to a maximum of $100.0 million as to any one policy. The vast
majority of title policies issued, however, carry exposures of $500,000 or less.
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 raised to the $100.0 million level, and as of January 1, 2005 they have
been further increased to $200.0 million. 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
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
12
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 and title
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 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, 2004, Old Republic employed approximately
6,500 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.
(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
13
(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 50% 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, 2004 was approximately $21.8 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
(a) Legal proceedings against the Company arise in the normal course of
business and usually pertain to claim matters related to insurance policies and
contracts issued by its insurance subsidiaries. Other legal proceedings are
discussed below.
In 1998 the City and County of San Francisco and certain escrow customers
of an underwritten title agency subsidiary headquartered in the State of
California filed lawsuits alleging that the subsidiary had: 1) failed to escheat
unclaimed escrow funds; 2) charged for services not necessarily provided; and 3)
collected illegal interest payments or fees from banks on the basis of funds
held for escrow customers. The subsidiary in turn conducted an internal review
of its records and concluded that it had certain liabilities for part of the
issues denoted at (1) and (2). The subsidiary defended against the alleged
practice denoted at (3) on the grounds that such practices are common within the
industry, are not in conflict with any laws or regulations, and other
meritorious defenses. The consolidated lawsuits were tried and a judgment
rendered, affirming in part and denying in part the subsidiary's defenses. In
the aggregate, the judgment, excluding post-judgment interest, amounted to
approximately $33.0 million, of which about $6.5 million was paid in partial
settlements. The subsidiary appealed the most significant portions of the
judgment. On January 20, 2005 the Court of Appeals affirmed the judgment against
the subsidiary. The subsidiary has elected not to pursue a further appeal and
instead paid the balance of the judgment on February 28, 2005.
Purported class actions have been filed in state courts in Ohio and Florida
against the Company's principal title insurance subsidiary, Old Republic
National Title Insurance Company ("ORNTIC"). Substantially similar lawsuits have
been filed against other title insurance companies in New York and Florida.
Plaintiffs allege that, pursuant to rate schedules filed by ORNTIC with
insurance regulators, ORNTIC was required to, but failed to give consumers a
reissue credit on the premiums charged for title insurance covering mortgage
refinancing transactions. Both actions seek damages and declaratory and
injunctive relief. ORNTIC intends to defend vigorously against these actions,
but at this early stage in the litigation the Company cannot estimate the costs
it may incur as the actions proceed to their conclusions. The Ohio case has been
stayed, pending an appeal in a similar action against another title insurer, and
ORNTIC has filed a motion to stay one of the two Florida cases.
An action was filed in the Federal District court for South Carolina
against the Company's wholly-owned mortgage guaranty insurance subsidiary,
Republic Mortgage Insurance Company ("RMIC"). Similar lawsuits have been filed
against the other six private mortgage insurers in different Federal District
Courts. The action against RMIC seeks certification of a nationwide class of
consumers who were allegedly required to pay for private mortgage insurance at a
cost greater than RMIC's "best available rate". The action alleges that the
decision to insure their loans at a higher rate was based on the consumers'
credit scores and constituted an "adverse action" within the meaning, and in
violation of the Fair Credit Reporting Act, that requires notice, allegedly not
given, to the consumers. The action seeks statutory and punitive damages, as
well as other costs. RMIC intends to defend vigorously against the action, but
at this early stage in the litigation the Company cannot estimate the costs it
may incur as the litigation proceeds to its conclusion. RMIC filed a motion to
compel arbitration of the dispute with the named plaintiff. The motion was
denied and RMIC has filed an appeal.
(b) Examinations of the Company are performed periodically by the Internal
Revenues Service ("IRS") and other taxing authorities. Discussed below is the
result of the latest of these examinations.
In April, 2004 the IRS provided the Company a so-called "30 Day Letter"
resulting from a recently completed examination of tax returns for years 1998 to
2000. In substance, the letter alleges that certain claim reserve deductions
taken through year end 2000 were overstated and thus served to reduce taxable
income for those years. The Company has made a review of the IRS calculations
15
and has concluded its loss reserves were calculated consistently and provide a
fair and reasonable estimate of its unpaid losses. Accordingly, the Company
intends to defend vigorously the validity of claim reserve deductions taken in
its tax returns. In the event the Company's position is not fully sustained,
payments of any additional taxes owed would be categorized as temporary
differences, and as such would likely have little effect on its GAAP financial
statements. The matter has been assigned to an IRS appeals officer.
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, 2004,
regarding the senior executive officers of the Company:
Name Age Position
- --------------------------- --- ------------------------------------------------------------------------------
Charles S. Boone 51 Senior Vice President - Investments and Treasurer since August, 2001.
James A. Kellogg 53 Senior Vice President/General Insurance and President of Old Republic
Insurance Company since October, 2002.
Spencer LeRoy, III 58 Senior Vice President, General Counsel and Secretary since 1992.
Karl W. Mueller 45 Senior Vice President and Chief Financial Officer since October, 2004. Prior
to joining Old Republic, Mr. Mueller was a partner with the public accounting
firm of KPMG LLP.
William A. Simpson 63 Senior Vice President/Mortgage Guaranty, and Director since 1980. President
since 1972 of Republic Mortgage Insurance Company, a wholly-owned subsidiary.
Rande K. Yeager 56 Senior Vice President/Title Insurance since March, 2003. President since
March, 2002 of Old Republic National Title Insurance Company.
A. C. Zucaro 65 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, except for Karl W. Mueller, has been
employed in executive capacities with the Company and/or its subsidiaries for
the past five years.
15
PART II
Item 5- Market for the Registrant's Common Equity, Related Security Holder
Matters and Issuer Purchases of Equity Securities
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 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 (1)
=========== ========== ==========
1st quarter 2004................................................... $ 27.19 $ 23.47 $ .113
2nd quarter 2004................................................... 25.37 21.37 .130
3rd quarter 2004................................................... 25.03 22.60 .130
4th quarter 2004................................................... $ 25.79 $ 23.15 $ .130
=========== ========== ==========
- ---------------
(1) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
As of January 31, 2005, there were 2,976 registered holders of the
Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial
Statements for a description of certain regulatory restrictions on the payment
of dividends by Old Republic's insurance subsidiaries. Closing prices have been
restated, as necessary, to reflect all stock dividends and splits declared
through December 31, 2004.
The Company made no common stock repurchases during the fourth quarter 2004
under its common stock repurchase plan.
16
Item 6-Selected Financial Data
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
FINANCIAL POSITION ($ millions):
Cash and Invested Assets (1)........... $ 7,519.5 $ 6,849.2 $ 6,168.2 $ 5,586.7 $ 5,144.3
Other Assets........................... 3,051.3 2,863.0 2,547.1 2,333.4 2,137.1
Total Assets.................... 10,570.8 9,712.3 8,715.4 7,920.2 7,281.4
Liabilities, Other than Debt........... 6,562.1 6,020.9 5,417.9 4,977.1 4,604.0
Debt................................... 143.0 137.7 141.5 159.0 238.0
Total Liabilities............... 6,705.1 6,158.6 5,559.5 5,136.1 4,842.0
Preferred Stock........................ - - - .3 .7
Common Shareholders' Equity............ 3,865.6 3,553.6 3,155.8 2,783.7 2,438.7
Total Capitalization (2)........ $ 4,008.6 $ 3,691.3 $ 3,297.4 $ 2,943.1 $ 2,677.4
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS ($ millions):
Net Premiums and Fees Earned........... $ 3,116.1 $ 2,936.0 $ 2,423.9 $ 2,029.5 $ 1,736.8
Net Investment and Other Income........ 327.5 330.5 318.5 314.1 300.1
Realized Investment Gains.............. 47.9 19.3 13.9 29.7 33.6
Net Revenues................... 3,491.6 3,285.8 2,756.4 2,373.4 2,070.6
Benefits, Claims, and
Settlement Expenses.................. 1,307.9 1,112.8 974.8 860.5 761.2
Underwriting and Other Expenses........ 1,532.7 1,493.2 1,220.8 1,006.2 880.7
Pretax Income..................... 650.9 679.7 560.7 506.6 428.6
Income Taxes.......................... 215.9 219.9 167.7 159.7 131.0
Net Income........................ $ 435.0 $ 459.8 $ 392.9 $ 346.9 $ 297.5
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA: (4)
Net Income:
Basic (3)............................. $ 2.38 $ 2.53 $ 2.17 $ 1.94 $ 1.66
============ ============ ============ ============ ============
Diluted ............................. $ 2.36 $ 2.51 $ 2.16 $ 1.92 $ 1.65
============ ============ ============ ============ ============
Dividends: Cash - Regular............... $ .503 $ .446 $ .420 $ .393 $ .367
- Special (5)........... - .667 - - -
------------ ------------ ------------ ------------ ------------
- Total................. $ .503 $ 1.113 $ .420 $ .393 $ .367
============ ============ ============ ============ ============
Stock........................ -% 50% -% -% -%
============ ============ ============ ============ ============
Book Value.............................. $ 21.17 $ 19.57 $ 17.45 $ 15.60 $ 13.75
============ ============ ============ ============ ============
Common Shares (thousands):
Outstanding........................... 182,563 181,606 180,898 178,465 177,380
============ ============ ============ ============ ============
Average: Basic........................ 182,541 181,549 180,863 178,436 178,977
============ ============ ============ ============ ============
Diluted...................... 184,607 183,302 182,323 180,491 180,295
============ ============ ============ ============ ============
- ---------------
(1) Consists of cash, investments and investment income due and accrued.
(2) Total capitalization consists of debt, preferred stock, and common
shareholders' equity.
(3) Calculated after deduction of minor amounts of preferred stock cash
dividends.
(4) All per share statistics herein have been restated to reflect all stock
dividends or splits declared through December 31, 2004.
(5) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
17
Item 7-Management Analysis of Financial Position and Results of Operations
($ in Millions, Except Share Data)
- --------------------------------------------------------------------------------
OVERVIEW AND EXECUTIVE SUMMARY
This management analysis of financial position and results of operations
pertains to the consolidated accounts of Old Republic International Corporation.
The Company conducts its business through three major segments, namely, its
General (property and liability), Mortgage Guaranty and Title insurance
segments. A small life and health insurance business, accounting for 2.1% of
consolidated revenues and 2.3% of consolidated assets, is included within the
corporate and other caption. The consolidated accounts are presented on the
basis of generally accepted accounting principles ("GAAP"). This analysis should
be read in conjunction with the most recent annual and quarterly consolidated
financial statements and the footnotes appended to them.
The insurance business is distinguished from most others in that the prices
(premiums) charged for various coverages are set without certainty of the
ultimate benefit and claim costs that will emerge or be incurred, often many
years after issuance of a policy. This basic fact casts Old Republic's business
as a long-term undertaking which is managed with a primary focus on the
achievement of favorable underwriting results over time. In addition to
operating income stemming from Old Republic's basic underwriting and related
services functions, significant revenues are obtained from investable funds
generated by those functions as well as from retained shareholders' capital. In
managing investable funds the Company aims to assure stability of income from
interest and dividends, protection of capital, and sufficient liquidity to meet
insurance underwriting and other obligations as they become payable in the
future. Securities trading and the realization of capital gains are not
objectives. The investment philosophy is therefore best categorized as
emphasizing value, credit quality, and relatively long-term holding periods. The
Company's ability to hold both fixed maturity and equity securities for long
periods of time is enabled by the scheduling of maturities in contemplation of
an appropriate matching of assets and liabilities.
In light of the above factors, the Company's affairs are managed for the
long run, without regard to the arbitrary strictures of quarterly or even annual
reporting periods that American industry must observe. In Old Republic's view,
short reporting time frames do not comport well with the long-term nature of
much of its business, driven as it is by a strong focus on the fundamental
underwriting and related service functions of the Company. Management believes
that Old Republic's operating results and financial condition can best be
evaluated by observing underwriting performance trends over succeeding five to
ten year intervals. Such time intervals are likely to encompass one or two
economic and/or underwriting cycles, and provide appropriate time frames for
such cycles to run their course and for reserved claim costs to be quantified
with greater finality and effect.
* * *
To aid investment analysis of Company results, both net operating income
and net income figures per share are provided to highlight the impact of certain
accounting rules or securities market-driven considerations that affect the
recording of investment gains or losses and lead to lessened period-to-period
comparability. The realization of investment gains or losses can be highly
discretionary and arbitrary due to such factors as the timing of individual
securities sales, losses from write-downs of impaired securities, tax-planning
considerations, and changes in investment management judgments relative to the
direction of securities markets or the future prospects of individual investees
or industry sectors. In particular, write-downs of securities deemed other than
temporarily impaired are affected by some of these factors as well as industry
or issuer-specific developments that can call for the recognition of a loss of
market value or non-recoverability of asset cost.
2004 consolidated earnings were affected adversely by special post-tax
charges of approximately $25.5 (14 cents per share). Nearly 75% of the charge
represents an increase in previously posted litigation reserves necessitated by
a ruling on January 20, 2005 by the California Court of Appeals affirming a
prior trial court verdict against Old Republic Title Company. The remainder
covers a write down of previously deferred acquisition costs applicable to a
life insurance product discontinued during the fourth quarter of 2004. Pretax
earnings for 2004 were also affected negatively by the expensing of stock option
benefits totaling $8.6 (3 cents per share after-tax) of which $5.6 represented a
charge for a non-recurring vesting acceleration of stock option costs in the
year's first quarter. Stock option expense charges reduced earnings per share by
less than 1 cent per share in 2003. The aggregate effect of all 2004 special
charges was to decrease pretax earnings by $38.3, and post-tax earnings by $29.0
(16 cents per share).
The major components of pretax income and resulting consolidated GAAP net
income discussed in this report were as follows:
18
Years Ended December 31,
-------------------------------------------------
2004 2003 2002
------------- ------------- -------------
Pretax operating income (loss):
General ............................................................ $ 333.0 $ 258.9 $ 182.1
Mortgage Guaranty .................................................. 224.5 276.4 267.7
Title .............................................................. 62.5 129.6 97.6
Corporate and other................................................. (17.2) (4.5) (.7)
Realized investment gains ............................................. 47.9 19.3 13.9
------------- ------------- -------------
Consolidated pretax income ............................................ 650.9 679.7 560.7
Income taxes........................................................ 215.9 219.9 167.7
------------- ------------- -------------
Net income............................................................. $ 435.0 $ 459.8 $ 392.9
============= ============= =============
Components of Diluted Earnings Per Share:
Net operating income ............................................... $ 2.19 $ 2.44 $ 2.11
Net realized gains ................................................. .17 .07 .05
------------- ------------- -------------
Net income ......................................................... $ 2.36 $ 2.51 $ 2.16
============= ============= =============
Old Republic's General Insurance Group, which underwrites mostly commercial
property and liability insurance coverages, registered pretax operating income
of $333.0 in 2004, compared to $258.9 and $182.1 in 2003 and 2002, respectively.
Net premium revenues in 2004 rose 17.6 percent to $1.6 billion compared to $1.3
billion one year ago, and increased 16.5 percent in 2003 over the $1.1 billion
recorded in 2002. The composite underwriting ratio was 90.7 percent, 93.3
percent and 98.4 percent for 2004, 2003 and 2002, respectively. Earned premiums
in the General Insurance Group increased as a result of positive pricing and
risk selection changes effected during the past few years, as well as additional
business produced in a reasonably stable underwriting environment. Underwriting
results in the past three years benefited mostly from lower claims incurred, and
relatively lower production and administrative expenses. The composite
underwriting ratio represents the most widely accepted indicator of underwriting
performance in the industry, and Old Republic has registered a declining
composite ratio since year end 2000. The ratio reached a high of 118.8 percent
in the third quarter of 1999 and has dropped fairly consistently since then to
the most recent lower levels.
Mortgage Guaranty Group pretax operating income declined 18.8 percent to
$224.5 in 2004, after increasing 3.2 percent in 2003 to $276.4 from $267.7 in
2002. Net premiums earned benefited from improved persistency in the traditional
primary business but were largely offset by the combination of lower origination
volumes and greater reinsurance cessions increasing to $403.2 from $400.9 earned
in 2003, which reflected an increase of 6.5 percent over the $376.2 earned in
2002. The composite underwriting ratio rose to 61.1 percent compared to the 47.5
percent and 46.4 percent registered in 2003 and 2002, respectively, mostly as a
result of an increase in the claims component. The higher claims ratio for 2004
resulted from greater loss provisions caused by an increase in paid losses and
net reserve additions that reflect moderately higher expectations of estimated
claim frequency and severity. The expense ratio was lower in 2004 and 2003 due,
in part, to lower litigation costs in 2003, and recovery of certain prior years'
litigation costs in 2004.
Title Insurance Group operating results declined during 2004 after
increasing in both 2003 and 2002. Premium and fee revenues totaled $1.0 billion
in 2004 compared to $1.1 billion and $813.4 in 2003 and 2002, respectively.
Pretax operating income dropped to $62.5 in 2004 from $129.6 in 2003 and $97.6
in 2002. The composite ratio was 96.3 percent, 90.4 percent, and 90.6 percent in
2004, 2003 and 2002, respectively. The decline in 2004 operating results is
attributable to a special charge representing an increase in previously posted
litigation reserves necessitated by a ruling on January 20, 2005 by the
California Court of Appeals affirming a prior trial court verdict against Old
Republic Title Company and a substantial reduction in premiums and fees
emanating from mortgage refinancing revenues, which reached a peak in the third
quarter of 2003, without a corresponding decline in certain relatively fixed
operating expenses.
Aggregate results for Old Republic's Holding Company and its small Life &
Health insurance business produced pretax net operating deficits of $17.2, $4.5
and $.7 in 2004, 2003 and 2002, respectively. These results are reflective of
holding company and internal services subsidiary expenses, debt service costs,
and investment income on temporary investment holdings. Life and health
operations were penalized by a pretax charge of $10.5 resulting from a write
down of previously deferred acquisition costs applicable to a life insurance
product discontinued during the fourth quarter of 2004, and benefited from
moderately higher earnings from Old Republic's combined book of life and
accident and health business.
Consolidated net investment income rose by 4.2 percent to $290.8 in 2004
when compared to $279.2 in 2003 and $272.6 in 2002. While the Company's
consolidated invested asset base has continued to grow as a result of strong
operating cash flows, a general downtrend in interest rates in the past several
years has inhibited a corresponding growth in investment income. Realized
investment gains amounted to $47.9, $19.3, and $13.9 in 2004, 2003 and 2002,
respectively. Above average net gains were realized in 2004 as the Company
liquidated approximately 50% of its actively managed equity portfolio and
redirected a significant portion of the sales proceeds toward a number of equity
index funds.
19
Cash and invested assets at December 31, 2004, totaled $7.51 billion, or
$41.19 per share, versus $6.84 billion, or $37.71 per share, at December 31,
2003. Consolidated operating cash flow grew by 15.0 percent to $828.3 in 2004,
with substantially all of this growth stemming from Old Republic's General
Insurance and Mortgage Guaranty segments. The investment portfolio reflects a
current allocation of approximately 88 percent in fixed-income investments and 6
percent in equities. As has been the case for many years, Old Republic has
little or no exposure to real estate investments, mortgage-backed securities,
derivatives, junk bonds, private placements or mortgage loans.
Common shareholders' equity grew by 8.8 percent to $3.86 billion at
December 31, 2004, compared to the equivalent balance of $3.55 billion at
December 31, 2003. Book value per share was $21.17 at the end of this year
versus $19.57 at year-end 2003. The year over year change was mostly the result
of earnings retained in excess of dividends paid to shareholders and changes in
the market value of fixed maturity and equity securities.
- --------------------------------------------------------------------------------
MANAGEMENT ANALYSIS
- --------------------------------------------------------------------------------
CHANGES IN ACCOUNTING POLICIES
During the first quarter of 2002, the Company adopted Statement of
Financial Accounting Standards No. 142 ("FAS 142") "Goodwill and Other
Intangible Assets". Under FAS 142, goodwill and certain intangible assets will
no longer be amortized against operations but must be tested at least annually
for possible impairment of their carrying values. At December 31, 2004 and 2003,
the Company's consolidated unamortized goodwill asset balance was $92.2 and
$87.5, respectively. During the first quarters of 2004 and 2003, the Company
evaluated the carrying value of its goodwill and intangible assets and
determined that there was no indication of impairment of such assets.
Effective January 1, 2003, the Company elected to reclassify its fixed
maturity securities categorized as held to maturity to the available for sale
classification. The securities involved are primarily utility and tax-exempt
bonds that accounted for approximately 34 percent of Old Republic's investment
portfolio. The decision was prompted by restrictive accounting rules affecting
held to maturity investment securities. The necessarily mechanical application
of these rules can inhibit the Corporation's ability to optimally manage its
investments from a practical business point of view. This change has no income
statement impact, no effect on Old Republic's ability to hold individual
securities to maturity as it may deem appropriate, and does not affect the
Company's necessary long-term orientation in the management of its business.
Going forward, Old Republic's shareholders' equity account could reflect
somewhat greater period-to-period volatility as the entire bond, note and stock
investment portfolio will now be marked to market on a quarterly basis.
Nevertheless, the Company believes that its ability to hold securities until
they mature or until such other time when they can be sold opportunistically are
much more significant and meaningful factors than the balance sheet or income
statement effect of changes in market values at any point in time.
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards No. 148 ("FAS 148") "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS No. 123" for
periods starting after December 15, 2002. As of April 1, 2003, the Company
adopted the requirements of FAS 148 utilizing the prospective method. Under this
method, stock-based compensation expense is recognized for awards granted after
the beginning of the fiscal year of adoption. For all other stock option awards
outstanding, the Company continues to use the intrinsic value method permitted
under existing accounting pronouncements. In estimating the compensation cost of
options, the fair value of options has been calculated using the Black-Scholes
option pricing model. Required stock option compensation charges of $8.6 for
2004 reduced earnings per share by 3 cents per share after-tax, of which $5.6
represented a charge for a non-recurring vesting acceleration of such costs in
the first quarter of 2004. Expense recognition of stock options granted in 2003
reduced earnings by $2.2 or by less than one cent per share after-tax.
During December, 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R") on
Share-Based Payment. FAS 123R requires entities to recognize the cost of
employee services received in exchange for awards of equity instruments based on
the grant-date fair value of those awards. The effective date of this
pronouncement is the beginning of the first interim or annual reporting period
that begins after June 15, 2005. The statement allows for three transition
methods of implementation: the modified prospective application and two versions
of the modified retrospective application. The modified prospective application
requires entities to expense share-based payments for new awards and awards
modified, repurchased, or cancelled after the required effective date.
Additionally, it requires entities to record as an expense, the cost
attributable to the unvested options outstanding as of the required effective
date. Modified retrospective application may be applied either (a) to all prior
years for which Statement 123 was effective (fiscal years beginning after
December 15, 1994) or (b) only to prior interim periods in the year of initial
adoption if the required effective date of this statement does not coincide with
the beginning of the entity's fiscal year.
The Company believes that the approximate reduction to fully diluted
earnings per share will be as follows: one cent per share in 2005 and less than
one cent per share cumulatively for all years from 2006 through 2009 calculated
by using the modified prospective transition method.
20
FINANCIAL POSITION
The Company's financial position at December 31, 2004 reflected increases
in assets, liabilities and common shareholders' equity of 8.8%, 8.9% and 8.8%,
respectively, when compared to the immediately preceding year-end. Cash and
invested assets represented 71.1% and 70.5% of consolidated assets as of
December 31, 2004 and 2003, respectively. Consolidated results produced positive
and growing consolidated operating cash flows for the latest three years, with
the Company's three operating segments providing substantially all such funds
from operations. In 2004, the invested asset base increased 9.8% to $7,519.5
principally as a result of such higher operating cash flow offset by a decline
in the fair value of fixed maturity investments.
During 2004 and 2003, the Corporation committed substantially all
investable funds to short to intermediate-term fixed maturity securities. At
both December 31, 2004 and 2003, approximately 99% of the Company's investments
consisted of marketable securities, including $499.3 and $446.5, respectively,
of U.S. Treasury tax and loss bonds held by its mortgage guaranty subsidiaries
for deferred tax purposes. Old Republic continues to adhere to its long-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 2004 decreased 10.6% in relation to the related invested
balance at year-end 2003, mostly due to the sales of equity securities and a
reduction in net unrealized gains. At December 31, 2004, the Company had no
fixed maturity investments in default as to principal and/or interest.
Relatively high short-term maturity investment positions continued to be
maintained as of December 31, 2004. Such positions reflect a large variety of
seasonal and intermediate-term factors including current operating needs,
expected operating cash flows, quarter-end cash flow seasonality, and investment
strategy considerations. Accordingly, the future level of short-term investments
will vary and respond to the interplay of these factors and may, as a result,
increase or decrease from current levels.
The Company does not own or utilize derivative financial instruments for
the purpose of hedging, enhancing the overall return of its investment
portfolio, or reducing the cost of its debt obligations. With regard to its
equity portfolio, the Company does not own any options nor does it engage in any
type of option writing. Traditional investment management tools and techniques
are employed to address the yield and valuation exposures of the invested assets
base. The long-term fixed maturity investment portfolio is managed so as to
limit various risks inherent in the bond market. Credit risk is addressed
through asset diversification and the purchase of investment grade securities.
Reinvestment rate risk is reduced by concentrating on non-callable issues, and
by taking asset-liability matching considerations into account. Purchases of
mortgage and asset backed securities, which have variable principal prepayment
options, are generally avoided. Market value risk is limited through the
purchase of bonds of intermediate maturity. The combination of these investment
management practices is expected to produce a more stable long-term fixed
maturity investment portfolio that is not subject to extreme interest rate
sensitivity and principal deterioration. The market value of the Company's
long-term fixed maturity investment portfolio is sensitive, however, to
fluctuations in the level of interest rates, but not materially affected by
changes in anticipated cash flows caused by any prepayments. The impact of
interest rate movements on the long-term fixed maturity investment portfolio
generally affects net unrealized gains or losses. As a general rule, rising
interest rates enhance currently available yields but typically lead to a
reduction in the fair value of existing fixed maturity investments. By contrast,
a decline in such rates reduces currently available yields but usually serves to
increase the fair value of the existing fixed maturity investment portfolio. All
such changes in fair value are reflected, net of deferred income taxes, directly
in the shareholders' equity account, and as a separate component of the
statement of comprehensive income. Given the Company's inability to forecast or
control the movement of interest rates, Old Republic sets the maturity spectrum
of its fixed maturity securities portfolio within parameters of estimated
liability payouts, and focuses the overall portfolio on high quality
investments. By so doing, Old Republic believes it is reasonably assured of its
ability to hold securities to maturity as it may deem necessary in changing
environments, and of ultimately recovering their aggregate cost.
Possible future declines in fair values for Old Republic's bond and stock
portfolios would affect negatively the common shareholders' equity account at
any point in time, but would not necessarily result in the recognition of
realized investment losses. The Company reviews the status and market value
changes of each of its investments on at least a quarterly basis during the
year, and estimates of other than temporary impairments in the portfolio's value
are evaluated and established at each quarterly balance sheet date. In reviewing
investments for other than temporary impairment, the Company, in addition to a
security's market price history, considers the totality of such factors as the
issuer's operating results, financial condition and liquidity, its ability to
access capital markets, credit rating trends, most current audit opinion,
industry and securities markets conditions, and analyst expectations to reach
its conclusions. Sudden market value declines caused by such adverse
developments as newly emerged or imminent bankruptcy filings, issuer default on
significant obligations, or reports of financial accounting developments that
bring into question the validity of previously reported earnings or financial
condition, are recognized as realized losses as soon as credible publicly
available information emerges to confirm such developments. Accordingly, the
recognition of losses from other than temporary value impairments is subject to
a great deal of judgment as well as turns of events over which the Company can
exercise little or no control. In the event the Company's estimate of other than
temporary impairments is insufficient at any point in time, future periods' net
income would be affected adversely by the recognition of additional realized or
impairment losses, but its financial condition would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses.
21
The following tables show certain information relating to the Company's
fixed maturity and equity portfolios as of the dates shown:
- -------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (1)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
--------------- --------------
Aaa............................................................................. 32.6% 29.7%
Aa.............................................................................. 19.5 19.1
A............................................................................... 27.5 32.0
Baa............................................................................. 19.8 18.5
--------------- --------------
Total investment grade................................................. 99.4 99.3
All other (2)................................................................... .6 .7
--------------- --------------
Total.................................................................. 100.0% 100.0%
=============== ==============
(1) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(2) "All other" includes non-investment or non-rated small issues of tax-exempt
bonds.
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities
as of December 31, 2004
- --------------------------------------------------------------------------------------------------------------------------------
Gross
Amortized Unrealized
Cost Losses
------------ ------------
Fixed Maturity Securities by Industry Concentration:
Municipals...................................................................... $ 343.7 $ 2.9
Utilities....................................................................... 120.0 1.5
Finance......................................................................... 120.8 1.4
Telecom......................................................................... 53.9 .6
Other (includes 16 industry groups)............................................. 631.8 5.1
------------ ------------
Total.................................................................. $ 1,270.5 (3) $ 11.8
============ ============
(3) Represents 20.3 percent of the total fixed maturity securities portfolio.
- --------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities
as of December 31, 2004
- --------------------------------------------------------------------------------------------------------------------------------
Gross
Unrealized
Cost Losses
------------ ------------
Equity Securities by Industry Concentration:
Health Care..................................................................... $ 33.5 $ 5.1
Retail.......................................................................... 9.6 .8
Service......................................................................... 7.2 .3
REIT's.......................................................................... .4 -
Other (includes 3 industry groups).............................................. .4 -
------------ ------------
Total.................................................................. $ 51.2 (4) $ 6.4 (5)
============ ============
(4) Represents 12.9 percent of the total equity securities portfolio.
(5) Represents 1.6 percent of the cost of the total equity securities
portfolio, while gross unrealized gains represent 17.3 percent of the
portfolio.
22
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified For All Fixed Maturity Securities
as of December 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Amortized Cost
of Fixed Maturity Securities Gross Unrealized Losses
---------------------------------- --------------------------------
Non-Investment Non-Investment
All Grade Only All Grade Only
------------- -------------- ------------ --------------
Maturity Ranges:
Due in one year or less............................. $ 114.4 $ - $ .3 $ -
Due after one year through five years............... 475.2 - 4.0 -
Due after five years through ten years.............. 664.6 - 7.3 -
Due after ten years................................. 16.1 - .1 -
------------- -------------- ------------ --------------
Total...................................... $ 1,270.5 $ - $ 11.8 $ -
============= ============== ============ ==============
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses
as of December 31, 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Amount of Gross Unrealized Losses
-----------------------------------------------------------------------
Total Gross
Less than 20% to 50% More than Unrealized
20 %of Cost of Cost 50% of Cost Loss
------------- ------------- ------------- -------------
Number of Months in Loss Position:
Fixed Maturity Securities:
One to six months.................... $ 6.9 $ - $ - $ 6.9
Seven to twelve months............... 2.3 - - 2.3
More than twelve months.............. 2.5 - - 2.5
------------- ------------- ------------- -------------
Total....................... $ 11.8 $ - $ - $ 11.8
============= ============= ============= =============
Equity Securities:
One to six months.................... $ 1.0 $ - $ - $ 1.0
Seven to twelve months............... 1.2 4.0 - 5.2
More than twelve months.............. - - - .1
------------- ------------- ------------- -------------
Total....................... $ 2.2 $ 4.1 $ - $ 6.4
============= ============= ============= =============
Number of Issues in Loss Position:
Fixed Maturity Securities:
One to six months.................... 246 - - 246
Seven to twelve months............... 31 - - 31
More than twelve months.............. 28 - - 28
------------- ------------- ------------- -------------
Total....................... 305 - - 305 (6)
============= ============= ============= =============
Equity Securities:
One to six months.................... 1 - - 1
Seven to twelve months............... 2 1 - 3
More than twelve months.............. 2 2 - 4
------------- ------------- ------------- -------------
Total....................... 5 3 - 8 (6)
============= ============= ============= =============
The aging of issues with unrealized losses employs closing market price
comparisons with an issue's original cost. The percentage reduction from
original cost reflects the decline as of a specific point in time (December 31,
2004 in the above table) and, accordingly, is not indicative of a security's
value having been consistently below its cost at the percentages and throughout
the periods shown.
(6) At December 31, 2004 the number of issues in a loss position represent 18.1
percent as to fixed maturities, and 21.6 percent as to equity securities of
the total number of such issues held by the Company.
23
- --------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- --------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
--------------- --------------
Maturity Ranges:
Due in one year or less............................................................. 12.5% 11.0%
Due after one year through five years............................................... 42.9 50.0
Due after five years through ten years.............................................. 43.5 37.7
Due after ten years through fifteen years........................................... 1.1 1.3
Due after fifteen years............................................................. - -
=============== ==============
Total...................................................................... 100.0% 100.0%
=============== ==============
Average Maturity.................................................................... 4.7 Years 4.5 Years
=============== ==============
Duration (7)........................................................................ 4.1 4.0
=============== ==============
(7) Duration is used as a measure of bond price sensitivity to interest rate
changes. A duration of 4.1 as of December 31, 2004 implies that a 100 basis
point parallel increase in interest rates from current levels would result
in a possible decline in the market value of the long-term fixed maturity
investment portfolio of approximately 4.1 percent.
- --------------------------------------------------------------------------------------------------------------------------------
Composition of Unrealized Gains (Losses)
- --------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
-------------- ---------------
Fixed Maturity Securities:
Amortized cost..................................................................... $ 6,273.2 $ 5,463.9
Estimated fair value............................................................... 6,455.9 5,741.1
-------------- ---------------
Gross unrealized gains............................................................. 194.5 285.0
Gross unrealized losses............................................................ (11.8) (7.8)
-------------- ---------------
Net unrealized gains ..................................................... $ 182.7 $ 277.1
============== ===============
Equity Securities:
Cost............................................................................... $ 396.8 $ 439.2
Estimated fair value............................................................... 459.0 513.5
-------------- ---------------
Gross unrealized gains............................................................. 68.6 98.2
Gross unrealized losses............................................................ (6.4) (23.9)
-------------- ---------------
Net unrealized gains...................................................... $ 62.2 $ 74.2
============== ===============
Among other major assets, substantially all of the Company's receivables
are not past due. Reinsurance recoverable balances on paid or estimated unpaid
losses are deemed recoverable from solvent reinsurers or have otherwise been
reduced by allowances for estimated amounts unrecoverable. Deferred policy
acquisition costs are estimated by taking into account the variable costs of
producing specific types of insurance policies, and evaluating their
recoverability on the basis of recent trends in claims costs. The Company's
deferred policy acquisition cost balances have not fluctuated substantially from
period-to-period and do not represent significant percentages of assets or
shareholders' equity.
The parent holding company meets its liquidity and capital needs
principally through dividends paid by its subsidiaries. The insurance
subsidiaries' ability to pay cash dividends to the parent company is generally
restricted by law or subject to approval of the insurance regulatory authorities
of the states in which they are domiciled. The Company can receive up to $341.5
in dividends from its subsidiaries in 2005 without the prior approval of
regulatory authorities. The liquidity achievable through such permitted dividend
payments is more than adequate to cover the parent holding company's currently
expected cash outflows represented mostly by interest on outstanding debt and
quarterly cash dividend payments to shareholders. In addition, Old Republic can
access the commercial paper market for up to $150.0 to meet unanticipated
liquidity needs.
Old Republic's capitalization of $4,008.6 at December 31, 2004 consisted of
debt of $143.0 and common shareholders' equity of $3,865.6. Changes in the
common shareholders' equity account for the three most recent years reflect
primarily the retention of earnings in excess of dividends paid to shareholders
as well as changes in the value of investments carried at market. Old Republic
has paid cash dividends to its shareholders without interruption since 1942, and
has increased the annual rate in each of the past 23 years. The annual dividend
rate is typically reviewed and approved by the Board of Directors in the first
quarter of each year. In establishing each year's cash dividend rate the
Corporation does not follow a strict formulaic approach and favors a gradual
rise in the annual dividend rate that is largely reflective of long-term
consolidated operating earnings trends. Accordingly, each year's dividend rate
is set judgmentally in consideration of such key factors as the dividend paying
capacity of the Corporation's insurance subsidiaries, the trends in average
annual statutory and GAAP earnings for the six most recent calendar years, and
the long-term expectations for the Corporation's consolidated business.
24
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, 2004 meeting, the Company's Board of Directors authorized the
reacquisition of up to $250.0 of common shares as market conditions warrant
during the two year period from that date; no stock had as yet been acquired
through December 31, 2004 pursuant to this authorization.
The following table shows certain information relating to the Company's
contractual obligations as of December 31, 2004:
Payments Due by Period
----------------------------------------------------------------------------------
Less than 1 - 3 3 - 5 More than 5
Total 1 Year Years Years Years
------------ ------------- ------------- ------------ -------------
Contractual Obligations:
-----------------------
Debt.................................. $ 143.0 $ 19.9 $ 121.1 $ .7 $ 1.2
Interest on Debt...................... 27.3 9.1 13.6 1.4 3.1
Operating Leases...................... 142.2 35.0 52.9 27.3 26.8
Pension Benefits Contributions (2).... 31.6 - 11.0 8.5 12.1
Claim & Claim Expense
Reserves (1)....................... 2,763.8 661.9 616.1 276.6 1,209.0
------------ ------------- ------------- ------------ -------------
Total............................. $ 3,108.0 $ 726.0 $ 814.7 $ 314.7 $ 1,252.3
============ ============= ============= ============ =============
(1) As discussed herein with respect to the nature of loss reserves and the
estimating process utilized in their establishment, the Company's loss
reserves do not have a contractual maturity date. Estimated loss payments
are based primarily on historical claim payment patterns, are subject to
change due to a wide variety of factors, and cannot be predicted with
certainty. Actual future loss payments may differ materially from the
current estimates shown in the table above.
(2) Represents estimated funding of contributions for the Old Republic
International Salaried Employees Restated Retirement Plan (the Old Republic
Plan), Bituminous Casualty Corporation Retirement Income Plan (the Bitco
Plan), and the Old Republic National Title Group Pension Plan (the Title
Plan). Funding of the plans is dependent on a number of factors including
actual performance versus actuarial assumptions made at the time of the
actuarial valuations, as well as, maintaining certain funding levels
relative to regulatory requirements.
RESULTS OF OPERATIONS
Revenues - Premiums & Fees:
Pursuant to GAAP applicable to the insurance industry, revenues are
associated with the related benefits, claims, and expenses.
Substantially all general insurance premiums are reflected in income on a
pro-rata basis. Earned but unbilled premiums are generally taken into income on
the billing date, while adjustments for retrospective premiums, commissions and
similar charges or credits are accrued on the basis of periodic evaluations of
current underwriting experience and contractual obligations. Nearly all of the
Company's mortgage guaranty premiums stem from monthly installment policies.
Accordingly, such premiums are written and earned in the month coverage is
effective. With respect to minor numbers of annual or single premium policies,
earned premiums are largely recognized on a pro-rata basis over the terms of the
policies. Title premium and fee revenues stemming from the Company's direct
operations (which includes branch offices of its title insurers and wholly owned
subsidiaries of the Company) represent approximately 38 percent of 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 62 percent of
consolidated title premium and fee revenues is produced by independent title
agents and underwritten title companies. Rather than making estimates that could
be subject to significant variance from actual premium and fee production, the
Company recognizes revenues from those sources upon receipt. Such receipts can
reflect a three to four month lag relative to the effective date of the
underlying title policy, and are offset concurrently by production expenses and
claim reserve provisions.
The major sources of Old Republic's earned premiums and fees for the
periods shown were as follows:
% Change
over prior
General Mortgage Title Other Total year period
---------- ---------- ---------- ---------- ---------- ------------
Years Ended December 31:
2000............................ $ 857.8 $ 331.4 $ 494.0 $ 53.4 $1,736.8 -2.5%
2001............................ 1,000.2 353.1 625.3 50.6 2,029.5 16.9
2002............................ 1,184.1 376.2 813.4 50.1 2,423.9 19.4
2003............................ 1,379.5 400.9 1,103.8 51.6 2,936.0 21.1
2004............................ $1,623.0 $ 403.2 $1,025.2 $ 64.6 $3,116.1 6.1%
========== ========== ========== ========== ========== ============
25
The percentage allocation of net premiums earned by major insurance
coverage for the General Insurance Group were as follows:
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------- --------------
Type of Coverage:
Commercial Automobile
(mostly trucking).................. 37.9% 39.5% 43.0% 45.7% 49.7%
Workers' Compensation................. 21.8 20.0 19.1 17.4 16.6
Financial Indemnity................... 11.8 11.7 8.7 7.2 7.9
Property.............................. 11.3 12.2 12.9 12.8 13.7
General Liability..................... 5.8 5.3 4.7 5.4 5.1
Other................................. 11.4 11.3 11.6 11.5 7.0
------------ ------------ ------------ ------------- --------------
Total................................. 100.0% 100.0% 100.0% 100.0% 100.0%
============ ============ ============ ============= ==============
The following tables provide information on risk exposure trends for Old
Republic's Mortgage Guaranty Group.
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------ ------------- ------------- ------------
New Insurance Written:
Traditional Primary................... $ 24,749.4 $ 37,255.8 $ 30,809.6 $ 25,085.4 $ 14,929.7
Bulk.................................. 4,487.8 6,806.6 5,130.0 2,614.4 35.3
Other................................. 7,324.7 5,802.8 7,555.5 3,675.3 1,594.8
------------- ------------ ------------- ------------- ------------
Total................................. $ 36,562.0 $ 49,865.2 $ 43,495.1 $ 31,375.1 $ 16,559.8
============= ============ ============= ============= ============
Net Risk In Force:
Traditional Primary................... $ 15,452.2 $ 15,329.5 $ 15,367.6 $ 15,043.5 $ 14,840.7
Bulk.................................. 834.8 802.2 513.0 167.0 8.7
Other................................. 580.9 493.4 450.7 336.9 271.5
------------- ------------ ------------- ------------- ------------
Total................................. $ 16,868.0 $ 16,625.1 $ 16,331.3 $ 15,547.4 $ 15,120.9
============= ============ ============= ============= ============
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------ ------------- ------------- ------------
Analysis of Traditional Primary
Risk in Force:
By Fair Isaac & Company ("FICO") Scores (1):
FICO less than 620.................. 8.6% 8.5% -% -% -%
FICO 620 to 680..................... 31.1 29.2 - - -
FICO greater than 680............... 51.4 48.8 - - -
Unscored/Unavailable................ 8.9% 13.5% -% -% -%
-------------
(1) Scores were unavailable for a substantial number of policies in force prior to 2003.
By Loan to Value ("LTV") Ratio:
LTV less than 85.................... 5.7% 6.4% 6.0% 5.7% 5.4%
LTV 85 to 90........................ 36.8 37.3 37.3 37.6 38.2
LTV 90 to 95........................ 42.0 43.8 47.0 48.8 50.3
LTV greater than 95................. 15.5% 12.5% 9.7% 7.9% 6.1%
By Type of Loan Documentation:
Full Documentation.................. 93.2% 94.4% 96.7% 99.4% 100.0%
Reduced Documentation............... 6.8% 5.6% 3.3% .6% -%
26
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------ ------------- ------------- ------------
Earned Premiums:
Direct................................ $ 483.6 $ 467.3 $ 432.4 $ 390.9 $ 359.0
============= ============ ============= ============= ============
Net................................... $ 403.2 $ 400.9 $ 376.2 $ 353.1 $ 331.4
============= ============ ============= ============= ============
Persistency / Traditional Primary........ 64.5% 46.0% 59.1% 65.3% 82.1%
Persistency / Bulk (2)................... 55.7% 31.8% 71.7% -% -%
- -----------------
(2) Due to the relative immaturity of the bulk business, the above trend may
prove to be highly volatile.
The following table indicates the percentage allocation of Title Group
premium and fee revenues by production sources:
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------- --------------
Direct operations......................... 38.1% 40.0% 43.7% 47.4% 45.8%
Independent title agents & other.......... 61.9 60.0 56.3 52.6 54.2
------------ ------------ ------------ ------------- --------------
Total..................................... 100.0% 100.0% 100.0% 100.0% 100.0%
============ ============ ============ ============= ==============
Consolidated net premiums and fees earned increased by 6.1%, 21.1%, and
19.4% in 2004, 2003 and 2002, respectively. Earned premiums in the General
Insurance Group grew by 17.6%, 16.5% and 18.4% in 2004, 2003 and 2002,
respectively, as a result of positive pricing and risk selection changes the
Company effected during the 2001 to 2003 period in particular, as well as
additional business produced in a reasonably stable underwriting environment.
Mortgage guaranty premium income trends reflect sales opportunities arising from
reasonably strong housing and mortgage lending markets, offset in part by high
levels of mortgage refinancing activity, particularly in the 2001 to 2003
period, as well as by greater amounts of reinsurance cessions and by the
introduction of various alternatives to traditional primary mortgage insurance.
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 declined by 7.1% in 2004, and increased by
35.7% and 30.1% in 2003 and 2002, respectively. 2003 and 2002 results reflected
favorable market conditions for the sale of new and used homes, and, most
importantly, strong mortgage refinancing activity that was driven by a fairly
consistent drop in mortgage rates. Reduced title revenues in 2004 are mostly
reflective of a substantial reduction in mortgage refinancing activity which
reached a peak in the third quarter of 2003.
Revenues - Net Investment Income:
Net investment income is affected by trends in interest and dividend yields
for the types of securities in which the Company's funds are invested during
individual reporting periods. The following tables reflect the segmented and
consolidated invested asset bases as of the indicated dates, and the investment
income earned and resulting yields on such assets. In calculating yields,
non-interest bearing U.S. Treasury tax and loss bonds, held by the Company's
mortgage guaranty subsidiaries for deferred tax purposes, are necessarily
excluded from the invested asset base. Since the Company can exercise little
control over market values, yields are evaluated on the basis of investment
income earned in relation to the amortized cost of the underlying invested
assets, though yields based on the market values of such assets are also shown
in the statistics below.
Market Invested
Invested Assets at Cost Value Assets at
------------------------------------------------------------------- Adjust- Market
General Mortgage Title Other Total ment Value
----------- ---------- ---------- --------- ----------- ---------- -----------
As of December 31:
2000.................. $ 3,112.3 $1,333.6 $ 373.7 $ 149.5 $ 4.969.2 $ 98.0 $ 5,067.2
2001.................. 3,198.8 1,542.3 423.9 150.1 5,315.0 219.7 5,534.8
2002.................. 3,446.0 1,700.9 489.6 226.9 5,863.4 305.5 6,169.0
2003.................. 3,798.2 1,827.9 556.9 177.1 6,360.1 360.3 6,720.4
2004.................. $ 4,217.8 $2,001.2 $ 595.2 $ 295.0 $ 7,109.4 $ 262.2 $ 7,371.6
=========== ========== ========== ========= =========== ========== ===========
27
Net Investment Income Yield at
------------------------------------------------------------------- ------------------------
General Mortgage Title Other Total Cost Market
---------- ---------- ---------- ---------- ---------- --------- ----------
Years Ended
December 31:
2000.................. $ 179.8 $ 56.8 $ 24.0 $ 13.3 $ 273.9 6.0% 5.9%
2001.................. 175.7 63.3 22.7 12.8 274.7 5.7 5.5
2002.................. 172.5 65.8 22.5 11.7 272.6 5.2 5.0
2003.................. 175.0 65.7 23.5 14.9 279.2 4.9 4.6
2004.................. $ 183.4 $ 67.7 $ 25.5 $ 14.0 $ 290.8 4.6% 4.4%
========== ========== ========== ========== ========== ========= ==========
Consolidated net investment income grew by 4.2% and 2.4% in 2004 and 2003,
respectively and was down 0.8% in 2002. 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.
Yield trends reflect at once the relatively short maturity of Old Republic's
fixed maturity securities portfolio as well as continuation of a lower yield
environment during the past several years.
Net Realized Gains:
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Rather, these policies aim to
assure a stable source of income from interest and dividends, protection of
capital, and provision of sufficient liquidity to meet insurance underwriting
and other obligations as they become payable in the future. Dispositions of
fixed maturity securities arise mostly from scheduled maturities and early
calls; in 2004, 2003 and 2002, 80.7%, 70.0% and 74.6%, 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,
-----------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ----------- ----------- ----------- -----------
Realized Gains (Losses) on Disposition of:
Fixed maturity securities..................... $ 4.6 $ 4.6 $ 3.8 $ (2.9) $ .8
Equity securities and
miscellaneous investments................. 48.5 31.1 29.1 39.4 32.9
---------- ----------- ----------- ----------- -----------
Total 53.2 35.7 33.0 36.5 33.6
---------- ----------- ----------- ----------- -----------
Impairment losses on:
Fixed maturity securities..................... - - (5.0) (1.2) -
Equity securities and
miscellaneous investments................. (5.2) (16.4) (14.0) (5.5) -
---------- ----------- ----------- ----------- -----------
Total (5.2) (16.4) (19.0) (6.7) -
---------- ----------- ----------- ----------- -----------
Net realized gains................................ $ 47.9 $ 19.3 $ 13.9 $ 29.7 $ 33.6
========== =========== =========== =========== ===========
Expenses:
In order to achieve a necessary matching of revenues and expenses, the
Company records the benefits, claims and related settlement costs that have been
incurred during each accounting period. Such costs are affected by the adequacy
of reserve estimates established for current and prior years' claim occurrences.
The establishment of claim reserves by the Company's insurance subsidiaries is a
reasonably complex and dynamic process influenced by a large variety of factors.
These factors principally include past experience applicable to the anticipated
costs of various types of claims, continually evolving and changing legal
theories emanating from the judicial system, recurring accounting, statistical,
and actuarial studies, the professional experience and expertise of the
Company's claim departments' personnel or attorneys and independent claim
adjusters, ongoing changes in claim frequency or severity patterns such as those
caused by natural disasters, illnesses, accidents, work-related injuries, and
changes in general and industry-specific economic conditions. Consequently, the
reserve-setting process relies on the opinions of a large number of persons, on
the application and interpretation of historical precedent and trends, on
expectations as to future developments, and on management's judgment in
interpreting all such factors. At any point in time, the Company is exposed to
possibly higher than anticipated claim costs due to all of these factors, and to
the evolution, interpretation, and expansion of tort law, as well as the effects
of unexpectedly adverse jury verdicts.
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
28
reserves have produced reasonable estimates of the cumulative ultimate net costs
of claims incurred. However, no representation is made that ultimate net claim
and related costs will not develop in future years to be greater or lower than
currently established reserve estimates.
In addition to the factors cited in the two preceding paragraphs, certain
events could impact adversely the Company's reserve adequacy and its future
operating results and financial condition. With respect to Old Republic's
general insurance business, such events or exposures would include but not be
limited to catastrophic workers' compensation claims caused by a terrorist
attack or a natural disaster such as an earthquake, legislated retroactive
incurrence of previously denied or settled claims, the levying of major guaranty
fund assessments by various states based on the costs of insurance company
failures apportioned against remaining and financially secure insurers, the
future failure of one or more significant assuming reinsurers that would void or
reduce the Company's reinsurance recoverable for losses paid or in reserve, and
greater than expected involuntary market assessments, such as those caused by
forced participation in assigned risk and similar involuntary market plans, all
of which cannot be reasonably estimated prior to their emergence.
Mortgage insurance claim reserves are determined on the basis of the
carried risk on reported loan defaults and on an estimate of defaulted loans
that have yet to be reported. In establishing its reserve position, the Company
establishes estimates of average claim frequency (the number of reported
defaults which will ultimately result in a claim payment) and average claim
severity (the amount of claim ultimately to be paid).
The majority of defaults reported to the Company are cured by the borrower
either by making the necessary number of mortgage payments to bring the loan
current, by refinancing the mortgage loan, or by selling the property in an
amount sufficient to cover the outstanding mortgage debt. Estimates of claim
frequency, which are based on historical trends and on judgments as to current
and future economic conditions, are applied according to the level of the
reported default. Claim severity is estimated based on historical claim payments
including the impact of loss mitigation strategies and potential salvage
recoveries. Once reported, the time required to cure a default or settle a claim
can be significant, often running years from the date of original default. As
such, ultimate cure and claim rates develop over long periods of time, often
through changing economic conditions. Higher mortgage guaranty loss ratios for
2004 resulted from greater loss provisions caused by an increase in paid losses
and net reserve additions that reflect moderately higher expectations of
estimated claim frequency and severity.
Title segment loss reserve levels could be impacted adversely by such
developments as reduced loan refinancing activity, the effect of which could be
to lengthen the period during which title policies remain exposed to loss
emergence, or reductions in either property values or the volume of transactions
which, by virtue of the speculative nature of some real estate developments,
could lead to increased occurrences of fraud, defalcations or mechanics' liens.
As to Old Republic's small life and health insurance operations, reserve
adequacy may be affected adversely by greater than anticipated medical care cost
inflation as well as greater than expected frequency and severity of claims.
In management's opinion, geographic concentrations of assureds' employees
in the path of an earthquake or acts of terrorism represent the most significant
catastrophic risks to Old Republic's General insurance segment. These risks
would largely impact the workers' compensation line since primary insurers such
as the Company must, by regulation, issue unlimited liability policies. While
Old Republic obtains a degree of protection through its reinsurance program as
to earthquake exposures, and, until December 31, 2005 through the Terrorism Risk
Insurance Act of 2002, there is no assurance that recoveries thereunder would be
sufficient to offset the costs of a major calamity nor eliminate its possible
major impact on operating results and financial condition. Old Republic has
availed itself of modeling techniques to evaluate the possible magnitude of
earthquake or terrorist induced claim costs for its most exposed coverage of
workers' compensation. Such models, however, have not been sufficiently
validated by past occurrences, and rely on a large variety and number of
assumptions. As a result, they may not be predictive of possible claims from
future events. With respect to the Company's mortgage guaranty business, the
most significant risk lies in the possibility of prolonged economic dislocations
that would result in high unemployment levels and depressed property values
conspiring to magnify loan default rates and resulting claim costs. In title
insurance, the Company's biggest exposure likely relates to defalcations and
fraud which can result in significant aggregations of claims or non-collection
of insurance premiums. In life insurance, as in general insurance,
concentrations of insured lives coupled with a catastrophic event would
represent the Company's largest exposure. In all of these regards, current GAAP
accounting does not permit the Company's reserving practices to anticipate and
provide for these exposures before they occur.
29
Most of Old Republic's consolidated claim and related expense reserves stem
from its general insurance business. At December 31, 2004, such reserves
accounted for 88.6% and 82.1% of consolidated gross and net of reinsurance
reserves, respectively, while similar reserves at December 31, 2003 accounted
for 88.6% and 81.9% of the respective consolidated amounts. The following table
shows a breakdown of gross and net of reinsurance claim reserve estimates for
major types of insurance coverages as of those dates:
December 31,
----------------------------------------------------------
2004 2003
-------------------------- ---------------------------
Gross Net Gross Net
----------- ----------- ----------- -----------
Claim and Loss Adjustment Expense Reserves:
Commercial automobile (mostly trucking).............................. $ 788.6 $ 635.9 $ 764.5 $ 616.6
Workers' compensation................................................ 1,607.0 814.0 1,482.6 743.4
General liability.................................................... 808.7 350.5 733.8 270.7
Other coverages...................................................... 576.0 382.1 498.0 333.2
Unallocated loss adjustment expense reserves......................... 122.0 87.2 83.7 83.6
----------- ----------- ----------- -----------
Total general insurance reserves............................... 3,902.4 2,269.7 3,562.8 2,047.7
Other coverages:
Mortgage guaranty.................................................... 200.5 199.1 181.5 179.7
Title................................................................ 252.5 252.5 237.1 237.1
Life and health...................................................... 22.6 16.9 18.2 12.6
Unallocated loss adjustment expense reserves -
other coverages................................................... 25.4 25.4 22.7 22.7
----------- ----------- ----------- -----------
Total claim and loss adjustment expense reserves............... $ 4,403.5 $ 2,763.8 $ 4,022.7 $ 2,500.1
=========== =========== =========== ===========
Asbestosis and environmental claim reserves included
in the above general insurance reserves:
Amount........................................................ $ 118.9 $ 97.1 $ 91.0 $ 56.6
=========== =========== =========== ===========
% of total general insurance reserves......................... 3.0% 4.3% 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 Group's
claim reserves stem from liability insurance coverages for commercial customers.
Liability claims typically require more extended periods of investigation and at
times protracted litigation before they are finally settled, and thus tend to
exhibit loss development and payment patterns that stretch over relatively long
periods of time.
The Company establishes point estimates for most reserves on an insurance
coverage line-by-line basis for individual subsidiaries, sub-classes, or
individual accounts and blocks of business that have similar attributes.
Actuarially or otherwise derived ranges of reserve levels are not utilized as
such in setting these reserves, and, accordingly, the reserves listed in the
above table represent the Company's point estimates at each reporting date. The
overall reserve level at any point in time therefore represents the compilation
of a very large number of reported ("case") reserve estimates and the results of
a variety of formula calculations intended to cover claims and related costs not
as yet reported or emerged ("IBNR"). Case reserves are based on continually
evolving assessments of the facts available to the Company during the claim
settlement process. Long-term, disability-type workers' compensation reserves
are discounted to present value based on interest rates that range from 3.5
percent to 4.0 percent. Formula calculations are utilized to provide for IBNR
claim costs as well as additional costs that can arise from such factors as
monetary and social inflation, changes in claims administration processes,
changes in reinsurance ceded and recoverability levels, and expected trends in
claim costs and related ratios. Typically, such formulas take into account
so-called link ratios that represent prior years' patterns of incurred or paid
loss trends between succeeding years, or past experience relative to
progressions of the number of claims reported over time and ultimate average
costs per claim. Reserves pertaining to large individual commercial insurance
accounts that exhibit sufficient statistical credibility, and that may be
subject to retrospective premium rating plans or the utilization of varying
levels or types of self-insured retentions are established on an account by
account basis using case reserves and applicable formula-driven methods. For
certain so-called long-tail categories of insurance such as excess liability or
excess workers' compensation, officers and directors' liability, and commercial
umbrella liability relative to which claim development patterns are particularly
long, more volatile, and immature in their early stages of development, the
Company judgmentally establishes the most current accident years' loss reserves
on the basis of expected loss ratios. As actual claims data emerges in
succeeding years, the original accident year loss ratio assumptions are
validated or otherwise adjusted sequentially through the application of
statistical or actuarial projection techniques such as the Bornhuetter/Ferguson
method which utilizes data from the more mature experience of prior years.
Except for a small portion that emanates from ongoing primary insurance
operations, a large majority of the asbestosis and environmental ("A&E") claim
reserves posted by Old Republic stem mainly from its participations in assumed
reinsurance treaties and insurance pools. Substantially all such participations
were discontinued fifteen or more years ago and have since been in run-off
status. With respect to the primary portion of gross A&E reserves, Old Republic
administers the related claims through its claims personnel as well as outside
attorneys, and posted reserves reflect its best estimates of ultimate claim
costs. Claims administration for the assumed portion of the Company's A&E
exposures is handled by the claims departments of unrelated primary or ceding
30
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 6.2 years (gross) and 9.6 years (net of reinsurance) as of
December 31, 2004 and 6.3 years (gross) and 9.8 years (net of reinsurance) as of
December 31, 2003. Fluctuations in this ratio between years can be caused by the
inconsistent pay out patterns associated with these types of claims. Incurred
net losses for asbestosis and environmental claims have averaged 2.6 percent of
General Insurance Group net incurred losses for the five years ended December
31, 2004.
Mortgage guaranty loss reserves are based on calculations that take into
account the number of reported insured mortgage loan defaults as of each balance
sheet date, as well as experience-based estimates of loan defaults that have
occurred but have not as yet been reported. Further, the resulting loss reserve
estimates take into account a large number of variables including trends in
claim severity, potential salvage recoveries, expected cure rates for reported
loan defaults at various stages of default, and judgments relative to future
employment levels, housing market activity, and mortgage loan demand and
extensions.
Title insurance and related escrow service loss and loss adjustment expense
reserves are established to cover the estimated settlement costs of known as
well as claims incurred but not reported, concurrently with the recognition of
premium and escrow service revenues. Reserves for known claims are based on an
assessment of the facts available to the Company during the settlement process.
Reserves for claims incurred but not reported are established on the basis of
past experience and evaluations of such variables as changes and trends in the
types of policies issued, changes in real estate markets and interest rate
environments, and changed levels of loan refinancings, all of which can have a
bearing on the emergence, number, and ultimate cost of claims.
In addition to the above reserve elements, the Company establishes reserves
for loss settlement costs that are not directly related to individual claims.
Such reserves are based on prior years' cost experience and trends, and are
intended to cover the unallocated costs of claim departments' administration of
known and IBNR claims.
Substantially all of the Company's reserves for IBNR claims relate to its
general insurance business. As of December 31, 2004 and 2003, the Company's
general insurance segment carried reserves of $735.2 and $595.1, respectively,
to cover claims incurred but not as yet reported as well as for the possible
adverse development of known case reserves. As noted above, the aggregate of
these provisions, known collectively as IBNR reserves, results from the
application of many formulas and reserve-setting approaches that are sensitive
to the wide variety of already enumerated factors. Should these reserves for
IBNR claims be understated by 10 percent for a deficiency of $73.5, or 3.2
percent of the Company's net general insurance reserves as of year end 2004 and
$59.5, or 2.9 percent as of the prior year end balance sheet date, the impact on
the Company's income statement would be to reduce pretax income by such amounts.
While Old Republic has not incurred such a deficiency level on total reserves
posted as of the 10 most recent year ends, there can be no assurance that this
favorable experience will continue in the future.
The percentage of net claims, benefits and related settlement expenses
measured against premiums and related fee revenues of the Company's three major
operating segments and its consolidated results were as follows:
General Mortgage Title Consolidated
-------------- ------------- ----------- -------------
Years Ended December 31:
2000............................................. 77.9% 15.0% 3.6% 43.9%
2001............................................. 75.3 16.1 4.0 42.4
2002............................................. 72.6 14.1 5.0 40.2
2003............................................. 67.8 22.7 5.8 37.9
2004............................................. 66.1% 35.5% 5.8% 42.0%
============== ============= =========== =============
The percentage of net claims, benefits and related settlement expenses
measured against premiums by major insurance coverage in the General Insurance
Group were as follows:
Years Ended December 31,
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------- --------------
Type of Coverage:
Commercial Automobile (Trucking).......... 66.5% 70.4% 78.4% 82.5% 91.4%
Workers' Compensation..................... 72.4 81.2 93.2 89.0 90.3
Financial Indemnity....................... 47.6 51.0 41.1 39.0 33.6
Property.................................. 56.2 59.1 51.5 59.5 54.1
General Liability......................... 108.6 89.5 67.6 71.0 64.7
Other..................................... 59.3% 52.2% 66.9% 68.5% 58.4%
============ ============ ============ ============= ==============
31
Average Mortgage Guaranty paid claims, and certain delinquency ratio data are
shown below:
Years Ended December 31, (1)
-------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- ------------ ------------- ------------
Average Paid Claim Amount:
Traditional Primary.................... $ 23,920 $ 22,339 $ 20,693 $ 19,221 $ 21,551
Bulk (2)............................... $ 19,885 $ 29,293 $ - $ - $ -
---------------
(1) Amounts are in whole dollars.
(2) Due to the relative immaturity of the bulk business, the above trend may prove to be highly volatile.
Delinquency Ratio:
Traditional Primary.................... 4.11% 3.95% 3.43% 2.84% 2.50%
Bulk .................................. 4.59% 4.76% 3.28% .33% -%
Traditional Primary Delinquency Ratios for Top Ten States (3):
Florida................................ 3.2% 3.5% 3.6% 3.4% 3.4%
Texas.................................. 5.0 4.6 3.9 3.2 2.7
Georgia................................ 5.6 4.9 3.9 2.9 2.9
Illinois............................... 3.8 4.0 3.3 2.9 2.6
North Carolina......................... 4.9 4.7 4.0 3.0 2.4
California............................. 2.1 2.8 2.9 3.1 2.9
Ohio................................... 7.6 6.9 4.9 3.8 3.2
Pennsylvania........................... 4.4 3.8 3.3 2.5 2.3
Minnesota.............................. 3.5 2.5 2.1 1.9 1.1
Arizona................................ 2.8% 3.4% 3.3% 2.7% 1.8%
---------------
(3) As determined by risk in force as of December 31, 2004. These 10 states
represent approximately 50% of risk in force as of that date.
The general insurance portion of the claims ratio has reflected a
reasonably consistent downtrend since 1999. The reduction in this major cost
factor reflects largely the aforementioned pricing and risk selection
improvements that have been applied since 2001, together with elements of
reduced loss severity and frequency. The mortgage guaranty claims ratio has
trended higher since the second quarter of 2003. The lower 2002 mortgage
guaranty claims ratio resulted from a decline in claim provisions driven
principally by a drop in expected claim severity, while recent trends reflect
increases in claim provisions principally due to such factors as higher loss
payments and expectations of higher severity and frequency of claims. A small
increase in 2001 was largely the result of a moderately higher loan default rate
factor. The title insurance loss ratios have been in the low single digits in
each of the past five years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. The
moderate uptrend in title insurance loss ratios since 2002 stems from a rise in
the net provision for ultimate claim costs from the historically low level
achieved in 2001 and 2000. The consolidated benefits and claims ratio reflects
the changing effects of period-to-period contributions of each segment to
consolidated results, and this ratio's variances within each segment.
The ratio of consolidated underwriting, acquisition, and insurance expenses
to net premiums and fees earned was 47.3% in 2004, 48.5% in 2003 and 47.9% in
2002. Variations in these consolidated ratios reflect a continually changing mix
of coverages sold and attendant costs of producing business in the Company's
three business segments. The following table sets forth the expense ratios
registered by each major business segment for the periods shown:
General Mortgage Title Consolidated
-------------- ------------- ----------- -------------
Years Ended December 31:
2000............................................. 28.1% 29.6% 92.4% 47.7%
2001............................................. 26.7 27.5 87.2 46.5
2002............................................. 25.8 32.3 85.6 47.9
2003............................................. 25.5 24.8 84.6 48.5
2004............................................. 24.6% 25.6% 90.5% 47.3%
============== ============= =========== =============
Expense ratios for the Company as a whole have remained basically stable
for the periods reported upon. To a significant degree, expense ratios for both
the general and title insurance segments are mostly reflective of variable
costs, such as commissions or similar charges, that rise or decline along with
corresponding changes in premium and fee income, as well as changes in general
operating expenses which can contract or expand in differing proportions due to
varying levels of operating efficiencies and expense management opportunities.
The slight downtrend in the General Insurance Group's expense ratio reflects the
benefits of firm general expense management in the face of a greater revenue
base. The mortgage guaranty segment's expense ratio decreased in 2003 and 2001
32
due to greater efficiencies gained in the distribution and servicing of its
products; the increase in this ratio for 2002 was due to the posting of special
operating charges aggregating $20.5. These charges stemmed from the cessation of
the development and marketing of a loan portfolio evaluation service aimed at
existing and potential mortgage guaranty insurance customers, and a reassessment
of certain class action litigation exposures. The 2003 ratio also benefited from
the resolution of the aforementioned class action litigation at a cost
approximately $5.0 less than the related reserves recorded in 2002. The increase
in 2004 resulted from higher stock option compensation expenses offset by
recovery of certain prior years' litigation costs. Increased title sales volume
in 2003 and 2002 led to a lower expense ratio for those years. Consumer and
regulatory litigation costs affecting Old Republic's California title insurance
subsidiary was responsible for expenses of $25.3, $2.4 and $3.4 charged to 2004,
2003,and 2002 operations, respectively.
The composite ratios of the above net claims, benefits and underwriting
expenses that reflect the sum total of all the factors enumerated above have
been as follows:
General Mortgage Title Consolidated
-------------- ------------- ----------- -------------
Years Ended December 31:
2000............................................. 106.0% 44.6% 96.0% 91.6%
2001............................................. 102.0 43.6 91.2 88.9
2002............................................. 98.4 46.4 90.6 88.1
2003............................................. 93.3 47.5 90.4 86.4
2004............................................. 90.7% 61.1% 96.3% 89.3%
============== ============= =========== =============
The effective consolidated income tax rates were 33.2% in 2004, 32.4% in
2003, and 29.9% in 2002. 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 due to 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 state and municipal tax-exempt
interest) on the one hand, and the combination of fully taxable investment
income, realized investment gains or losses, and underwriting and service
income, on the other hand.
OTHER INFORMATION
Reference is here made to "Information About Segments of Business"
appearing elsewhere herein.
Historical data pertaining to the operating performance, liquidity, and
other financial indicators applicable to an insurance enterprise such as Old
Republic are not necessarily indicative of results to be achieved in succeeding
years. In addition to the factors cited below, the long-term nature of the
insurance business, seasonal and annual patterns in premium production and
incidence of claims, changes in yields obtained on invested assets, changes in
government policies and free markets affecting inflation rates and general
economic conditions, and changes in legal precedents or the application of law
affecting the settlement of disputed claims can have a bearing on
period-to-period comparisons and future operating results.
Some of the statements made in this report, as well as oral statements or
commentaries made by the Company's management in conference calls following
earnings releases, can constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Any such
forward-looking statements, commentaries, or inferences, of necessity, involve
assumptions, uncertainties, and risks that may affect the Company's future
performance. With regard to Old Republic's General insurance segment, its
results can be affected in particular by the level of market competition, which
is typically a function of available capital and expected returns on such
capital among competitors, the levels of interest and inflation rates, and
periodic changes in claim frequency and severity patterns caused by natural
disasters, weather conditions, accidents, illnesses, work-related injuries, and
unanticipated external events. Mortgage Guaranty and Title insurance results can
be impacted by similar factors and, most particularly, by changes in national
and regional housing demand and values, the availability and cost of mortgage
loans, employment trends, and default rates on mortgage loans. Additionally,
mortgage guaranty results, may also be impacted by various risk-sharing
arrangements with business producers as well as the risk management and pricing
policies of government sponsored enterprises. Life and health insurance earnings
can be affected by the levels of employment and consumer spending, variations in
mortality and health trends, and changes in policy lapsation rates. At the
parent company level, operating earnings or losses are generally reflective of
the amount of debt outstanding and its cost, interest income on temporary
holdings of short-term investments, and period-to-period variations in the costs
of administering the Company's widespread operations.
Any forward-looking statements or commentaries speak only as of their
dates. Old Republic undertakes no obligation to publicly update or revise all
such comments, whether as a result of new information, future events or
otherwise, and accordingly they may not be unduly relied upon.
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.
33
Item 8-Financial Statements
Listed below are the financial statements included herein:
OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES
Page No.
--------
Consolidated Balance Sheets ....................................... 35
Consolidated Statements of Income.................................. 36
Consolidated Statements of Comprehensive Income.................... 37
Consolidated Statements of Preferred Stock and
Common Shareholders' Equity..................................... 38
Consolidated Statements of Cash Flows.............................. 39
Notes to Consolidated Financial Statements......................... 40-59
Report of Independent Registered Public Accounting Firm............ 60
34
Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets (Unaudited)
($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2004 2003
------------- -------------
Assets
Investments:
Available for sale:
Fixed maturity securities (at fair value) (cost: $6,273.2 and $5,463.9)............ $ 6,455.9 $ 5,741.1
Equity securities (at fair value) (cost: $396.8 and $439.2)......................... 459.0 513.5
Short-term investments (at fair value which approximates cost)...................... 388.6 403.9
Miscellaneous investments........................................................... 54.4 53.2
------------- -------------
Total........................................................................... 7,358.1 6,711.8
Other investments................................................................... 13.4 8.5
------------- -------------
Total investments............................................................... 7,371.6 6,720.4
------------- -------------
Other Assets:
Cash................................................................................ 60.5 47.2
Securities and indebtedness of related parties...................................... 60.2 54.9
Accrued investment income........................................................... 87.3 81.5
Accounts and notes receivable....................................................... 543.9 509.5
Federal income tax recoverable: Current............................................. - 15.9
Reinsurance balances and funds held................................................. 92.5 69.9
Reinsurance recoverable: Paid losses................................................ 53.3 55.9
Policy and claim reserves.................................. 1,793.2 1,667.8
Deferred policy acquisition costs................................................... 232.3 221.9
Sundry assets....................................................................... 275.6 267.0
------------- -------------
3,199.2 2,991.8
------------- -------------
Total Assets.................................................................... $ 10,570.8 $ 9,712.3
============= =============
Liabilities, Preferred Stock, and Common Shareholders' Equity
Liabilities:
Losses, claims and settlement expenses.............................................. $ 4,403.5 $ 4,022.7
Unearned premiums................................................................... 903.1 814.8
Other policyholders' benefits and funds............................................. 175.9 172.3
------------- -------------
Total policy liabilities and accruals........................................... 5,482.6 5,009.8
Commissions, expenses, fees and taxes............................................... 235.9 206.1
Reinsurance balances and funds...................................................... 157.8 147.8
Federal income tax payable: Current................................................. 8.4 -
Deferred................................................ 554.5 556.8
Debt................................................................................ 143.0 137.7
Sundry liabilities.................................................................. 122.7 100.2
Commitments and contingent liabilities.............................................. - -
------------- -------------
Total Liabilities............................................................... 6,705.1 6,158.6
------------- -------------
Preferred Stock:
Convertible preferred stock (1)..................................................... - -
------------- -------------
Common Shareholders' Equity:
Common stock(1)..................................................................... 185.4 184.4
Additional paid-in capital.......................................................... 270.4 245.5
Retained earnings................................................................... 3,240.1 2,896.8
Accumulated other comprehensive income ............................................. 179.5 236.8
Treasury stock (at cost) (1)........................................................ (10.0) (10.0)
------------- -------------
Total Common Shareholders' Equity............................................... 3,865.6 3,553.6
------------- -------------
Total Liabilities, Preferred Stock and Common Shareholders' Equity.............. $ 10,570.8 $ 9,712.3
============= =============
- -------------
(1) At December 31, 2004 and 2003, there were 75,000,000 shares of $0.01 par
value preferred stock authorized, of which no shares were outstanding. As
of the same dates, there were 500,000,000 shares of common stock, $1.00 par
value, authorized, of which 185,429,127 in 2004 and 184,471,698 in 2003
were issued and outstanding. At December 31, 2004 and 2003, there were
100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of
which no shares were issued. Common shares classified as treasury stock
were 2,865,582 and 2,865,542 as of December 31, 2004 and 2003,
respectively.
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
35
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
($ in Millions, Except Share Data)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------
2004 2003 2002
---------------- ---------------- ----------------
Revenues:
Net premiums earned.......................................... $ 2,804.8 $ 2,582.1 $ 2,135.4
Title, escrow, and other fees................................ 311.2 353.9 288.5
---------------- ---------------- ----------------
Total premiums and fees.................................. 3,116.1 2,936.0 2,423.9
Net investment income........................................ 290.8 279.2 272.6
Other income................................................. 36.7 51.2 45.8
---------------- ---------------- ----------------
Total operating revenues................................. 3,443.7 3,266.5 2,742.4
Realized investment gains.................................... 47.9 19.3 13.9
---------------- ---------------- ----------------
Total revenues........................................... 3,491.6 3,285.8 2,756.4
---------------- ---------------- ----------------
Benefits, Claims and Expenses:
Benefits, claims, and settlement expenses.................... 1,305.6 1,097.6 975.3
Dividends to policyholders................................... 2.2 15.1 (.4)
Underwriting, acquisition, and other expenses................ 1,523.8 1,484.9 1,212.0
Interest and other charges................................... 8.9 8.2 8.8
---------------- ---------------- ----------------
Total expenses........................................... 2,840.7 2,606.0 2,195.7
---------------- ---------------- ----------------
Income before income taxes .................................. 650.9 679.7 560.7
---------------- ---------------- ----------------
Income Taxes: Currently payable.............................. 183.4 168.0 109.1
Deferred....................................... 32.5 51.9 58.5
---------------- ---------------- ----------------
Total.......................................... 215.9 219.9 167.7
---------------- ---------------- ----------------
Net Income................................................... $ 435.0 $ 459.8 $ 392.9
================ ================ ================
Net Income Per Share:
Basic:................................................... $ 2.38 $ 2.53 $ 2.17
================ ================ ================
Diluted:................................................. $ 2.36 $ 2.51 $ 2.16
================ ================ ================
Average shares outstanding: Basic........................ 182,541,822 181,549,485 180,863,325
================ ================ ================
Diluted...................... 184,607,632 183,302,935 182,323,316
================ ================ ================
Dividends Per Common Share:
Cash: Regular........................................... $ .503 $ .446 $ .420
Special........................................... - .667 -
---------------- ---------------- ----------------
Total............................................. $ .503 $ 1.113 $ .420
================ ================ ================
Stock.................................................... -% 50% -%
================ ================ ================
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
36
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------
2004 2003 2002
---------------- ---------------- ----------------
Net income as reported....................................... $ 435.0 $ 459.8 $ 392.9
---------------- ---------------- ----------------
Other comprehensive income (loss):
Foreign currency translation adjustment................... 7.3 13.9 .6
---------------- ---------------- ----------------
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period......... (49.9) 191.2 43.6
Less: elimination of pretax realized gains
included in income as reported...................... 47.9 19.3 13.9
---------------- ---------------- ----------------
Pretax unrealized gains (losses) on securities
carried at market value............................. (97.8) 171.9 29.6
Deferred income taxes (credits) ....................... (34.2) 60.1 10.3
---------------- ---------------- ----------------
Net unrealized gains (losses) on securities............. (63.5) 111.7 19.2
---------------- ---------------- ----------------
Minimum Pension Liability:
Minimum pension liability............................... (1.5) - -
Deferred income tax credits ............................ (.5) - -
---------------- ---------------- ----------------
Minimum pension liability, net of tax credits........... (.9) - -
---------------- ---------------- ----------------
Net adjustments.............................................. (57.2) 125.7 19.9
---------------- ---------------- ----------------
Comprehensive income......................................... $ 377.7 $ 585.5 $ 412.9
================ ================ ================
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
37
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Preferred Stock
and Common Shareholders' Equity (Unaudited)
($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Convertible Preferred Stock:
Balance, beginning of year.................................... $ - $ - $ .3
Converted into common stock................................ - - (.2)
-------------- -------------- --------------
Balance, end of year.......................................... $ - $ - $ -
============== ============== ==============
Common Stock:
Balance, beginning of year.................................... $ 184.4 $ 123.7 $ 122.1
Stock dividend............................................. - 61.4 -
Dividend reinvestment plan................................. - - -
Exercise of stock options.................................. .9 .4 1.3
Conversion of convertible preferred stock.................. - - -
Acquisition of subsidiary.................................. - - .1
Treasury stock restored to unissued status................. - (1.2) -
-------------- -------------- --------------
Balance, end of year.......................................... $ 185.4 $ 184.4 $ 123.7
============== ============== ==============
Additional Paid-in Capital:
Balance, beginning of year.................................... $ 245.5 $ 253.1 $ 219.8
Dividend reinvestment plan................................. .8 1.5 .6
Exercise of stock options.................................. 15.3 9.9 27.9
Stock option compensation.................................. 8.7 2.2 -
Conversion of convertible preferred stock.................. - - .2
Acquisition of subsidiary.................................. - - 4.4
Treasury stock restored to unissued status................. - (21.4) -
-------------- -------------- --------------
Balance, end of year.......................................... $ 270.4 $ 245.5 $ 253.1
============== ============== ==============
Retained Earnings:
Balance, beginning of year.................................... $ 2,896.8 $ 2,700.5 $ 2,383.2
Net income................................................. 435.0 459.8 392.9
Dividends on common stock: cash .......................... (91.6) (201.9) (75.7)
stock.......................... - (61.4) -
Cash dividends on preferred stock.......................... - - -
-------------- -------------- --------------
Balance, end of year.......................................... $ 3,240.1 $ 2,896.8 $ 2,700.5
============== ============== ==============
Accumulated Other Comprehensive Income:
Balance, beginning of year.................................... $ 236.8 $ 111.0 $ 91.1
Foreign currency translation adjustments................... 7.3 13.9 .6
Net unrealized gains (losses) on securities................ (63.5) 111.7 19.2
Minimum pension liability, net of tax credits.............. (.9) - -
-------------- -------------- --------------
Balance, end of year.......................................... $ 179.5 $ 236.8 $ 111.0
============== ============== ==============
Treasury Stock:
Balance, beginning of year.................................... $ (10.0) $ (32.6) $ (32.6)
Acquired during the year................................... - - -
Restored to unissued status................................ - 22.6 -
-------------- -------------- --------------
Balance, end of year.......................................... $ (10.0) $ (10.0) $ (32.6)
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
38
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($ in Millions)
- ---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Cash flows from operating activities:
Net income....................................................... $ 435.0 $ 459.8 $ 392.9
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs.............................. (9.4) (21.6) (18.6)
Premiums and other receivables................................. (33.4) (34.6) (54.4)
Unpaid claims and related items................................ 262.8 192.1 128.6
Other policyholders' benefits and funds........................ 82.8 92.9 94.7
Income taxes................................................... 56.5 36.4 50.0
Reinsurance balances and funds................................. (10.5) (24.9) 10.7
Realized investment gains...................................... (47.9) (19.3) (13.9)
Accounts payable, accrued expenses and other................... 92.5 39.5 48.1
-------------- -------------- --------------
Total............................................................ 828.3 720.2 638.2
-------------- -------------- --------------
Cash flows from investing activities:
Fixed maturity securities:
Available for sale:
Maturities and early calls.................................... 625.8 704.3 258.9
Sales......................................................... 149.6 302.0 198.7
Held to maturity:
Maturities and early calls.................................... - - 329.3
Sales......................................................... - - 1.0
Sales of equity securities....................................... 334.0 211.0 125.5
Sales of other investments....................................... 12.7 7.6 2.3
Sales of fixed assets for company use............................ .9 1.0 1.3
Cash and short-term investments of subsidiary acquired........... 2.5 - 1.7
Purchases of fixed maturity securities:
Available for sale............................................. (1,604.1) (1,428.9) (915.6)
Held to maturity............................................... - - (279.1)
Purchases of equity securities................................... (250.3) (119.0) (305.7)
Purchases of other investments................................... (1.9) (4.0) (2.6)
Purchases of fixed assets for company use........................ (20.1) (22.1) (16.3)
Other-net........................................................ 1.1 1.3 (3.5)
-------------- -------------- --------------
Total............................................................ (749.6) (346.5) (604.1)
-------------- -------------- --------------
Cash flows from financing activities:
Issuance of preferred and common shares.......................... 14.6 9.7 22.0
Repayments of term loans......................................... - (1.0) (15.0)
Redemption of debentures and notes............................... (.6) (2.8) (2.8)
Dividends on common shares....................................... (91.6) (201.9) (75.7)
Other-net........................................................ (2.8) (17.5) (7.9)
-------------- -------------- --------------
Total............................................................ (80.5) (213.6) (79.5)
-------------- -------------- --------------
Increase (decrease) in cash and short-term investments............. (1.9) 160.0 (45.5)
Cash and short-term investments, beginning of year............... 451.2 291.1 336.6
-------------- -------------- --------------
Cash and short-term investments, end of year..................... $ 449.2 $ 451.2 $ 291.1
============== ============== ==============
Supplemental cash flow information:
Cash paid during the year for: Interest ......................... $ 8.7 $ 8.7 $ 9.2
============== ============== ==============
Income Taxes...................... $ 156.5 $ 180.6 $ 109.4
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
- --------------------------------------------------------------------------------
39
Old Republic International Corporation and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
($ in Millions, Except as Otherwise Indicated)
- --------------------------------------------------------------------------------
Old Republic International Corporation is a Chicago-based insurance holding
company with subsidiaries engaged mainly in the general (property and
liability), mortgage guaranty and title 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 and Title Insurance Groups, and references herein
to such groups apply to the Company's subsidiaries engaged in the respective
segments of business. Note 6 shows summary results for 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, 2004, the Company's invested assets were classified
as "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 book value per share
by approximately 42 cents. 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 "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
40
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses. The Company recognized other than
temporary impairments of investments in the amounts of $5.2, $16.4, and $19.0
for the years ended December 31, 2004, 2003 and 2002, 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, 2004:
Available for sale:
U.S. & Canadian Governments.............. $ 1,107.7 $ 28.3 $ .8 $ 1,135.3
Tax-exempt............................... 1,538.6 38.4 2.9 1,574.0
Utilities................................ 850.2 29.0 2.7 876.4
Corporate................................ 2,776.6 98.7 5.2 2,870.0
------------ ------------- ------------ -------------
$ 6,273.2 $ 194.5 $ 11.8 $ 6,455.9
============ ============= ============ =============
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
============ ============= ============ =============
The amortized cost and estimated fair value at December 31, 2004, 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.................................................... $ 782.3 $ 790.0
Due after one year through five years...................................... 2,692.8 2,800.5
Due after five years through ten years..................................... 2,731.0 2,787.5
Due after ten years........................................................ 66.9 77.7
--------------- --------------
$ 6,273.2 $ 6,455.9
=============== ==============
Bonds and other investments carried at $166.5 as of December 31, 2004 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
-------------- ------------- ------------- --------------
December 31, 2004:
Equity securities.......................... $ 396.8 $ 68.6 $ 6.4 $ 459.0
============== ============= ============= ==============
December 31, 2003:
Equity securities.......................... $ 439.2 $ 98.2 $ 23.9 $ 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
any deferred income taxes, are recorded directly as a component of accumulated
other comprehensive income in shareholders' equity.
41
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 an unrealized loss position employing closing market price comparisons
with an issuer's original cost at December 31, 2004 and 2003:
12 Months or Less Greater than 12 Months Total
------------------------- ------------------------- ---------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ----------- ----------- ---------- ----------- ------------
December 31, 2004:
Fixed Maturity Securities:
U.S & Canadian Governments......... $ 209.7 $ .8 $ - $ - $ 209.7 $ .8
Tax-exempt......................... 307.7 2.4 33.1 .5 340.8 2.9
Corporates......................... 634.4 6.0 73.6 2.0 708.0 8.0
---------- ----------- ----------- ---------- ----------- ------------
1,151.9 9.2 106.7 2.5 1,258.6 11.8
Equity Securities.................... 44.0 6.3 .7 .1 44.7 6.4
---------- ----------- ----------- ---------- ----------- ------------
Total................................ $1,195.9 $ 15.6 $ 107.4 $ 2.6 $ 1,303.4 $ 18.2
========== =========== =========== ========== =========== ============
December 31, 2003:
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, 2004, 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 $499.3 required to be held 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,
--------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Investment income from:
Fixed maturity securities.................................... $ 267.2 $ 256.4 $ 253.1
Equity securities............................................ 14.3 14.6 12.4
Short-term investments....................................... 5.7 4.5 6.0
Other sources................................................ 6.8 6.8 5.2
-------------- -------------- --------------
Gross investment income................................... 294.1 282.5 276.9
Investment expenses (1)...................................... 3.2 3.2 4.2
-------------- -------------- --------------
Net investment income..................................... $ 290.8 $ 279.2 $ 272.6
============== ============== ==============
Realized gains (losses) on:
Fixed maturity securities:
Held to maturity.......................................... $ - $ - $ (2.4)
-------------- -------------- --------------
Available for sale:
Gains................................................... 5.2 9.0 4.0
Losses.................................................. (.5) (4.4) (2.7)
-------------- -------------- --------------
Net..................................................... 4.6 4.6 1.3
-------------- -------------- --------------
Total..................................................... 4.6 4.6 (1.1)
Equity securities & other long-term investments.............. 43.2 14.6 15.0
-------------- -------------- --------------
Total..................................................... 47.9 19.3 13.9
Income taxes................................................. 17.0 6.7 4.8
-------------- -------------- --------------
Net realized gains........................................ $ 30.9 $ 12.5 $ 9.0
============== ============== ==============
(Table continued on next page.)
42
Years Ended December 31,
--------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Changes in unrealized investment gains (losses) on:
Fixed maturity securities:
Held to maturity (2)...................................... $ - $ (117.5) $ 55.7
============== ============== ==============
Available for sale........................................ $ (94.3) $ 94.0 $ 109.1
Less: Deferred income taxes (credits).................... (33.0) 32.9 38.1
-------------- -------------- --------------
Net changes in unrealized investment gains (losses)....... $ (61.3) $ 61.1 $ 71.0
============== ============== ==============
Equity securities & other long-term investments.............. $ (3.5) $ 77.8 $ (79.4)
Less: Deferred income taxes (credits)........................ (1.2) 27.2 (27.7)
-------------- -------------- --------------
Net changes in unrealized investment gains (losses)....... $ (2.2) $ 50.6 $ (51.7)
============== ============== ==============
- ---------------
(1) Investment expenses consist of personnel costs and investment management
and custody service fees, as well as interest incurred on funds held of
$.3, $.1 and $.3 for the years ended December 31, 2004, 2003 and 2002,
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 $117.5 of
unrealized investment gains imbedded in such securities at December 31,
2002.
(d) Revenue Recognition -Pursuant to GAAP applicable to the insurance industry,
revenues are associated with the related benefits, claims, and expenses.
Substantially all general insurance premiums are reflected in income on a
pro-rata basis. Earned but unbilled premiums are generally taken into income on
the billing date, while adjustments for retrospective premiums, commissions and
similar charges or credits are accrued on the basis of periodic evaluations of
current underwriting experience and contractual obligations. Nearly all of the
Company's mortgage guaranty premiums stem from monthly installment policies.
Accordingly, such premiums are written and earned in the month coverage is
effective. With respect to annual or single premium policies, earned premiums
are recognized on a pro-rata basis over the terms of the policies. Title premium
and fee revenues stemming from the Company's direct operations (which includes
branch offices of its title insurer and wholly owned subsidiaries of the
Company) represent approximately 38 percent of such consolidated title business
revenues. Such premiums are generally recognized as income at the escrow closing
date which approximates the policy effective date. Fee income related to escrow
and other closing services is recognized when the related services have been
performed and completed. The remaining 62 percent of consolidated title premium
and fee revenues is produced by independent title agents and underwritten title
companies. Rather than making estimates that could be subject to significant
variance from actual premium and fee production, the Company recognizes revenues
from those sources upon receipt. Such receipts can reflect a three to four month
lag relative to the effective date of the underlying title policy, and are
offset concurrently by production expenses and claim reserve provisions.
(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. To the
extent that future policy revenues on existing policies are not adequate to
cover related costs and expenses, deferred policy acquisition costs are charged
to earnings. As discussed elsewhere in this document, a write down of previously
deferred acquisition costs applicable to a discontinued life product amounted to
$10.5 during the fourth quarter of 2004.
The following table summarizes deferred policy acquisition costs and
related data for the years shown:
Years Ended December 31,
--------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Deferred, beginning of year.................................... $ 221.9 $ 197.8 $ 179.8
-------------- -------------- --------------
Acquisition costs deferred:
Commissions - net of reinsurance........................... 209.4 178.6 159.3
Premium taxes.............................................. 69.9 58.2 45.5
Salaries and other marketing expenses...................... 91.5 102.5 92.1
-------------- -------------- --------------
Sub-total.............................................. 370.9 339.3 297.0
Amortization charged to income................................. (360.5) (315.2) (279.1)
-------------- -------------- --------------
Change for the year.................................... 10.4 24.0 17.9
-------------- -------------- --------------
Deferred, end of year.......................................... $ 232.3 $ 221.9 $ 197.8
============== ============== ==============
43
(f) Unearned Premiums-General insurance unearned premium reserves are generally
calculated by application of pro-rata factors to premiums in force. Mortgage
guaranty unearned premium reserves are calculated on a pro-rata basis. At
December 31, 2004 and 2003, unearned premiums consisted of the following:
December 31,
---------------------------------------
2004 2003
-------------- --------------
General Insurance Group ....................................... $ 860.2 $ 766.8
Mortgage Guaranty Group........................................ 42.9 47.9
-------------- --------------
Total...................................................... $ 903.1 $ 814.8
============== ==============
(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, portions 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
a large number of formulas that take into account various criteria, including
historical cost experience and anticipated costs of servicing reinsured and
other risks. Estimates of possible recoveries from salvage or subrogation
opportunities are considered in the establishment of such reserves as
applicable. As part of overall claim and claim expense reserves, the point
estimates incorporate amounts to cover net estimates of unusual claims such as
those emanating from asbestosis and environmental ("A&E") exposures as discussed
below. Such reserves can affect claim costs and related loss ratios for such
insurance coverages as general liability, commercial automobile (truck),
workers' compensation and property.
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 volume of new claim reports has abated in
2003 and 2004. 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 as well as assumptions relative to the effect
of the revised regulations. Inasmuch as a variety of challenges are likely as
the revised regulations are implemented through 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 and $2.0 and
44
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.
Old Republic's exposure to A&E claims cannot 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 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, 2004,
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 to quantify with a high degree of precision. 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. At
December 31, 2004 and 2003, Old Republic's aggregate indemnity and loss
adjustment expense reserves specifically identified with A&E exposures amounted
to approximately $118.9 and $91.0 gross, respectively, and $97.1 and $56.6 net
of reinsurance, respectively. Old Republic's average five year survival ratios
stood at 6.2 years (gross) and 9.6 years (net of reinsurance) as of December 31,
2004 and 6.3 years (gross) and 9.8 years (net of reinsurance) as of December 31,
2003. Fluctuations in this ratio between years can be caused by the inconsistent
pay out patterns associated with these types of claims.
Mortgage guaranty loss reserves are based on calculations that take into
account the number of reported insured mortgage loan defaults as of each balance
sheet date, as well as experience-based estimates of loan defaults that have
occurred but have not as yet been reported. Further, the resulting loss reserve
estimates take into account a large number of variables including trends in
claim severity, potential salvage recoveries, expected cure rates for reported
loan defaults at various stages of default, and judgments relative to future
employment levels, housing market activity, and mortgage loan demand and
extensions.
Title insurance and related escrow service loss and loss adjustment expense
reserves are established to cover the estimated settlement costs of known as
well as claims incurred but not reported, concurrently with the recognition of
premium and escrow service revenues. Reserves for known claims are based on an
assessment of the facts available to the Company during the settlement process.
Reserves for claims incurred but not reported are established on the basis of
past experience and evaluations of such variables as changes and trends in the
types of policies issued, changes in real estate markets and interest rate
environments, and changed levels of loan refinancings, all of which can have a
bearing on the emergence, number, and ultimate cost of claims.
In addition to the above reserve elements, the Company establishes reserves
for loss settlement costs that are not directly related to individual claims.
Such reserves are based on prior years' cost experience and trends, and are
intended to cover the unallocated costs of claim departments' administration of
known and IBNR claims.
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,
------------------------------------------------
2004 2003 2002
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