OLD REPUBLIC INTERNATIONAL CORP - Annual Report: 2006 (Form 10-K)
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,
2006
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:
Title of each
class
Name of Each Exchange 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 if the registrant is a well-known seasoned issuer, as defined in Rule
405
of the Securities Act.
Yes:
X/
No:
Indicate
by check
mark if the registrant is not required to file reports pursuant to Section
13 or
Section 15(d) of the Act.
Yes:
/ No:X
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.
¨
Indicate
by check
mark whether the registrant is a large accelerated filer, an accelerated
filer,
or a non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one).
Large
accelerated
filer x Accelerated
filer
¨ Non-accelerated
filer ¨
Indicate
by check
mark whether the registrant is a shell company (as defined in Exchange Act
Rule
12b-2). Yes:
/ No:X
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, 2006, the last day of
the registrant’s most recently completed second fiscal quarter, was
$4,582,172,544.
The
registrant had
231,170,576 shares of Common Stock outstanding as of February 2,
2007.
Documents
incorporated by reference:
The
following
documents are incorporated by reference into that part of this Form 10-K
designated to the right of the document title.
Title
Part
Proxy
statement for
the 2007 Annual Meeting of Shareholders
III, Items 10, 11, 12, 13 and 14
Exhibits
as specified in
exhibit index (page 76) IV,
Item
15
________________
There
are 77 pages
in this report
PART
I
Item
1 -
Business
(a)
General
Description of Business.
Old Republic
International Corporation is a Chicago-based insurance holding company. The
Company is engaged in the single business of insurance underwriting. It conducts
its business through a number of regulated insurance company subsidiaries
organized into three major segments, namely, it’s General (property and
liability), Mortgage Guaranty, and Title insurance segments. References herein
to such groups apply to the Company's subsidiaries engaged in these respective
segments of business. A small life and health insurance business is included
within the corporate and other caption of this financial report. In this report,
“Old Republic”, or “the Company” refers to Old Republic International
Corporation and its subsidiaries as the context requires.
Financial
Information Relating to Segments of Business
(1)
|
The
contributions
to net revenues and income (loss) before taxes of each Old Republic segment
are
set forth below for the years shown, together with their respective assets
at
the end of each year. The information below should be read in conjunction with
the consolidated financial statements, the notes thereto, and the “Management
Analysis of Financial Position and Results of Operations” appearing elsewhere
herein.
Net
Revenues (2)
|
($
in
Millions)
|
|||||
Years
Ended
December 31:
|
2006
|
2005
|
2004
|
|||
General
|
$
2,138.7
|
$
2,017.6
|
$
1,822.5
|
|||
Mortgage
Guaranty
|
529.9
|
516.0
|
489.9
|
|||
Title
|
1,007.3
|
1,108.6
|
1,051.8
|
|||
Corporate
& Other - Net (3)
|
99.2
|
98.6
|
79.3
|
|||
Consolidated
Realized Investment Gains
|
19.0
|
64.9
|
47.9
|
|||
Consolidated
|
$
3,794.2
|
$
3,805.9
|
$
3,491.6
|
Income
(Loss) Before Taxes
|
||||||
Years
Ended
December 31:
|
2006
|
2005
|
2004
|
|||
General
|
$
401.6
|
$
350.0
|
$
333.0
|
|||
Mortgage
Guaranty
|
228.4
|
243.7
|
224.5
|
|||
Title
|
31.0
|
88.7
|
62.5
|
|||
Corporate
& Other - Net (3)
|
-
|
(.1
|
)
|
(17.2
|
)
|
|
Consolidated
Realized Investment Gains
|
19.0
|
64.9
|
47.9
|
|||
Consolidated
|
$
680.1
|
$
747.3
|
$
650.9
|
Assets
|
|||
As
of
December 31:
|
2006
|
2005
|
|
General
|
$
9,363.5
|
$
8,178.9
|
|
Mortgage
Guaranty
|
2,189.6
|
2,211.8
|
|
Title
|
772.7
|
776.3
|
|
Corporate
& Other - Net (3)
|
286.3
|
376.0
|
|
Consolidated
|
$
12,612.2
|
$
11,543.2
|
|
(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 the 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 since the investment
portfolio
is managed as a whole.
(3) Represents
amounts
for Old Republic’s holding company parent, minor corporate services
subsidiaries, and a small life and health insurance operation. The
significant
loss in 2004 was mostly due to a pretax charge of $10.5 million for
previously
deferred acquisition costs on term-life business which was terminated
and placed
in run-off mode as of year end 2004.
2
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 and overall operating 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.
General
Insurance Group
|
Through
its General
Insurance Group subsidiaries, the Company assumes risks and provides related
risk management services that encompass a large variety of property and
liability insurance coverages. Old Republic does not have a meaningful exposure
to personal lines of insurance such as homeowners and private automobile
coverages, and does not insure significant amounts of commercial and other
property. Approximately 85% of the Company’s general insurance business is
produced through independent agency and brokerage channels, while the remaining
15% is obtained through direct production facilities.
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 focuses on a number of industries, most prominently the transportation
(trucking and general aviation), construction, forest products, and energy
industries.
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 selective mergers with other companies.
For 2006, production of commercial automobile direct insurance premiums
accounted for 34.8% of consolidated direct premiums written by the General
Insurance Group, while workers' compensation and general liability direct
insurance premiums amounted to 22.2% and 13.2%, 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
Company 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.
The
Company also
covers fidelity, surety and credit exposures for a wide range of business
enterprises. Fidelity and surety policies are issued through some 9,000
independent agents by the Old Republic Surety Group. Surety bonds, such as
those
covering 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 underwritten consumer
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.
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.
Extended
warranty
coverages for new and used automobiles, as well as home warranty policies
covering appliances and other mechanical systems in pre-owned 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.
3
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
incorporating 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 Company
may
pay the entire claim amount, take title to the mortgaged property, and
subsequently sell the property to mitigate its loss. Pool insurance, which
is
written on a group of loans in negotiated transactions, provides coverage that
ranges 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 Company-managed
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 Company 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 Company insures. Delegated underwriting programs allow approved
lenders to commit the Company to insure loans provided they adhere to
predetermined underwriting guidelines. In 2006, delegated underwriting approvals
accounted for approximately 66% of the Company’s new traditional primary risk
written.
Bulk
and other
insurance is issued on groups of loans to mortgage banking customers through
a
centralized risk assessment and underwriting department. These groups of loans
are priced in the aggregate, on a bid or negotiated basis. Coverage for
insurance issued in this manner can be provided through primary insurance
policies (loan level coverage) or pool insurance policies (aggregate coverage).
The Company considers transactions designated as bulk insurance to be exposed
to
higher risk (as determined by characteristics such as origination channel,
loan
amount, credit quality, and loan documentation) than those designated as other
insurance.
Before
insuring any
loans, the Company 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 providing pool
coverage, a separate pool insurance policy is issued covering the particular
loans applicable to each transaction.
As
to all types of
mortgage insurance products, 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
categorized as an investment or owner occupied property. 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 the inception of coverage
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 the original or outstanding loan amount. The majority of the Company’s
direct premiums are written under monthly premium plans. Premiums may be paid
by borrowers as part of their monthly mortgage payment and passed through
to the Company by the servicer of the loan or they may be paid directly by
the
originator of, or investor in the mortgage loan.
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, 2006, approximately 32% 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 68% 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.
4
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 minor corporate services
subsidiaries that perform investment management, payroll, administrative and
minor marketing services.
The
Company’s small
life and health business registered 2006 and 2005 net premium revenues of $74.1
million and $70.3 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,
travel agents, and marketing channels that are also utilized in some of Old
Republic’s general insurance operations. Production of term life insurance,
accounting for net premiums earned of $18.5 million in 2006 and $19.5 million
in
2005, was terminated and placed in run off mode as of year end 2004. As a result
of the changed circumstances, it was then concluded that previously deferred
acquisition costs could no longer be amortized for their full amount over the
product’s expected run-off years. Accordingly, 2004 operations were charged in
the sum of $10.5 million to reflect revised estimates of deferrable
costs.
5
Consolidated
Underwriting Statistics
|
The
following table
reflects underwriting statistics covering: premiums and related loss, expense,
and policyholders' dividend ratios for the major coverages underwritten in
the
General, Mortgage Guaranty and Title insurance groups:
($
in
Millions)
|
|||||
Years
Ended
December 31,
|
|||||
2006
|
2005
|
2004
|
|||
General
Insurance Group:
|
|||||
Overall
Experience:
|
|||||
Net
Premiums
Earned
|
$
1,902.1
|
$
1,805.2
|
$
1,623.0
|
||
Claim
Ratio
|
65.5%
|
66.6%
|
65.8%
|
||
Policyholders’
Dividend Benefit
|
.4
|
.3
|
.1
|
||
Expense
Ratio
|
24.4
|
24.6
|
24.8
|
||
Composite
Ratio
|
90.3%
|
91.5%
|
90.7%
|
||
Experience
by Major Coverages:
|
|||||
Commercial
Automobile (Principally Trucking):
|
|||||
Net
Premiums
Earned
|
$
756.2
|
$
707.9
|
$
616.3
|
||
Claim
Ratio
|
75.2%
|
67.1%
|
66.5%
|
||
Workers’
Compensation:
|
|||||
Net
Premiums
Earned
|
$
412.8
|
$
396.5
|
$
353.9
|
||
Claim
Ratio
|
73.6%
|
78.2%
|
71.9%
|
||
Policyholders’
Dividend Benefit
|
1.0%
|
.7%
|
.5%
|
||
General
Liability:
|
|||||
Net
Premiums
Earned
|
$
96.2
|
$
96.8
|
$
94.4
|
||
Claim
Ratio
|
57.2%
|
97.1%
|
108.6%
|
||
Three
Above
Coverages Combined:
|
|||||
Net
Premiums
Earned
|
$
1,265.3
|
$
1,201.2
|
$
1,064.7
|
||
Claim
Ratio
|
73.3%
|
73.2%
|
72.0%
|
||
Financial
Indemnity: (1)
|
|||||
Net
Premiums
Earned
|
$
209.4
|
$
186.3
|
$
191.4
|
||
Claim
Ratio
|
41.5%
|
48.9%
|
47.5%
|
||
Inland
Marine
and Property: (2)
|
|||||
Net
Premiums
Earned
|
$
203.1
|
$
198.8
|
$
184.5
|
||
Claim
Ratio
|
54.0%
|
51.4%
|
56.0%
|
||
Home
and
Automobile Warranty:
|
|||||
Net
Premiums
Earned
|
$
133.1
|
$
124.8
|
$
103.6
|
||
Claim
Ratio
|
63.8%
|
59.3%
|
57.9%
|
||
Other
Coverages: (3)
|
|||||
Net
Premiums
Earned
|
$
90.2
|
$
95.6
|
$
81.6
|
||
Claim
Ratio
|
41.3%
|
57.5%
|
61.2%
|
||
Mortgage
Guaranty Group:
|
|||||
Net
Premiums
Earned
|
$
444.3
|
$
429.5
|
$
403.2
|
||
Claim
Ratio
|
42.8%
|
37.2%
|
35.5%
|
||
Expense
Ratio
|
22.5
|
22.4
|
25.6
|
||
Composite
Ratio
|
65.3%
|
59.6%
|
61.1%
|
||
Title
Insurance Group:
(4)
|
|||||
Net
Premiums
Earned
|
$
733.6
|
$
757.2
|
$
714.0
|
||
Combined
Net
Premiums & Fees Earned
|
$
980.0
|
$
1,081.8
|
$
1,025.2
|
||
Claim
Ratio
|
5.9%
|
6.0%
|
5.8%
|
||
Expense
Ratio
|
93.6
|
88.2
|
90.5
|
||
Composite
Ratio
|
99.5%
|
94.2%
|
96.3%
|
||
All
Coverages Consolidated:
|
|||||
Net
Premiums
& Fees Earned
|
$
3,400.5
|
$
3,386.9
|
$
3,116.1
|
||
Claim
and
Benefit Ratio
|
45.3%
|
43.3%
|
42.0%
|
||
Expense
Ratio
|
44.7
|
45.2
|
47.3
|
||
Composite
Ratio
|
90.0%
|
88.5%
|
89.3%
|
||
Any
necessary
reclassifications of prior year data are 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 multi-peril and inland marine coverages.
(3)
Consists
principally of aviation and travel accident coverages.
(4)
Title claim,
expense, and composite ratios are calculated on the basis of combined net
premiums and fees earned.
6
Variations
in claim
ratios are typically caused by changes in the frequency and severity of claims
incurred, changes in premium rates and the level of premium refunds, and
periodic changes in claim and claim expense reserve estimates resulting from
ongoing reevaluations of reported and incurred but not reported claims and
claim
expenses. The Company 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 basic 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 reflects reasonably consistent trends for all reporting
periods. This major cost factor reflects largely pricing and risk selection
improvements that have been applied since 2001, together with elements of
reduced loss severity and frequency. 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 increase in the claims ratio during
the
past three years was primarily due to greater claim frequency. Better results
in
workers’ compensation in 2006 have been 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 intended
to
produce lower net loss ratios. The claims ratio for a relatively small book
of
general liability coverages has tended to be highly volatile, usually rising
due
to the impact of higher claims emergence and greater than anticipated severity,
mostly from legacy asbestos and environmental claims exposures.
Mortgage
guaranty
claim ratios have continued to rise in recent years, principally reflecting
higher paid losses, as well as expectations of greater claim frequency and
severity. The most recent year-over-year claim ratio comparisons reflect
continued upward pressure from these factors.
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 in the past fifteen years or so.
The
consolidated
claims, expense, and composite ratios reflect all the above factors and the
changing period-to-period contributions of each segment to consolidated results.
General
Insurance Claim Reserves
The
Company'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 as to 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 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 reserves
established are a reflection of the opinions of a large number of persons,
of
the application and interpretation of historical precedent and trends, of
expectations as to future developments, and of management’s judgment in
interpreting all such factors. At any point in time the Company is exposed
to
possibly higher or lower than anticipated claim costs due to all of these
factors, and to the evolution, interpretation, and expansion of tort law, as
well as the effects of unexpected jury verdicts.
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
7
rules
mandated by
the Securities and Exchange Commission, however, Old Republic has made
statistical studies of applicable workers' compensation reserves to obtain
estimates of the amounts by which claim and claim adjustment expense reserves,
net of reinsurance, have been discounted. These studies have resulted in
estimates of such amounts at approximately $151.0 million, $138.3 million
and
$139.3 million, as of December 31, 2006, 2005 and 2004, 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 recent years. 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 Company'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 subsidiaries’
net 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
which has produced inconsistent court decisions 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, 2006, 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 Company's reserves for such claims and related costs will
not
prove to be overstated or understated in the future. At December 31, 2006,
Old
Republic’s aggregate indemnity and loss adjustment expense reserves specifically
identified with A&E exposures amounted to approximately $194.9 million
gross, and $157.8 million net of reinsurance. Based on average annual claims
payments during the five most recent calendar years, such reserves represented
7.6 years (gross) and 10.9 years (net of reinsurance) 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, 2006, incurred A&E claim and related loss
settlement costs have averaged 3.4% 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 nor is any guaranty given 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 1996 through 2006. 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 one or
series of years since cumulative retrospective premium and
commission adjustments employed in
8
various
parts of
the Company's business may partially offset such effects. The moderately
deficient development of reserves at year-ends 1998 to 2002 and the reduced
levels of redundancies shown for year-ends 1996 and 1997, pertain mostly to
claims incurred in prior accident years, generally for business written in
the
1980’s. (See “Consolidated Underwriting Statistics” above, and “Reserves,
Reinsurance, and Retrospective Adjustments” elsewhere herein).
($
in
Millions)
|
|||||||||||
(a) As
of
December 31:
|
2006
|
2005
|
2004
|
2003
|
2002
|
2001
|
2000
|
1999
|
1998
|
1997
|
1996
|
(b) Liability(1)
for unpaid claims
|
|||||||||||
and
claim
adjustment
|
|||||||||||
expenses(2):
|
$
2,924
|
$
2,414
|
$
2,182
|
$
1,964
|
$
1,802
|
$
1,678
|
$
1,661
|
$
1,699
|
$
1,742
|
$
1,846
|
$
1,829
|
(c) Paid
(cumulative) as of (3):
|
|||||||||||
One
year
later
|
-
%
|
14.2%
|
24.4%
|
24.7%
|
23.7%
|
23.6%
|
23.6%
|
22.5%
|
22.8%
|
21.3%
|
18.4%
|
Two
years
later
|
-
|
-
|
32.5
|
39.2
|
38.9
|
37.8
|
37.6
|
37.2
|
36.1
|
35.4
|
31.5
|
Three
years
later
|
-
|
-
|
-
|
44.3
|
48.7
|
48.3
|
46.8
|
46.5
|
45.4
|
43.4
|
40.4
|
Four
years
later
|
-
|
-
|
-
|
-
|
51.6
|
54.7
|
53.6
|
52.7
|
51.5
|
50.0
|
45.3
|
Five
years
later
|
-
|
-
|
-
|
-
|
-
|
55.9
|
58.4
|
57.7
|
56.2
|
54.5
|
50.2
|
Six
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
58.6
|
61.7
|
60.3
|
58.3
|
54.0
|
Seven
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
61.3
|
63.8
|
61.9
|
57.5
|
Eight
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
63.1
|
65.2
|
61.1
|
Nine
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
64.4
|
64.4
|
Ten
years
later
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
63.5%
|
(d)
Liability
reestimated (i.e.,
|
|||||||||||
cumulative
payments plus
|
|||||||||||
reestimated
ending liability)
|
|||||||||||
As
of (4):
x
|
|||||||||||
One
year
later
|
-
%
|
95.2%
|
97.6%
|
97.2%
|
98.6%
|
99.6%
|
97.3%
|
96.1%
|
96.2%
|
93.3%
|
94.2%
|
Two
years
later
|
-
|
-
|
94.8
|
97.0
|
98.2
|
101.3
|
98.1
|
94.9
|
93.3
|
89.2
|
88.5
|
Three
years
later
|
-
|
-
|
-
|
95.6
|
99.7
|
102.7
|
100.1
|
96.5
|
93.0
|
87.0
|
83.9
|
Four
years
later
|
-
|
-
|
-
|
-
|
100.4
|
105.8
|
102.2
|
98.0
|
95.1
|
87.1
|
82.4
|
Five
years
later
|
-
|
-
|
-
|
-
|
-
|
106.7
|
105.6
|
100.7
|
96.5
|
89.2
|
82.5
|
Six
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
106.9
|
104.2
|
99.4
|
90.6
|
84.7
|
Seven
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
105.4
|
103.0
|
93.6
|
86.1
|
Eight
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
104.1
|
97.0
|
89.3
|
Nine
years
later
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
98.0
|
92.8
|
Ten
years
later
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
-
%
|
93.8%
|
(e)Redundancy
(deficiency)(5)
|
|||||||||||
for
each
year-end at (a):
|
-
%
|
4.8%
|
5.2%
|
4.4%
|
-0.4%
|
-6.7%
|
-6.9%
|
-5.4%
|
-4.1%
|
2.0%
|
6.2%
|
Average
for
all year-ends
|
|||||||||||
at
(a):
|
0.4%
|
____________
(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).
9
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,
|
|||||||||||||||
2006
|
2005
|
2004
|
2003
|
2002
|
2001
|
2000
|
1999
|
1998
|
1997
|
1996
|
|||||
(a)
Beginning
net reserves
|
$
2,414
|
$
2,182
|
$
1,964
|
$
1,802
|
$
1,678
|
$
1,661
|
$
1,699
|
$
1,742
|
$
1,846
|
$
1,829
|
$
1,821
|
||||
Incurred
claims and claim expenses:
|
|||||||||||||||
(b)
Current
year provision
|
1,295
|
1,191
|
1,070
|
893
|
814
|
749
|
690
|
734
|
728
|
713
|
668
|
||||
(c)
Change in
prior years’ provision
|
(116)
|
(52))
|
(55))
|
(25))
|
(7))
|
(44))
|
(66))
|
(66))
|
(123))
|
(105))
|
(74))
|
||||
(d) Total incurred | 1,179 | 1,138 | 1,014 | 868 | 807 | 704 | 623 | 668 | 604 | 608 | 593 | ||||
Claim
payments on:
|
|||||||||||||||
(e)
Current
years’ events
|
342
|
402
|
332
|
277
|
260
|
269
|
258
|
298
|
322
|
275
|
243
|
||||
(f)
Prior
years’ events
|
326
|
504
|
463
|
428
|
423
|
418
|
402
|
412
|
385
|
316
|
342
|
||||
(g)
Total
payments
|
668
|
907
|
796
|
706
|
683
|
687
|
661
|
710
|
708
|
591
|
585
|
||||
(h)
Ending
net reserves (a + d - g)
|
2,924
|
2,414
|
2,182
|
1,964
|
1,802
|
1,678
|
1,661
|
1,699
|
1,742
|
1,846
|
1,829
|
||||
(i)
Unallocated loss adjustment
|
|||||||||||||||
expense
reserves
|
97
|
92
|
87
|
83
|
78
|
76
|
73
|
71
|
73
|
73
|
71
|
||||
(j)
Reinsurance recoverable on
|
|||||||||||||||
claims
reserves
|
1,929
|
1,894
|
1,632
|
1,515
|
1,363
|
1,261
|
1,235
|
1,238
|
1,190
|
1,232
|
1,296
|
||||
(k)
Gross
claims reserves (h + I + j)
|
$
4,951
|
$
4,401
|
$
3,902
|
$
3,562
|
$
3,244
|
$
3,016
|
$
2,969
|
$
3,009
|
$
3,005
|
$
3,151
|
$
3,197
|
(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 two years, together with investment income for each of the
last
three years:
Consolidated
Investments
|
||||
($
in
Millions)
|
||||
December
31,
|
||||
|
2006
|
2005
|
||
Available
for Sale
|
||||
Fixed
Maturity Securities:
|
||||
U.S.
&
Canadian Governments
|
$
714.7
|
$
713.4
|
||
Tax-Exempt
|
2,229.5
|
1,975.2
|
||
Utilities
|
923.8
|
923.0
|
||
Corporate
|
2,964.4
|
2,719.8
|
||
6,832.6
|
6,331.6
|
|||
Equity
Securities
|
669.1
|
552.4
|
||
Short-term
Investments
|
493.6
|
275.3
|
||
Miscellaneous
Investments
|
52.7
|
62.7
|
||
Total
available for sale
|
8,048.1
|
7,222.2
|
||
Other
Investments
|
7.9
|
8.0
|
||
Total
Investments
|
$
8,056.1
|
$
7,230.2
|
10
Sources
of Consolidated Investment Income
|
||||||||
($
in
Millions)
|
||||||||
Years
Ended
December 31,
|
||||||||
|
2006
|
2005
|
2004
|
|||||
Fixed
Maturity Securities:
|
||||||||
Taxable
|
$
222.5
|
$
219.4
|
$
214.0
|
|||||
Tax-Exempt
|
75.5
|
64.7
|
53.1
|
|||||
298.0
|
284.1
|
267.2
|
||||||
Equity
Securities
|
13.9
|
9.4
|
14.3
|
|||||
Other
Investment Income:
|
||||||||
Interest
on
Short-term Investments
|
26.6
|
15.9
|
5.7
|
|||||
Sundry
|
6.5
|
5.4
|
6.8
|
|||||
33.1
|
21.3
|
12.5
|
||||||
Gross
Investment Income
|
345.1
|
315.0
|
294.1
|
|||||
Less:
Investment Expenses (1)
|
3.5
|
4.9
|
3.2
|
|||||
Net
Investment Income
|
$
341.6
|
$
310.1
|
$
290.8
|
(1) |
Investment
expenses consist primarily of personnel costs, investment management
and
custody service fees and includes interest incurred on funds held
of $1.0,
$.7, and $.3 for the years ended December 31, 2006, 2005, and 2004
respectively.
|
For
many years, Old
Republic's investment policy has been to acquire and retain primarily investment
grade, publicly traded, fixed maturity securities. Accordingly, the Company'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 $4.0 million and $3.2 million of bond or note investments in default
as to principal and/or interest at December 31, 2006 and 2005,
respectively.
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, 2006 have
been classified as “available for sale” pursuant to the existing investment
policy.
The
independent
credit quality ratings and maturity distribution for Old Republic's consolidated
fixed maturity investments, excluding short-term investments, at the end of
the
last two years are shown in the following tables. These investments, $6.8
billion and $6.3 billion at December 31, 2006 and 2005, respectively,
represented approximately 54% and 55%, respectively, of consolidated assets,
and
83% and 84%, respectively, of consolidated liabilities as of such
dates.
Credit
Quality Ratings of Fixed Maturity Securities
(1)
|
|||||
December
31,
|
|||||
2006
|
2005
|
||||
(%
of total
portfolio)
|
|||||
Aaa
|
32.9%
|
32.6%
|
|||
Aa
|
19.0
|
18.4
|
|||
A
|
26.4
|
27.9
|
|||
Baa
|
20.1
|
20.2
|
|||
Total investment grade
|
98.4
|
99.1
|
|||
All
others
(2)
|
1.6
|
.9
|
|||
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.
|
11
Age
Distribution of Fixed Maturity Securities
|
|||||||
December
31,
|
|||||||
2006
|
2005
|
||||||
(%
of total
portfolio)
|
|||||||
Maturity
Ranges:
|
|||||||
Due
in one
year or less
|
9.6%
|
10.9%
|
|||||
Due
after one
year through five years
|
44.4
|
41.5
|
|||||
Due
after
five years through ten years
|
45.6
|
46.9
|
|||||
Due
after ten
years through fifteen years
|
.4
|
.7
|
|||||
Due
after
fifteen years
|
-
|
-
|
|||||
100.0
|
%
|
100.0
|
%
|
||||
Average
Maturity in Years
|
4.5
|
4.7
|
|||||
(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 2006.
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 39.7%, 44.2%, and
41.8% of traditional primary new insurance written in 2006, 2005, and 2004,
respectively. The largest single customer accounted for 8.8% of traditional
primary new insurance written in 2006 compared to 11.5% and 11.7% in 2005 and
2004, 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 and related real estate settlement
products are sold through 263 Company offices and through agencies and
underwritten title companies in Puerto Rico, the District of Columbia and all
50
states. 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 title companies (not themselves title insurers) pursuant to
underwriting agreements. These agreements generally provide that the agency
or
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 2006, approximately 68% 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.
12
At
least one Old
Republic general insurance subsidiary is licensed to do business in each of
the
50 states, the District of Columbia, Puerto Rico, Virgin Islands, Guam, 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 50 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 Consolidated Direct Premiums
Written
|
|||||||||
2006
|
2005
|
2004
|
|||||||
United
States:
|
|||||||||
Northeast
|
8.4
|
%
|
9.2
|
%
|
9.1
|
%
|
|||
Mid-Atlantic
|
8.8
|
9.5
|
8.9
|
||||||
Southeast
|
21.1
|
19.8
|
18.8
|
||||||
Southwest
|
12.8
|
11.8
|
11.8
|
||||||
East
North Central
|
13.3
|
13.3
|
14.6
|
||||||
West
North Central
|
13.0
|
12.7
|
12.7
|
||||||
Mountain
|
8.1
|
7.7
|
7.6
|
||||||
Western
|
11.8
|
13.4
|
14.2
|
||||||
Foreign
(Principally Canada)
|
2.7
|
2.6
|
2.3
|
||||||
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.
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 costs 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 Company 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.
13
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): $1,800,000 for workers' compensation;
$1,800,000 for commercial auto liability; $1,800,000 for general liability;
$4,600,000 for executive protection (directors & officers and errors &
omissions); $1,000,000 for aviation; and $1,000,000 for property coverages.
Substantially all the mortgage guaranty insurance risk is retained, with the
exposure on any one risk currently averaging approximately $23,000, 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 Company 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 once again
to
the $100.0 million level, and as of January 1, 2005, they were 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 program
applies to insured commercial property and casualty losses resulting from an
act
of terrorism, as defined in the TRIA. Congress extended and modified the program
in late 2005 through the Terrorism Risk Insurance Extension Act of 2005 (the
“TRIEA”). The temporary program will now sunset on December 31, 2007 if not
extended or replaced by similar legislation. The TRIA automatically voided
all
policy exclusions which were in effect for terrorism related losses and
obligated insurers to offer terrorism coverage with most commercial property
and
casualty insurance lines. The TRIEA revised the definition of “property and
casualty insurance” to exclude commercial automobile, burglary and theft,
surety, professional liability and farm owners multi-peril insurance. Although
insurers are permitted to charge an additional premium for terrorism coverage,
insureds may reject the coverage. Under TRIEA, the program’s protection is not
triggered for losses arising from an act of terrorism after March 31, 2006
until
the industry first suffers losses of $50 billion in the aggregate in 2006.
The
program trigger amount increases to $100 billion for 2007. Once the program
trigger is met, the program will pay 90% of an insurer’s terrorism losses that
exceed that individual insurer’s deductible. The federal share drops to 85% for
2007. The insurer’s deductible is 17.5% of direct earned premium on property and
casualty insurance for 2006 and increases to 20% for 2007. Insurers may reinsure
that portion of the risk they retain under the program, but the reinsurance
market has not displayed a widespread willingness to accept such risks. To
date,
coverage for acts of terrorism are excluded from substantially all the Company’s
reinsurance treaties and are effectively retained by it subject to any recovery
that would be collected under the temporary federal reinsurance
program.
(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 Company.
The rates charged for many of the insurance coverages in which the Company
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, ex-pertise 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 Company'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 Company 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 Company'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 Company's insurance
coverages, are subject to rate regulations which require that rates be
reasonable, adequate, and not unfairly discriminatory.
14
The
Federal
National Mortgage Association (“FNMA” or “Fannie Mae”) and the Federal Home Loan
Mortgage Corporation (“FHLMC” or “Freddie Mac”) have various qualifying
requirements for private mortgage guaranty insurers which write mortgage
insurance on loans ac-quired 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 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,
2006, Old Republic employed approximately 6,370 persons on a full time basis.
A
majority of eligible full time employees participate in various pension or
similar plans which provide 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 (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 in any of the reports the Company files with the SEC.
Item
1A -
Risk Factors
Risk
factors are
uncertainties and events over which the Company has limited or no control,
and
which can have a materially adverse effect on its business, results of
operations or financial condition. The Company and its business segments
are
subject to a variety of risk factors and, within individual segments, each
type
of insurance coverage may be exposed to varying risk factors. The following
sections set forth management’s evaluation of the most prevalent material risk
factors for the Company as a whole and for each business segment. There may
be
risks, which management does not presently consider material or relative
to
which it has no present knowledge, that may later prove to be material risk
factors as well.
Parent
Company
|
Dividend
Dependence and Liquidity
The
Company is an
insurance holding company with no operations of its own. Its principal assets
consist of the business conducted by its insurance subsidiaries. It relies
upon
dividends from such subsidiaries in order to pay the interest and principal
on
its debt obligations, dividends to its shareholders and corporate expenses.
The
ability of the insurance subsidiaries to declare and pay dividends is subject
to
regulations under state laws that limit dividends based on the amount of their
adjusted unassigned surplus, and require them to maintain minimum amounts of
capital, surplus and reserves. Dividends in excess of the ordinary limitations
can only be declared and paid with prior regulatory approval, of which there
can
be no assurance. The inability of the insurance subsidiaries to pay dividends
in
an amount sufficient to meet debt service and cash dividends on stock, as well
as other cash requirements of the Company could result in liquidity issues
for
Old Republic.
15
Investment
Risks
The
Company’s
invested assets and those of its subsidiaries are centrally managed through
a
wholly-owned asset management subsidiary. Most of the investments consist of
fixed-maturity securities. Changes in interest rates directly affect the income
from, and the market value of fixed-maturity investments and could reduce the
value of the Company’s investment portfolio and adversely affect the Company’s,
and its subsidiaries’, results of operations and financial condition.
A smaller percentage of total investments are in indexed funds and actively
managed equities. A change in general economic conditions, the stock market,
or
many other external factors could adversely affect the value of those
investments and, in turn, the Company’s, or its subsidiaries’ results and
financial condition. Further, the Company manages its fixed-maturity investments
by taking into account the maturities of such securities and the anticipated
liquidity needs of the Company and its subsidiaries. Should the Company suddenly
experience greater than anticipated liquidity needs for any reason, it could
face a liquidity risk that may adversely affect its financial condition or
operating results.
Risk
Factors Common to All
Subsidiaries
|
Excessive
Losses
and Loss Expenses
Although
the
Company’s three major business segments encompass different types of insurance,
the greatest risk factor common to all insurance coverages is excessive losses
due to unanticipated claims frequency, severity or a combination of both. Many
of the factors affecting the frequency and severity of claims depend upon the
type of insurance coverage, but others are shared in common. Severity and
frequency can be affected by unexpectedly adverse outcomes in claims litigation,
often as a result of unanticipated jury verdicts, changes in court-made law,
adverse court interpretations of insurance policy provisions resulting in
increased liability or new judicial theories of liability, together with
unexpectedly high costs of defending claims.
Inadequate
Reserves
Reserves
are the
amounts that an insurance company sets aside for its anticipated policy
liabilities. Claim reserves are an estimate of liability for unpaid claims
and
claims defense and adjustment expenses, and cover both reported as well as
incurred, but not yet reported claims. It is not possible to calculate precisely
what these liabilities will amount to in advance and, therefore, the reserves
represent a best estimate at any point in time. Such estimates are based upon
known historical loss data and expectations of future trends in claims
frequency, severity, interest rates and other considerations which in turn
are
affected by a large variety of factors over which insurers have little or no
control. Reserve estimates are periodically reviewed in light of known
developments and, where necessary, adjusted and refined as circumstances may
warrant. Nevertheless, the reserve-setting process is inherently uncertain.
If
for any of these reasons reserve estimates prove to be inadequate, the Company’s
subsidiaries can be forced to increase their reported liabilities; such an
occurrence could result in a materially adverse impact on their results of
operations and financial condition.
Inadequate
Pricing
Premium
rates are
generally determined on the basis of historical data for claims frequency and
severity as well as related production and other expense patterns. In the event
ultimate claims and expenses exceed historically projected levels, premium
rates
are likely to prove insufficient. Premium rate inadequacy may not become evident
quickly and may require time to correct. Inadequate premiums, much like
excessive losses, if material, can adversely affect the Company’s business,
operating results and financial condition.
Liquidity
Risk
As
indicated above,
the Company manages its fixed-maturity investments with a view toward matching
the maturities of those investments with the anticipated liquidity needs of
its
subsidiaries for the payment of claims and expenses. If a subsidiary suddenly
experienced greater-than-anticipated liquidity needs for any reason, it could
require an injection of funds that might not necessarily be available to the
Company to meet its obligations at a point in time.
Regulatory
Environment
The
Company’s
insurance businesses are subject to extensive governmental regulation in all
of
the state and similar jurisdictions in which they operate. These regulations
relate to such matters as licensing requirements, types of insurance products
that may be sold, premium rates, marketing practices, capital and surplus
requirements, investment limitations, underwriting limitations, dividend payment
limitations, transactions with affiliates, accounting practices, taxation and
other matters. While most of the regulation is at the state level, the federal
government has increasingly expressed an interest in regulating the insurance
business and has injected itself through the Graham-Leach-Bliley Act,
the Patriot Act, financial services regulation, changes in the Internal
Revenue Code and other legislation. All of these regulations raise the costs
of
conducting an insurance business through increased compliance expenses.
Furthermore, as existing regulations evolve through administrative and court
interpretations, and as new regulations are adopted, there can be no way of
predicting what impact these changes will have on the Company’s businesses in
the future, and the impact could adversely affect the Company’s profitability
and limit its growth.
16
Competition
Each
of the
Company’s lines of insurance business is highly competitive and is likely to
remain so for the foreseeable future. Moreover, existing competitors and the
capital markets have brought an influx of capital and newly-organized entrants
into the industry in recent years, and changes in laws have allowed financial
institutions, like banks and savings and loans, to sell insurance products.
Increases in competition threaten to reduce demand for the Company’s insurance
products, reduce its market share, reduce its growth, reduce its profitability
and generally adversely affect its results of operations and financial
condition.
Rating
Downgrades
The
competitive
positions of insurance companies, in general, have come to depend increasingly
on independent ratings of their financial strength and claims-paying ability.
The rating agencies base their ratings on criteria they establish regarding
an
insurer’s financial strength, operating performance, strategic position and
ability to meet its obligations to policyholders. A significant downgrade in
the
ratings of any of the Company’s major policy-issuing subsidiaries could
negatively impact their ability to compete for new business and retain existing
business and, as a result, adversely affect their results of operations and
financial condition.
Financial
Institutions Risk
The
Company’s
subsidiaries have significant business relationships with financial
institutions, particularly national banks. The subsidiaries are the
beneficiaries of a considerable amount of security in the form of letters of
credit which they hold as collateral securing the obligations of insureds and
certain reinsurers. Some of the banks themselves have subsidiaries that reinsure
the Company’s business. Other banks are depositories holding large sums of money
in escrow accounts established by the Company’s title subsidiaries. There is
thus a risk of concentrated financial exposures in one or more such banking
institutions. If any of these institutions fail or are unable to honor their
credit obligations, or if escrowed funds become lost or tied up due to the
failure of a bank, the result could be adverse to the Company’s business,
results of operations and financial condition.
In
addition to the
foregoing, the following are risk factors that are particular to each of the
Company’s three major business segments.
General
Insurance Group
|
Catastrophic
Losses
While
the Company
limits the property exposures it writes, the casualty or liability insurance
it
underwrites creates an exposure to claims arising out of catastrophes. The
two
principal catastrophe exposures are earthquakes and acts of terrorism in areas
where there are large concentrations of employees of an insured employer or
other individuals who could potentially be injured and assert claims against
an
insured.
Following
the
September 11, 2001 terrorist attack, the reinsurance industry eliminated
coverage from substantially all reinsurance contracts for claims arising from
acts of terrorism. The Terrorism Risk Insurance Act of 2002 (“TRIA”)
subsequently passed by the U. S. Congress required primary insurers to offer
coverage for certified acts of terrorism under most commercial property and
casualty insurance policies. Although TRIA established a temporary federal
reinsurance program through December 31, 2005, a program which has recently
been extended for two more years but with reduced coverage, primary insurers
like the Company’s general insurance subsidiaries retain significant exposure
for terrorist act-related losses.
Long-Tailed
Losses
Coverage
for
general liability is considered long-tailed coverage. Written in most cases
on
an “occurrence” basis, it often takes longer for the claims to be reported
and become known, adjusted and settled than it does for property claims, for
example, which are generally considered short-tailed. The extremely long-tailed
aspect of such claims as pollution, asbestos, silicosis, manganism (welding
rod
fume exposure), black lung, lead paint and other toxic tort claims, coupled
with
uncertain and sometimes variable judicial rulings on coverage and policy
allocation issues and the possibility of legislative actions, makes reserving
for these exposures highly uncertain. While the Company believes that it has
reasonably estimated its liabilities for such exposures to date, and that its
exposures are relatively modest, there is a risk of materially adverse
developments in both known and as-yet-unknown claims.
Workers’
Compensation Coverage
Workers’
compensation coverage is the second largest line of insurance written within
the
Company. The frequency and severity of claims under, and the adequacy of
reserves for workers’ compensation claims and expenses can all be significantly
influenced by such risk factors as future wage inflation in states that index
benefits, the speed with which injured employees are able to return to work
in
some capacity, the cost and rate of inflation in medical treatments, the types
of medical procedures and treatments, the cost of prescription medications,
the
frequency with which closed claims reopen for additional or related medical
issues, the mortality of injured workers with lifetime benefits and medical
treatments, the use of health insurance to cover some of the expenses, the
assumption of some of the expenses by states’ second injury funds, the use of
cost containment practices like preferred provider networks, and the
opportunities to recover against third parties through subrogation. Adverse
developments in any of these factors, if significant, could have a materially
adverse effect on the Company’s operating results and financial
condition.
17
Reinsurance
Reinsurance
is a
contractual arrangement whereby one insurer (the reinsurer) assumes some or
all
of the risk exposure written by another insurer (the reinsured). The Company
uses reinsurance to manage its risks both in terms of the amount of coverage
it
is able to write, the amount it is able to retain for its own account, and
the
price at which it is able to write it. The availability of reinsurance and
its
price, however, are determined in the reinsurance market by conditions beyond
the Company’s control.
Reinsurance
does
not relieve the reinsured company of its primary liability to its insureds
in
the event of a loss. It merely reimburses the reinsured company. The ability
and
willingness of reinsurers to honor their obligations represent credit risks
inherent in reinsurance transactions. The Company addresses these risks by
limiting its reinsurance to those reinsurers it considers the best credit risks.
In recent years, however, there has been an ever-decreasing number of reinsurers
considered to be acceptable risks by the Company.
There
can be no
assurance that the Company will be able to find the desired or even adequate
amounts of reinsurance at favorable rates from acceptable reinsurers in the
future. If unable to do so, the Company would be forced to reduce the volume
of
business it writes or retain increased amounts of liability exposure. Because
of
the declining number of reinsurers the Company finds acceptable, there is a
risk
that too much reinsurance risk may become concentrated in too few reinsurers.
Each of these results could adversely affect the Company’s business, results of
operations and financial condition.
Insureds
as
Credit Risks
A
significant
amount of the Company’s liability and workers’ compensation business,
particularly for large commercial insureds, is written on the basis of
risk-sharing underwriting methods utilizing large deductibles, captive insurance
risk retentions, or other arrangements whereby the insureds effectively retain
and fund varying and at times significant amounts of their losses. Their
financial strength and ability to pay are carefully evaluated as part of the
underwriting process and monitored periodically thereafter, and their retained
exposures are estimated and collateralized based on pertinent credit analysis
and evaluation. Because the Company is primarily liable for losses incurred
under its policies, the possible failure or inability of insureds to honor
their
retained liability represents a credit risk. Any subsequently developing
shortage in the amount of collateral held would also be a risk, as would the
failure or inability of a bank to honor a letter of credit issued as collateral.
These risk factors could have a material adverse impact on the Company’s results
of operations and financial condition.
Guaranty
Funds
and Residual Markets
In
nearly all
states, licensed property and casualty insurers are required to participate
in
guaranty funds through assessments covering a portion of insurance claims
against impaired or insolvent property and casualty insurers. Any increase
in
the number or size of impaired companies would likely result in an increase
in
the Company’s share of such assessments.
Many
states have
established second-injury funds that compensate injured employees for
aggravation of prior injuries or conditions. These second-injury funds are
funded by assessments or premium surcharges.
Residual
market or
pooling arrangements exist in many states to provide various types of insurance
coverage to those that are otherwise unable to find private insurers willing
to
insure them. All licensed property and casualty insurers writing such coverage
voluntarily are required to participate in these residual market or pooling
mechanisms.
A
material increase
in any of these assessments or charges could adversely affect the Company’s
results of operations and financial condition.
Prior
Approval
of Rates
Most
of the lines
of insurance underwritten by the Company are subject to prior regulatory
approval of premium rates in a majority of the states. The process of securing
regulatory approval can be time consuming and can impair the Company’s ability
to effect necessary rate increases in an expeditious manner. Furthermore, there
is a risk that the regulators will not approve a requested increase,
particularly in regard to workers’ compensation insurance with respect to which
rate increases often confront strong opposition from local business and
political interests.
18
Mortgage
Guaranty Group
|
Housing
and
Mortgage Lending Markets
Any
significant
development which adversely affects the housing and related mortgage lending
markets could be a risk factor for the Company’s mortgage insurance
subsidiaries. Rising mortgage interest rates, increases in unemployment or
recessions and the general health of the national or regional economies are
all
factors that could result in a decline of new business. A significant downturn
in the economy and rising unemployment could also result in an increase in
mortgage defaults and, in turn, an increase in claims under the subsidiaries’
policies. Declining home values could also result in greater severity of claim
costs. The affordability and rate of housing price escalation are also factors
because mortgage insurance generally applies only to mortgage loans with
loan-to-value ratios exceeding 80%.
On
the other hand,
low interest rates can also be a risk factor inasmuch as they can threaten
persistency of coverage. Declining rates can encourage mortgage refinance
activity. When a mortgage loan insured by the Company is refinanced, there
is a
risk the lender will replace the Company’s coverage with coverage written by
another mortgage insurer or, alternatively, that coverage may no longer be
necessary in the event that price appreciation of the property has served to
reduce the loan-to-value ratio below 80%. Each of these factors, if significant
enough, could have a materially adverse affect on the business, results of
operations and financial condition of the Company’s mortgage guaranty
subsidiaries.
Competition
Competition
is
always a risk factor and comes not only from the six other mortgage insurers
which comprise the industry, but also from government-sponsored enterprises
(“GSE”), such as Fannie Mae and Freddie Mac, and the insured mortgage lenders
themselves. The market for private mortgage insurance exists primarily as a
result of restrictions within the federal charters of the GSEs which require
an
acceptable form of credit enhancement on loans purchased by the GSEs that have
loan to value (LTV) ratios in excess of 80%. These institutions establish the
levels of required coverage, the underwriting standards for the loans they
will
purchase and the loss mitigation efforts that must be followed on insured loans.
Changes in any of these respects can result in a reduction of the Mortgage
Guaranty Group’s business or an increase in its claim costs.
Lender
consolidation has resulted in fewer lenders originating a greater share of
all
mortgage loans. In 2006, 47% of all mortgage loans were purchased or
originated by the top 5 nationwide lenders. Consequently, mortgage
insurance business is increasingly becoming controlled by a small number of
nationwide mortgage lenders, some of which have reduced the number of mortgage
insurers they do business with, thus increasing competition among the
insurers.
Increasingly,
mortgage lenders have organized their own captive reinsurers as a means of
extending their business to the underwriting of mortgage guaranty risks. Through
such captives they provide excess of loss, and in some cases, quota share
reinsurance protection to the mortgage guaranty insurers such as the Company’s
subsidiaries in this segment. This involvement is a competitive risk factor
inasmuch as it reduces the amount of business that the Company could otherwise
retain.
Other
competitive
risk factors faced by the Company’s Mortgage Guaranty Group stem from certain
credit enhancement alternatives to private mortgage insurance. These
include:
· |
the
use of
so-called piggy-back or 80-10-10 type mortgage loan extensions whose
effect is to eliminate the need for mortgage guaranty insurance by
structuring the mortgage note as an 80% loan-to-value first
mortgage;
|
· |
the
retention
of mortgage loans on an uninsured basis in the lender’s portfolio of
assets;
|
· |
the
use of
alternative mortgage insurance programs such as those afforded by
the
Federal Housing and Veterans Administrations;
and
|
· |
capital
markets utilizing alternative credit
enhancements.
|
Litigation
and
Regulation
The
possibly
adverse effect of litigation and regulation are ever present risk factors.
Captive reinsurance and other risk-participating structures with mortgage
lenders have been challenged in recent years as potential violations of the
Real
Estate Settlement Procedures Act (“RESPA”). From time to time, the U. S.
Department of Housing and Urban Development has considered adopting RESPA
regulations which would have adversely impacted mortgage insurance by requiring
that the premiums be combined with all other settlement service charges in
a
single package fee. Adverse litigation or regulatory developments could have
a
materially adverse effect on the Company’s mortgage guaranty business, results
of operations and financial condition.
19
Title
Insurance Group
|
Housing
and
Mortgage Lending Markets
The
fortunes of
title insurance are even more directly tied to the level of real estate activity
than are those of mortgage insurance. The principal risk factor for title
insurance is a decline in residential real estate activity. The major factors
that can impact real estate activity adversely include:
· |
high
or
rising mortgage interest rates;
|
· |
high
or
rising unemployment;
|
· |
any
downturn
in a regional or the national economy, any reduction in the availability
or affordability of housing, as well as, any precipitous decline
in
housing prices;
|
· |
any
reduction
in mortgage refinancing activity;
and
|
· |
any
reduction
in the availability of mortgage
funding.
|
A
significant
adverse development among any of these risk factors could have a materially
adverse effect on the Company’s title insurance business, results of operations
and financial condition.
Competition
Business
comes to
title insurers primarily by referral from real estate agents, lenders,
developers and other settlement providers. The sources of business lead to
a
great deal of competition among title insurers. Although the top five title
insurance companies account for about 90% of industry-wide premium volume,
there
are numerous smaller companies representing the remainder at the regional and
local levels. The smaller companies are an ever-present competitive risk in
the
regional and local markets where their business connections can give them a
competitive edge. Moreover, there is almost always competition among the major
companies for key employees, especially those who are engaged in the production
side of the business.
Regulation
and
Litigation
Regulation
is also
a risk factor for title insurers. The title insurance industry has recently
been, and continues to be, under intense regulatory scrutiny in a number of
states with respect to pricing practices, and possible RESPA violations and
unlawful rebating practices. The regulatory investigations could lead to
industry-wide reductions in premium rates and escrow fees, the inability to
get
rate increases when necessary, as well as to changes that could adversely affect
the Company’s ability to compete for or retain business or raise the costs of
additional regulatory compliance.
As
with the
Company’s other business segments, litigation poses a risk factor. Recent
litigation in a number of states seeks class certification in actions against
a
number of title insurers alleging violations of rate applications in those
states with respect to title insurance issued in certain mortgage refinancing
transactions.
Other
Risks
Inadequate
title
searches are among the risk factors faced by the entire industry. If a title
search is conducted thoroughly and accurately, there should theoretically never
be a claim. When the search is less than thorough or complete, title defects
can
go undetected and claims result.
To
a lesser extent,
fraud is also a risk factor for all title companies -- sometimes in the form
of
an agent’s or an employee’s defalcation of escrowed funds, sometimes in the form
of fraudulently issued title insurance policies.
Item
1B -
Unresolved Staff Comments
None
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 57% 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 owned headquarters building. This building contains 110,000 square feet
of
floor space of which approximately 65% is occupied by the Old Republic National
Title Insurance Company. The remainder of the building is leased to others.
Eleven 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, 2006
was
approximately $39.3 million.
20
Certain
other
operations of the Company and its subsidiaries are directed from leased
premises. See Note 4(b) of the Notes to Consolidated Financial Statements for
a
summary of all material lease obligations.
Item
3
- Legal
Proceedings
Legal
proceedings
against the Company arise in the normal course of business and usually pertain
to claim matters related to insurance policies and contracts issued by its
in-surance subsidiaries. Other legal proceedings are discussed
below.
Purported
class
actions have been filed against the Company’s principal title insurance
subsidiary, Old Republic National Title Insurance Company (“ORNTIC”) in state
courts in Connecticut, Florida, New Jersey, Ohio, and Pennsylvania. The
plaintiffs allege that, pursuant to rate schedules filed by ORNTIC or by state
rating bureaus with the state insurance regulators, ORNTIC was required to,
but
failed to give consumers reissue credits on the premiums charged for title
insurance covering mortgage refinancing transactions. Substantially similar
lawsuits have been filed against other unaffiliated title insurance companies
in
these and other states as well. The actions seek damages and declaratory and
injunctive relief. ORNTIC has reached a tentative settlement in Florida for
an
amount not to exceed $1.2 million, exclusive of attorneys’ fees and costs.
ORNTIC intends to defend vigorously against the actions in the other states
as
well but, at this stage in the litigation, the Company cannot estimate the
ultimate costs it may incur as the actions proceed to their
conclusions.
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
sought 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 sought statutory and punitive damages, as well as other costs. A
settlement agreement was reached in the action on November 29, 2006 and awaits
final court approval. While the ultimate cost of the settlement will depend
upon
the number of consumers who participate, the Company reasonably expects the
cost
to be under $1 million.
Item
4 -
Submission of Matters to a Vote of Security Holders
None.
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
|
2005
|
$
|
20.10
|
$
|
18.41
|
$
|
.104
|
|||
2nd
quarter
|
2005
|
20.39
|
17.85
|
.136
|
||||||
3rd
quarter
|
2005
|
21.34
|
20.02
|
.136
|
||||||
4th
quarter
|
2005
|
22.44
|
19.88
|
.136
|
||||||
Special
Dec.
|
2005
|
$
|
-
|
$
|
-
|
$
|
.800
|
(1)
|
||
1st
quarter
|
2006
|
$
|
22.35
|
$
|
20.72
|
$
|
.140
|
|||
2nd
quarter
|
2006
|
22.35
|
20.20
|
.150
|
||||||
3rd
quarter
|
2006
|
22.15
|
20.79
|
.150
|
||||||
4th
quarter
|
2006
|
$
|
23.50
|
$
|
22.04
|
$
|
.150
|
_______________
(1) In December, 2005 a special cash dividend of $.800 per share (adjusted for a concurrent 25% stock dividend of the Company’s
(1) In December, 2005 a special cash dividend of $.800 per share (adjusted for a concurrent 25% stock dividend of the Company’s
common stock)
was declared
and paid.
As
of January 31,
2007, there were 2,931 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,
2006.
The
Company made no
common stock repurchases during 2006 under its common stock repurchase
plan.
21
Comparative
Five-Year Performance Graph for Common Stock
The
following
table, prepared on the basis of market and related data furnished by Standard
& Poor's Total Return Service, reflects total market return data for the
most recent five calendar years ended December 31, 2006. For purposes of the
presentation, the information is shown in terms of $100 invested at the close
of
trading on the last trading day preceding the first day of the fifth preceding
year. The $100 investment is deemed to have been made either in Old Republic
Common Stock, in the S&P 500 Index of common stocks, or in an aggregate of
the common shares of the Peer Group of publicly held insurance businesses
selected by Old Republic. In each instance the cumulative total return assumes
reinvestment of cash dividends on a pretax basis.
The
information
utilized to prepare this table has been obtained from sources believed to be
reliable, but no representation is made that it is accurate or complete in
all
respects.
Comparison
of Five Year Total Market Return
OLD
REPUBLIC INTERNATIONAL CORPORATION vs. S&P 500 vs. Peer
Group
(For
the
five years ended December 31, 2006)
![Comparison of 5 Year Total Market Return Performance Graph](https://www.sec.gov/Archives/edgar/data/0000074260/000007426007000021/graph.jpg)
Dec
01
|
Dec
02
|
Dec
03
|
Dec
04
|
Dec
05
|
Dec
06
|
||||||
ORI
|
$100.00
|
$102.09
|
$145.28
|
$147.91
|
$163.47
|
$186.10
|
|||||
S&P
500
|
100.00
|
77.90
|
100.25
|
111.15
|
116.61
|
135.03
|
|||||
Peer
Group 1
|
100.00
|
84.33
|
104.64
|
115.36
|
134.56
|
151.55
|
|||||
Peer
Group
2
|
100.00
|
85.94
|
107.62
|
120.30
|
140.58
|
158.38
|
Peer
Group 1
consists of the following publicly held corporations selected by the Company
for
its 2001 to 2006 comparison: Ace Limited, American Financial Group, Inc.,
The
Chubb Corporation, Cincinnati Financial Corporation, First American Corporation,
LandAmerica Financial Group, MGIC Investment Corporation, Ohio Casualty
Corporation, Radian Group Inc., SAFECO Corporation, St. Paul Travelers
Companies, Inc. and XL Capital Ltd. The composition of Peer Group 1 has been
approved by the Compensation Committee. It is comprised of the same companies
as
last year’s Peer Group except for one company (Fidelity National Financial Inc.)
that was replaced by LandAmerica Financial Group because a spin-off by the
former resulted in a change of its consolidated business mix which is not
as
representative of the Company’s business mix. Peer Group 2 consists of the same
companies used by the Company for its 2005 peer group
comparison.
22
Item
6 - Selected Financial Data
($
in millions, except share
data)
|
December
31,
|
||||
2006
|
2005
|
|||
FINANCIAL
POSITION:
|
||||
Cash and Invested Assets (1)
|
$
8,230.8
|
$
7,394.1
|
||
Other Assets
|
4,381.4
|
4,149.0
|
||
Total Assets
|
$
12,612.2
|
$
11,543.2
|
||
Liabilities, Other than Debt
|
$
8,098.6
|
$
7,376.4
|
||
Debt
|
144.3
|
142.7
|
||
Total Liabilities
|
8,243.0
|
7,519.1
|
||
Preferred Stock
|
-
|
-
|
||
Common Shareholders' Equity
|
4,369.2
|
4,024.0
|
||
Total Liabilities and Shareholders’ Equity
|
$
12,612.2
|
$
11,543.2
|
||
Total
Capitalization (2)
|
$
4,513.5
|
$
4,166.7
|
||
Years
Ended
December 31,
|
|||||||
2006
|
2005
|
2004
|
|||||
RESULTS
OF OPERATIONS:
|
|||||||
Net Premiums and Fees Earned
|
$
3,400.5
|
$
3,386.9
|
$
3,116.1
|
||||
Net Investment and Other Income
|
374.6
|
354.0
|
327.5
|
||||
Realized Investment Gains
|
19.0
|
64.9
|
47.9
|
||||
Net
Revenues
|
3,794.2
|
3,805.9
|
3,491.6
|
||||
Benefits, Claims, and
|
|||||||
Settlement Expenses
|
1,539.6
|
1,465.4
|
1,307.9
|
||||
Underwriting and Other Expenses
|
1,574.3
|
1,593.0
|
1,532.7
|
||||
Pretax Income
|
680.1
|
747.3
|
650.9
|
||||
Income Taxes
|
215.2
|
195.9
|
215.9
|
||||
Net Income
|
$
464.8
|
$
551.4
|
$
435.0
|
||||
COMMON
SHARE DATA: (3)
|
|||||||
Net Income:
|
|
||||||
Basic
|
$
2.01
|
$
2.40
|
$
1.91
|
||||
Diluted
|
$
1.99
|
$
2.37
|
$
1.89
|
||||
Dividends:
Cash -
Regular
|
$
.590
|
$
.512
|
$
.402
|
||||
-
Special
(4)
|
-
|
.800
|
-
|
||||
-
Total
|
$
.590
|
$
1.312
|
$
.402
|
||||
Stock |
-%
|
25%
|
-%
|
||||
Book Value
|
$
18.91
|
$
17.53
|
$
16.94
|
||||
Common Shares (thousands):
|
|||||||
Outstanding
|
231,047
|
229,575
|
228,204
|
||||
|
|||||||
Average: Basic
|
231,017
|
229,487
|
228,177
|
||||
Diluted
|
233,034
|
232,108
|
230,759
|
||||
(1) Consists
of cash,
investments and investment income due and accrued.
(2) Total
capitalization consists of debt, preferred stock, and common shareholders'
equity.
(3) All
per share
statistics herein have been restated to reflect all stock dividends or splits
declared through December 31, 2006.
(4) A
special cash
dividend of $.800 per share was paid in December 2005.
23
Item
7 -
Management Analysis of Financial Position and Results of
Operations
($
in
Millions, Except Share Data)
OVERVIEW
|
This
management
analysis of financial position and results of operations pertains to the
consolidated accounts of Old Republic International Corporation (“Old Republic”
or “the Company”). The Company conducts its operations through three major
regulatory segments, namely, its General (property and liability), Mortgage
Guaranty, and Title insurance segments. A small life and health insurance
business, accounting for approximately 2% of both consolidated revenues for
the
year ended December 31, 2006 and consolidated assets as of December 31, 2006,
is
included within the corporate and other caption of this report. The consolidated
accounts are presented on the basis of generally accepted accounting principles
(“GAAP”). This management analysis should be read in conjunction with the
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 and overall operating performance trends over succeeding
five to ten year intervals. Such time intervals are likely to encompass one
or
two economic and/or underwriting cycles, and provide appropriate time frames
for
such cycles to run their course and for reserved claim costs to be quantified
with greater finality and effect.
EXECUTIVE
SUMMARY
|
During
2006, Old
Republic’s business posted new financial performance records. Assets exceeded
$12.6 billion and common shareholders’ equity climbed above $4.3 billion.
Consolidated earnings for the year ended December 31, 2006 benefited from the
continued strength of General Insurance lines. The Company’s Mortgage Guaranty
segment posted slightly lower results, while Title operations were affected
by
significant downturns in housing and related mortgage lending markets. Favorable
investment income trends throughout Old Republic’s operating groups attenuated
moderately lower underwriting/service profitability. Consolidated results for
2006 and 2005 were also affected differently by certain unusual charges or
credits. Pursuant to recently issued accounting rules, 2006 earnings were
constrained by accelerated recognition of stock option costs which resulted
in
an incremental expense of $3.7 ($2.4 after tax, or one cent per diluted share).
On the other hand, 2005 earnings were enhanced by a non-recurring recovery
of
income taxes and related accumulated interest of $57.9 ($45.9 net of tax, or
20
cents per diluted share). The recovery was related to tax returns for the three
years ended December 31, 1990.
24
Consolidated
Results - The
major
components of Old Republic’s consolidated results were as follows for the
periods being reported on:
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||||
Operating
Revenues:
|
||||||||||||
General
insurance
|
$
|
2,138.7
|
$
|
2,017.6
|
$
|
1,822.5
|
||||||
Mortgage
guaranty
|
529.9
|
516.0
|
489.9
|
|||||||||
Title
insurance
|
1,007.3
|
1,108.6
|
1,051.8
|
|||||||||
Corporate
and
other
|
99.2
|
98.6
|
79.3
|
|||||||||
Total
|
$
|
3,775.2
|
$
|
3,741.0
|
$
|
3,443.7
|
||||||
Pretax
operating income (loss):
|
||||||||||||
General
insurance
|
$
|
401.6
|
$
|
350.0
|
$
|
333.0
|
||||||
Mortgage
guaranty
|
228.4
|
243.7
|
224.5
|
|||||||||
Title
insurance
|
31.0
|
88.7
|
62.5
|
|||||||||
Corporate
and
other
|
-
|
(.1)
|
|
(17.2)
|
||||||||
Sub-total
|
661.1
|
682.4
|
602.9
|
|||||||||
Realized
investment gains (losses):
|
||||||||||||
From
sales
|
19.0
|
74.1
|
53.2
|
|||||||||
From
impairments
|
-
|
(9.2)
|
|
(5.2)
|
||||||||
Net
realized
investment gains
|
19.0
|
64.9
|
47.9
|
|||||||||
Consolidated
pretax income
|
680.1
|
747.3
|
650.9
|
|||||||||
Income
taxes
|
215.2
|
195.9
|
215.9
|
|||||||||
Net
income
|
$
|
464.8
|
$
|
551.4
|
$
|
435.0
|
||||||
Consolidated
underwriting ratio:
|
||||||||||||
Benefits
and
claims
|
45.3
|
%
|
43.3
|
%
|
42.0
|
%
|
||||||
Expenses
ratio
|
44.7
|
45.2
|
%
|
47.3
|
%
|
|||||||
Composite
ratio
|
90.0
|
%
|
88.5
|
%
|
89.3
|
%
|
||||||
Components
of diluted net income per share:
|
||||||||||||
Net
operating
income:
|
||||||||||||
Before
non-recurring income tax benefit
|
$
|
1.94
|
$
|
1.99
|
$
|
1.75
|
||||||
2005
non-recurring income tax benefit
|
-
|
.20
|
-
|
|||||||||
Total
|
1.94
|
2.19
|
1.75
|
|||||||||
Net
realized
investment gains
|
.05
|
.18
|
.14
|
|||||||||
Net
income
|
$
|
1.99
|
$
|
2.37
|
$
|
1.89
|
The
table above
presents consolidated results in terms of both operating and net income to
highlight the effects of investment gain or loss recognition and non-recurring
items on period-to-period comparisons. Operating income, however, does not
replace net income computed in accordance with Generally Accepted Accounting
Principles (“GAAP”) as a measure of total profitability. The recognition of
investment gains or losses can be highly discretionary and arbitrary due to
such
factors as the timing of individual securities sales, recognition of estimated
losses from write-downs for 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. Likewise, non-recurring items such as the income tax recovery described
above, can distort the comparability of the Company’s operating performance from
period-to-period. Accordingly, management uses the non-GAAP financial measures
to evaluate and explain operating performance, and believes their use enhances
an understanding of Old Republic’s results.
During
the final
quarters of 2005 and 2004, the Company liquidated approximately 55% and 50%,
respectively, of its then actively managed equity investment portfolios. As
a
result, above average net realized investment gains of $40.3 and $25.2,
respectively, were registered in these periods. A significant portion of the
sales proceeds were redirected toward index-style investment portfolios.
Approximately 84% and 87% of total equity investments at December 31, 2006
and
2005, respectively, were committed to such indexed portfolios, and the remaining
16% and 13%, respectively, represented actively managed equity investment
portfolios.
25
General
Insurance Results - The
General
Insurance Group continued to post favorable operating results. Key indicators
of
that performance follow:
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||||
Net
premiums
earned
|
$
|
1,902.1
|
$
|
1,805.2
|
$
|
1,623.0
|
||||||
Net
investment income
|
221.5
|
197.0
|
183.4
|
|||||||||
Pretax
operating income
|
$
|
401.6
|
$
|
350.0
|
$
|
333.0
|
||||||
Claims
ratio
|
65.9
|
%
|
66.9
|
%
|
65.9
|
%
|
||||||
Expense
ratio
|
24.4
|
24.6
|
24.8
|
|||||||||
Composite
ratio
|
90.3
|
%
|
91.5
|
%
|
90.7
|
%
|
General
Insurance
earned premium growth for the past three years reflects the positive pricing
and
risk selection changes effected since 2000 in particular, as well as additional
business produced in an environment marked by reasonably stable underwriting
discipline on the part of many competitors. Premiums earned registered 5.4%
growth for 2006. Substantially all 2006 premium growth stemmed from trucking
insurance, home warranty, and financial indemnity insurance coverages. Loss
costs remained at very acceptable levels for most major coverages, continuing
to
benefit from reasonably contained inflationary pressures on claim settlement
costs and favorable overall development of prior years’ reserves. Production and
general operating expenses remained well aligned with premium growth. Through
year-end 2006, the composite underwriting ratio of claims and expenses, the
most
widely accepted indicator of underwriting performance in the industry, has
now
registered positive outcomes for five consecutive years. Net investment income
rose on the strength of higher market yields and a greater invested asset
base.
Claim
costs
attributable to hurricane damages added less than one percentage point to the
composite ratio for 2005. Old Republic’s business is concentrated on liability
rather than property coverages. The slight decline in underwriting results
for
2005 relative to 2004 was more than offset by an increase in net investment
income.
Mortgage
Guaranty Results - Old
Republic’s
Mortgage Guaranty Group has performed within expectations in recent years.
Key
indicators of the Group’s performance are shown below:
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||||
Net
premiums
earned
|
$
|
444.3
|
$
|
429.5
|
$
|
403.2
|
||||||
Net
investment income
|
74.3
|
70.1
|
67.7
|
|||||||||
Pretax
operating income
|
$
|
228.4
|
$
|
243.7
|
$
|
224.5
|
||||||
Claims
ratio
|
42.8
|
%
|
37.2
|
%
|
35.5
|
%
|
||||||
Expense
ratio
|
22.5
|
22.4
|
25.6
|
|||||||||
Composite
ratio
|
65.3
|
%
|
59.6
|
%
|
61.1
|
%
|
Mortgage
Guaranty
Group pretax operating income for 2006 reflects a moderate decline in
underwriting/service profitability partially offset by net investment income
growth. For the three most recent years, premium revenue trends have responded
to a combination of improving persistency, lower overall mortgage originations,
and varying levels of bulk insurance production. The composite underwriting
ratio for the past three years has been affected negatively by a fairly
persistent rise in the claims ratio, while a decline in the expense ratio has
been a positive offsetting factor. The claims ratio has risen due to the
combination of increased paid claims, as well as higher claim frequency and
severity levels. Production and administrative expenses remained largely within
an approximate range of 22.5% to 25.5% for the periods reported upon. The higher
ratio in 2004 resulted from greater stock option compensation expenses offset
by
recovery of certain prior years’ litigation costs. In concert with higher market
yield trends in Old Republic’s overall business, Mortgage Guaranty net
investment income has trended higher in the past three years even though the
invested asset base has been reduced due to high shareholder dividend payments
by the Group.
Title
Insurance Results - Old
Republic’s
Title Insurance segment registered a substantial drop in profitability for
2006.
Key indicators of that performance follow:
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||||
Net
premiums
and fees earned
|
$
|
980.0
|
$
|
1,081.8
|
$
|
1,025.2
|
||||||
Net
investment income
|
26.9
|
26.0
|
25.5
|
|||||||||
Pretax
operating income
|
$
|
31.0
|
$
|
88.7
|
$
|
62.5
|
||||||
Claims
ratio
|
5.9
|
%
|
6.0
|
%
|
5.8
|
%
|
||||||
Expense
ratio
|
93.6
|
88.2
|
90.5
|
|||||||||
Composite
ratio
|
99.5
|
%
|
94.2
|
%
|
96.3
|
%
|
Title
premium and
fee revenues dropped by 9.4% in 2006 and profit margins from
underwriting/service operations deteriorated as housing and related mortgage
lending activity reflected significant downtrends throughout 2006. Substantially
all the margin compression occurred in the segment’s direct
operations, most of which are concentrated in the Western United
States. Revenues
in that
region alone dropped by 29.7% in 2006. The resulting production levels in those
states have been lower than
necessary to
support the fixed portion of the operating expense structure. 2006 pretax
operating income was also affected by special charges of approximately $7.0.
The
charges stem from estimated adjustments to filed premium rate classifications,
and from additional expense provisions associated with ongoing industry-wide
class action litigation. As a consequence of all these factors, Old Republic’s
Title segment posted the higher 2006 composite underwriting ratio shown in
the
above table. While investment income reflected moderate growth, the increase
was
largely insufficient to counteract the reduction in underwriting/service
profitability.
26
Title
insurance
premiums and fees increased by 5.5% in 2005 and dropped by 7.1% in 2004. The
decline in 2004 and modest growth achieved in 2005 are generally reflective
of a
significant reduction in mortgage refinance activity beginning in mid-2003.
The
higher composite ratio for 2004 was impacted by a 2.2 percentage point increase
due to title litigation costs incurred of $22.2, as well as a lower revenue
base. The 2.1 percentage point improvement in the 2005 composite ratio was
the
result of a drop in the expense ratio from the absence of this litigation cost,
offset by a slight increase in the claims ratio.
Corporate
and Other Operations -
Old Republic’s
small life and health business, and the net costs associated with the parent
holding company and its corporate services subsidiaries produced near break-even
results in 2006, and pretax operating deficits of $.1 and $17.2 for 2005 and
2004, respectively. Period-to-period variability in the results of these
relatively minor elements of Old Republic’s operations usually stems from the
volatility inherent to the Company’s small scaled life and health business and
fluctuations in the timing of expense recognition related to costs such as
the
aforementioned stock option expenses. The significant operating deficit for
2004
was affected by a pretax charge of $10.5 for previously deferred term-life
acquisition costs.
Cash,
Invested Assets, and Shareholders’ Equity - The
following table
reflects the consolidated cash and invested assets as well as shareholders’
equity at the dates shown:
As
of
December 31,
|
2006
|
2005
|
|||
Cash
and
invested assets
|
$
|
8,230.8
|
$
|
7,394.1
|
|
Shareholders’
equity:
|
|||||
Total
|
4,369.2
|
4,024.0
|
|||
Per
share
|
$
|
18.91
|
$
|
17.53
|
|
Composition
of shareholders’ equity per share:
|
|||||
Equity
before
items below
|
$
|
18.72
|
$
|
17.26
|
|
Unrealized
investment gains or losses and
|
|||||
other accumulated comprehensive income
|
.19
|
.27
|
|||
Total
|
$
|
18.91
|
$
|
17.53
|
The
investment
portfolio reflects a current allocation of approximately 85% to fixed-maturity
securities, and 8% to equities most of which are committed to several indexed
stock portfolios. As has been the case for many years, Old Republic’s invested
asset base is structured to address enterprise-wide risk management
considerations, and to assure a solid funding of its subsidiaries’ long-term
obligations to insurance beneficiaries. As a result, it contains little or
no
exposure to real estate investments, mortgage-backed securities, derivatives,
junk bonds, non-liquid private equity commitments, or mortgage loans.
The
latest periods’
changes in the shareholders’ equity account reflect principally additions from
earnings in excess of dividend payments.
Effective
January
1, 2006, the Company reclassified its long-term investments in U.S. Treasury
Tax
and Loss Bonds held by its mortgage guaranty insurance subsidiaries. The
reclassification is intended to conform to more common industry reporting
practices and to better align such assets with the corresponding long-term
deferred income tax liabilities to which they relate. As a result of this
reclassification, invested asset balances have been reduced and the prepaid
income tax asset has been increased, and periodic cash flow from operating
and
investing activities have been adjusted by the correspondingly identical amounts
shown in the following tables. The reclassification has no effect on the
financial position or net income of the Company, nor does it call for the
receipt or disbursement of any additional cash resources. The following table
shows the effect of these adjustments on pertinent financial statement
performance indicators as of the balance sheet dates and for the periods
shown.
As
of
December 31,
|
2006
|
2005
|
2004
|
|||||
Cash
and
invested assets:
|
||||||||
Previous
classification
|
$
|
8,699.3
|
$
|
7,939.9
|
$
|
7,519.5
|
||
After
reclassification
|
8,230.8
|
7,394.1
|
7,020.2
|
|||||
Change
|
(468.4
|
)
|
(545.7
|
)
|
(499.3)
|
|||
Total
other
assets:
|
||||||||
Previous
classification
|
3,913.0
|
3,603.2
|
3,051.3
|
|||||
After
reclassification
|
4,381.4
|
4,149.0
|
3,550.6
|
|||||
Change
|
$
|
468.4
|
$
|
545.7
|
$
|
499.3
|
27
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||
Cash
flows
from operating activities:
|
||||||||
Previous
classification
|
$
|
927.4
|
$
|
880.0
|
$
|
828.3
|
||
After
reclassification
|
1,004.7
|
833.6
|
775.5
|
|||||
Change
|
77.3
|
(46.4
|
)
|
(52.8)
|
||||
Cash
flows
from investing activities:
|
||||||||
Previous
classification
|
(810.1
|
)
|
(589.9
|
)
|
(734.1)
|
|||
After
reclassification
|
(887.4
|
)
|
(543.5
|
)
|
(681.3)
|
|||
Change
|
$
|
(77.3
|
)
|
$
|
46.4
|
$
|
52.8
|
Each
of the
Company’s major segments have registered positive operating cash flow during the
past three years. Consolidated operating cash flow amounted to $1,004.7 for
2006
versus $833.6 for 2005 and $775.5 for 2004. 2006 operating cash flow was
enhanced by approximately $198 as a result of the acquisition of a casualty
book
of insurance business in the final quarter of the year. On the other hand,
2005
operating cash flow benefited from the aforementioned non-recurring tax recovery
of $45.9.
TECHNICAL
MANAGEMENT
ANALYSIS
|
CRITICAL
ACCOUNTING ESTIMATES
|
The
Company’s
annual and interim financial statements incorporate a large number and types
of
estimates relative to matters which are highly uncertain at the time the
estimates are made. The estimation process required of an insurance enterprise
is by its very nature highly dynamic inasmuch as it necessitates a continual
process of evaluating, analyzing, and quantifying factual data as it becomes
known to the Company. As a result, actual experienced outcomes can differ from
the estimates made at any point in time, and thus affect future periods’
reported revenues, expenses, net income, and financial condition.
Old
Republic
believes that its most critical accounting estimates relate to: a) the
determination of other-than-temporary impairments in the value of fixed maturity
and equity investments; b) the establishment of deferred acquisition costs
which
vary directly with the production of insurance premiums; c) the recoverability
of reinsured paid and/or outstanding losses; and d) the reserves for losses
and
loss adjustment expenses. The major assumptions and methods used in the
establishment of these estimates are discussed in the pertinent sections of
this
Management Analysis and are summarized as follows:
(a)
Other-than-temporary impairments in the value of
investments:
Individual
securities are considered for a possible write-down:
· |
In
the event
their market value has dropped by 20% or more below their par or
amortized
cost and/or the security has been in an unrealized loss position
for
twelve consecutive months;
|
· |
In
the event
of issuer default on significant obligations or emergence of such
adverse
information as to bring into question the validity of previously
reported
earnings or financial condition;
and
|
· |
When
the
probability of non-recovery of the original investment is established,
the
foregoing events or occurrences
notwithstanding.
|
For
the three years
ended December 31, 2006, pretax charges due to other-than-temporary impairments
in the value of securities reduced pretax income within a range of - % and
1.2%
and averaged .7% of such income.
(b)
Establishment of deferred acquisition costs (“DAC”)
The
eligibility for
deferral and the recoverability of DAC is based on the current terms and recent
profitability of the insurance contracts to which they relate. As of the three
most recent year ends, consolidated DAC balances ranged between 2.1% and 2.2%
and averaged 2.1% of consolidated assets. The annual change in DAC balances
for
the three-year period reduced underwriting, acquisition and other expenses
within a range of .5% and 1.6%, and averaged .9 %
of such
expenses.
(c)
The
recoverability of reinsured paid and/or outstanding
losses
Assets
consisting
of gross paid losses recoverable from assuming reinsurers, and balance sheet
date reserves similarly recoverable in future periods as gross losses are
settled and paid, are established at the same time as the gross losses are
paid
or recorded as reserves. Accordingly, these assets are subject to the same
estimation processes and valuations as the related gross amounts that are
discussed below. As of the three most recent year ends, paid and outstanding
reinsurance recoverable balances ranged between 36.1% and 39.7% and averaged
38.1% of the related gross reserves.
28
(d)
The
reserves for losses and loss adjustment expenses
As
discussed in
pertinent sections of this Management Analysis, the reserves for losses and
related loss adjustment expenses are based on a wide variety of factors and
calculations. Among these the Company believes the most critical
are:
· |
The
establishment of expected loss ratios for the three latest accident
years,
particularly for so-called long tail coverages as to which information
about covered losses emerges and becomes more accurately quantified
over
long periods of time. Long tail lines of business generally include
workers compensation, auto liability, general liability, errors and
omissions and directors and officers’ liability, and title insurance.
Gross loss reserves related to such long tail coverages ranged between
83.8% and 85.1%, and averaged 84.4% of gross consolidated claim reserves
as of the three most recent year ends. Net of reinsurance recoverables,
such reserves ranged between 82.1% and 84.0% and averaged 82.8% as
of the
same dates.
|
· |
Loss
trend
factors that are used to establish the above noted expected loss
ratios.
Such factors take into account such variables as judgments and estimates
for premium rate trends and adequacy, current and expected interest
rates,
current and expected social and economic inflation trends, and insurance
industry statistical claim trends.
|
· |
Loss
development factors based on Company and/or industry statistics that
are
used to project reported losses to their estimated ultimate cost
in each
accounting period.
|
For
each of the
three most recent calendar years, prior accident years’ consolidated claim costs
have developed favorably and consequently have had the effect of reducing
consolidated annual loss costs between 2.9% and 6.9%, or by an average of
approximately 4.3% per annum. As a percentage of each of these years’
consolidated earned premiums and fees the favorable developments have ranged
between 1.3% and 3.4%, and have averaged 2.0%.
In
all the above
regards the Company anticipates that future periods’ financial statements will
continue to reflect changes in estimates. As in the past such changes will
result from altered circumstances, the continuum of newly emerging information
and its effect on past assumptions and judgments, the effects of securities
markets valuations, and changes in inflation rates and future economic
conditions beyond the Company’s control. As a result, Old Republic cannot
predict, quantify, or guaranty the likely impact that probable changes in
estimates will have on its future financial condition or results of
operations.
CHANGES
IN ACCOUNTING POLICIES
|
On
January 1, 2006,
the Company adopted Statement of Financial Accounting Standards No. 123-Revised
(“FAS 123R”), “Share-Based Payment” using the modified prospective transition
method. The impact of the adoption of FAS123R is discussed in note 1(q) of
the
notes to consolidated financial statements.
On
December 31,
2006, the Company adopted Statement of Financial Accounting Standards No. 158
(“FAS158”) “Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans”. The impact of the adoption of FAS 158 is discussed in
note 1(m) of the notes to the consolidated financial statements.
In
July 2006, the
Financial Accounting Standards Board (FASB) issued its Interpretation No. 48
(“FIN 48”), “Accounting for Uncertainty in Income Taxes”, effective in the first
quarter of 2007. FIN 48 provides recognition criteria and a related measurement
model for uncertain tax positions taken or expected to be taken in income tax
returns. FIN 48 requires that a position taken or expected to be taken in a
tax
return be recognized in the financial statements when it is more likely than
not
that the position would be sustained upon examination by tax authorities. The
Company anticipates that adoption of FIN 48 will not have a material effect
on
its consolidated financial statements. As indicated in Note 1(i) of the Notes
to
Consolidated Financial Statements, the Company believes that the major
uncertainties relating to its tax position pertain to timing differences in
the
recognition of taxable income. Accordingly, the annual effective tax rate,
other
than possible interest and penalties, would be largely unaffected as an increase
in currently due income taxes would likely be offset by a corresponding deferred
income tax adjustment.
FINANCIAL
POSITION
|
The
Company’s
financial position at December 31, 2006 reflected increases in assets,
liabilities and common shareholders’ equity of 9.3%, 9.6% and 8.6%,
respectively, when compared to the immediately preceding year-end. Cash and
invested assets represented 65.3% and 64.1% of consolidated assets as of
December 31, 2006 and December 31, 2005, respectively. Consolidated operating
cash flow was positive at $1,004.7 in 2006 compared to $833.6 in 2005 and $775.5
in 2004. As of December 31, 2006, the invested asset base increased 11.4% to
$8,056.1 principally as a result of positive operating cash flows.
During
2006 and
2005, the Company committed substantially all investable funds to short to
intermediate-term fixed maturity securities. At both December 31, 2006 and
2005,
approximately 99% of the Company’s investments consisted of marketable
securities. Old Republic continues to adhere to its long-term policy of
investing primarily in investment grade, marketable securities. Investable
funds
have not been directed to so-called “junk bonds” or types of securities
categorized as derivatives. At December 31, 2006, the Company had $4.0 of fixed
maturity investments in default as to principal and/or interest.
29
Relatively
high
short-term maturity investment positions continued to be maintained as of
December 31, 2006. 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.
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,
|
|||||||
2006
|
2005
|
||||||
Aaa
|
32.9
|
%
|
32.6
|
%
|
|||
Aa
|
19.0
|
18.4
|
|||||
A
|
26.4
|
27.9
|
|||||
Baa
|
20.1
|
20.2
|
|||||
Total
investment grade
|
98.4
|
99.1
|
|||||
All
other
(2)
|
1.6
|
.9
|
|||||
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.
30
Gross
Unrealized Losses Stratified by Industry Concentration for Non-Investment
Grade Fixed Maturity Securities
|
|||||||
December
31,
2006
|
|||||||
Amortized
Cost
|
Gross
Unrealized
Losses
|
||||||
Fixed
Maturity Securities by Industry Concentration:
|
|||||||
Service
|
$
|
31.0
|
$
|
1.4
|
|||
Retail
|
13.3
|
.8
|
|||||
Consumer
Durables
|
7.6
|
.8
|
|||||
Finance
|
17.1
|
.2
|
|||||
Consumer
Non-durables
|
8.1
|
.1
|
|||||
Total
|
$
|
77.3
|
(3)
|
$
|
3.4
|
(3) Represents
1.1% of
the total fixed maturity securities portfolio.
Gross
Unrealized Losses Stratified by Industry Concentration for Investment
Grade Fixed Maturity Securities
|
|||||||
December
31,
2006
|
|||||||
Amortized
Cost
|
Gross
Unrealized
Losses
|
||||||
Fixed
Maturity Securities by Industry Concentration:
|
|||||||
Municipals
|
$
|
1,343.4
|
$
|
14.7
|
|||
Utilities
|
487.3
|
13.1
|
|||||
Consumer
Non-durables
|
272.7
|
5.9
|
|||||
Industrials
|
322.9
|
5.0
|
|||||
Other
(includes 17 industry groups)
|
2,226.1
|
45.5
|
|||||
Total
|
$
|
4,652.6
|
(4)
|
$
|
84.4
|
(4) Represents
67.7% of
the total fixed maturity securities portfolio.
Gross
Unrealized Losses Stratified by Industry Concentration for Equity
Securities
|
|||||||
December
31,
2006
|
|||||||
Cost
|
Gross
Unrealized
Losses
|
||||||
Equity
Securities by Industry Concentration:
|
|||||||
Insurance
|
$
|
7.6
|
$
|
.8
|
|||
Consumer
Non-durables
|
8.2
|
.4
|
|||||
Banking
|
3.6
|
.3
|
|||||
Consumer
Durables
|
3.5
|
.1
|
|||||
Health
Care
|
3.9
|
.1
|
|||||
Total
|
$
|
27.0
|
(5)
|
$
|
1.8
|
(6)
|
(5) Represents
5.1% of
the total equity securities portfolio.
(6) Represents
.3% of
the cost of the total equity securities portfolio, while gross unrealized gains
represent 25.5% of the portfolio.
Gross
Unrealized Losses Stratified by Maturity Ranges for All Fixed Maturity
Securities
|
||||||||||||||
December
31,
2006
|
||||||||||||||
Amortized
Cost
of
Fixed
Maturity Securities
|
Gross
Unrealized Losses
|
|||||||||||||
All
|
Non-
Investment
Grade
Only
|
All
|
Non-
Investment
Grade
Only
|
|||||||||||
Maturity
Ranges:
|
||||||||||||||
Due
in one
year or less
|
$
|
385.6
|
$
|
6.0
|
$
|
1.8
|
$
|
-
|
||||||
Due
after one
year through five years
|
1,904.2
|
50.5
|
34.0
|
1.6
|
||||||||||
Due
after
five years through ten years
|
2,423.9
|
20.6
|
51.6
|
1.7
|
||||||||||
Due
after ten
years
|
16.1
|
-
|
.3
|
-
|
||||||||||
Total
|
$
|
4,730.0
|
$
|
77.3
|
$
|
87.8
|
$
|
3.4
|
31
Gross
Unrealized Losses Stratified by Duration and Amount of Unrealized
Losses
|
|||||||||||||
December
31,
2006
|
|||||||||||||
Amount
of
Gross Unrealized Losses
|
|||||||||||||
Less
than
20%
of
Cost
|
20%
to
50%
of
Cost
|
More
than 50%
of Cost
|
Total
Gross
Unrealized Loss
|
||||||||||
Number
of
Months in Loss Position:
|
|||||||||||||
Fixed
Maturity Securities:
|
|||||||||||||
One
to six
months
|
$
|
5.2
|
$
|
-
|
$
|
-
|
$
|
5.2
|
|||||
Seven
to
twelve months
|
10.2
|
-
|
-
|
10.2
|
|||||||||
More
than
twelve months
|
72.3
|
-
|
-
|
72.3
|
|||||||||
Total
|
$
|
87.8
|
$
|
-
|
$
|
-
|
$
|
87.8
|
|||||
Equity
Securities:
|
|||||||||||||
One
to six
months
|
$
|
.5
|
$
|
-
|
$
|
-
|
$
|
.5
|
|||||
Seven
to
twelve months
|
1.2
|
-
|
-
|
1.2
|
|||||||||
More
than
twelve months
|
-
|
-
|
-
|
-
|
|||||||||
Total
|
$
|
1.8
|
$
|
-
|
$
|
-
|
$
|
1.8
|
|||||
Number
of
Issues in Loss Position:
|
|||||||||||||
Fixed
Maturity Securities:
|
|||||||||||||
One
to six
months
|
295
|
-
|
-
|
295
|
|||||||||
Seven
to
twelve months
|
184
|
-
|
-
|
184
|
|||||||||
More
than
twelve months
|
735
|
-
|
-
|
735
|
|||||||||
Total
|
1,214
|
-
|
-
|
1,214
|
(7)
|
||||||||
Equity
Securities:
|
|||||||||||||
One
to six
months
|
3
|
-
|
-
|
3
|
|||||||||
Seven
to
twelve months
|
4
|
-
|
-
|
4
|
|||||||||
More
than
twelve months
|
-
|
-
|
1
|
1
|
|||||||||
Total
|
7
|
-
|
1
|
8
|
(7)
|
(7) At
December 31,
2006 the number of issues in an unrealized loss position represent 63.6% as
to
fixed maturities, and
9.8% as
to equity securities of the total number of such issues held by the
Company.
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, 2006 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.
Age
Distribution of Fixed Maturity Securities
|
|||||||
December
31,
|
|||||||
2006
|
2005
|
||||||
Maturity
Ranges:
|
|||||||
Due
in one
year or less
|
9.6
|
%
|
10.9
|
%
|
|||
Due
after one
year through five years
|
44.4
|
41.5
|
|||||
Due
after
five years through ten years
|
45.6
|
46.9
|
|||||
Due
after ten
years through fifteen years
|
.4
|
.7
|
|||||
Due
after
fifteen years
|
-
|
-
|
|||||
Total
|
100.0
|
%
|
100.0
|
%
|
|||
Average
Maturity in Years
|
4.5
|
4.7
|
|||||
Duration
(8)
|
3.9
|
4.0
|
(8)
Duration
is used as
a measure of bond price sensitivity to interest rate changes. A duration of
3.9
as of December 31, 2006 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 3.9%.
32
Composition
of Unrealized Gains (Losses)
|
|||||||||
December
31,
|
|||||||||
2006
|
2005
|
||||||||
Fixed
Maturity Securities:
|
|||||||||
Amortized
cost
|
$
|
6,873.8
|
$
|
6,323.7
|
|||||
Estimated
fair value
|
6,832.6
|
6,331.6
|
|||||||
Gross
unrealized gains
|
46.6
|
79.5
|
|||||||
Gross
unrealized losses
|
(87.8
|
)
|
(71.5
|
)
|
|||||
Net
unrealized gains (losses)
|
$
|
(41.2
|
)
|
$
|
7.9
|
||||
Equity
Securities:
|
|||||||||
Cost
|
$
|
534.7
|
$
|
500.9
|
|||||
Estimated
fair value
|
669.1
|
552.4
|
|||||||
Gross
unrealized gains
|
136.1
|
55.1
|
|||||||
Gross
unrealized losses
|
(1.8
|
)
|
(3.6
|
)
|
|||||
Net
unrealized gains
|
$
|
134.3
|
$
|
51.5
|
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 $533.6 in dividends from its subsidiaries in
2007
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 of which $19.0 was
outstanding at December 31, 2006.
Old
Republic’s
total capitalization of $4,513.5 at December 31, 2006 consisted of debt of
$144.3 and common shareholders' equity of $4,369.2. Changes in the common
shareholders’ equity account for the three most recent years reflect primarily
the retention of earnings in excess of dividend requirements. Old Republic
has
paid cash dividends to its shareholders without interruption since 1942, and
has
increased the annual rate in each of the past 25 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 Company
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 Company’s insurance subsidiaries, the trends in average annual
statutory and GAAP earnings for the five most recent calendar years, and the
long-term expectations for the Company’s consolidated business. At its February
14, 2006 meeting, the Board of Directors approved a new quarterly cash dividend
rate of 15 cents per share effective in the second quarter of 2006, up from
14
cents per share, subject to the usual quarterly authorizations.
At
its May, 2006
meeting, the Company’s Board of Directors authorized the reacquisition of up to
$500.0 of common shares as market conditions warrant during the two year period
from that date; no stock had been acquired through December 31, 2006 pursuant
to
this authorization. In December 2005, the Company cancelled 3.5 million common
shares previously reported as treasury stock, restoring them to unissued status;
this had no effect on total shareholders’ equity or the financial condition of
the Company.
The
following table
shows certain information relating to the Company’s contractual obligations as
of December 31, 2006:
Payments
Due
in the Following Years
|
||||||||||||||
Total
|
2007
|
2008
and
2009
|
2010
and
2011
|
2012
and
after
|
||||||||||
Contractual
Obligations:
|
||||||||||||||
Debt
|
$
|
144.3
|
$
|
140.4
|
$
|
1.7
|
$
|
1.6
|
$
|
.4
|
||||
Interest
on
Debt
|
4.7
|
4.1
|
.4
|
.1
|
-
|
|||||||||
Operating
Leases
|
159.1
|
39.3
|
55.0
|
26.0
|
38.7
|
|||||||||
Pension
Benefits Contributions (1)
|
81.0
|
-
|
10.1
|
24.7
|
46.2
|
|||||||||
Claim
&
Claim Expense Reserves (2)
|
5,534.7
|
1,222.2
|
1,188.3
|
538.5
|
2,585.5
|
|||||||||
Total
|
$
|
5,923.9
|
$
|
1,406.2
|
$
|
1,255.7
|
$
|
591.1
|
$
|
2,670.9
|
33
(1) |
Represents
estimated minimum 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.
|
(2) |
Amounts
are
reported gross of reinsurance. 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 gross loss payments are based primarily
on
historical claim payment patterns, are subject to change due to a
wide
variety of factors, do not reflect anticipated recoveries under the
terms
of reinsurance contracts, and cannot be predicted with certainty.
Actual
future loss payments may differ materially from the current estimates
shown in the table above.
|
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 generally 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 include branch offices of its title insurers and wholly owned
subsidiaries of the Company) represent approximately 32% of consolidated title
business revenues. Such premiums are generally recognized as income at the
escrow closing date which approximates the policy effective date. Fee income
related to escrow and other closing services is recognized when the related
services have been performed and completed. The remaining 68% 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:
General
|
Mortgage
|
Title
|
Other
|
Total
|
%
Change
from
prior
period
|
||||||||||||
Years
Ended
December 31:
|
|||||||||||||||||
2004
|
$
|
1,623.0
|
$
|
403.2
|
$
|
1,025.2
|
$
|
64.6
|
$
|
3,116.1
|
6.1
|
%
|
|||||
2005
|
1,805.2
|
429.5
|
1,081.8
|
70.3
|
3,386.9
|
8.7
|
|||||||||||
2006
|
$
|
1,902.1
|
$
|
444.3
|
$
|
980.0
|
$
|
74.1
|
$
|
3,400.5
|
.4
|
%
|
Earned
premiums in
the General Insurance Group grew by 5.4%, 11.2%, and 17.6% in 2006, 2005, and
2004, respectively, as a result of additional business produced in a reasonably
stable underwriting environment. Mortgage guaranty premium revenue trends for
2006 reflect improved business persistency, lower overall mortgage originations,
and higher levels of bulk insurance production. 2005 net premiums earned rose
due to bulk business growth as well as a higher average premium rate on new
traditional primary business production. Title Group premium and fee revenues
decreased by 9.4% in 2006. The decline was particularly accentuated in the
segment’s direct operations most of which are concentrated in the Western United
States.
The
percentage
allocation of net premiums earned for major insurance coverages in the General
Insurance Group was as follows:
Type
of
Coverage
|
|||||||||||||||||
Commercial
Automobile
(mostly
trucking)
|
Workers’
Compensation
|
Financial
Indemnity
|
Inland
Marine
and
Property
|
General
Liability
|
Other
|
||||||||||||
Years
Ended
December 31:
|
|||||||||||||||||
2004
|
37.9
|
%
|
21.8
|
%
|
11.8
|
%
|
11.3
|
%
|
5.8
|
%
|
11.4
|
%
|
|||||
2005
|
39.2
|
21.9
|
10.3
|
11.0
|
5.4
|
12.2
|
|||||||||||
2006
|
39.8
|
%
|
21.7
|
%
|
11.0
|
%
|
10.7
|
%
|
5.1
|
%
|
11.7
|
%
|
34
The
following
tables provide information on risk exposure trends for Old Republic’s Mortgage
Guaranty Group.
New
Insurance Written
|
Traditional
Primary
|
Bulk
|
Other
|
Total
|
||||||||
Years
Ended
December 31:
|
||||||||||||
2004
|
$
|
24,749.4
|
$
|
4,487.8
|
$
|
7,324.7
|
$
|
36,562.0
|
||||
2005
|
20,554.5
|
9,944.3
|
498.2
|
30,997.1
|
||||||||
2006
|
$
|
17,187.0
|
$
|
13,716.7
|
$
|
583.7
|
$
|
31,487.5
|
New
Risk
Written
|
||||||||||||
Years
Ended
December 31:
|
||||||||||||
2004
|
$
|
6,100.2
|
$
|
112.4
|
$
|
89.9
|
$
|
6,302.5
|
||||
2005
|
5,112.4
|
1,053.1
|
11.7
|
6,177.4
|
||||||||
2006
|
$
|
4,246.8
|
$
|
1,146.6
|
$
|
12.2
|
$
|
5,405.7
|
Net
Risk
In Force
|
||||||||||||
As
of
December 31:
|
||||||||||||
2004
|
$
|
15,452.2
|
$
|
834.8
|
$
|
580.9
|
$
|
16,868.0
|
||||
2005
|
14,711.2
|
1,758.8
|
586.1
|
17,056.2
|
||||||||
2006
|
$
|
14,582.1
|
$
|
2,471.1
|
$
|
578.9
|
$
|
17,632.2
|
Analysis
of Risk
in Force:
By
Fair
Isaac & Company (“FICO”) Scores:
|
FICO
less
than 620
|
FICO
620 to
680
|
FICO
greater
than 680
|
Unscored/
Unavailable
|
||||||||
Traditional
Primary
|
||||||||||||
As
of
December 31:
|
||||||||||||
2004
|
8.6
|
%
|
31.1
|
%
|
51.4
|
%
|
8.9
|
%
|
||||
2005
|
8.3
|
31.8
|
53.1
|
6.8
|
||||||||
2006
|
8.5
|
%
|
32.6
|
%
|
54.6
|
%
|
4.3
|
%
|
||||
Bulk
(1)
|
||||||||||||
As
of
December 31:
|
||||||||||||
2004
|
11.5
|
%
|
45.4
|
%
|
40.9
|
%
|
2.2
|
%
|
||||
2005
|
21.2
|
38.7
|
38.7
|
1.4
|
||||||||
2006
|
24.1
|
%
|
35.7
|
%
|
39.8
|
%
|
.4
|
%
|
By
Loan to
Value (“LTV”) Ratio:
|
LTV
less than
85
|
LTV
85
to
90
|
LTV
90
to
95
|
LTV
Greater
than 95
|
||||||||
Traditional
Primary
|
||||||||||||
As
of
December 31:
|
||||||||||||
2004
|
5.7
|
%
|
36.8
|
%
|
42.0
|
%
|
15.5
|
%
|
||||
2005
|
5.4
|
37.7
|
39.1
|
17.8
|
||||||||
2006
|
5.0
|
%
|
37.4
|
%
|
36.0
|
%
|
21.6
|
%
|
||||
Bulk
(1)
|
||||||||||||
As
of
December 31:
|
||||||||||||
2004
|
66.4
|
%
|
16.9
|
%
|
12.9
|
%
|
3.8
|
%
|
||||
2005
|
57.3
|
27.4
|
11.6
|
3.7
|
||||||||
2006
|
63.4
|
%
|
23.1
|
%
|
9.0
|
%
|
4.5
|
%
|
By
Type of
Loan Documentation:
|
Full
Documentation
|
Reduced
Documentation
|
||||
Traditional
Primary
|
||||||
As
of
December 31:
|
||||||
2004
|
93.2
|
%
|
6.8
|
%
|
||
2005
|
90.6
|
9.4
|
||||
2006
|
89.4
|
%
|
10.6
|
%
|
||
Bulk
(1)
|
||||||
As
of
December 31:
|
||||||
2004
|
34.0
|
%
|
66.0
|
%
|
||
2005
|
51.9
|
48.1
|
||||
2006
|
51.9
|
%
|
48.1
|
%
|
(1)
Bulk pool risk
in-force, which represented 44.7% of total bulk risk in-force at December 31,
2006, has been allocated pro-rata based on insurance in-force.
35
Premium
and
Persistency Trends:
Earned
Premiums
|
Persistency
|
|||||||||||
Direct
|
Net
|
Traditional
Primary
|
Bulk
(1)
|
|||||||||
Years
Ended
December 31:
|
||||||||||||
2004
|
$
|
483.6
|
$
|
403.2
|
64.5
|
%
|
55.7
|
%
|
||||
2005
|
508.0
|
429.5
|
65.5
|
59.5
|
||||||||
2006
|
$
|
524.7
|
$
|
444.3
|
73.1
|
%
|
70.5
|
%
|
||||
(1)
Due to
the relative immaturity of the bulk business, the above trends may
prove
to be highly volatile.
|
The
following table
shows the percentage distribution of Title Group premium and fee revenues by
production sources:
Direct
Operations
|
Independent
Title Agents & Other
|
|||||
Years
Ended
December 31:
|
||||||
2004
|
38.1
|
%
|
61.9
|
%
|
||
2005
|
37.1
|
62.9
|
||||
2006
|
32.3
|
%
|
67.7
|
%
|
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. 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
|
||||||||||||||||||
General
|
Mortgage
|
Title
|
Corporate
and
Other
|
Total
|
Adjust-
ment
|
Market
Value
|
||||||||||||||
As
of
December 31:
|
||||||||||||||||||||
2005
|
$
|
4,694.8
|
$
|
1,515.4
|
$
|
616.8
|
$
|
326.4
|
$
|
7,153.5
|
$
|
76.6
|
$
|
7,230.2
|
||||||
2006
|
$
|
5,524.8
|
$
|
1,571.6
|
$
|
611.1
|
$
|
246.6
|
$
|
7,954.3
|
$
|
101.8
|
$
|
8,056.1
|
Net
Investment Income
|
Yield
at
|
|||||||||||||||||||
General
|
Mortgage
|
Title
|
Corporate
and
Other
|
Total
|
Cost
|
Market
|
||||||||||||||
Years
Ended
|
||||||||||||||||||||
December 31:
|
||||||||||||||||||||
2004
|
$
|
183.4
|
$
|
67.7
|
$
|
25.5
|
$
|
14.0
|
$
|
290.8
|
4.6
|
%
|
4.4
|
%
|
||||||
2005
|
197.0
|
70.1
|
26.0
|
16.9
|
310.1
|
4.5
|
4.4
|
|||||||||||||
2006
|
$
|
221.5
|
$
|
74.3
|
$
|
26.9
|
$
|
18.7
|
$
|
341.6
|
4.5
|
%
|
4.5
|
%
|
Consolidated
net
investment income grew by 10.2%, 6.6% and 4.2% in 2006, 2005 and 2004,
respectively. 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 securities, and by changes in market
yields. Yield trends reflect the relatively short maturity of Old Republic’s
fixed maturity securities portfolio as well as continuation of a lower yield
environment during the past several years.
Revenues:
Net Realized Gains
|
The
Company's
investment policies have not been designed to maximize or emphasize the
realization of investment gains. Rather, these policies aim to assure a stable
source of income from interest and dividends, protection of capital, and
provision of sufficient liquidity to meet insurance underwriting and other
obligations as they become payable in the future. Dispositions of fixed maturity
securities arise mostly from scheduled maturities and early calls; in 2006,
2005, and 2004, 77.2%, 67.9% and 80.3%, 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 the basics of its
insurance business.
36
The
following table
reflects the composition of net realized gains or losses for the periods shown.
As previously noted, relatively greater realized gains in equity securities
in
2004 and 2005 resulted largely from sales of substantial portions of actively
managed equity holdings and reinvestment of proceeds in index-style investment
portfolios.
Realized
Gains on Disposition of:
|
Impairment
Losses on:
|
|||||||||||||||||||
Fixed
maturity securities
|
Equity
securities and miscell-aneous investments
|
Total
|
Fixed
maturity securities
|
Equity
securities and miscell-aneous investments
|
Total
|
Net
realized
gains
|
||||||||||||||
Years
Ended
|
||||||||||||||||||||
December 31:
|
||||||||||||||||||||
2004
|
$
|
4.6
|
$
|
48.5
|
$
|
53.2
|
$
|
-
|
$
|
(5.2)
|
$
|
(5.2)
|
$
|
47.9
|
||||||
2005
|
4.5
|
69.6
|
74.1
|
(2.7)
|
(6.5)
|
(9.2)
|
64.9
|
|||||||||||||
2006
|
$
|
2.0
|
$
|
16.9
|
$
|
19.0
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
19.0
|
Expenses:
Benefits and Claims
|
In
order to achieve
a necessary matching of premium and fee revenues and expenses, the Company
records the benefits, claims and related settlement costs that have been
incurred during each accounting period. Total claim costs are affected by the
amount of paid claims and the adequacy of reserve estimates established for
current and prior years’ claim occurrences at each balance sheet
date.
The
following table
shows a breakdown of gross and net of reinsurance claim reserve estimates for
major types of insurance coverages as of December 31, 2006 and
2005:
December
31,
|
|||||||
2006
|
2005
|
||||||
Gross
|
Net
|
Gross
|
Net
|
||||
Claim
and Loss Adjustment Expense Reserves:
|
|||||||
Commercial
automobile (mostly trucking)
|
$
977.7
|
$
810.9
|
$
878.4
|
$
692.9
|
|||
Workers'
compensation
|
2,093.2
|
1,175.7
|
1,775.0
|
915.1
|
|||
General
liability
|
1,123.8
|
537.3
|
991.3
|
418.1
|
|||
Other
coverages
|
610.0
|
400.7
|
597.5
|
387.8
|
|||
Unallocated
loss adjustment expense reserves
|
147.0
|
97.8
|
159.2
|
92.9
|
|||
Total
general
insurance reserves
|
4,951.8
|
3,022.6
|
4,401.7
|
2,507.0
|
|||
Mortgage
guaranty
|
248.6
|
247.9
|
214.7
|
213.7
|
|||
Title
|
278.4
|
278.4
|
268.8
|
268.8
|
|||
Life
and
health
|
28.4
|
21.6
|
26.5
|
19.9
|
|||
Unallocated
loss adjustment expense reserves -
other coverages
|
27.2
|
27.2
|
28.0
|
28.0
|
|||
Total
claim
and loss adjustment expense reserves
|
$
5,534.7
|
$
3,598.0
|
$
4,939.8
|
$
3,037.6
|
|||
Asbestosis
and environmental claim reserves included
in the above general insurance reserves:
|
|||||||
Amount
|
$
194.9
|
$
157.8
|
$
170.7
|
$
132.2
|
|||
% of total general insurance reserves
|
3.9%
|
5.2%
|
3.9%
|
5.3%
|
The
Company’s
reserve for loss and loss adjustment expenses represents the accumulation of
estimates of ultimate losses, including incurred but not reported losses and
loss adjustment 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 as further discussed below. Consequently, reserves
established are a reflection of the opinions of a large number of persons,
of
the application and interpretation of historical precedent and trends, of
expectations as to future developments, and of management’s judgment in
interpreting all such factors. At any point in time the Company is exposed
to
possibly higher or lower than anticipated claim costs and the resulting changes
in estimates are recorded in operations of the periods during which they are
made. Increases to prior reserve estimates are often referred to as unfavorable
development whereas any changes that decrease previous estimates of the
Company’s ultimate liability are referred to as favorable
development.
Overview
of
Loss Reserving Process
Most
of Old
Republic’s consolidated claim and related expense reserves stem from its
general
insurance
business. At
December 31, 2006, such reserves accounted for 89.5% and 84.0% of consolidated
gross and net of reinsurance reserves, respectively, while similar reserves
at
December 31, 2005 represented 89.1% and 82.5% of the respective consolidated
amounts.
37
The
Company’s
reserve setting process reflects the nature of its insurance business and the
decentralized basis upon which it is conducted. Old Republic’s general
insurance
operations
encompass 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.
Additionally, the Company’s insurance subsidiaries do not provide significant
amounts of insurance protection for premises; most of its property insurance
exposures relate to cargo, incidental property, and insureds’ inland marine
assets. Consequently, the wide variety of policies issued and commercial
insurance customers served require that loss reserves be analyzed and
established in the context of the unique or different attributes of each block
or class of business produced by the Company. For example, accident liability
claims emanating from insured trucking companies or from general aviation
customers become known relatively quickly, whereas claims of a general liability
nature arising from the building activities of a construction company may emerge
over extended periods of time. Similarly, claims filed pursuant to errors and
omissions or directors and officers’ (“E&O/D&O”) liability coverages are
usually not prone to immediate evaluation or quantification inasmuch as many
such claims may be litigated over several years and their ultimate costs may
be
affected by the vagaries of judged or jury verdicts. Approximately 87% of the
general
insurance
group’s claim
reserves stem from liability insurance coverages for commercial customers which
typically require more extended periods of investigation and at times protracted
litigation before they are finally settled. As a consequence of these and other
factors, Old Republic does not utilize a single, overarching loss reserving
approach.
The
Company
prepares periodic analyses of its loss reserve estimates for its significant
insurance coverages. It establishes point estimates for most losses on an
insurance coverage line-by-line basis for individual subsidiaries, sub-classes,
individual accounts, blocks of business or other unique concentrations of
insurance risks such as directors and officers’ liability, that have similar
attributes. Actuarially or otherwise derived ranges of reserve levels are not
utilized as such in setting these reserves. Instead the reported reserves
encompass the Company’s best point estimates at each reporting date and the
overall reserve level at any point in time therefore represents the compilation
of a very large number of reported reserve estimates and the results of a
variety of formula calculations largely driven by statistical analysis of
historical data. Reserve releases or additions are implicitly covered by the
point estimates incorporated in total reserves at each balance sheet date.
The
Company does not project future variability or make an explicit provision for
uncertainty when determining its best estimate of loss reserves, although,
as
discussed below, over the most recent ten-year period management’s estimates
have developed slightly favorably on an overall basis.
Overall
loss
reserves consist of liability estimates for claims that have been reported
(“case”) to the Company’s insurance subsidiaries and reserves for claims that
have been incurred but not yet reported (“IBNR”) or whose ultimate costs may not
become fully apparent until a future time. Additionally, the Company establishes
unallocated loss adjustment expense 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 case and IBNR claims over time.
Long-term, disability-type workers’ compensation reserves are discounted to
present value based on interest rates that range from 3.5% to 4.0%. The amount
of discount reflected in the year end net reserves totaled approximately $151.0,
$138.3 and $139.3 as of December 31, 2006, 2005, and 2004,
respectively.
A
large variety of
statistical analyses and 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.
Overall,
reserves
pertaining to several hundred large individual commercial insurance accounts
that exhibit sufficient statistical credibility, and at times may be subject
to
retrospective premium rating plans or the utilization of varying levels or
types
of self-insured retentions through captive insurers and similar risk management
mechanisms are established on an account by account basis using case reserves
and applicable formula-driven methods. Large account reserves are usually set
and analyzed for groups of coverages such as workers compensation, commercial
auto and general liability that are typically underwritten jointly for many
customers. For certain so-called long-tail categories of insurance such as
retained or assumed 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.
Expected loss ratios typically reflect the projected loss ratio from prior
accident years, adjusted for the effect of actual and anticipated rate changes,
actual and anticipated changes in coverage, reinsurance, or mix of business,
and
other anticipated changes in external factors such as trends in loss costs
or
the legal and claims environment. Expected loss ratios are generally used for
the two to three most recent accident years depending on the individual class
or
category of business. As actual claims data emerges in succeeding interim and
annual periods, the original accident year loss ratio assumptions are validated
or otherwise adjusted sequentially through the application of statistical
projection techniques such as the Bornhuetter/Ferguson method which utilizes
data from the more mature experience of prior years to arrive at a likely
indication of more recent years’ loss trends and costs.
38
Mortgage
guaranty
insurance loss
reserves are
based on statistical 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 IBNR. Further, such loss reserve estimates also
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 interest costs,
demand, and extensions.
Title
insurance and
related escrow
services loss and loss adjustment expense reserves are established as point
estimates to cover the projected settlement costs of known as well as IBNR
losses, 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. The point estimates
covering all claim reserves take into account IBNR claims based on past
experience and evaluations of such variables as changing trends in the types
of
policies issued, changes in real estate markets and interest rate environments,
and changing levels of loan refinancing, all of which can have a bearing on
the
emergence, number, and ultimate costs of claims.
Incurred
Loss Experience
Management
is of
the opinion that the Company’s overall reserving practices have been
consistently applied over many years. For at least the past ten years,
previously established aggregate reserves have produced reasonable estimates
of
the cumulative ultimate net costs of claims incurred. However, there are no
guarantees that such outcomes will continue, and accordingly, 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
management’s opinion, however, such potential development is not likely to have
a material effect on the Company’s consolidated financial position, although it
could have a material effect on its consolidated results of operations for
any
one annual or interim reporting period. See further discussion in this Annual
Report on Form 10-K under Item 1A - Risk Factors.
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:
|
2006
|
2005
|
2004
|
|||
Gross
reserves at beginning of year
|
$
4,939.8
|
$
4,403.5
|
$
4,022.7
|
|||
Less:
reinsurance losses recoverable
|
1,902.1
|
1,639.6
|
1,522.5
|
|||
Net reserves at beginning of year
|
3,037.6
|
2,763.8
|
2,500.1
|
|||
Incurred
claims and claim adjustment expenses:
|
||||||
Provisions for insured events of the current year
|
1,646.4
|
1,504.5
|
1,348.7
|
|||
Change in provision for insured events of prior years
|
(114.0)
|
(43.9)
|
(43.1)
|
|||
Total incurred claims and claim adjustment expenses
|
1,532.5
|
1,460.7
|
1,305.7
|
|||
Payments:
|
||||||
Claims and claim adjustment expenses attributable to
|
||||||
insured events of the current year
|
432.4
|
484.6
|
403.6
|
|||
Claims and claim adjustment expenses attributable to
|
||||||
insured events of prior years
|
539.6
|
702.1
|
638.2
|
|||
Total payments
|
972.1
|
1,186.8
|
1,041.9
|
|||
Amount
of
reserves for unpaid claims and claim adjustment
|
||||||
expenses at the end of each year, net of reinsurance
|
||||||
losses recoverable
|
3,598.0
|
3,037.6
|
2,763.8
|
|||
Reinsurance
losses recoverable
|
1,936.6
|
1,902.1
|
1,639.6
|
|||
Gross
reserves at end of year
|
$
5,534.7
|
$
4,939.8
|
$
4,403.5
|
The
percentage of
net claims, benefits and related settlement expenses incurred as a percentage
of
premiums and related fee revenues of the Company’s three major operating
segments and for its consolidated results were as follows:
Years
Ended December 31:
|
2006
|
2005
|
2004
|
||||||
General
|
65.9
|
%
|
66.9
|
%
|
65.9
|
%
|
|||
Mortgage
|
42.8
|
37.2
|
35.5
|
||||||
Title
|
5.9
|
6.0
|
5.8
|
||||||
Consolidated
benefits and claims ratio
|
45.3
|
%
|
43.3
|
%
|
42.0
|
%
|
Reconciliation
of consolidated ratio:
|
|||||||||
Provision
for
insured events of the current year
|
48.7
|
%
|
44.6
|
%
|
43.4
|
%
|
|||
Change
in
provision for insured events of prior years:
|
|||||||||
Due
to asbestos and environmental
|
1.1
|
1.5
|
2.0
|
||||||
Due to all other coverages
|
(4.5
|
)
|
(2.8
|
)
|
(3.4
|
)
|
|||
Net (favorable) unfavorable development
|
(3.4
|
)
|
(1.3
|
)
|
(1.4
|
)
|
|||
Consolidated
benefits and claims ratio
|
45.3
|
%
|
43.3
|
%
|
42.0
|
%
|
39
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. For the three most recent calendar years, the
above table indicates that the one-year development of consolidated reserves
at
the beginning of each year produced average favorable developments that reduced
the consolidated loss ratio by 2.1%.
The
percentage of
net claims, benefits and related settlement expenses measured against premiums
earned by major general
insurance
coverage types
were as follows:
Type
of
Coverage
|
|||||||||||
Commercial
Automobile
(mostly
trucking)
|
Workers’
Compensation
|
Financial
Indemnity
|
Inland
Marine
and
Property
|
General
Liability
|
Other
|
||||||
Years
Ended
December 31:
|
|||||||||||
2004
|
66.5%
|
72.4%
|
47.6%
|
56.2%
|
108.6%
|
59.3%
|
|||||
2005
|
67.2
|
78.9
|
48.9
|
52.2
|
97.4
|
58.5
|
|||||
2006
|
75.3%
|
74.6%
|
41.5%
|
55.0%
|
57.5%
|
54.8%
|
|||||
The
general
insurance
portion of the
claims ratio reflects reasonably consistent trends for all reporting periods.
To
a large extent this major cost factor reflects pricing and risk selection
improvements that have been applied since 2001, together with elements of
reduced loss severity and frequency. During the three most recent
calendar years,
the general
insurance
group experienced
favorable development of prior year loss reserves primarily stemming from the
commercial automobile and the E&O/D&O (financial indemnity) lines of
business; this was partially offset by unfavorable development in excess workers
compensation coverages and for ongoing development of asbestos and environmental
(“A&E”) exposures (general liability). Unfavorable developments attributable
to A&E claim reserves are due to periodic re-evaluations of such reserves as
well as reclassifications of other coverages’ reserves, typically workers
compensation, deemed to be assignable to A&E types of losses.
Except
for a small
portion that emanates from ongoing primary insurance operations, a large
majority of the A&E claim reserves posted by Old Republic stem mainly from
its participations in assumed reinsurance treaties and insurance pools which
were discontinued fifteen or more years ago and have since been in run-off
status. With respect to the primary portion of gross A&E reserves, Old
Republic administers the related claims through its claims personnel as well
as
outside attorneys, and posted reserves reflect its best estimates of ultimate
claim costs. Claims administration for the assumed portion of the Company’s
A&E exposures is handled by the claims departments of unrelated primary or
ceding reinsurance companies. While
the Company
performs periodic reviews of certain claim files managed by third parties,
the
overall A&E reserves it establishes respond to the paid claim and case
reserve activity reported to the Company as well as available industry
statistical data such as so-called survival ratios. Such ratios represent the
number of years’ average paid losses for the three or five most recent calendar
years that are encompassed by an insurer’s A&E reserve level at any point in
time. According to this simplistic appraisal of an insurer’s A&E loss
reserve level, Old Republic’s average five year survival ratios stood at 7.6
years (gross) and 10.9 years (net of reinsurance) as of December 31, 2006 and
7.4 years (gross) and 10.4 years (net of reinsurance) as of December 31, 2005.
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
A&E claims have averaged 3.4% of general
insurance
group net incurred
losses for the five years ended December 31, 2006.
A
summary of
reserve activity, including estimates for IBNR, relating to A&E claims at
December 31, 2006 and 2005 is as follows:
December
31,
|
|||||||||||||
2006
|
2005
|
||||||||||||
Gross
|
Net
|
Gross
|
Net
|
||||||||||
Asbestos:
|
|||||||||||||
Reserves
at
beginning of year
|
$
|
141.1
|
$
|
108.9
|
$
|
90.1
|
$
|
74.2
|
|||||
Loss
and loss
expenses incurred
|
29.6
|
18.1
|
70.0
|
47.6
|
|||||||||
Claims
and
claim adjustment expenses paid
|
(18.9
|
)
|
(9.6
|
)
|
(19.1
|
)
|
(12.9
|
)
|
|||||
Reserves
at
end of year
|
151.8
|
117.3
|
141.1
|
108.9
|
|||||||||
Environmental:
|
|||||||||||||
Reserves
at
beginning of year
|
29.6
|
23.2
|
28.8
|
22.8
|
|||||||||
Loss
and loss
expenses incurred
|
20.1
|
19.9
|
9.5
|
3.8
|
|||||||||
Claims
and
claim adjustment expenses paid
|
(6.7
|
)
|
(2.7
|
)
|
(8.7
|
)
|
(3.4
|
)
|
|||||
Reserves
at
end of year
|
43.1
|
40.4
|
29.6
|
23.2
|
|||||||||
Total
asbestos and environmental reserves
|
$
|
194.9
|
$
|
157.8
|
$
|
170.7
|
$
|
132.2
|
The
mortgage
guaranty
claims ratios have
continued to rise in recent years, principally reflecting higher paid losses,
as
well as expectations of greater claim frequency and severity. The most recent
year-over-year claim ratio comparisons reflect continued upward pressure from
these factors.
40
Average
mortgage
guaranty
paid claims, and
certain delinquency ratio data as of the end of the periods shown are listed
below:
Average
Paid
Claim Amount (1)
|
Delinquency
Ratio
|
|||||||||
Traditional
Primary
|
Bulk
(2)
|
Traditional
Primary
|
Bulk
(2)
|
|||||||
Years
Ended
December 31:
|
||||||||||
2004
|
$
23,920
|
$
19,885
|
4.11%
|
4.59%
|
||||||
2005
|
24,255
|
20,639
|
4.67
|
3.67
|
||||||
2006
|
$
25,989
|
$
21,846
|
4.41%
|
3.29%
|
||||||
(1) Amounts are in whole dollars.
|
||||||||||
(2) Due to the relative immaturity of the bulk business, the above
trends
may prove to be highly volatile.
|
Traditional
Primary Delinquency Ratios for Top Ten States (3):
|
|||||||||||||||||||||
FL
|
TX
|
GA
|
IL
|
OH
|
PA
|
MN
|
SC
|
NC
|
MI
|
||||||||||||
As
of
December 31:
|
|||||||||||||||||||||
2004
|
3.2%
|
|
5.0%
|
|
5.6%
|
3.8%
|
7.6%
|
4.4%
|
3.5%
|
5.0%
|
4.9%
|
6.1%
|
|||||||||
2005
|
3.1
|
5.7
|
5.9
|
4.2
|
8.3
|
4.7
|
4.0
|
5.4
|
4.9
|
7.3
|
|||||||||||
2006
|
2.7%
|
|
4.5%
|
6.1%
|
4.5%
|
7.8%
|
4.8%
|
5.4%
|
4.8%
|
4.6%
|
8.2%
|
||||||||||
Bulk
Delinquency Ratios for Top Ten States (3):
|
|||||||||||||||||||||
FL
|
TX
|
GA
|
IL
|
OH
|
PA
|
CA
|
NJ
|
AZ
|
NY
|
||||||||||||
As
of
December 31:
|
|||||||||||||||||||||
2004
|
2.5%
|
6.1%
|
7.0%
|
5.2%
|
13.3%
|
6.5%
|
1.3%
|
3.3%
|
3.6%
|
4.9%
|
|||||||||||
2005
|
1.9
|
5.5
|
5.8
|
3.0
|
8.4
|
5.3
|
.9
|
3.7
|
.9
|
4.3
|
|||||||||||
2006
|
1.6%
|
4.0%
|
4.4%
|
4.2%
|
9.3%
|
5.1%
|
1.6%
|
3.5%
|
1.0%
|
4.4%
|
|||||||||||
Total
Delinquency Ratios for Top Ten States (includes “other” business)
(3):
|
|||||||||||||||||||||
FL
|
TX
|
GA
|
IL
|
OH
|
PA
|
CA
|
|
NJ
|
|
NC
|
|
MI
|
|||||||||
As
of
December 31:
|
|||||||||||||||||||||
2004
|
2.7%
|
4.8%
|
5.1%
|
2.5%
|
7.2%
|
4.1%
|
1.1%
|
3.7%
|
3.5%
|
5.3%
|
|||||||||||
2005
|
2.4
|
5.3
|
5.3
|
2.8
|
7.5
|
4.3
|
.9
|
3.7
|
3.8
|
6.4
|
|||||||||||
2006
|
2.0%
|
4.1%
|
5.2%
|
3.1%
|
7.3%
|
4.3%
|
1.4%
|
3.6%
|
3.3%
|
7.2%
|
|||||||||||
(3)
As
determined by risk in force as of December 31, 2006, these 10 states
represent approximately 50%, 59%, and 50% of traditional primary,
bulk,
and total risk in force, respectively.
|
The
title
insurance
loss ratios have
been in the low single digits in each of the past three years due to a
continuation of favorable trends in claims frequency and severity for business
underwritten since 1992 in particular.
Volatility
of Reserve Estimates and Sensitivity
There
is a great
deal of uncertainty in the estimates of loss and loss adjustment expense
reserves and unanticipated events can have both a favorable or unfavorable
impact on such estimates. The Company believes that the factors most
responsible, in varying and continually changing degrees, for such favorable
or
unfavorable development are as follows:
General
insurance
net claim reserves
could be affected by lower than expected frequencies of claims incurred but
not
reported, the effect of reserve discounts applicable to workers’ compensation
claims, higher than expected severity of litigated claims in particular,
governmental or judicially imposed retroactive conditions in the settlement
of
claims such as noted above in regard to black lung disease claims, greater
than
anticipated inflation rates applicable to repairs and the medical benefits
portion of claims, and higher than expected IBNR due to the slower and highly
volatile emergence patterns applicable to certain types of claims such as those
stemming from litigated, assumed reinsurance, or the A&E types of claims
noted above.
Mortgage
guaranty
net claim reserve
levels could be affected adversely by several factors, including a change in
the
mix of insured business toward loans that have a higher probability of default,
a deterioration of regional or national economic conditions leading to a
reduction in borrowers’ income and thus their ability to make mortgage payments,
and a drop in housing values and/or an increase in housing supply that could
increase the rate at which defaults go to claim and the overall severity of
such
claims.
Title
insurance
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.
41
With
respect 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 life insurance, as in general insurance, concentrations of insured
lives coupled with a catastrophic event would represent the Company’s largest
exposure.
Loss
reserve uncertainty is
illustrated by the variability in loss reserve development presented in the
schedule which appears on page 9 under Item 1 of this Annual Report on Form
10-K. That schedule shows the cumulative loss reserve development for each
of
the past ten years through December 31, 2006 for the general
insurance
business which
comprises the largest portion of Old Republic’s loss and loss adjustment expense
reserves at 84.0% of the total. For each of these ten calendar years, prior
accident years’ general
insurance
claim reserves
have developed, as a percentage of the original estimates, within a range of
6.9% unfavorable in 2000 to a 6.2% favorable development in 1996. For the ten
year period the net development has averaged .4% favorable.
On a consolidated basis, which includes all coverages provided by the Company,
the annual favorable development on prior year loss reserves over the same
ten
year period has ranged from 1.6% to 7.4% and averaged 4.6%. Although management
does not have a practical business reason for making projections of likely
outcomes of future loss developments, its analysis and evaluation of Old
Republic’s existing business mix, current aggregate loss reserve levels, and
loss development patterns suggests the reasonable likelihood that 2006 year-end
loss reserves could ultimately develop within a range of +/- 5%. The most
significant factors impacting the potential reserve development for each of
the
Company’s insurance segments is discussed above. While the Company has generally
experienced favorable loss developments for the latest ten year period on an
overall basis, the current analysis of loss development factors and economic
conditions influencing the Company’s insurance coverages indicates a gradual
downward trend in favorable development during the most recent three years.
Consequently, management believes that using a 5% potential range of reserve
development provides a reasonable benchmark for a sensitivity analysis of the
Company’s reserves as of December 31, 2006.
Reinsurance
Programs
To
maintain premium
production within its capacity and limit maximum losses and risks for which
it
might become liable under its policies, Old Republic 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. Further
discussion of the Company’s reinsurance programs can be found in Part 1 of this
Annual Report on Form 10-K on pages 13 and 14.
Subsidiaries
within
the general
insurance
segment have
generally obtained reinsurance coverage from independent insurance or
reinsurance companies pursuant to excess of loss agreements. Under excess of
loss reinsurance agreements, the Company is generally reimbursed for losses
exceeding contractually agreed-upon levels. During the three year period ended
December 31, 2006, the Company’s net retention has been increasing gradually
within the general insurance segment; however, such changes have not had a
material impact on the Company’s consolidated financial statements.
Generally,
mortgage
guaranty
insurance risk is
reinsured through excess of loss contracts through insurers owned by or
affiliated with lending institutions, and financial and other intermediaries
whose customers are insured by Old Republic. Except for minor amounts of
facultative reinsurance covering large risks, the title
insurance
segment does not
utilize reinsurance in managing its insurance risk. The Company does not
anticipate any significant changes to its reinsurance programs during
2007.
Expenses:
Underwriting Acquisition and Other
Expenses
|
The
following table
sets forth the expense ratios registered by each major business segment and
in
consolidation for the periods shown:
General
|
Mortgage
|
Title
|
Consolidated
|
|||||
Years
Ended
December 31:
|
||||||||
2004
|
24.8%
|
25.6%
|
90.5%
|
47.3%
|
||||
2005
|
24.6
|
22.4
|
88.2
|
45.2
|
||||
2006
|
24.4%
|
22.5%
|
93.6%
|
44.7%
|
Expense
ratios for
the Company as a whole have remained basically stable for the periods reported
upon. 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. 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
in
the face of changing market conditions.
The
General
Insurance Group’s expense ratio reflects the benefits of well-controlled
production and administrative expense management in the face of a greater
revenue base. The decline in the Mortgage Guaranty segment’s 2005 ratio reflects
the absence of this segments’ share of 2004 stock option costs, as well as a
combination of lower contract underwriting costs, reductions in variable sales
expenses, and continued attention to operating efficiencies. The slight increase
in the 2006 expense ratio reflects higher stock option compensation
costs.
42
Increased
title
sales volume and the absence of settlement charges related to consumer and
regulatory litigation affecting Old Republic’s California title insurance
subsidiary in 2004 led to a lower expense ratio in 2005. The increase in the
2006 expense ratio results from a decline in revenues from direct operations,
most of which are concentrated in the Western United States, to a level lower
than necessary to support the fixed portion of the operating expense
structure.
Expenses:
Total
|
The
composite
ratios of the above net claims, benefits and underwriting expenses that reflect
the sum total of all the factors enumerated above have been as
follows:
General
|
Mortgage
|
Title
|
Consolidated
|
|||||
Years
Ended
December 31:
|
||||||||
2004
|
90.7%
|
61.1%
|
96.3%
|
89.3%
|
||||
2005
|
91.5
|
59.6
|
94.2
|
88.5
|
||||
2006
|
90.3%
|
65.3%
|
99.5%
|
90.0%
|
Expenses:
Income Taxes
|
The
effective
consolidated income tax rates were 31.7% in 2006, 26.2% in 2005, and 33.2%
in
2004. The 2005 effective tax rate was reduced and net earnings enhanced by
tax
and related interest recoveries of $57.9 ($45.9 net of tax, or 20 cents per
share), in the second quarter due to the favorable resolution of tax issues
applicable to the three years ended December 31, 1990. Excluding the effects
of
these tax and related interest recoveries, the effective tax rates remained
consistent with those of the corresponding prior periods. 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 results, liquidity, and other performance 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 and other 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. Of necessity, any such forward-looking
statements, commentaries, or inferences, involve assumptions, uncertainties,
and
risks that may affect the Company’s future performance. With regard to Old
Republic’s General insurance segment, its results can be affected, in
particular, by the level of market competition, which is typically a function
of
available capital and expected returns on such capital among competitors, the
levels of interest and inflation rates, and periodic changes in claim frequency
and severity patterns caused by natural disasters, weather conditions,
accidents, illnesses, work-related injuries, and unanticipated external events.
Mortgage Guaranty and Title insurance results can be affected by similar factors
and, most particularly, by changes in national and regional housing demand
and
values, the availability and cost of mortgage loans, employment trends, and
default rates on mortgage loans. Mortgage guaranty results, in particular,
may
also be affected by various risk-sharing arrangements with business producers
as
well as the risk management and pricing policies of government sponsored
enterprises. Life and 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 holding 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. A more detailed discussion of all the foregoing
risks appears in Part I, Item 1A - Risk Factors, of this Annual Report, which
is
specifically incorporated herein by reference.
Any
forward-looking
statements or commentaries speak only as of their dates. Old Republic undertakes
no obligation to publicly update or revise any and all such comments, whether
as
a result of new information, future events or otherwise, and accordingly they
may not be unduly relied upon.
43
Item
7A - Quantitative and Qualitative Disclosure About Market
Risk
|
Market
risk
represents the potential for loss due to adverse changes in the fair value
of
financial instruments as a result of changes in interest rates, equity prices,
foreign exchange rates and commodity prices. Old Republic’s primary market risks
consist of interest rate risk associated with investments in fixed maturities
and equity price risk associated with investments in equity securities. The
Company has no material foreign exchange or commodity risk.
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.
The following table illustrates the hypothetical effect on the fixed income
and
equity investment portfolios resulting from movements in interest rates and
fluctuations in the equity securities markets, using the S&P 500 index as a
proxy, at December 31, 2006:
Estimated
Fair
Value
|
Hypothetical
Change in
Interest
Rates or S&P 500
|
Estimated
Fair Value
After
Hypothetical Change in
Interest
Rates or S&P 500
|
|
Interest
Rate
Risk:
|
|||
Fixed
Maturities
|
$
6,832.6
|
100
basis
point rate increase
|
$
6,594.4
|
200
basis
point rate increase
|
6,335.8
|
||
100
basis
point rate decrease
|
7,149.9
|
||
200
basis
point rate decrease
|
$
7,448.3
|
||
Equity
Price
Risk:
|
|||
Equity
Securities
|
$
669.1
|
10%
increase
in the S&P 500
|
$
732.0
|
20%
increase
in the S&P 500
|
794.9
|
||
10%
decline
in the S&P 500
|
606.2
|
||
20%
decline
in the S&P 500
|
$
543.3
|
Item
8 - Financial Statements and Supplementary
Data
|
Listed
below are
the consolidated financial statements included herein for
Old
Republic
International Corporation and Subsidiairies:
|
|
Page
No.
|
|
Consolidated
Balance Sheets
|
45
|
Consolidated
Statements of Income
|
46
|
Consolidated
Statements of Comprehensive Income
|
47
|
Consolidated
Statements of Preferred Stock and
|
|
Common
Shareholders' Equity
|
48
|
Consolidated
Statements of Cash Flows
|
49
|
Notes
to
Consolidated Financial Statements
|
50
-
70
|
Report
of
Independent Registered Public Accounting Firm
|
71
|
44
Old
Republic International Corporation and Subsidiaries
Consolidated
Balance Sheets
($
in
Millions, Except Share Data)
December
31,
|
||||
2006
|
2005
|
|||
Assets
|
||||
Investments:
|
||||
Available
for
sale:
|
||||
Fixed
maturity securities (at fair value) (cost: $6,873.8 and
$6,323.7)
|
$
6,832.6
|
$
6,331.6
|
||
Equity
securities (at fair value) (cost: $534.7 and $500.9)
|
669.1
|
552.4
|
||
Short-term
investments (at fair value which approximates cost)
|
493.6
|
275.3
|
||
Miscellaneous
investments
|
52.7
|
62.7
|
||
Total
|
8,048.1
|
7,222.2
|
||
Other
investments
|
7.9
|
8.0
|
||
Total investments
|
8,056.1
|
7,230.2
|
||
Other
Assets:
|
||||
Cash
|
71.6
|
68.3
|
||
Securities
and indebtedness of related parties
|
21.8
|
16.4
|
||
Accrued
investment income
|
102.9
|
95.5
|
||
Accounts
and
notes receivable
|
962.1
|
803.4
|
||
Federal
income tax recoverable: Current
|
15.5
|
-
|
||
Prepaid
federal income tax
|
468.4
|
545.7
|
||
Reinsurance
balances and funds held
|
74.2
|
81.0
|
||
Reinsurance
recoverable: Paid
losses
|
58.6
|
59.4
|
||
Policy
and
claim reserves
|
2,172.7
|
2,107.8
|
||
Deferred
policy acquisition costs
|
264.9
|
240.0
|
||
Sundry
assets
|
342.9
|
294.9
|
||
4,556.1
|
4,312.9
|
|||
Total Assets
|
$
12,612.2
|
$
11,543.2
|
||
Liabilities,
Preferred Stock, and Common Shareholders’ Equity
|
||||
Liabilities:
|
||||
Losses,
claims, and settlement expenses
|
$
5,534.7
|
$
4,939.8
|
||
Unearned
premiums
|
1,209.4
|
1,039.3
|
||
Other
policyholders' benefits and funds
|
188.6
|
188.8
|
||
Total policy liabilities and accruals
|
6,932.8
|
6,167.9
|
||
Commissions,
expenses, fees, and taxes
|
243.5
|
227.2
|
||
Reinsurance
balances and funds
|
314.4
|
307.0
|
||
Federal
income tax payable: Current
|
-
|
129.3
|
||
Deferred
|
469.4
|
421.6
|
||
Debt
|
144.3
|
142.7
|
||
Sundry
liabilities
|
138.4
|
123.1
|
||
Commitments
and contingent liabilities
|
||||
Total Liabilities
|
8,243.0
|
7,519.1
|
||
Preferred
Stock:
|
||||
Convertible
preferred stock (1)
|
-
|
-
|
||
Common
Shareholders’ Equity:
|
||||
Common
stock
(1)
|
231.0
|
229.5
|
||
Additional
paid-in capital
|
319.5
|
288.6
|
||
Retained
earnings
|
3,773.9
|
3,444.9
|
||
Accumulated
other comprehensive income
|
44.6
|
60.8
|
||
Total Common Shareholders' Equity
|
4,369.2
|
4,024.0
|
||
Total Liabilities, Preferred Stock and Common Shareholders’
Equity
|
$
12,612.2
|
$
11,543.2
|
_______________
(1) At
December 31,
2006 and 2005, 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
231,047,890 in 2006 and 229,575,404 in 2005 were issued and outstanding. At
December 31, 2006 and 2005, there were 100,000,000 shares of Class B Common
Stock, $1.00 par value, authorized, of which no shares were issued.
See
accompanying Notes to Consolidated Financial
Statements.
|
45
Old
Republic International Corporation and Subsidiaries
Consolidated
Statements of Income
($
in
Millions, Except Share Data)
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Revenues:
|
||||||
Net
premiums
earned
|
$
3,154.1
|
$
3,062.3
|
$
2,804.8
|
|||
Title,
escrow, and other fees
|
246.3
|
324.6
|
311.2
|
|||
Total
premiums and fees
|
3,400.5
|
3,386.9
|
3,116.1
|
|||
Net
investment income
|
341.6
|
310.1
|
290.8
|
|||
Other
income
|
33.0
|
43.9
|
36.7
|
|||
Total
operating revenues
|
3,775.2
|
3,741.0
|
3,443.7
|
|||
Realized
investment gains
|
19.0
|
64.9
|
47.9
|
|||
Total
revenues
|
3,794.2
|
3,805.9
|
3,491.6
|
|||
Benefits,
Claims and Expenses:
|
||||||
Benefits,
claims, and settlement expenses
|
1,532.3
|
1,460.1
|
1,305.6
|
|||
Dividends
to
policyholders
|
7.3
|
5.3
|
2.2
|
|||
Underwriting,
acquisition, and other expenses
|
1,564.4
|
1,583.4
|
1,523.8
|
|||
Interest
and
other charges
|
9.9
|
9.5
|
8.9
|
|||
Total
expenses
|
3,114.0
|
3,058.5
|
2,840.7
|
|||
Income
before
income taxes
|
680.1
|
747.3
|
650.9
|
|||
Income
Taxes:
|
||||||
Current
|
158.8
|
263.0
|
183.4
|
|||
Deferred
(Credits)
|
56.4
|
(67.1)
|
32.5
|
|||
Total
|
215.2
|
195.9
|
215.9
|
|||
Net
Income
|
$
464.8
|
$
551.4
|
$
435.0
|
|||
Net
Income Per Share:
|
||||||
Basic:
|
$
2.01
|
$
2.40
|
$
1.91
|
|||
Diluted:
|
$
1.99
|
$
2.37
|
$
1.89
|
|||
Average
shares outstanding: Basic
|
231,017,947
|
229,487,273
|
228,177,278
|
|||
Diluted
|
233,034,986
|
232,108,491
|
230,759,540
|
|||
Dividends
Per Common Share:
|
||||||
Cash:
Regular
|
$
.590
|
$
.512
|
$
.402
|
|||
Special
|
-
|
.800
|
-
|
|||
Total
|
$
.590
|
$
1.312
|
$
.402
|
|||
Stock
|
-%
|
25%
|
-%
|
See
accompanying Notes to Consolidated Financial
Statements.
|
46
Old
Republic International Corporation and Subsidiaries
Consolidated
Statements of Comprehensive Income
($
in
Millions)
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Net
income as reported
|
$
464.8
|
$
551.4
|
$
435.0
|
|||
Other
comprehensive income (loss):
|
||||||
Foreign currency translation adjustment
|
(1.4)
|
2.9
|
7.3
|
|||
Unrealized gains (losses) on securities:
|
||||||
Unrealized gains (losses) arising during period
|
44.2
|
(120.5))
|
(49.9))
|
|||
Less: elimination of pretax realized gains
|
||||||
included in income as reported
|
19.0
|
64.9
|
47.9
|
|||
Pretax unrealized gains (losses) on securities
|
||||||
carried at market value
|
25.2
|
(185.4))
|
(97.8))
|
|||
Deferred income taxes (credits)
|
8.7
|
(64.9))
|
(34.2))
|
|||
Net unrealized gains (losses) on securities
|
16.4
|
(120.5))
|
(63.5))
|
|||
Minimum Pension Liability:
|
||||||
Minimum pension liability
|
(17.1)
|
(1.7))
|
(1.5))
|
|||
Deferred income tax credits
|
(6.0)
|
(.6))
|
(.5))
|
|||
Minimum pension liability, net of tax credits
|
(11.1)
|
(1.1))
|
(.9))
|
|||
Net
adjustments
|
3.8
|
(118.7))
|
(57.2))
|
|||
Comprehensive
income
|
$
468.7
|
$
432.6
|
$
377.7
|
See
accompanying Notes to Consolidated Financial
Statements.
|
47
Old
Republic International Corporation and Subsidiaries
Consolidated
Statements of Preferred Stock
and
Common
Shareholders' Equity
($
in
Millions)
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Convertible
Preferred Stock:
|
||||||
Balance,
end
of year
|
$
-
|
$
-
|
$
-
|
|||
Common
Stock:
|
||||||
Balance,
beginning of year
|
$
229.5
|
$
185.4
|
$
184.4
|
|||
Stock
dividend
|
-
|
45.9
|
-
|
|||
Dividend
reinvestment plan
|
-
|
-
|
-
|
|||
Exercise
of
stock options
|
1.4
|
.9
|
.9
|
|||
Stock
awards
|
-
|
-
|
-
|
|||
Treasury
stock restored to unissued status
|
-
|
(2.8))
|
-
|
|||
Balance,
end
of year
|
$
231.0
|
$
229.5
|
$
185.4
|
|||
Additional
Paid-in Capital:
|
||||||
Balance,
beginning of year
|
$
288.6
|
$
270.4
|
$
245.5
|
|||
Dividend
reinvestment plan
|
1.1
|
2.0
|
.8
|
|||
Exercise
of
stock options
|
16.4
|
18.1
|
15.3
|
|||
Stock
option
compensation
|
13.3
|
4.8
|
8.7
|
|||
Stock
awards
|
-
|
.2
|
-
|
|||
Treasury
stock restored to unissued status
|
-
|
(7.1))
|
-
|
|||
Balance,
end
of year
|
$
319.5
|
$
288.6
|
$
270.4
|
|||
Retained
Earnings:
|
||||||
Balance,
beginning of year
|
$
3,444.9
|
$
3,240.1
|
$
2,896.8
|
|||
Net
income
|
464.8
|
551.4
|
435.0
|
|||
Dividends
on
common stock: cash
|
(135.8)
|
(300.7))
|
(91.6))
|
|||
stock
|
-
|
(45.9))
|
-
|
|||
Balance,
end
of year
|
$
3,773.9
|
$
3,444.9
|
$
3,240.1
|
|||
Accumulated
Other Comprehensive Income:
|
||||||
Balance,
beginning of year
|
$
60.8
|
$
179.5
|
$
236.8
|
|||
Foreign
currency translation adjustments
|
(1.4)
|
2.9
|
7.3
|
|||
Net
unrealized gains (losses) on securities
|
16.4
|
(120.5))
|
(63.5))
|
|||
Minimum
pension liability, net of tax credits
|
(11.1)
|
(1.1)
|
(.9)
|
|||
Adjustment
to
initially apply FAS 158, net of tax credits
|
(20.0)
|
-
|
-
|
|||
Balance,
end
of year
|
$
44.6
|
$
60.8
|
$
179.5
|
|||
Treasury
Stock:
|
||||||
Balance,
beginning of year
|
$
-
|
$
(10.0)
|
$
(10.0)
|
|||
Acquired
during the year
|
-
|
-
|
-
|
|||
Restored
to
unissued status
|
-
|
10.0
|
-
|
|||
Balance,
end
of year
|
$
-
|
$
-
|
$
(10.0)
|
See
accompanying Notes to Consolidated Financial
Statements.
|
48
Old
Republic International Corporation and Subsidiaries
Consolidated
Statements of Cash Flows
($
in
Millions)
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Cash
flows from operating activities:
|
||||||
Net
income
|
$
464.8
|
$
551.4
|
$
435.0
|
|||
Adjustments
to reconcile net income to
|
||||||
net
cash
provided by operating activities:
|
||||||
Deferred
policy acquisition costs
|
(24.6)
|
(7.2)
|
(9.4)
|
|||
Premiums
and
other receivables
|
(85.5)
|
(212.7)
|
(33.4)
|
|||
Unpaid
claims
and related items
|
560.2
|
273.9
|
262.8
|
|||
Other
policyholders’ benefits and funds
|
138.9
|
96.2
|
82.8
|
|||
Income
taxes
|
(89.1)
|
53.9
|
56.5
|
|||
Prepaid
federal income taxes
|
77.3
|
(46.4)
|
(52.8)
|
|||
Reinsurance
balances and funds
|
(77.7)
|
154.3
|
(10.5)
|
|||
Realized
investment gains
|
(19.0)
|
(64.9)
|
(47.9)
|
|||
Accounts
payable, accrued expenses and other
|
59.6
|
34.9
|
92.5
|
|||
Total
|
1,004.7
|
833.6
|
775.5
|
|||
Cash
flows from investing activities:
|
||||||
Fixed
maturity securities:
|
||||||
Maturities
and early calls
|
729.1
|
794.7
|
608.4
|
|||
Sales
|
215.3
|
375.2
|
149.6
|
|||
Sales
of:
|
||||||
Equity
securities
|
21.7
|
325.8
|
334.0
|
|||
Other
investments
|
21.2
|
12.9
|
12.7
|
|||
Fixed
assets
for company use
|
.8
|
5.7
|
.9
|
|||
Investment
in
subsidiary
|
7.7
|
-
|
-
|
|||
Cash
and
short-term investments of subsidiaries acquired
|
17.6
|
1.2
|
2.5
|
|||
Purchases
of:
|
||||||
Fixed
maturity securities
|
(1,517.5)
|
(1,748.4)
|
(1,533.9)
|
|||
Equity
securities
|
(50.7)
|
(380.8)
|
(250.3)
|
|||
Other
investments
|
(9.2)
|
(5.2)
|
(1.9)
|
|||
Fixed
assets
for company use
|
(19.6)
|
(37.6)
|
(20.1)
|
|||
Investments
in subsidiaries
|
(71.3)
|
(10.1)
|
(1.4)
|
|||
Cash
and
short-term investments of subsidiaries sold
|
(5.5)
|
-
|
-
|
|||
Net
decrease
(increase) in short-term investments
|
(218.2)
|
118.9
|
15.5
|
|||
Other-net
|
(8.9)
|
4.0
|
2.6
|
|||
Total
|
(887.4)
|
(543.5)
|
(681.3)
|
|||
|
||||||
Cash
flows from financing activities:
|
||||||
Issuance
of
debentures and notes
|
3.2
|
1.0
|
-
|
|||
Issuance
of
common shares
|
18.9
|
18.4
|
14.6
|
|||
Redemption
of
debentures and notes
|
(1.5)
|
(1.4)
|
(.6)
|
|||
Dividends
on
common shares
|
(135.8)
|
(300.7)
|
(91.6)
|
|||
Other-net
|
1.2
|
.2
|
(3.1)
|
|||
Total
|
(113.9)
|
(282.4)
|
(80.8)
|
|||
Increase
(decrease) in cash:
|
3.3
|
7.7
|
13.3
|
|||
Cash,
beginning of year
|
68.3
|
60.5
|
47.2
|
|||
Cash,
end of
year
|
$
71.6
|
$
68.3
|
$
60.5
|
|||
Supplemental
cash flow information:
|
||||||
Cash
paid
during the year for: Interest
|
$
9.7
|
$
9.4
|
$
8.7
|
|||
Income
taxes
|
$
302.0
|
$
138.4
|
$
156.5
|
See
accompanying Notes to Consolidated Financial
Statements.
|
49
Old
Republic International Corporation and Subsidiaries
Notes
to
Consolidated Financial Statements
($
in
Millions, Except as Otherwise Indicated)
Old
Republic
International Corporation is a Chicago-based insurance holding company with
subsidiaries engaged mainly in the general (property and liability), mortgage
guaranty and title insurance businesses. In this report, “Old Republic”, 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 Company and those of its major
insurance underwriting and service subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(b)
Accounting
Principles-The
Company'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 (“GAAP”).
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.
Accordingly, 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,
2006
and 2005, the Company's invested assets were classified as “available for
sale.”
Fixed
maturity
securities classified as “available for sale” and other preferred and common
stocks (equity securities) are included at fair value with changes in such
values, net of deferred income taxes, reflected directly in shareholders’
equity. Fair values for fixed maturity securities and equity securities are
based on quoted market prices or estimates using values obtained from
independent pricing services as applicable.
The
Company reviews
the status and market value changes of each of its investments on at least
a
quarterly basis during the year, and estimates of other than temporary
impairments in the portfolio’s value are evaluated and established at each
quarterly balance sheet date. In reviewing investments for other than temporary
impairment, the Company, in addition to a security’s market price history,
considers the totality of such factors as the issuer’s operating results,
financial condition and liquidity, its ability to access capital markets, credit
rating trends, most current audit opinion, industry and securities markets
conditions, and analyst expectations to reach its conclusions. Sudden market
value declines caused by such adverse developments as newly emerged or imminent
bankruptcy filings, issuer default on significant obligations, or reports of
financial accounting developments that bring into question the validity of
previously reported earnings or financial condition, are recognized as realized
losses as soon as credible publicly available information emerges to confirm
such developments. Accordingly, the recognition of losses from
other-than-temporary value impairments is subject to a great deal of judgment
as
well as turns of events over which the Company can exercise little or no
control. In the event the Company’s estimate of other than temporary impairments
is insufficient at any point in time, future periods’ net income would be
adversely affected by the recognition of additional realized or impairment
losses, but its financial position would not necessarily be affected adversely
inasmuch as such losses, or a portion of them, could have been recognized
previously as unrealized losses. The Company recognized no other than temporary
impairments of investments for the year ended December 31, 2006, while
recognizing $9.2 and $5.2 for the years ended December 31, 2005 and 2004,
respectively.
50
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,
2006:
|
||||||||
U.S.
&
Canadian Governments
|
$
708.7
|
$
11.6
|
$
5.6
|
$
714.7
|
||||
Tax-exempt
|
2,234.1
|
10.1
|
14.7
|
2,229.5
|
||||
Utilities
|
936.5
|
7.2
|
19.8
|
923.8
|
||||
Corporate
|
2,994.4
|
17.6
|
47.6
|
2,964.4
|
||||
$
6,873.8
|
$
46.6
|
$
87.8
|
$
6,832.6
|
|||||
December
31,
2005:
|
||||||||
U.S.
&
Canadian Governments
|
$
699.3
|
$
18.2
|
$
4.0
|
$
713.4
|
||||
Tax-exempt
|
1,976.4
|
15.0
|
16.2
|
1,975.2
|
||||
Utilities
|
924.2
|
13.1
|
14.3
|
923.0
|
||||
Corporate
|
2,723.7
|
33.1
|
36.9
|
2,719.8
|
||||
$
6,323.7
|
$
79.5
|
$
71.5
|
$
6,331.6
|
The
amortized cost
and estimated fair value at December 31, 2006, 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:
|
||||
Due
in one
year or less
|
$
662.6
|
$
662.5
|
||
Due
after one
year through five years
|
3,052.3
|
3,048.6
|
||
Due
after
five years through ten years
|
3,134.2
|
3,097.0
|
||
Due
after ten
years
|
24.6
|
24.4
|
||
$
6,873.8
|
$
6,832.6
|
Bonds
and other
investments with a statutory carrying value of $231.1 as of December 31, 2006
were on deposit with governmental authorities by the Company'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,
2006:
|
||||||||
Equity
securities
|
$
534.7
|
$
136.1
|
$
1.8
|
$
669.1
|
||||
December
31,
2005:
|
||||||||
Equity
securities
|
$
500.9
|
$
55.1
|
$
3.6
|
$
552.4
|
||||
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.
51
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, 2006 and 2005:
12
Months or
Less
|
Greater
than
12 Months
|
Total
|
|||||||||
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
||||||
December
31,
2006:
|
|||||||||||
Fixed
Maturity Securities:
|
|||||||||||
U.S. & Canadian Governments
|
$
210.6
|
$
2.0
|
$
229.5
|
$
3.5
|
$
440.2
|
$
5.6
|
|||||
Tax-exempt
|
402.9
|
1.7
|
925.7
|
13.0
|
1,328.7
|
14.7
|
|||||
Corporates
|
1,047.5
|
11.7
|
1,825.6
|
55.7
|
2,873.1
|
67.5
|
|||||
1,661.1
|
15.5
|
2,980.9
|
72.3
|
4,642.1
|
87.8
|
||||||
Equity
Securities
|
25.1
|
1.8
|
-
|
-
|
25.1
|
1.8
|
|||||
Total
|
$
1,686.3
|
$
17.3
|
$
2,980.9
|
$
72.3
|
$
4,667.3
|
$
89.7
|
|||||
December
31,
2005:
|
|||||||||||
Fixed
Maturity Securities:
|
|||||||||||
U.S. & Canadian Governments
|
$
312.9
|
$
2.9
|
$
72.5
|
$
.8
|
$
385.4
|
$
3.7
|
|||||
Tax-exempt
|
969.6
|
12.2
|
154.4
|
4.0
|
1,124.0
|
16.2
|
|||||
Corporates
|
1,773.8
|
36.1
|
377.2
|
15.4
|
2,151.0
|
51.5
|
|||||
3,056.3
|
51.2
|
604.2
|
20.3
|
3,660.6
|
71.5
|
||||||
Equity
Securities
|
94.6
|
3.5
|
-
|
-
|
94.6
|
3.6
|
|||||
Total
|
$
3,151.0
|
$
54.8
|
$
604.2
|
$
20.3
|
$
3,755.3
|
$
75.1
|
At
December 31,
2006, the Company held 1,214 fixed maturity and 8 equity securities in an
unrealized loss position, representing 63.6% as to fixed maturities and 9.8%
as
to equity securities of the total number of such issues held by the Company.
Of
the 1,214 fixed maturity securities, 735 had been in a continuous unrealized
loss position for greater than 12 months. The unrealized losses on these
securities are primarily attributable to a rising interest rate environment
as
opposed to a decline in credit quality of the issuer. As part of its assessment
of other than temporary impairment, the Company considers its intent and ability
to continue to hold investment securities in an unrealized loss position until
cost recovery, principally on the basis of its asset and liability maturity
matching procedures. The Company has not sold nor does it expect to sell
investments for purposes of generating cash to pay claim or expense obligations,
thereby supporting its ability to continue to hold securities until their cost
basis may be recovered.
At
December 31,
2006, the Company and its subsidiaries had $3.8 of non-income producing fixed
maturity securities.
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,
|
||||||||
2006
|
2005
|
2004
|
||||||
Investment
income from:
|
||||||||
Fixed
maturity securities
|
$
298.0
|
$
284.1
|
$
267.2
|
|||||
Equity
securities
|
13.9
|
9.4
|
14.3
|
|||||
Short-term
investments
|
26.6
|
15.9
|
5.7
|
|||||
Other
sources
|
6.5
|
5.4
|
6.8
|
|||||
Gross
investment income
|
345.1
|
315.0
|
294.1
|
|||||
Investment
expenses (1)
|
3.5
|
4.9
|
3.2
|
|||||
Net investment income
|
$
341.6
|
$
310.1
|
$
290.8
|
|||||
Realized
gains (losses) on:
|
||||||||
Fixed
maturity securities:
|
||||||||
Gains
|
$
2.7
|
$
5.8
|
$
5.2
|
|||||
Losses
|
(.6)
|
(4.0)
|
(.5)
|
|||||
Net
|
2.0
|
1.7
|
4.6
|
|||||
Equity
securities & other long-term investments
|
16.9
|
63.1
|
43.2
|
|||||
Total
|
19.0
|
64.9
|
47.9
|
|||||
Income
taxes
|
6.6
|
22.6
|
17.0
|
|||||
Net
realized
gains
|
$
12.3
|
$
42.2
|
$
30.9
|
|||||
(Table
continued on
next page.)
52
(Table
continued
from previous page.)
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Changes
in
unrealized investment gains (losses) on:
|
||||||
Fixed
maturity securites
|
$ (49.2)
|
$
(174.7)
|
$
(94.3)
|
|||
Less:
Deferred income taxes (credits)
|
(17.3)
|
(61.1)
|
(33.0)
|
|||
Net
changes
in unrealized investment gains (losses)
|
$
(31.9)
|
$
(113.5)
|
$
(61.3)
|
|||
Equity
securities & other long-term investments
|
$
74.4
|
$
(10.7)
|
$
(3.5)
|
|||
Less:
Deferred income taxes (credits)
|
26.0
|
(3.7)
|
(1.2)
|
|||
Net
changes
in unrealized investment gains (losses)
|
$
48.3
|
$
(6.9)
|
$
(2.2)
|
_______________
(1) Investment
expenses
consist of personnel costs and investment management and custody service fees,
as well as interest
incurred on funds held of $1.0, $.7 and $.3 for the years ended December
31, 2006, 2005 and 2004, respectively.
(d)
Revenue
Recognition
-Pursuant to GAAP
pertaining to the insurance industry, revenues are associated with the related
benefits, claims, and expenses by application of numerous management estimates,
accounting rules, and conventions.
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 generally 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 32% 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 68% of consolidated title premium and
fee
revenues are produced by independent title agents and underwritten title
companies. Rather than making estimates that could be subject to significant
variance from actual premium 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 largely
offset concurrently by applicable production expenses and claim reserve
provisions.
(e)
Deferred
Policy Acquisition Costs-The
Company'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 revenues on existing policies are not adequate to cover
related costs and expenses, deferred policy acquisition costs are charged to
earnings. A write down of previously deferred acquisition costs applicable
to a
discontinued life insurance 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,
|
||||||
2006
|
2005
|
2004
|
||||
Deferred,
beginning of year
|
$
240.0
|
$
232.3
|
$
221.9
|
|||
Acquisition
costs deferred:
|
||||||
Commissions
-
net of reinsurance
|
241.7
|
219.1
|
209.4
|
|||
Premium
taxes
|
68.2
|
75.5
|
69.9
|
|||
Salaries
and
other marketing expenses
|
81.6
|
92.6
|
91.5
|
|||
Sub-total
|
391.8
|
387.4
|
370.9
|
|||
Amortization
charged to income
|
(366.9)))
|
(379.8)))
|
(360.5)))
|
|||
Change
for
the year
|
24.9
|
7.6
|
10.4
|
|||
Deferred,
end
of year
|
$
264.9
|
$
240.0
|
$
232.3
|
(f)
Unearned
Premiums-Unearned
premium
reserves are generally calculated by application of pro-rata factors to premiums
in force. At December 31, 2006 and 2005, unearned premiums consisted of the
following:
December
31,
|
||||||
2006
|
2005
|
|||||
General
Insurance Group
|
$
1,153.8
|
$
993.3
|
||||
Mortgage
Guaranty Group
|
55.6
|
45.9
|
||||
Total
|
$
1,209.4
|
$
1,039.3
|
53
(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, reserves established are a reflection of
the
opi-nions of a large number of persons, of the application and interpretation
of
historical precedent and trends, of expectations as to future developments,
and
of management’s judgment in interpreting all such factors. At any point in time,
the Company is exposed to possibly higher or lower than anticipated claim costs
due to all of these factors, and to the evolution, interpretation, and expansion
of tort law, as well as the effects of unexpected jury verdicts.
All
reserves are
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 recent years. 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 Company's property and
liability insurance subsidiaries have typically issued general liability
insurance policies with face amounts ranging between $1.0 and $2.0 and rarely
exceeding $10.0. Such policies have, in turn, been subject to reinsurance
cessions which have usually reduced the Company'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
which has produced inconsistent court decisions 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
54
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, 2006, 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 Company's reserves for such claims and related costs will
not
prove to be overstated or understated in the future. At December 31, 2006 and
2005, Old Republic’s aggregate indemnity and loss adjustment expense reserves
specifically identified with A&E exposures amounted to approximately $194.9
and $170.7 gross, respectively, and $157.8 and $132.2 net of reinsurance,
respectively. Old Republic’s average five year survival ratios stood at 7.6
years (gross) and 10.9 years (net of reinsurance) as of December 31, 2006 and
7.4 years (gross) and 10.4 years (net of reinsurance) as of December 31, 2005.
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 statistical 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, such loss reserve estimates also 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 interest costs, demand and
extensions.
Title
insurance and
related escrow services loss and loss adjustment expense reserves are
established as point estimates to cover the projected 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. The point estimates covering all claim reserves take into account
incurred but not reported claims based on past experience and evaluations of
such variables as changing trends in the types of policies issued, changes
in
real estate markets and interest rate environments, and changing levels of
loan
refinancing, 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,
|
||||||||||
2006
|
2005
|
2004
|
||||||||
Gross
reserves at beginning of year
|
$
4,939.8
|
$
4,403.5
|
$
4,022.7
|
|||||||
Less:
reinsurance losses recoverable
|
1,902.1
|
1,639.6
|
1,522.5
|
|||||||
Net reserves at beginning of year
|
3,037.6
|
2,763.8
|
2,500.1
|
|||||||
Incurred
claims and claim adjustment expenses:
|
||||||||||
Provisions for insured events of the current year
|
1,646.4
|
1,504.5
|
1,348.7
|
|||||||
Change in provision for insured events of prior years
|
(114.0)
|
(43.9)
|
(43.1)
|
|||||||
Total incurred claims and claim adjustment expenses
|
1,532.5
|
1,460.7
|
1,305.7
|
|||||||
Payments:
|
||||||||||
Claims and claim adjustment expenses attributable to
|
||||||||||
insured events of the current year
|
432.4
|
484.6
|
403.6
|
|||||||
Claims and claim adjustment expenses attributable to
|
||||||||||
insured events of prior years
|
539.6
|
702.1
|
638.2
|
|||||||
Total payments
|
972.1
|
1,186.8
|
1,041.9
|
|||||||
Amount
of
reserves for unpaid claims and claim adjustment
|
||||||||||
expenses at the end of each year, net of reinsurance
|
||||||||||
losses recoverable
|
3,598.0
|
3,037.6
|
2,763.8
|
|||||||
Reinsurance
losses recoverable
|
1,936.6
|
1,902.1
|
1,639.6
|
|||||||
Gross
reserves at end of year
|
$
5,534.7
|
$
4,939.8
|
$
4,403.5
|
For
the three most
recent calendar years, the above table indicates that the one-year development
of consolidated reserves at the beginning of each year produced average
favorable annual developments of about 2.4%. The Company believes that the
factors most responsible, in varying and continually changing degrees, for
such
redundancies or deficiencies included differences in originally estimated
salvage and subrogation recoveries, in sales and prices of homes that can impact
claim costs upon the sale of foreclosed properties, by changes in regional
or
local economic conditions, by changes in employment levels, in levels of loan
refinancing activity that can reduce the period of time over which a policy
remains at risk, in lower than expected frequencies of claims incurred but
not
reported, in the effect of reserve discounts applicable to workers’ compensation
claims, in higher than expected severity of litigated claims in particular,
in
governmental or judicially imposed retroactive conditions in the settlement
of
claims such as noted above in regard to black lung disease claims, in greater
than anticipated inflation rates applicable to repairs and the medical portion
of claims in particular, and in higher than expected claims incurred but not
reported due to the slower and highly volatile emergence patterns applicable
to
certain types of claims such as those stemming from litigated, assumed
reinsurance, or the A&E types of claims noted above.
55
(h)
Reinsurance-The
cost of
reinsurance is recognized over the terms of reinsurance contracts. Amounts
recoverable from reinsurers for loss and loss adjustment expenses are estimated
in a manner consistent with the claim liability associated with the reinsured
business. The Company evaluates the financial condition of its reinsurers on
a
regular basis. Allowances are established for amounts deemed uncollectible
and
are included in the Company’s net claim and claim expense reserves.
(i)
Income
Taxes-The
Company and
most of its subsidiaries file a consolidated tax return and provide for income
taxes payable currently. Deferred income taxes included in the accompanying
consolidated financial statements will not necessarily become
payable/recoverable in the future. The Company uses the asset and liability
method of calculating deferred income taxes. This method calls for the
establishment of a deferred tax, calculated at currently enacted tax rates
that
are applied to the cumulative temporary differences between financial
statement and tax bases of assets and liabilities.
The
provision for
combined current and deferred income taxes reflected in the consolidated
statements of income does not bear the usual relationship to income before
income taxes as the result of permanent and other differences between pretax
income and taxable income determined under existing tax regulations. The more
significant differences, their effect on the statutory income tax rate, and
the
resulting effective income tax rates are summarized below:
Years
Ended
December 31,
|
|||||||||
2006
|
2005
|
2004
|
|||||||
Statutory
tax
rate
|
35.0
|
%
|
35.0
|
%
|
35.0
|
%
|
|||
Tax
rate
increases (decreases):
|
|||||||||
Tax-exempt
interest
|
(3.3
|
)
|
(2.6
|
)
|
(2.4
|
)
|
|||
Dividends received exclusion
|
(.4
|
)
|
(.2
|
)
|
(.5
|
)
|
|||
Other items - net (1)
|
.4
|
(6.0
|
)
|
1.1
|
|||||
Effective
tax
rate
|
31.7
|
%
|
26.2
|
%
|
33.2
|
%
|
_______________
(1) |
During
2004,
the Company recorded a pretax charge of $22.9 in response to a court
ruling against Old Republic Title Company. Of that amount, approximately
$11.8 was non-deductible, resulting in an increase in the effective
tax
rate of 0.6 percentage points. Tax and related interest recoveries
of
$57.9 ($45.9 net of tax) were recorded in the second quarter of 2005
due
to the favorable resolution of tax issues applicable to the three
years
ended December 31, 1990. This adjustment reduced the 2005 effective
tax
rate by approximately 6.2 percentage points.
|
The
tax effects of
temporary differences that give rise to significant portions of the Company's
net deferred tax assets (liabilities) are as follows at the dates
shown:
December
31,
|
|||||||||||
2006
|
2005
|
2004
|
|||||||||
Deferred
Tax
Assets:
|
|||||||||||
Losses,
claims, and settlement expenses
|
$
192.0
|
$
176.5
|
$
177.1
|
||||||||
Pension
and deferred compensation plans
|
30.3
|
9.6
|
8.3
|
||||||||
Other
timing differences
|
1.9
|
6.2
|
15.6
|
||||||||
Total deferred tax assets (1)
|
224.3
|
192.3
|
201.0
|
||||||||
Deferred
Tax
Liabilities:
|
|||||||||||
Unearned premium reserves
|
22.6
|
29.5
|
30.1
|
||||||||
Deferred policy acquisition costs
|
87.2
|
77.7
|
75.7
|
||||||||
Mortgage guaranty insurers' contingency reserves
|
536.6
|
468.5
|
545.8
|
||||||||
Fixed maturity securities adjusted to cost
|
7.6
|
6.8
|
7.4
|
||||||||
Net unrealized investment gains
|
35.0
|
26.9
|
91.9
|
||||||||
Title plants and records
|
4.4
|
4.4
|
4.4
|
||||||||
Total deferred tax liabilities
|
693.7
|
614.0
|
755.5
|
||||||||
Net deferred tax liabilities
|
$
469.4
|
$
421.6
|
$
554.5
|
_______________
(1) |
The
Company
has evaluated its deferred tax assets as of each of these dates and
has
concluded that no valuation allowance is
warranted.
|
Pursuant
to special
provisions of the Internal Revenue Code pertaining to mortgage guaranty
insurers, a contingency reserve (established in accordance with insurance
regulations designed to protect policyholders against extraordinary volumes
of
claims) is deductible from gross income. The tax benefits obtained from such
deductions must, however, be invested in a special type of non-interest bearing
U.S. Treasury Tax and Loss Bonds which aggregated $468.4 at December 31, 2006.
For Federal income tax purposes, amounts deducted from the contingency reserve
are taken into gross statutory taxable income in the period in which they are
released. Contingency reserves may be released when incurred losses exceed
thresholds established under state law or regulation, upon special request
and
approval by state insurance regulators, or in any event, upon the expiration
of
ten years. The Company released contingency reserves of $350.0 during the fourth
quarter of 2005 and consequently, $122.5 of U.S. Treasury Tax and Loss Bonds
were redeemed during January 2006.
56
Through
December
31, 2005, cumulative tax and loss bonds purchased and subsequent redemptions
were reflected as U.S. government securities within the investments section
of
the consolidated balance sheets. Effective January 1, 2006 the Company has
reclassified such bonds to conform to more common industry reporting practices
and to better align these investments with the corresponding long-term deferred
income tax liabilities to which they relate. As a result of this
reclassification, invested asset balances have been reduced and the prepaid
income tax asset has been increased, while periodic operating cash flow and
cash
flow from investing activities have been adjusted by correspondingly identical
amounts. The reclassification has no effect on the financial position or net
income of the Company, nor does it call for the receipt or disbursement of
any
additional cash resources.
In
July 2006, FASB
Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes”
was issued. This interpretation, which is effective in the first quarter of
2007, provides recognition criteria and a related measurement model for
uncertain tax positions taken or expected to be taken in income tax returns.
The
Company anticipates that adoption of FIN 48 will not have a material effect
on
its consolidated financial statements. The Company views its income tax
exposures as consisting of timing differences whereby the ultimate deductibility
of a tax position is highly certain but the timing of its deductibility is
uncertain. Such differences relate principally to the timing of deductions
for
loss and premium reserves. As in prior examinations, the Internal Revenue
Service (IRS) could assert that claim reserve deductions were overstated thereby
reducing taxable income in any particular year. The Company believes that it
establishes the aforementioned reserves fairly and consistently at each balance
sheet date, and that it would succeed in defending its tax position in these
regards. Because of the impact of deferred tax accounting, other than possible
interest and penalties, the resulting accelerated payment of tax to the IRS
would not affect the annual effective tax rate.
The
Company’s
consolidated Federal income tax returns have been audited by the IRS through
year end 2003 and no significant adjustments ultimately resulted.
(j)
Property
and Equipment-Property
and
equipment is generally depreciated or amortized over the estimated useful lives
of the assets, (2 to 27 years), substantially by the straight-line method.
Depreciation and amortization expenses related to property and equipment were
$18.5, $19.0, and $18.2 in 2006, 2005, and 2004, respectively. Expenditures
for
maintenance and repairs are charged to income as incurred, and expenditures
for
major renewals and additions are capitalized.
(k)
Title
Plants and Records-Title
plants and
records are carried at original cost or appraised value at the date of purchase.
Such values represent the cost of producing or acquiring interests in title
records and indexes and the appraised value of purchased subsidiaries' title
records and indexes at dates of acquisition. The cost of maintaining, updating,
and operating title records is charged to income as incurred. Title records
and
indexes are ordinarily not amortized unless events or circumstances indicate
that the carrying amount of the capitalized costs may not be
recoverable.
(l)
Goodwill
and Intangible Assets-Goodwill
resulting
from business combinations is no longer amortizable against operations but
must
be tested annually for possible impairment of its continued value ($98.5,
excluding the value of goodwill associated with the acquisition discussed in
Note 7, and
$93.1 at
December 31, 2006 and 2005, respectively). No impairment charges were required
for any period presented. Goodwill and intangible assets of $58.5 were recorded
during 2006 as a result of the November 30, 2006 acquisition of a casualty
insurance book of business (see note 7). Intangible assets related to the
acquisition will be amortized against future operating results.
(m)
Employee
Benefit Plans-
The Company has
three pension plans covering a portion of its work force. The three plans are
the Old Republic International Salaried Employees Restated Retirement Plan
(the
Old Republic Plan), the Bituminous Casualty Corporation Retirement Income Plan
(the Bituminous Plan) and the Old Republic National Title Group Pension Plan
(the Title Plan). The plans are defined benefit plans pursuant to which pension
payments are based primarily on years of service and employee compensation
near
retirement. It is the Company's policy to fund the plans' costs as they accrue.
These plans have been closed to new participants since December 31, 2004. Plan
assets are comprised principally of bonds, common stocks and short-term
investments. The dates used to determine pension measurements are December
31
for the Old Republic Plan and the Bituminous Plan, and September 30 for the
Title Plan.
Effective
December
31, 2006, the Company adopted the recognition and disclosure provisions of
Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans” (“FAS 158”). FAS 158
requires the Company to recognize the funded status of its pension and other
postretirement plans in the consolidated balance sheet. Effective with fiscal
years ending after December 15, 2008, FAS 158 also requires the Company to
measure the funded status of its plans as of the end of its fiscal year. The
funded status is measured as the difference between the fair value of plan
assets and the projected benefit obligation on a plan-by-plan basis. The funded
status of an overfunded benefit plan is recognized as a net pension asset while
the funded status for underfunded benefit plans is recognized as a net pension
liability, with the offsetting entry reflected as a component of shareholders’
equity in accumulated other comprehensive income, net of deferred taxes. Changes
in the funded status of the plans will be recognized in the period in which
they
occur.
57
The
impact of the
adoption of FAS 158’s recognition provisions on individual line items in the
December 31, 2006 consolidated balance sheet is demonstrated in the table below.
The amounts presented in this footnote exclude the effect of FAS 158 as it
pertains to various postretirement benefit plans and other miscellaneous defined
benefit plans which are immaterial to the consolidated financial
statements.
Pre-FAS
158
with Minimum Pension Liability Adjustment
|
FAS
158
Adoption Adjustments
|
After
Application
of
FAS
158
|
||||||
Liability
for
pension benefits
|
$
|
6.1
|
$
|
33.5
|
$
|
39.6
|
||
Deferred
income tax asset
|
2.1
|
11.7
|
13.8
|
|||||
Accumulated
other comprehensive income, net of tax
|
$
|
13.1
|
$
|
21.8
|
$
|
34.9
|
The
changes in the
projected benefit obligation are as follows at the above measurement
dates:
2006
|
2005
|
2004
|
|||||||
Projected
benefit obligation at beginning of year
|
$
|
230.9
|
$
|
214.4
|
$
|
195.8
|
|||
Increases
(decreases) during the year attributable to:
|
|||||||||
Service
cost
|
9.3
|
8.5
|
7.7
|
||||||
Interest
cost
|
13.0
|
12.2
|
11.5
|
||||||
Actuarial
losses
|
5.9
|
4.4
|
7.6
|
||||||
Benefits
paid
|
(9.1
|
)
|
(8.7
|
)
|
(8.3
|
)
|
|||
Net
increase
for the year
|
19.1
|
16.5
|
18.5
|
||||||
Projected
benefit obligation at end of year
|
$
|
250.1
|
$
|
230.9
|
$
|
214.4
|
The
changes in the
fair value of net assets available for plan benefits as of the above measurement
dates are as follows:
2006
|
2005
|
2004
|
|||||||
Fair
value of
net assets available for plan benefits
|
|||||||||
at
beginning
of the year
|
$
|
195.6
|
$
|
185.7
|
$
|
175.0
|
|||
Increases
(decreases) during the year attributable to:
|
|||||||||
Actual
return
on plan assets
|
17.1
|
10.8
|
13.5
|
||||||
Sponsor
contributions
|
6.8
|
8.0
|
5.7
|
||||||
Benefits
paid
|
(9.1
|
)
|
(8.7
|
)
|
(8.3
|
)
|
|||
Administrative
expenses
|
-
|
(.1
|
)
|
(.1
|
)
|
||||
Net
increase
for year
|
14.8
|
9.8
|
10.7
|
||||||
Fair
value of
net assets available for plan benefits
|
|||||||||
at
end of the
year
|
$
|
210.5
|
$
|
195.6
|
$
|
185.7
|
The
components of
aggregate annual net periodic pension costs that take into account the above
measurement dates consisted of the following:
2006
|
2005
|
2004
|
||||
Service
cost
|
$
9.3
|
$
8.5
|
$
7.7
|
|||
Interest
cost
|
13.0
|
12.2
|
11.5
|
|||
Expected
return on plan assets
|
(14.8
|
)
|
(14.7)
|
(14.4)
|
||
Recognized
loss
|
3.4
|
2.4
|
2.3
|
|||
Net
cost
|
$
10.9
|
$
8.5
|
$
7.1
|
The
amounts
recognized in other comprehensive income for the period ending December 31,
2006
consist of the following:
Amounts
arising during the period:
|
|||
Net
recognized gain (loss)
|
$
|
-
|
|
Net
prior
service cost
|
-
|
||
Reclassification
adjustment to components of net period pension cost:
|
-
|
||
Net
recognized gain (loss)
|
-
|
||
Net
prior
service cost
|
-
|
||
Minimum
pension liability
|
16.9
|
||
Net
amount
recognized
|
$
|
16.9
|
The
amounts
included in accumulated other comprehensive income that have not yet been
recognized as components of net periodic pension cost as of December 31, 2006
consist of the following:
Net
recognized gain (loss)
|
$
|
(53.7)
|
|
Net
prior
service cost
|
-
|
||
Total
|
$
|
(53.7)
|
58
The
amounts included
in accumulated other comprehensive income expected to be recognized as
components of net periodic pension cost during 2007 consist of the
following:
Net
recognized gain (loss)
|
|
$
(3.6)
|
|
Net
prior
service cost
|
-
|
||
Total
|
|
$
(3.6)
|
The
projected
benefit obligations for the plans were determined using the following
weighted-average assumptions as of the above measurement dates:
2006
|
2005
|
|||
Settlement
discount rates
|
5.75%
|
5.67%
|
||
Rates
of
compensation increase
|
3.92%
|
3.59%
|
The
net periodic
benefit cost for the plans were determined using the following weighted-average
assumptions, for the plan years taking into account the above measurement
dates:
2006
|
2005
|
|||
Settlement
discount rates
|
5.67%
|
5.93%
|
||
Rates
of
compensation increase
|
3.59%
|
3.54%
|
||
Long-term
rates of return on plans’ assets
|
7.83%
|
8.09%
|
The
assumed
settlement discount rates were determined by matching the current estimate
of
each Plan’s projected cash outflows against spot rate yields on a portfolio of
high quality bonds as of their respective measurement date. To develop the
expected long-term rate of return on assets assumption, the Plans considered
the
historical returns and the future expectations for returns for each asset class,
as well as the target asset allocation of the pension portfolios.
The
accumulated
benefit obligation for the plans was $221.1 and $202.6 for the 2006 and 2005
plan years taking into account the above measurement dates,
respectively.
The
following
information is being provided for plans with projected benefit obligations
in
excess of plan assets as of December 31:
2006
|
2005
|
|||
Projected
benefit obligations
|
$
250.1
|
$
151.7
|
||
Fair
value of
plan assets
|
$
210.5
|
$
114.4
|
The
following
information is being provided for plans with accumulated benefit obligations
in
excess of plan assets as of December 31:
2006
|
2005
|
|||
Projected
benefit obligations
|
$
165.1
|
$
73.9
|
||
Accumulated
benefit obligations
|
145.5
|
64.1
|
||
Fair
value of
plan assets
|
$
125.7
|
$
46.9
|
The
benefits
expected to be paid as of December 31, 2006 for the next 10 years are as
follows: 2007: $9.9; 2008: $11.0; 2009: $11.4; 2010: $12.2; 2011: $12.7; and
for
the five years after 2011: $76.2.
The
companies are
not expecting to make any cash or non-cash contributions to their pension plans
in calendar year 2007.
The
weighted-average asset allocations of the Plans as of the above measurement
dates are as follows:
Plan
Assets
|
Investment
Policy Asset
|
|||||||
2006
|
2005
|
Allocation
%
Range Target
|
||||||
Equity
securities:
|
||||||||
Common shares of Company stock
|
-
%
|
-
%
|
||||||
Other
|
52.4
|
48.9
|
||||||
Sub-total
|
52.4
|
48.9
|
30%
to
70%
|
|||||
Debt
securities
|
44.5
|
43.7
|
30%
to
70%
|
|||||
Other
(including short-term and
|
||||||||
accrued interest and dividends)
|
3.1
|
7.4
|
1%
to
20%
|
|||||
Total
|
100.0%
|
100.0%
|
Plan
assets are
managed pursuant to the investment policies set forth at Note 1(c).
59
recognition
and disclosure provisions of FAS 158 are required to be applied on a prospective
basis. Prior periods have not been restated. The following prior year
disclosures continue to be presented for years prior to the adoption of FAS
158:
A
reconciliation of
the funded status of the plans as of the above measurement dates is as
follows:
2005
|
2004
|
|||||
Plan
assets
less than projected benefit obligations
|
$
|
(35.3
|
)
|
$
|
(28.6)
|
|
Prior
service
cost not yet recognized in net periodic
|
||||||
pension cost
|
-
|
.1
|
||||
Unrecognized
net loss
|
53.4
|
47.3
|
||||
Pension
asset
recognized in the consolidated balance sheet
|
$
|
18.1
|
$
|
18.7
|
Amounts
recognized
in the statement of financial position as of the above measurement dates consist
of the following:
Pension
Benefits
|
||||||
2005
|
2004
|
|||||
Prepaid
benefit cost
|
$
|
32.1
|
$
|
29.6
|
||
Accrued
benefit cost
|
(17.2
|
)
|
(12.4)
|
|||
Additional
minimum pension liability
|
3.2
|
1.5
|
||||
Net
amount
recognized
|
$
|
18.1
|
$
|
18.7
|
The
Company has a
number of profit sharing and other incentive compensation programs for the
benefit of a substantial number of its employees. The costs related to such
programs are summarized below:
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Employees
Savings and Stock Ownership Plan
|
$
6.8
|
$
6.5
|
$
5.6
|
|||
Other
profit
sharing plans
|
9.6
|
9.3
|
8.3
|
|||
Cash
and
deferred incentive compensation
|
$
25.7
|
$ 29.1
|
$
32.1
|
The
Company
sponsors an Employees Savings and Stock Ownership Plan (ESSOP) in which a
majority of its employees participate. Current Company contributions are
directed to the open market purchase of its shares. Dividends on shares are
allocated to participants as earnings, and likewise invested in Company stock.
The Company's annual contributions are based on a formula that takes the growth
in net operating income per share over consecutive five year periods into
account. As of December 31, 2006, there were 10,977,680 Old Republic common
shares owned by the ESSOP, all of which were allocated to employees’ account
balances. There are no repurchase obligations in existence.
(n)
Escrow
Funds-Segregated
cash
deposit accounts and the offsetting liabilities for escrow deposits in
connection with Title Insurance Group real estate transactions in the same
amounts ($928.6 and $1,426.3 at December 31, 2006 and 2005, respectively) are
not included as assets or liabilities in the accompanying consolidated balance
sheets as the escrow funds are not available for regular
operations.
60
(o)
Earnings
Per Share-Consolidated
basic
earnings per share excludes the dilutive effect of common stock equivalents
and
is computed by dividing income available to common stockholders by the
weighted-average number of common shares actually outstanding for the year.
Diluted earnings per share are similarly calculated with the inclusion of common
stock equivalents. The following table provides a reconciliation of net income
and number of shares used in basic and diluted earnings per share
calculations.
Years
Ended
December 31,
|
||||||
2006
|
2005
|
2004
|
||||
Numerator:
|
||||||
Net Income
|
$
464.8
|
$
551.4
|
$
435.0
|
|||
Less: Convertible preferred stock dividends
|
-
|
-
|
-
|
|||
Numerator for basic earnings per share -
|
||||||
income available to common stockholders
|
464.8
|
551.4
|
435.0
|
|||
Effect of dilutive securities:
|
||||||
Convertible preferred stock dividends
|
-
|
-
|
-
|
|||
Numerator for diluted earnings per share -
|
||||||
income available to common stockholders
|
||||||
after assumed conversions
|
$
464.8
|
$
551.4
|
$
435.0
|
|||
Denominator:
|
||||||
Denominator for basic earnings per share -
|
||||||
weighted-average shares
|
231,017,947
|
229,487,273
|
228,177,278
|
|||
Effect of dilutive securities:
|
||||||
Stock options
|
2,017,039
|
2,621,218
|
2,582,262
|
|||
Convertible preferred stock
|
-
|
-
|
-
|
|||
Dilutive potential common shares
|
2,017,039
|
2,621,218
|
2,582,262
|
|||
Denominator for diluted earnings per share -
|
||||||
adjusted weighted-average shares and
|
||||||
assumed conversions
|
233,034,986
|
232,108,491
|
230,759,540
|
|||
Basic earnings per share (1)
|
$
2.01
|
$
2.40
|
$
1.91
|
|||
Diluted earnings per share (1)
|
$
1.99
|
$
2.37
|
$
1.89
|
_____________
(1)
All per share
statistics have been restated to reflect all stock dividends or splits declared
through December 31, 2006.
(p)
Concentration of Credit Risk-
The Company is
not exposed to material concentrations of credit risks as to any one
issuer.
(q)
Stock
Option Compensation-
Effective April 1,
2003, the Company adopted the requirements of Statement of Financial Accounting
Standards No. 148 (“FAS 148”), “Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of FAS No. 123” on a prospective basis.
Under FAS 148, stock-based compensation expense is recognized for awards granted
after the beginning of the fiscal year of adoption, as such awards become
vested. Prior to April 1, 2003, the Company accounted for stock options under
APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and
related interpretations under Statement of Financial Accounting Standards No.
123 (“FAS 123”), “Accounting for Stock-Based Compensation” which permitted the
inclusion of stock-based compensation as a pro forma disclosure in the financial
statements.
On
January 1, 2006,
the Company adopted Statement of Financial Accounting Standards No. 123-Revised
(“FAS 123R”), “Share-Based Payment” using the modified prospective transition
method. Under this method, compensation cost in 2006 includes the portion
vesting in the period for (1) all stock option awards granted prior to, but
not
vested as of January 1, 2006, based on the grant date fair value estimated
in
accordance with the original provisions of FAS 123, and (2) all stock option
awards granted subsequent to January 1, 2006, based on the grant date fair
value
estimated in accordance with the provisions of FAS 123R. Further, FAS 123R
requires that compensation cost be recognized immediately for awards granted
to
the Company’s retirement eligible employees after January 1, 2006. Earnings for
2006 include the accelerated recognition of stock option expenses of $3.7 ($2.4
net of tax), attributable to the 2006 option grants to retirement eligible
employees who meet certain age and service criteria, typically long-term
employees who are ages 57 or older. Prior to adoption of FAS 123R, the Company
recognized compensation cost for such awards on a straight line basis over
the
nominal vesting period. Results for prior periods have not been restated. The
cumulative effect of the initial adoption of FAS 123R on the Company’s financial
statements and earnings per share information was immaterial.
61
The
following table
presents the stock based compensation expense and income tax benefit recognized
in the financial statements:
2006
|
2005
|
2004
|
|||
Stock
based
compensation expense
|
$
10.6
|
$
4.6
|
$
8.6
|
||
Income
tax
benefit
|
$
3.7
|
$
1.6
|
$
3.0
|
The
following table
illustrates the effect on net income and earnings per share as if the Company
had applied the fair value provisions of FAS 123 to all options granted under
the Company’s stock option plans during 2005 and 2004.
Years
Ended
December 31,
|
|||||
2005
|
2004
|
||||
Net
income,
as reported
|
$
551.4
|
$
435.0
|
|||
Add:
Stock-based compensation expense included in
reported
income, net of related tax effects
|
3.0
|
5.6
|
|||
Deduct:
Total
stock-based employee compensation expense
determined
under the fair value based method for
all
awards,
net of related tax effects
|
8.6
|
11.0
|
|||
Pro
forma
basis
|
$
545.7
|
$
429.5
|
|||
Basic
earnings per share:
|
|||||
As
reported
|
$
2.40
|
$
1.91
|
|||
Pro
forma
basis
|
2.38
|
1.88
|
|||
Diluted
earnings per share:
|
|||||
As
reported
|
2.37
|
1.89
|
|||
Pro
forma
basis
|
$
2.35
|
$
1.86
|
The
fair value of
each stock option award is estimated on the date of grant using the
Black-Scholes-Merton Model. The following table presents the assumptions used
in
the Black-Scholes Model for the awards granted during the periods presented.
Expected volatilities are based on the historical experience of Old Republic’s
common stock. The expected term of stock options represents the period of time
that stock options granted are assumed to be outstanding. Beginning in 2006,
the
Company uses historical data to estimate the effect of stock option exercise
and
employee departure behavior; groups of employees that have similar historical
behavior are considered separately for valuation purposes. The risk-free rate
of
return for periods within the contractual term of the share option is based
on
the U.S. Treasury rate in effect at the time of the grant.
|
2006
|
2005
|
2004
|
||
Expected
volatility
|
.25
|
.26
|
.26
|
||
Expected
dividends
|
3.35%
|
3.82%
|
2.68%
|
||
Expected
term
(in years)
|
7
|
10
|
10
|
||
Risk-free
rate
|
4.81%
|
4.62%
|
4.06%
|
A
summary of stock
option activity under the plan as of December 31, 2006, 2005 and 2004, and
changes in outstanding options during the years then ended is presented
below:
As
of and for
the Years Ended December 31,
|
||||||||||||
2006
|
2005
|
2004
|
||||||||||
Weighted
|
Weighted
|
Weighted
|
||||||||||
Average
|
Average
|
Average
|
||||||||||
Exercise
|
Exercise
|
Exercise
|
||||||||||
Shares
|
Price
|
Shares
|
Price
|
Shares
|
Price
|
|||||||
Outstanding
at beginning of year
|
12,266,170
|
$
15.76
|
11,602,443
|
$
15.00
|
10,468,096
|
$
13.64
|
||||||
Granted
|
2,511,800
|
22.01
|
2,057,500
|
18.44
|
2,525,625
|
19.33
|
||||||
Exercised
|
1,419,404
|
12.56
|
1,249,709
|
13.04
|
1,149,432
|
11.91
|
||||||
Forfeited
and
canceled
|
76,238
|
18.66
|
144,064
|
17.01
|
241,846
|
15.81
|
||||||
Outstanding
at end of year
|
13,282,329
|
17.26
|
12,266,170
|
15.76
|
11,602,443
|
15.00
|
||||||
Exercisable
at end of year
|
8,077,223
|
$
15.51
|
7,725,233
|
$
14.31
|
7,465,064
|
$
13.58
|
||||||
Weighted
average fair value of
|
||||||||||||
options granted during the year (1)
|
$
5.12
|
per
share
|
$
4.34
|
per
share
|
$
5.42
|
per
share
|
_______________
(1)
Based on the
Black-Scholes option pricing model and the assumptions outlined
above.
62
A
summary of stock
options outstanding and exercisable at December 31, 2006 follows:
Options
Outstanding
|
Options
Exercisable
|
|||||||||||
Weighted
-
Average
|
Weighted
|
|||||||||||
Year(s)
|
Number
|
Remaining
|
Average
|
|||||||||
Of
|
Out-
|
Contractual
|
Exercise
|
Number
|
Exercise
|
|||||||
Ranges
of
Exercise Prices
|
Grant
|
Standing
|
Life
|
Price
|
Exercisable
|
Price
|
||||||
$15.49
|
1998
|
1,001,983
|
1.00
|
$
15.49
|
868,532
|
$
15.49
|
||||||
$
9.37
to $10.40
|
1999
|
541,931
|
2.00
|
10.40
|
534,180
|
10.40
|
||||||
$
6.40
to $ 7.23
|
2000
|
430,099
|
3.00
|
6.40
|
408,273
|
6.40
|
||||||
$14.36
|
2001
|
1,294,054
|
4.00
|
14.36
|
1,226,654
|
14.36
|
||||||
$16.85
|
2002
|
1,581,746
|
5.00
|
16.85
|
1,581,746
|
16.85
|
||||||
$14.37
|
2003
|
1,564,330
|
6.00
|
14.37
|
1,539,626
|
14.37
|
||||||
$19.32
to
$20.02
|
2004
|
2,356,498
|
7.00
|
19.33
|
1,098,569
|
19.33
|
||||||
$18.41
to
$20.87
|
2005
|
2,009,162
|
8.00
|
18.44
|
555,313
|
18.44
|
||||||
$21.36
to
$22.35
|
2006
|
2,502,525
|
9.00
|
22.01
|
264,329
|
22.03
|
||||||
Total
|
13,282,329
|
6.09
|
$
17.26
|
8,077,223
|
$
15.51
|
Pursuant
to the
Company’s self-imposed limits, the maximum number of options available for
future issuance as of December 31, 2006, is approximately 7,511,981
shares.
As
of December 31,
2006, there was $19.1 of total unrecognized compensation cost related to
nonvested stock-based compensation arrangements granted under the plan. That
cost is expected to be recognized over a weighted average period of
approximately 3 years.
The
cash received
from stock option exercises, the total intrinsic value of stock options
exercised, and the actual tax benefit realized for the tax deductions from
option exercises are as follows:
2006
|
2005
|
2004
|
|||
Cash
received
from stock option exercise
|
$
17.8
|
$
16.3
|
$
13.7
|
||
Intrinsic
value of stock options exercised
|
13.1
|
9.4
|
8.6
|
||
Actual
tax
benefit realized for tax deductions
from
stock
options exercised
|
$
4.6
|
$
3.3
|
$
3.0
|
(r)
Statement
Presentation-Amounts
shown in
the consolidated financial statements and applicable notes are stated (except
as
otherwise indicated and as to share data) in millions, which amounts may not
add
to totals shown due to truncation. Necessary reclassifications are made in
prior
periods' financial statements whenever appropriate to conform to the most
current presentation.
Note
2 -
Debt - Consolidated
debt
of Old Republic and its subsidiaries is summarized below:
December
31,
|
||||||||
2006
|
2005
|
|||||||
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||
Amount
|
Value
|
Amount
|
Value
|
|||||
Commercial
paper due within 180 days with an
|
||||||||
average yield of 5.51% and 4.48%, respectively
|
$
18.8
|
$
18.8
|
$
18.8
|
$
18.8
|
||||
Debentures
maturing in 2007 at 7.0%
|
114.9
|
115.7
|
114.9
|
118.2
|
||||
Other
miscellaneous debt
|
10.5
|
10.5
|
8.8
|
8.8
|
||||
Total Debt
|
$
144.3
|
$
145.1
|
$
142.7
|
$
145.9
|
The
Company has
access to the commercial paper market for up to $150.0 of which $131.0 remains
unused as of December 31, 2006. The carrying amount of the Company's commercial
paper borrowings approximates its fair value. The fair value of publicly traded
debt is based on its quoted market price.
Scheduled
maturities of the above debt at December 31, 2006 are as follows: 2007: $140.4;
2008: $.8; 2009: $.8; 2010: $.8; 2011: $.7; 2012 and after: $.4. During 2006,
2005 and 2004, $9.8, $9.5 and $8.7, respectively, of interest expense on debt
was charged to consolidated operations.
63
Note
3 -
Shareholders' Equity -
All common and
preferred share data herein has been retroactively adjusted as applicable for
stock dividends or splits declared through December 31, 2006.
(a)
Preferred
Stock-The
following
table shows certain information pertaining to the Company's preferred shares
issued and outstanding:
Convertible
|
||
Preferred
Stock Series:
|
Series
G(1)
|
|
Annual
cumulative dividend rate per share
|
$
(1)
|
|
Conversion
ratio of preferred into common shares
|
1
for
.95
|
|
Conversion
right begins
|
Anytime
|
|
Redemption
and liquidation value per share
|
(1)
|
|
Redemption
beginning in year
|
(1)
|
|
Total
redemption value (millions)
|
(1)
|
|
Vote
per
share
|
one
|
|
Shares
outstanding:
|
||
December 31, 2005
|
0
|
|
December 31, 2006
|
0
|
_______________
(1) The
Company has
authorized up to 1,000,000 shares of Series G Convertible Preferred Stock for
issuance pursuant to the Company's Stock Option Plan. Series G had been issued
under the designation “G-2”. As of December 31, 2003, all Series “G-2” had been
converted into shares of common stock. In 2001, the Company created a new
designation, “G-3”, from which no shares have been issued as of December 31,
2006. Management believes this designation will be the source of possible future
issuances of Series G stock. Except as otherwise stated, Series “G-2” and Series
“G-3” are collectively referred to as Series “G”. Each share of Series G pays a
floating rate dividend based on the prime rate of interest. At December 31,
2006, the annual dividend rate for Series G-3 would have been 86 cents per
share. Each share of Series G is convertible at any time, after being held
six
months, into .95 shares of Common Stock (See Note 3(c)). Unless previously
converted, Series G shares may be redeemed at the Company's sole option five
years after their issuance.
(b)
Cash
Dividend Restrictions-The
payment of
cash dividends by the Company is principally dependent upon the amount of its
insurance subsidiaries' statutory policyholders' surplus available for dividend
distribution. The insurance subsidiaries' ability to pay cash dividends to
the
Company is in turn generally restricted by law or subject to approval of the
insurance regulatory authorities of the states in which they are domiciled.
These authorities recognize only statutory accounting practices for determining
financial position, results of operations, and the ability of an insurer to
pay
dividends to its shareholders. Based on 2006 data, the maximum amount of
dividends payable to the Company by its insurance and a small number of
non-insurance company subsidiaries during 2007 without the prior approval of
appropriate regulatory authorities is approximately $533.6.
(c)
Stock
Option Plan-
The Company has
had stock option plans in effect for certain eligible key employees since 1978.
An amended plan adopted in 1992 was replaced at its expiration by a plan
approved by the shareholders in 2002, and the 2002 plan was replaced by the
2006
Incentive Compensation Plan approved by the shareholders in May 2006. Under
the
current plan, options awarded at the date of grant together with options
previously issued and then-outstanding may not exceed 9% of the Company’s
outstanding common stock at the end of the month immediately preceding an option
grant. Under the current plan, like its predecessors, the exercise price of
stock options is equal to the market price of the Company’s common stock at the
date of the grant, and the contractual life of the grant is generally ten years
from the date of the grant. Options granted in 2001 and prior years under the
1992 plan may be exercised to the extent of 10% of the number of shares covered
thereby on and after the date of grant, and cumulatively, to the extent of
an
additional 10% on and after each of the first through ninth subsequent calendar
years. Options granted in 2002 and thereafter may be exercised to the extent
of
10% of the number of shares covered thereby as of December 31st of the year
of
the grant and, cumulatively, to the extent of an additional 15%, 20%, 25% and
30% on and after the second through fifth calendar years, respectively. Options
granted to employees who meet certain retirement eligibility provisions become
fully vested upon retirement.
In
the event the
closing market price of Old Republic’s common stock reaches a pre-established
value (“the vesting acceleration price”), options granted in 2001 and prior
years may be exercised cumulatively to the extent of 10% of the number of shares
covered by the grant for each year of employment by the optionee. For grants
in
2002 and 2003, optionees become vested on an accelerated basis to the extent
of
the greater of 10% of the options granted times the number of years of
employment, or the sum of the optionee’s already vested grant plus 50% of the
remaining unvested grant. There is no vesting acceleration for 2004 and
subsequent years’ grants.
The
option plans
enable optionees to, alternatively, exercise their options that have vested
through December 31, 2004, into Series “G” Convertible Preferred Stock. The
exercise of options into such Preferred Stock reduces by 5% the number of
equivalent common shares which would otherwise be obtained from the exercise
of
options into common shares.
64
(d) Common
Stock-At
December 31,
2006, there were 500,000,000 shares of common stock authorized. At the same
date, there were 100,000,000 shares of Class “B” common stock authorized, though
none were issued or outstanding. Class “B” common shares have the same rights as
common shares except for being entitled to 1/10th of a vote per share. In
December, 2005, the Company canceled 3,581,979 common shares previously reported
as treasury stock and restored them to unissued status; this had no effect
on
total shareholders’ equity or the financial position of the
Company.
(e)
Undistributed Earnings-At
December 31,
2006, the equity of the Company in the GAAP undistributed earnings, and net
unrealized investment gains (losses) of its subsidiaries amounted to $3,143.5
and $66.7, respectively. Dividends declared during 2006, 2005 and 2004, to
the
Company by its subsidiaries amounted to $362.3, $287.2 and $186.3,
respectively.
(f)
Statutory
Data-The
policyholders’
surplus and net income (loss), determined in accordance with statutory
accounting practices, of the Company's insurance company subsidiaries was as
follows at the dates and for the periods shown:
Policyholders’
Surplus
|
Net
Income
(Loss)
|
|||||||||||
December
31,
|
Years
Ended
December 31,
|
|||||||||||
2006
|
2005
|
2006
|
2005
|
2004
|
||||||||
General
Insurance Group
|
$
2,239.0
|
$
1,899.1
|
$
240.3
|
$
312.4
|
$
243.5
|
|||||||
Mortgage
Guaranty Group
|
231.2
|
369.4
|
226.7
|
93.4
|
208.4
|
|||||||
Title
Insurance Group
|
182.1
|
172.6
|
34.9
|
43.3
|
51.7
|
|||||||
Other
(1)
|
54.7
|
55.6
|
5.3
|
3.0
|
(2.9)
|
|||||||
Combined
(2)
|
$
2,693.9
|
$
2,483.6
|
$
507.2
|
$
452.1
|
$
500.7
|
|||||||
(1) Represents
amounts
for Old Republic’s small life and health operation.
(2) After
elimination
of intercompany investments.
Note
4 -
Commitments and Contingent Liabilities:
(a)
Reinsurance
and Retention Limits-In
order to
maintain premium production within their capacity and to limit maximum losses
for which they might become liable under policies they’ve underwritten, Old
Republic's insurance subsidiaries, as is the common practice in the insurance
industry, may cede all or a portion of their premiums and related liabilities
on
certain classes of business to other insurers and reinsurers. Although the
ceding of insurance does not ordinarily discharge an insurer from 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 and a large variety of risk-sharing procedures and arrangements for
parts of its business in order to reduce underwriting losses for which it might
become liable under insurance policies it issues. To the extent that any
reinsurance companies, assured or producer might be unable to meet their
obligations under existing reinsurance, retrospective insurance and production
agreements, Old Republic would be liable for the defaulted amounts. As deemed
necessary, reinsurance ceded to other companies is secured by letters of credit,
cash, and/or securities.
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 thousands): $1,800 for workers' compensation; $1,800 for commercial
auto
liability; $1,800 for general liability; $4,600 for executive protection
(directors & officers and errors & omissions); $1,000 for aviation; and
$1,000 for property coverages. Substantially all the mortgage guaranty insurance
risk is retained, with the exposure on any one risk currently averaging
approximately $23, 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 $100,000 as to any one policy.
The vast majority of title policies issued, however, carry exposures of $500
or
less.
65
Due
to worldwide
reinsurance capacity and related cost constraints, effective January 1, 2002,
the Company began retaining exposures for all, but most predominantly workers’
compensation liability insurance coverages in excess of $40.0 that were
previously assumed by unaffiliated reinsurers for up to $100.0. Effective
January 1, 2003 reinsurance ceded limits were raised to the $100.0 level, and
as
of January 1, 2005, they were further increased to $200.0. 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 for an insurer such as the Company. Such aggregations could
result from a catastrophe such as caused by an earthquake that could 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
excluded 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 the Treasury. The program
applies to insured commercial property and casualty losses resulting from an
act
of terrorism, as defined in the TRIA. Congress extended and modified the program
in late 2005 through the Terrorism Risk Insurance Extension Act of 2005 (the
“TRIEA”). The temporary program will now sunset on December 31, 2007 if not
extended or replaced by similar legislation. The TRIA automatically voided
all
policy exclusions which were in effect for terrorism related losses and
obligated insurers to offer terrorism coverage with most commercial property
and
casualty insurance lines. The TRIEA revised the definition of “property and
casualty insurance” to exclude commercial automobile, burglary and theft,
surety, professional liability and farm owners multi-peril insurance. Although
insurers are permitted to charge an additional premium for terrorism coverage,
insureds may reject the coverage. Under TRIEA, the program’s protection is not
triggered for losses arising from an act of terrorism after March 31, 2006
until
the industry first suffers losses of $50 billion in the aggregate in 2006.
The
program trigger amount increases to $100 billion for 2007. Once the program
trigger is met, the program will pay 90% of an insurer’s terrorism losses that
exceed an individual insurer’s deductible. The federal share drops to 85% for
2007. The insurer’s deductible is 17.5% of direct earned premium on property and
casualty insurance for 2006 and increases to 20% for 2007. Insurers may reinsure
that portion of the risk they retain under the program, but the reinsurance
market has not displayed a widespread willingness to accept such risks. To
date,
coverage for acts of terrorism are excluded from substantially all the Company’s
reinsurance treaties and are effectively retained by it subject to any recovery
that would be collected under the temporary federal reinsurance program.
Reinsurance
ceded
by the Company's insurance subsidiaries in the ordinary course of business
is
typically placed on an excess of loss basis. Under excess of loss reinsurance
agreements, the companies are generally reimbursed for losses exceeding
contractually agreed-upon levels. Quota share reinsurance is most often effected
between the Company’s insurance subsidiaries and industry-wide assigned risk
plans or captive insurers owned by assureds. Under quota share reinsurance,
the
Company remits to the assuming entity an agreed upon percentage of premiums
written and is reimbursed for underwriting expenses and proportionately related
claims costs.
Reinsurance
recoverable asset balances represent amounts due from or credited by assuming
reinsurers for paid and unpaid claims and premium reserves. Such reinsurance
balances as are recoverable from non-admitted foreign and certain other
reinsurers such as captive insurance companies owned by assureds, 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 self-insured deductible policies. Estimates of unrecoverable amounts totaling
$30.2 as of December 31, 2006 and $36.8 as of December 31, 2005 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.
At
December 31,
2006, the Company’s ten largest reinsurers represented approximately 65% of
reinsurance recoverable on paid and unpaid losses of which 32.3% of the total
was due from Munich Re America, Inc. Of the balance due from these ten
reinsurers, 78.1% was recoverable from A or better rated reinsurance companies,
14.0% from industry-wide insurance assigned risk pools, and 7.9% from captive
reinsurance companies.
The
following
information relates to reinsurance and related data for the General Insurance
and Mortgage Guaranty Groups for the three years ended December 31, 2006.
Reinsurance transactions of the Title Insurance Group and small life and health
insurance operation are not material.
Property
and
liability insurance companies are required to annualize certain policy premiums
in their regulatory financial statements though such premiums may not be
contractually due nor ultimately collectable. The annualization process relies
on a large number of estimates, and has the effect of increasing direct, ceded,
and net premiums written, and of grossing up corresponding balance sheet premium
balances and liabilities such as unearned premium reserves. The accrual of
these
estimates has no effect on net premiums earned or GAAP net income. During 2005,
the Company further refined certain premium annualization estimates and
concurrently reclassified various related premium balances. In the following
table, the sum total of these adjustments had the effect of increasing general
insurance direct premiums written by $66.3, premiums written ceded by $43.2,
and
net premiums written by $23.1. As of year end 2005, net premiums receivable
were
increased by $131.6, unearned premium reserves by $23.1, and various other
liabilities by $108.5.
66
Years
Ended
December 31,
|
|||||||||||
2006
|
2005
|
2004
|
|||||||||
General
Insurance Group
|
|||||||||||
Written
premiums:
|
Direct
|
$
2,389.4
|
$
2,424.9
|
$
2,228.1
|
|||||||
Assumed
|
137.8
|
37.9
|
34.8
|
||||||||
Ceded
|
$
504.4
|
$
573.5
|
$
561.8
|
||||||||
Earned
premiums:
|
Direct
|
$
2,345.4
|
$
2,291.9
|
$
2,140.9
|
|||||||
Assumed
|
30.7
|
35.9
|
30.2
|
||||||||
Ceded
|
$
474.0
|
$
522.6
|
$
548.1
|
||||||||
Claims
ceded
|
$
330.3
|
$
469.0
|
$
395.7
|
||||||||
Mortgage
Guaranty Group
|
|||||||||||
Written
premiums:
|
Direct
|
$
534.9
|
$
511.7
|
$
479.4
|
|||||||
Assumed
|
.1
|
.1
|
.2
|
||||||||
Ceded
|
$
81.0
|
$
79.3
|
$
81.3
|
||||||||
Earned
premiums:
|
Direct
|
$
524.7
|
$
508.0
|
$
483.6
|
|||||||
Assumed
|
.6
|
.8
|
1.0
|
||||||||
Ceded
|
$
81.0
|
$
79.3
|
$
81.4
|
||||||||
Claims
ceded
|
$
.3
|
$
.5
|
$
.6
|
||||||||
Insurance
in
force as of December 31:
|
|||||||||||
Direct
|
$
111,172.7
|
$
102,919.7
|
$
104,351.1
|
||||||||
Assumed
|
1,964.6
|
2,196.3
|
2,840.3
|
||||||||
Ceded
|
$
6,940.7
|
$
6,467.2
|
$
5,944.1
|
(b)
Leases-Some
of the
Company's subsidiaries maintain their offices in leased premises. Some of these
leases provide for the payment of real estate taxes, insurance, and other
operating expenses. Rental expenses for operating leases amounted to $41.0,
$39.9 and $38.8 in 2006, 2005 and 2004, respectively. These expenses relate
primarily to building leases of the Company. A number of the Company’s
subsidiaries also lease other equipment for use in their businesses. At December
31, 2006, aggregate minimum rental commitments (net of expected sub-lease
receipts) under noncancellable operating leases are summarized as follows:
2007:
$39.3; 2008: $31.8; 2009: $23.3; 2010: $15.4; 2011: $10.6; 2012 and after:
$38.7.
(c)
General-In
the normal
course of business, the Company and its subsidiaries are subject to various
contingent liabilities, including possible income tax assessments resulting
from
tax law interpretations or issues raised by taxing or regulatory authorities
in
their regular examinations, catastrophic claim occurrences not indemnified
by
reinsurers such as noted at 4(a) above, or failure to collect all amounts on
its
investments or balances due from assureds and reinsurers. The Company does
not
have a basis for anticipating any significant losses or costs that could result
from any known or existing contingencies.
(d)
Legal
Proceedings-
Legal proceedings
against the Company arise in the normal course of business and usually pertain
to claim matters related to insurance policies and contracts issued by its
insurance
subsidiaries. Other legal proceedings are discussed below.
Purported
class
actions have been filed against the Company’s principal title insurance
subsidiary, Old Republic National Title Insurance Company (“ORNTIC”) in state
courts in Connecticut, Florida, New Jersey, Ohio, and Pennsylvania. The
plaintiffs allege that, pursuant to rate schedules filed by ORNTIC or by state
rating bureaus with the state insurance regulators, ORNTIC was required to,
but
failed to give consumers reissue credits on the premiums charged for title
insurance covering mortgage refinancing transactions. Substantially similar
lawsuits have been filed against other unaffiliated title insurance companies
in
these and other states as well. The actions seek damages and declaratory and
injunctive relief. ORNTIC has reached a tentative settlement in Florida for
an
amount not to exceed $1.2, exclusive of attorneys’ fees and costs. ORNTIC
intends to defend vigorously against the actions in other states as well but,
at
this stage in the litigation, the Company cannot estimate the ultimate costs
it
may incur as the actions proceed to their conclusions.
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
sought 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 sought statutory and punitive damages, as well as other costs. A
settlement agreement was reached in the action on November 29, 2006 and awaits
final court approval. While the ultimate cost of the settlement will depend
upon
the number of consumers who participate, the Company reasonably expects the
cost
to be under $1.0.
67
Note
5 -
Consolidated Quarterly Results-Unaudited - Old
Republic's
consolidated quarterly operating data for the two years ended December 31,
2006
is presented below.
In
the opinion of
management, all adjustments consisting of normal recurring adjustments necessary
for a fair statement of quarterly results have been reflected in the data which
follows. It is also management's opinion, however, that quarterly operating
data
for insurance enterprises such as the Company is not indicative of results
to be
achieved in succeeding quarters or years. The long-term nature of the insurance
business, seasonal and cyclical factors affecting premium production, the
fortuitous nature and, at times, delayed emergence of claims, and changes in
yields on invested assets are some of the factors necessitating a review of
operating results, changes in shareholders' equity, and cash flows for periods
of several years to obtain a proper indicator of performance trends. The data
below should be read in conjunction with the “Management Analysis of Financial
Position and Results of Operations”:
1st
|
2nd
|
3rd
|
4th
|
|||||
Quarter
|
Quarter
|
Quarter
|
Quarter
|
|||||
Year
Ended December 31, 2006:
|
||||||||
Operating
Summary:
|
||||||||
Net
premiums,
fees, and other income
|
$
852.6
|
$
858.0
|
$
876.9
|
$
845.6
|
||||
Net
investment income and realized gains (losses)
|
90.2
|
90.7
|
87.8
|
91.6
|
||||
Total
revenues
|
942.9
|
948.9
|
964.9
|
937.4
|
||||
Benefits,
claims, and expenses
|
770.9
|
762.4
|
795.7
|
784.8
|
||||
Net
income
|
$
117.4
|
$
126.6
|
$
116.1
|
$
104.6
|
||||
Net
income per share: Basic
|
$
.51
|
$
.55
|
$
.50
|
$
.45
|
||||
Diluted
|
$
.51
|
$
.54
|
$
.50
|
$
.45
|
||||
Average
shares outstanding:
|
||||||||
Basic
|
229,835,408
|
230,013,892
|
230,470,356
|
231,037,520
|
||||
Diluted
|
231,999,922
|
232,240,816
|
232,517,359
|
233,244,626
|
1st
|
2nd
|
3rd
|
4th
|
|||||
Quarter
|
Quarter
|
Quarter
|
Quarter
|
|||||
Year
Ended December 31, 2005:
|
||||||||
Operating
Summary:
|
||||||||
Net
premiums,
fees, and other income
|
$
796.8
|
$
856.1
|
$
872.8
|
$
904.7
|
||||
Net
investment income and realized gains (losses)
|
83.6
|
88.6
|
81.7
|
121.0
|
||||
Total
revenues
|
880.6
|
944.9
|
954.7
|
1,025.9
|
||||
Benefits,
claims, and expenses
|
712.0
|
757.4
|
774.8
|
814.4
|
||||
Net
income
|
$
114.3
|
$
172.3
|
$
121.6
|
$
143.1
|
||||
Net
income per share: Basic
|
$
.50
|
$
.75
|
$
.53
|
$
.62
|
||||
Diluted
|
$
.49
|
$
.74
|
$
.52
|
$
.61
|
||||
Average
shares outstanding:
|
||||||||
Basic
|
228,351,494
|
228,629,783
|
229,021,348
|
229,511,029
|
||||
Diluted
|
230,861,205
|
231,190,413
|
232,037,923
|
232,587,552
|
Note
6 -
Information About Segments of Business - The
Company’s major
business segments are organized as the General Insurance (property and liability
insurance), Mortgage Guaranty and Title Insurance Groups. Effective with the
second quarter of 2004, the Company has included the results of its small life
& health insurance business with those of its holding company parent and
minor corporate services operations; prior period data has been reclassified
accordingly. Each of the Company’s segments underwrites and services only those
insurance coverages which may be written by it pursuant to state insurance
regulations and corporate charter provisions. Segment results exclude realized
investment gains or losses and impairments, and these are aggregated in
consolidated totals. The contributions of Old Republic’s insurance industry
segments to consolidated totals are shown in the following table.
The
Company does
not derive over 10% of its consolidated revenues from any one customer. Revenues
and assets connected with foreign operations are not significant in relation
to
consolidated totals.
The
General
Insurance Group provides property and liability insurance primarily to
commercial clients. Old Republic does not have a meaningful participation in
personal lines of insurance. Commercial automobile (principally trucking)
insurance is the largest type of coverage underwritten by the General Insurance
Group, accounting for 34.8% of the Group’s direct premiums written in 2006. The
remaining premiums written by the General Insurance Group are derived largely
from a wide variety of coverages, including workers’ compensation, general
liability, loan credit indemnity, general aviation, directors and officers
indemnity, fidelity and surety indemnities, and home and auto
warranties.
68
Private
mortgage
insurance produced by the Mortgage Guaranty Group 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.
The Mortgage Guaranty segment’s ten largest customers were responsible for
39.7%, 44.2% and 41.8% of traditional primary new insurance written in 2006,
2005 and 2004, respectively. The largest single customer accounted for 8.8%
of
traditional primary new insurance written in 2006 compared to 11.5% and 11.7%
in
2005 and 2004, respectively.
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, loans and encumbrances affecting the insured
title and not excluded or excepted from the coverage of the policy.
The
accounting
policies of the segments parallel those described in the summary of significant
accounting policies pertinent thereto.
Segment
Reporting
Years
Ended
December 31,
|
|||||||||
2006
|
2005
|
2004
|
|||||||
General
Insurance:
|
|||||||||
Net
premiums
earned
|
$
|
1,902.1
|
$
|
1,805.2
|
$
|
1,623.0
|
|||
Net
investment income and other income
|
236.5
|
212.4
|
199.5
|
||||||
Total
revenues before realized gains or losses
|
$
|
2,138.7
|
$
|
2,017.6
|
$
|
1,822.5
|
|||
Income
before
taxes and realized investment gains or losses
|
$
|
401.6
|
$
|
350.0
|
$
|
333.0
|
|||
Income
tax
expense on above (1)
|
$
|
123.2
|
$
|
62.9
|
$
|
104.3
|
|||
Segment
assets - at year end
|
$
|
9,363.5
|
$
|
8,178.9
|
$
|
7,222.8
|
|||
Mortgage
Guaranty:
|
|||||||||
Net
premiums
earned
|
$
|
444.3
|
$
|
429.5
|
$
|
403.2
|
|||
Net
investment income and other income
|
85.6
|
86.5
|
86.6
|
||||||
Total
revenues before realized gains or losses
|
$
|
529.9
|
$
|
516.0
|
$
|
489.9
|
|||
Income
before
taxes and realized investment gains or losses
|
$
|
228.4
|
$
|
243.7
|
$
|
224.5
|
|||
Income
tax
expense on above
|
$
|
75.3
|
$
|
81.1
|
$
|
75.2
|
|||
Segment
assets - at year end
|
$
|
2,189.6
|
$
|
2,211.8
|
$
|
2,205.9
|
|||
Title
Insurance:
|
|||||||||
Net
premiums
earned
|
$
|
733.6
|
$
|
757.2
|
$
|
714.0
|
|||
Title,
escrow
and other fees
|
246.3
|
324.6
|
311.2
|
||||||
Sub-total
|
980.0
|
1,081.8
|
1,025.2
|
||||||
Net
investment income and other income
|
27.3
|
26.7
|
26.5
|
||||||
Total
revenues before realized gains or losses
|
$
|
1,007.3
|
$
|
1,108.6
|
$
|
1,051.8
|
|||
Income
before
taxes and realized investment gains or losses(2)
|
$
|
31.0
|
$
|
88.7
|
$
|
62.5
|
|||
Income
tax
expense on above
|
$
|
9.9
|
$
|
30.1
|
$
|
25.9
|
|||
Segment
assets - at year end
|
$
|
772.7
|
$
|
776.3
|
$
|
753.0
|
|||
69
Reconciliations
of Segmented Amounts to Consolidated Totals
|
Years
Ended
December 31,
|
|||||||||||
2006
|
2005
|
2004
|
||||||||||
Consolidated
Revenues:
|
||||||||||||
Total
revenues of above Company segments
|
$
|
3,676.0
|
$
|
3,642.3
|
$
|
3,364.3
|
||||||
Other
sources
(3)
|
127.1
|
122.5
|
83.5
|
|||||||||
Consolidated
net realized investment gains
|
19.0
|
64.9
|
47.9
|
|||||||||
Elimination
of intersegment revenues (4)
|
(27.9)
|
(23.9)
|
(4.1)
|
|||||||||
Consolidated
revenues
|
$
|
3,794.2
|
$
|
3,805.9
|
$
|
3,491.6
|
||||||
Consolidated
Income before taxes:
|
||||||||||||
Total
income
before taxes and realized investment
|
||||||||||||
gains or losses of above Company segments
|
$
|
661.2
|
$
|
682.6
|
$
|
620.1
|
||||||
Other
sources
- net (3)(5)
|
-
|
(.1)
|
(17.2)
|
|||||||||
Consolidated
net realized investment gains
|
19.0
|
64.9
|
47.9
|
|||||||||
Consolidated
income before income taxes
|
$
|
680.1
|
$
|
747.3
|
$
|
650.9
|
||||||
Consolidated
Income Tax Expense:
|
||||||||||||
Total
income
tax expense of above Company segments
|
$
|
208.6
|
$
|
174.2
|
$
|
205.4
|
||||||
Other
sources
- net (3)
|
-
|
(.9)
|
(6.5)
|
|||||||||
Income
tax
expense on consolidated net realized
|
||||||||||||
investment
gainss
|
6.6
|
22.6
|
17.0
|
|||||||||
Consolidated
income tax expense
|
$
|
215.2
|
$
|
195.9
|
$
|
215.9
|
||||||
December
31,
|
||||||||||||
2006
|
2005
|
|||||||||||
Consolidated
Assets:
|
||||||||||||
Total
assets
for above Company segments
|
$
|
12,325.9
|
$
|
11,167.1
|
||||||||
Other
assets
(3)
|
443.4
|
528.5
|
||||||||||
Elimination
of intersegment investments (4)
|
(157.0)
|
(152.4)
|
||||||||||
Consolidated
assets
|
$
|
12,612.2
|
$
|
11,543.2
|
||||||||
_______________
In
the above
tables, net premiums earned on a GAAP basis differ slightly from statutory
amounts due to certain differences in calculations of unearned premium reserves
under each accounting method.
(1) General
Insurance
tax expense was reduced by $45.9 in 2005 as discussed in note 1(i).
(2) Title
Insurance
income before taxes and realized investment gains or losses was reduced by
$22.9
in 2004 due to 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.
(3) Represents
amounts
for Old Republic’s holding company parent, minor corporate services
subsidiaries, and a small life and
health insurance operation.
(4) Represents
consolidation elimination adjustments.
(5) Includes
a $10.5
special charge in 2004 resulting from a write down of previously deferred
acquisition costs applicable to a life
insurance product discontinued during the fourth quarter of that
year.
Note
7 -
Acquisition of Contractors Insurance Book of Business - As
of November 30,
2006, Old Republic Insurance Company (“ORINSCO”), a wholly owned subsidiary of
the Company, acquired a casualty insurance book of business from an insurance
subsidiary of Aon Corporation (“Aon”). ORINSCO acquired policy renewal rights
and certain other minor assets for a purchase price of $85, inclusive of
deferred policy acquisition costs. Concurrently, the Company assumed certain
insurance assets and liabilities through a quota share reinsurance agreement
covering the net liabilities of the Aon insurance subsidiary. The liabilities
assumed included unearned premium and claim reserves of $106.9 and $228.3,
respectively, which relate to business previously written through the Aon
insurance subsidiary. The insurance book of business is focused on specialized
casualty insurance coverages and services for trade contractors and large
commercial construction projects. Renamed Old Republic Construction Program
Group, Inc., the business has been organized as a joint underwriting venture
between Old Republic and certain principals previously associated with the
book
of business.
70
REPORT
OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Board of
Directors and Shareholders of
Old
Republic International Corporation:
We
have completed integrated audits of Old Republic International Corporation
and
its subsidiaries’ consolidated financial statements and of its internal control
over financial reporting as of December 31, 2006, in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Our
opinions, based on our audits, are presented below.
Consolidated
financial statements
In
our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, comprehensive income, preferred stock and
common shareholders' equity and cash flows, present fairly, in all material
respects, the financial position of Old Republic International Corporation
and
its subsidiaries at
December 31, 2006 and 2005, and the results of their operations and their cash
flows for each of the three years in the period ended December 31,
2006 in
conformity with accounting principles generally accepted in the United States
of
America. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements
in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit
to
obtain reasonable assurance about whether the financial statements are free
of
material misstatement. An audit of financial statements includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
Internal
control
over financial reporting
Also,
in our
opinion, management’s assessment, included in “Management’s Report on Internal
Control Over Financial Reporting,” appearing under Item 9A, that the Company
maintained effective internal control over financial reporting as of December
31, 2006 based on criteria established in Internal
Control - Integrated Framework issued
by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), is
fairly stated, in all material respects, based on those criteria. Furthermore,
in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal
Control - Integrated Framework issued
by the COSO.
The Company’s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness
of
internal control over financial reporting. Our responsibility is to express
opinions on management’s assessment and on the effectiveness of the
Company’s internal control over financial reporting based on our audit. We
conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal control
over financial reporting includes obtaining an understanding of internal control
over financial reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we consider necessary in the circumstances.
We believe that our audit provides a reasonable basis for our opinions.
A
company’s
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures
of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use,
or
disposition of the company’s assets that could have a material effect on the
financial statements.
Because
of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness
to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/
PricewaterhouseCoopers LLP
Chicago,
Illinois
February
28,
2007
71
Management’s
Responsibility for Financial Statements
Management
is
responsible for the preparation of the Company’s consolidated financial
statements and related information appearing in this report. Management believes
that the consolidated financial statements fairly reflect the form and substance
of transactions and that the financial statements reasonably present the
Company’s financial position and results of operations in conformity with
generally accepted accounting principles. Management also has included in the
Company’s financial statement amounts that are based on estimates and judgments
which it believes are reasonable under the circumstances.
The
independent
registered public accounting firm has advised that it audits the Company’s
consolidated financial statements in accordance with the standards of the Public
Company Accounting Oversight Board and provides an objective, independent review
of the fairness of reported operating results and financial
position.
The
Board of
Directors of the Company has an Audit Committee composed of seven non-management
Directors. The committee meets periodically with financial management, the
internal auditors and the independent registered public accounting firm to
review accounting, control, auditing and financial reporting
matters.
Item
9 -
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
Item
9A -
Controls and Procedures
Evaluation
of
Disclosure Controls and Procedures
The
Company’s
principal executive officer and its principal financial officer have evaluated
the Company’s disclosure controls and procedures as of the end of the period
covered by this annual report. Based upon their evaluation, the principal
executive officer and principal financial officer have concluded that the
Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are effective for the
above
referenced evaluation period.
Changes
in
Internal Control
During
the year
ended December 31, 2006, there were no changes in internal control over
financial reporting that have materially affected, or are reasonably likely
to
materially affect, the Company’s internal control over financial
reporting.
Management’s
Report on Internal Control Over Financial Reporting
Our
management is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f)
and
15d-15(f). Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer,
we
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal
Control - Integrated Framework issued
by the
Committee of Sponsoring Organizations of the Treadway Commission.
The
Company’s
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. The Company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors
of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company’s assets that could have a material effect on the financial
statements.
Because
of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness
to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Based
on our
evaluation under the framework in Internal
Control - Integrated Framework, our
management
concluded that our internal control over financial reporting was effective
as of
December 31, 2006. PricewaterhouseCoopers LLP, an independent registered public
accounting firm, has audited our management’s assessment of the effectiveness of
our internal control over financial reporting as of December 31, 2006. Their
report is shown on page 71 in this Annual Report.
72
Item
9B -
Other Information
Pursuant
to the
requirements of Section 303A.12(a) of the New York Stock Exchange Listed
Company
Manual, the Company has filed the Annual CEO Certification with the New York
Stock Exchange on June 1, 2006.
PART
III
Item
10 -
Directors and Executive Officers of the Registrant
Executive
Officers of the Registrant
The
following table
sets forth certain information as of December 31, 2006, regarding the senior
executive officers of the Company:
Name
|
Age
|
Position
|
Charles
S.
Boone
|
53
|
Senior
Vice
President - Investments and Treasurer since August,
2001.
|
James
A.
Kellogg
|
55
|
President
and
Chief Operating Officer since July, 2006 and President of Old Republic
Insurance Company since October, 2002.
|
Spencer
LeRoy, III
|
60
|
Senior
Vice
President, Secretary and General Counsel since 1992.
|
Karl
W.
Mueller
|
47
|
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.
|
Christopher
Nard
|
43
|
Senior
Vice
President - Mortgage Guaranty since May, 2005. President and Chief
Executive Officer of Republic Mortgage Insurance Companies since
May,
2005.
|
R.
Scott
Rager
|
58
|
Senior
Vice
President - General Insurance and President and Chief Operating Officer
of
Old Republic General Insurance Companies since July,
2006.
|
Rande
K.
Yeager
|
58
|
Senior
Vice
President - Title Insurance since March, 2003; President and Chief
Executive Officer of Old Republic Title Insurance Companies since
March,
2002.
|
Aldo
C.
Zucaro
|
67
|
Chairman
of
the Board, Chief Executive Officer, and Director since 1993, 1990
and
1976, 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.
The
Company will
file with the Commission prior to March 30, 2007 a definitive proxy statement
pursuant to Regulation 14a in connection with its Annual Meeting of Shareholders
to be held on May 25, 2007. A list of Directors appears on the “Signature” page
of this report. Information about the Company’s directors is contained in the
Company’s definitive proxy statement for the 2007 Annual Meeting of
shareholders, which is incorporated herein by reference.
The
Company has
adopted a code of ethics that applies to its principal executive officer and
principal financial officer. A copy has been filed with the Commission and
appears as Exhibit (14) in the exhibit index under Item 15. The Company has
also
posted the text of its code of ethics on its internet website at
www.oldrepublic.com.
Item
11 -
Executive Compensation
Information
with
respect to this Item is incorporated herein by reference to the section entitled
“Executive Compensation” in the Company’s proxy statement in connection with the
Annual Meeting of Shareholders to be held on May 25, 2007, which will be on
file
with the Commission by March 30, 2007.
Item
12 - Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information
with
respect to this Item is incorporated herein by reference to the sections
entitled “General Information” and “Principal Holders of Securities” in the
Company’s proxy statement to be filed with the Commission by March 30, 2007, in
connection with the Annual Meeting of Shareholders to be held on May 25,
2007.
73
Item
13 -
Certain Relationships and Related Transactions
Information
with
respect to this Item is incorporated herein by reference to the section entitled
“Principal Holders of Securities” in the Company’s Proxy Statement in connection
with the Annual Meeting of Shareholders to be held on May 25, 2007, which will
be on file with the Commission by March 30, 2007.
Item
14 -
Principal Accountant Fees and Services
Information
with
respect to this Item is incorporated herein by reference to the section entitled
“Board Committees” in the Company’s Proxy Statement in connection with the
Annual Meeting of Shareholders to be held on May 25, 2007, which will be on
file
with the Commission by March 30, 2007.
PART
IV
Item
15 -
Exhibits and Financial Statement Schedules
Documents
filed as
a part of this report:
1.
Financial
statements: See Item 8, Index to Financial Statements.
2.
Financial
statement schedules will be filed on or before April 13, 2007 under cover of
Form 10-K/A.
3.
See exhibit
index on page 76 of this report.
74
SIGNATURES
Pursuant
to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized (Name, Title or Principal Capacity,
and
Date).
(Registrant): Old
Republic International Corporation
By
: /s/
Aldo C.
Zucaro
02/28/07
Aldo C. Zucaro, Chairman of the Board,
Chief Executive Officer and Director
By
: /s/
Karl W.
Mueller
02/28/07
Karl W. Mueller, Senior Vice President
and Chief Financial Officer
Pursuant
to
the requirements of the Securities Exchange Act of 1934, this report
has
been signed below by the following persons on behalf of the registrant
and
in the capacities and on the dates indicated (Name, Title or Principal
Capacity, and Date).
|
/s/ Harrington Bischof | /s/ William A. Simpson | |
Harrington
Bischof, Director*
|
William
A.
Simpson, Director*
Chairman
of
Republic Mortgage
Insurance
Company
|
|
/s/ Jimmy A. Dew | /s/ Arnold L. Steiner | |
Jimmy
A. Dew,
Director*
Vice
Chairman
of
Republic
Mortgage Insurance Company
|
Arnold
L.
Steiner, Director*
|
|
/s/ John M. Dixon | /s/ Fredicka Taubitz | |
John
M.
Dixon, Director*
|
Fredricka
Taubitz, Director*
|
|
/s/ Leo E. Knight, Jr. | /s/ Charles F. Titterton | |
Leo
E.
Knight, Jr., Director*
|
Charles
F.
Titterton, Director*
|
|
/s/ Peter Lardner | /s/ Dennis P. Van Mieghem | |
Peter
Lardner, Director*
|
Dennis
P. Van
Mieghem, Director*
|
|
/s/ Wilbur S. Legg | /s/ Steven Walker | |
Wilbur
S.
Legg, Director*
|
Steven
Walker, Director*
|
|
/s/ John W. Popp | ||
John
W. Popp,
Director*
|
*
By/s/Aldo C.
Zucaro
Attorney-in-fact
Date:
February 22, 2007
75
EXHIBIT
INDEX
An index of exhibits required by Item 601 of Regulation S-K
follows:
(3) Articles
of
incorporation and by-laws.
(A) *
Restated
Certificate of Incorporation. (Exhibit 3(A) to Registrant’s Annual Report on
Form 10-K for 2004).
(B) *
By-laws,
as
amended. (Exhibit99.2 to Form 8-K filed May 19, 2006).
(4)
Instruments
defining the rights of security holders, including indentures.
(A) *
Amended
and
Restated Rights Agreement dated as of May 15, 1997 between Old Republic
International Corporation and First Chicago Trust Company of New York. (Exhibit
4.1 to Registrant’s Form 8-K filed May 30, 1997).
(B) *
Agreement
to
furnish certain long term debt instruments to the Securities & Exchange
Commission upon request. (Exhibit 4(D) on Form 8 dated August 28,
1987).
(C) *
Form
of Indenture dated as of August 15, 1992 between Old Republic International
Corporation and Wilmington Trust Company, as Trustee. (Exhibit 4(G) to
Registrant’s Annual Report on Form 10-K for 1993).
(D) *
Supplemental
Indenture No. 1 dated as of June 16, 1997 supplementing the Indenture. (Exhibit
4.3 to Registrant’s Form 8-A filed June 16, 1997).
(E) *
Supplemental
Indenture No. 2 dated as of December 31, 1997 supplementing the Indenture.
(Exhibit 4(G) to Registrant’s Annual Report on Form 10-K for 1997).
(10)
Material
contracts.
**
(A) *
Amended
and
Restated Old Republic International Corporation Key Employees Performance
Recognition Plan. (Exhibit 10(A) to Registrant’s Annual Report on Form 10-K for
2002).
** (B)
Old
Republic International Corporation 2005 Key Employees Performance Recognition
Plan.
**
(C) *
Amended
and
Restated 1992 Old Republic International Corporation Non-qualified Stock Option
Plan. (Exhibit 10(B) to Registrant’s Annual Report on Form 10-K for 2002).
**
(D) *
Amended
and
Restated 2002 Old Republic International Corporation Non-qualified Stock Option
Plan. (Exhibit 10(C) to Registrant’s Annual Report on Form 10-K for
2005).
**
(E) *
Old
Republic International Corporation 2006 Incentive Compensation Plan. (Exhibit
99.1 to Form 8-K/A filed June 2, 2006).
**
(F) *
Amended
and
Restated Old Republic International Corporation Executives Excess Benefits
Pension Plan. (Exhibit 10(E) to Registrant’s Annual Report on Form 10-K for
1997).
**
(G) *
Form
of Indemnity Agreement between Old Republic International Corporation and each
of its directors and certain officers. (Exhibit 10 to Form S-3 Registration
Statement No. 33-16836).
**
(H) *
Bitco
Key Employees Performance Recognition Plan. (Exhibit 10(H) to Registrant’s
Annual Report on Form 10-K for 1997).
**
(I)
*
RMIC
Corporation/Republic Mortgage Insurance Company Amended and Restated Key
Employees Performance Recognition Plan. (Exhibit 10(I) to Registrant’s Annual
Report on Form 10-K for 2000).
**
(J)
RMIC/Republic
Mortgage Insurance Company 2005 Key Employees Performance Recognition
Plan.
**
(K) *
RMIC
Corporation/Republic Mortgage Insurance Company Executives Excess Benefits
Pension Plan. (Exhibit 10(J) to Registrant’s Annual Report on Form 10-K for
2000).
**
(L) *
Amended
and
Restated Old Republic Risk Management Key Employees Recognition Plan. (Exhibit
10(J) to Registrant’s Annual Report on Form 10-K for 2002).
76
(Exhibit
Index, Continued)
** (M)
Old
Republic Risk Management, Inc. 2005 Key Employees Performance Recognition
Plan.
**
(N) *
Old
Republic National Title Group Incentive Compensation Plan. (Exhibit 10(K) to
Registrant’s Annual Report on Form 10-K for 2003).
**
(O)
ORI
Great West Holdings, Inc. Key Employees Performance Recognition
Plan.
** (P)
ORI
Great West Holdings, Inc. 2005 Key Employees Performance Recognition
Plan.
(12)
Not
applicable
(13)
Not
applicable
(14)
*
Code
of Ethics for the Principal Executive Officer and Senior Financial Officer.
(Exhibit 14 to Registrant’s Annual Report on Form 10-K for 2003).
(21) Subsidiaries
of the
registrant.
(23) Consent
of
PricewaterhouseCoopers LLP.
(24) Powers
of
attorney.
(28) Consolidated
Schedule P (To be filed by amendment).
(31.1)
Certification
by
Aldo C. Zucaro, Chief Executive Officer, pursuant to Rule 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbannes-Oxley Act of
2002.
(31.2)
Certification
by
Karl W. Mueller, Chief Financial Officer, pursuant to Rule 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the Sarbannes-Oxley Act of
2002.
(32.1)
Certification
by
Aldo C. Zucaro, Chief Executive Officer, pursuant to Section 1350, Chapter
63 of
Title 18, United States Code, as adopted pursuant to Section 906 of the
Sarbannes-Oxley Act of 2002.
(32.2)
Certification
by
Karl W. Mueller, Chief Financial Officer, pursuant to Section 1350, Chapter
63
of Title 18, United States Code, as adopted pursuant to Section 906 of the
Sarbannes-Oxley Act of 2002.
(99.1) * Old
Republic
International Corporation Audit Committee Charter. (Exhibit 99.1 of Registrant’s
Form 8-K filed February 27, 2006).
(99.2) * Old
Republic
International Corporation Nominating Committee Charter. (Exhibit 99.2 to
Registrant’s Annual Report on Form 10-K for 2003).
(99.3) * Old
Republic
International Corporation Compensation Committee Charter. (Exhibit 99.2 of
Registrant’s Form 8-K filed February 27, 2006).
(99.4) * Code
of Business
Conduct and Ethics. (Exhibit 99.4 to Registrant’s Annual Report on Form 10-K for
2003).
(99.5) * Corporate
Governance Guidelines. (Exhibit 99.5 to Registrant’s Annual Report on Form 10-K
for 2003).
_______________
* Exhibit
incorporated herein by reference.
** Denotes
a
management or compensatory plan or arrangement required to be filed as an
exhibit pursuant to Item 601 of Regulation S-K.
77