UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended: June 30, 2006 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 001-10607
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OLD REPUBLIC INTERNATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
-------------------------------------------- ---------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes:_X_ No:___
Indicate by check mark whether the registrant is 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_
Shares Outstanding
Class June 30, 2006
----------------------------- ------------------------------
Common Stock / $1 par value 230,026,330
There are 35 pages in this report
OLD REPUBLIC INTERNATIONAL CORPORATION
Report on Form 10-Q / June 30, 2006
INDEX
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PAGE NO.
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PART I FINANCIAL INFORMATION:
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7 - 13
MANAGEMENT ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS 14 - 31
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 32
CONTROLS AND PROCEDURES 32
PART II OTHER INFORMATION:
ITEM 1A - RISK FACTORS 33
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 33
ITEM 6 - EXHIBITS 33
SIGNATURE 34
EXHIBIT INDEX 35
2
Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets
($ in Millions, Except Share Data)
------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
June 30, December 31,
2006 2005
-------------------- -------------------
Assets
Investments:
Available for sale:
Fixed maturity securities (at fair value)(cost: $6,376.2 and $6,323.7)............ $ 6,238.7 $ 6,331.6
Equity securities (at fair value)(cost: $533.4 and $500.9)........................ 599.3 552.4
Short-term investments (at fair value which approximates cost).................... 458.0 275.3
Miscellaneous investments......................................................... 53.0 62.7
-------------------- -------------------
Total......................................................................... 7,349.2 7,222.2
Other investments................................................................. 8.0 8.0
-------------------- -------------------
Total investments............................................................. 7,357.3 7,230.2
-------------------- -------------------
Other Assets:
Cash.............................................................................. 60.3 68.3
Securities and indebtedness of related parties.................................... 20.3 16.4
Accrued investment income......................................................... 95.2 95.5
Federal income tax recoverable: current........................................... 5.8 -
Accounts and notes receivable..................................................... 796.3 803.4
Prepaid federal income taxes...................................................... 468.4 545.7
Reinsurance balances and funds held............................................... 80.9 81.0
Reinsurance recoverable: Paid losses.............................................. 72.3 59.4
Policy and claim reserves................................ 2,160.8 2,107.8
Deferred policy acquisition costs................................................. 241.3 240.0
Sundry assets..................................................................... 293.1 294.9
-------------------- -------------------
4,295.2 4,312.9
-------------------- -------------------
Total Assets.................................................................. $ 11,652.5 $ 11,543.2
==================== ===================
------------------------------------------------------------------------------------------------------------------------------------
Liabilities, Preferred Stock, and Common Shareholders' Equity
Liabilities:
Losses, claims and settlement expenses............................................ $ 5,134.1 $ 4,939.8
Unearned premiums................................................................. 1,070.8 1,039.3
Other policyholders' benefits and funds........................................... 188.5 188.8
-------------------- -------------------
Total policy liabilities and accruals......................................... 6,393.5 6,167.9
Commissions, expenses, fees and taxes............................................. 203.6 227.2
Reinsurance balances and funds.................................................... 259.4 307.0
Federal income tax payable: Current............................................... - 129.3
Deferred.............................................. 398.9 421.6
Debt.............................................................................. 142.1 142.7
Sundry liabilities................................................................ 124.1 123.1
Commitments and contingent liabilities............................................
Total Liabilities............................................................. 7,521.9 7,519.1
-------------------- -------------------
Preferred Stock:
Convertible preferred stock (1)................................................... - -
-------------------- -------------------
Common Shareholders' Equity:
Common stock (1).................................................................. 230.0 229.5
Additional paid-in capital........................................................ 302.1 288.6
Retained earnings................................................................. 3,622.4 3,444.9
Accumulated other comprehensive income (loss)..................................... (23.9) 60.8
Total Common Shareholders' Equity............................................. 4,130.6 4,024.0
-------------------- -------------------
Total Liabilities, Preferred Stock, and Common Shareholders' Equity........... $ 11,652.5 $ 11,543.2
==================== ===================
(1) At June 30, 2006 and December 31, 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 230,026,330 at June 30, 2006
and 229,575,404 at December 31, 2005 were issued and outstanding. At June
30, 2006 and December 31, 2005, there were 100,000,000 shares of Class B
Common Stock, $1.00 par value, authorized, of which no shares were issued.
See accompanying Notes to Consolidated Financial Statements.
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3
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
($ in Millions, Except Share Data)
------------------------------------------------------------------------------------------------------------------------------------
Quarters Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2006 2005 2006 2005
--------------- -------------- --------------- --------------
Revenues:
Net premiums earned..................................... $ 781.6 $ 761.7 $ 1,566.1 $ 1,478.8
Title, escrow, and other fees........................... 66.7 85.9 126.1 157.7
--------------- -------------- --------------- --------------
Total premiums and fees............................. 848.4 847.6 1,692.2 1,636.5
Net investment income................................... 82.6 75.8 165.3 151.2
Other income............................................ 9.6 8.5 18.5 16.5
--------------- -------------- --------------- --------------
Total operating revenues............................ 940.7 932.1 1,876.1 1,804.4
Realized investment gains............................... 8.1 12.8 15.7 20.8
--------------- -------------- --------------- --------------
Total revenues...................................... 948.9 944.9 1,891.8 1,825.2
--------------- -------------- --------------- --------------
Benefits, Claims and Expenses:
Benefits, claims, and settlement expenses............... 372.2 367.2 736.2 713.0
Dividends to policyholders.............................. 1.7 2.1 3.1 2.8
Underwriting, acquisition, and other expenses........... 385.5 385.2 788.7 748.5
Interest and other charges.............................. 2.8 2.7 5.3 4.7
--------------- -------------- --------------- --------------
Total expenses...................................... 762.4 757.4 1,533.4 1,469.1
--------------- -------------- --------------- --------------
Income before income taxes ............................. 186.4 187.5 358.3 356.0
--------------- -------------- --------------- --------------
Income Taxes:
Currently payable (recoverable)......................... 42.4 (1.8) 87.8 42.4
Deferred................................................ 17.3 17.0 26.4 27.0
--------------- -------------- --------------- --------------
Total............................................... 59.7 15.2 114.3 69.4
--------------- -------------- --------------- --------------
Net Income.............................................. $ 126.6 $ 172.3 $ 244.0 $ 286.6
=============== ============== =============== ==============
Net Income Per Share:
Basic............................................... $ .55 $ .75 $ 1.06 $ 1.25
=============== ============== =============== ==============
Diluted............................................. $ .54 $ .74 $ 1.05 $ 1.24
=============== ============== =============== ==============
Average shares outstanding: Basic................... 230,013,892 228,629,783 230,007,372 228,616,296
=============== ============== =============== ==============
Diluted................. 232,240,816 231,190,413 232,233,930 231,142,306
=============== ============== =============== ==============
Dividends Per Common Share:
Cash............................................... $ .150 $ .136 $ .290 $ .240
=============== ============== =============== ==============
See accompanying Notes to Consolidated Financial Statements.
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4
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
($ in Millions)
------------------------------------------------------------------------------------------------------------------------------------
Quarters Ended Six Months Ended
June 30, June 30,
--------------------------------- --------------------------------
2006 2005 2006 2005
-------------- --------------- -------------- --------------
Net income as reported................................... $ 126.6 $ 172.3 $ 244.0 $ 286.6
-------------- --------------- -------------- --------------
Other comprehensive income (loss):
Foreign currency translation adjustment............... 5.2 (1.5) 5.1 (2.9)
-------------- --------------- -------------- --------------
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period..... (57.0) 79.2 (122.6) (31.7)
Less: elimination of pretax realized gains
included in income as reported.................. 8.1 12.8 15.7 20.8
-------------- --------------- -------------- --------------
Pretax unrealized gains (losses) on securities
carried at market value......................... (65.2) 66.4 (138.3) (52.5)
Deferred income taxes (credits)..................... (22.8) 23.4 (48.4) (18.1)
-------------- --------------- -------------- --------------
Net unrealized gains (losses) on securities......... (42.3) 43.0 (89.9) (34.3)
-------------- --------------- -------------- --------------
Net adjustments....................................... (37.1) 41.4 (84.7) (37.2)
-------------- --------------- -------------- --------------
Comprehensive income..................................... $ 89.5 $ 213.7 $ 159.3 $ 249.3
============== =============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
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5
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($ in Millions)
------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
----------------------------------
2006 2005
-------------- --------------
Cash flows from operating activities:
Net income............................................................................... $ 244.0 $ 286.6
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs...................................................... (.3) 2.0
Premiums and other receivables......................................................... 7.2 (32.2)
Unpaid claims and related items........................................................ 144.5 154.2
Other policyholders' benefits and funds................................................ 26.2 2.6
Income taxes........................................................................... (109.5) (25.8)
Prepaid federal income taxes........................................................... 77.3 (46.4)
Reinsurance balances and funds......................................................... (60.5) 27.0
Realized investment gains.............................................................. (15.7) (20.8)
Accounts payable, accrued expenses and other........................................... 12.1 (22.5)
-------------- --------------
Total.................................................................................... 325.5 324.7
-------------- --------------
Cash flows from investing activities:
Fixed maturity securities:
Maturities and early calls............................................................ 262.0 375.2
Sales................................................................................. 50.7 135.1
Sales of:
Equity securities..................................................................... 15.4 69.5
Other investments..................................................................... 19.2 1.1
Fixed assets for company use.......................................................... .5 4.9
Cash and short-term investments of subsidiary acquired................................... - 1.2
Purchases of:
Fixed maturity securities............................................................. (375.2) (741.6)
Equity securities..................................................................... (46.7) (28.5)
Other investments..................................................................... (6.3) (2.8)
Fixed assets for company use.......................................................... (8.1) (22.2)
Investment in affiliates.............................................................. - (9.7)
Net decrease (increase) in short-term investments........................................ (182.1) (60.7)
Other-net................................................................................ (1.8) .4
-------------- --------------
Total.................................................................................... (272.3) (278.1)
-------------- --------------
Cash flows from financing activities:
Issuance of debentures and notes......................................................... - 1.0
Issuance of common shares................................................................ 6.3 5.5
Redemption of debentures and notes....................................................... (.5) (1.1)
Dividends on common shares............................................................... (66.6) (54.8)
Other-net................................................................................ (.3) (.8)
-------------- --------------
Total.................................................................................... (61.2) (50.2)
-------------- --------------
Increase (decrease) in cash (7.9) (3.7)
Cash, beginning of period................................................................ 68.3 60.5
-------------- --------------
Cash, end of period...................................................................... $ 60.3 $ 56.8
============== ==============
Supplemental cash flow information:
Cash paid during the period for: Interest ............................................... $ 4.7 $ 4.7
============== ==============
Income taxes............................................ $ 223.4 $ 94.1
============== ==============
See accompanying Notes to Consolidated Financial Statements.
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6
OLD REPUBLIC INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
($ in Millions, Except Share Data)
--------------------------------------------------------------------------------
1. Accounting Policies and Basis of Presentation:
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP") as
described in the Corporation's latest annual report to shareholders or
otherwise disclosed herein. The financial accounting and reporting process
relies on estimates and on the exercise of judgment, but in the opinion of
management all adjustments, consisting only of normal recurring accruals,
necessary for a fair presentation of the results were recorded for the
interim periods. 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.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).
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. Tax
positions that meet the more likely than not threshold are then measured
using a probability weighted approach recognizing the largest amount of tax
benefit that is greater than 50% likely of being realized upon ultimate
settlement. FIN 48 becomes effective for the Company in the first quarter of
2007. The Company anticipates that the impact of its adoption of FIN 48 will
not have a material effect on the consolidated financial statements.
2. Common Share Data:
(a) Earnings Per Share - The following table provides a reconciliation of the
income and number of shares used in basic and diluted earnings per share
calculations.
Quarters Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Numerator:
Net Income ........................................ $ 126.6 $ 172.3 $ 244.0 $ 286.6
-------------- -------------- -------------- --------------
Numerator for basic earnings per share -
income available to common stockholders.......... 126.6 172.3 244.0 286.6
-------------- -------------- -------------- --------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions........................ $ 126.6 $ 172.3 $ 244.0 $ 286.6
============== ============== ============== ==============
Denominator:
Denominator for basic earnings per share
weighted-average shares (1) .................... 230,013,892 228,629,783 230,007,372 228,616,296
Effect of dilutive securities - stock options...... 2,226,924 2,560,630 2,226,558 2,526,010
-------------- -------------- -------------- --------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions (1).......................... 232,240,816 231,190,413 232,233,930 231,142,306
============== ============== ============== ==============
Earnings per share: Basic............................. $ .55 $ .75 $ 1.06 $ 1.25
============== ============== ============== ==============
Diluted........................... $ .54 $ .74 $ 1.05 $ 1.24
============== ============== ============== ==============
(1) Common share data has been retroactively adjusted to reflect all stock
dividends and splits declared through June 30, 2006.
(b) Stock Options Compensation - The Company has had stock option plans in
effect for certain eligible key employees since 1992. The 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
7
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 term 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.
Prior to January 1, 2006, the Company accounted for stock options under APB
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees" and
related interpretations as permitted by 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. The measurement and recognition
provisions of APB 25 were followed until April 1, 2003, at which time 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 was recognized for
awards granted after the beginning of the fiscal year of adoption, as such
awards became vested.
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 transition 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. FAS 123R also requires that
compensation cost be recognized immediately for awards granted to the
Company's retirement eligible employees after January 1, 2006. Second quarter
and first half 2006 earnings include the accelerated recognition of stock
option expenses of $4.1 attributable to second quarter option grants to
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.
The following table presents the stock based compensation expense and income
tax benefit recognized in the financial statements:
Quarters Ended Six Months Ended
June 30, June 30,
--------------------------------- --------------------------------
2006 2005 2006 2005
-------------- --------------- -------------- --------------
Stock based compensation expense................... $ 5.9 $ 1.3 $ 7.0 $ 2.0
Income tax benefit................................. $ 2.0 $ .4 $ 2.4 $ .7
============== =============== ============== ==============
8
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 in the second
quarter and first six months of 2005.
Quarter Ended Six Months Ended
June 30, 2005 June 30, 2005
------------------- -------------------
Net income, as reported..................................................... $ 172.3 $ 286.6
Add: Stock-based compensation expense included in
reported income, net of related tax effects......................... .8 1.3
Deduct: Total stock-based employee compensation
expense determined under the fair value based
method for all awards, net of related tax effects................ 1.5 5.4
------------------- -------------------
Pro forma basis.......................................................... $ 171.6 $ 282.4
=================== ===================
Basic earnings per share:
As reported.............................................................. $ .75 $ 1.25
Pro forma basis.......................................................... .75 1.23
Diluted earnings per share:
As reported.............................................................. .74 1.24
Pro forma basis.......................................................... $ .74 $ 1.22
=================== ===================
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
second quarter and first half of 2006. 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
expected to be outstanding. Beginning in 2006, the Company uses historical
data to estimate 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 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.
Quarters Ended Six Months Ended
June 30, June 30,
------------------------------------- ------------------------------------
2006 2005 2006 2005
---------------- ----------------- ---------------- ----------------
Expected volatility...................... .27 .26 .25 .26
Expected dividends....................... 3.54% 3.82% 3.35% 3.82%
Expected term (in years)................. 8 10 7 10
Risk-free rate........................... 5.10% 4.63% 4.81% 4.63%
A summary of stock option activity under the plan as of June 30, 2006 and
changes during the six month period then ended is presented below:
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Shares Price Term Value
---------------- ----------------- ---------------- ----------------
Outstanding, January 1, 2006............... 12,266,170 $ 15.76
Granted................................. 2,506,800 22.01
Exercised............................... 422,514 13.57
Forfeited and canceled.................. 53,146 18.13
----------------
Outstanding, June 30, 2006................. 14,297,311 $ 16.91 5.8 Years $ 63.7
================ ================= ================ ================
Exercisable, June 30, 2006................. 8,062,586 $ 14.57 4.7 Years $ 54.8
================ ================= ================ ================
The weighted average grant date fair value of stock options granted during
the quarter and six months ended June 30, 2006 was $5.46 and $5.12 per share,
respectively. As of June 30, 2006, there was $21.4 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 4 years.
9
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:
Quarters Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
2006 2005 2006 2005
------------ ----------- ----------- ------------
Cash received from stock option exercise........................ $ 2.2 $ 3.1 $ 5.7 $ 5.0
Intrinsic value of stock options exercised...................... 1.2 1.7 3.3 2.6
Actual tax benefit realized for tax deductions
from stock options exercised............................... $ .4 $ .6 $ 1.1 $ .9
============ =========== =========== ============
3. Unrealized Appreciation/(Depreciation) of Investments:
Cumulative net unrealized losses on fixed maturity securities available for
sale and equity securities included in a separate account in common
shareholders' equity amounted to $39.7 at June 30, 2006. Unrealized
depreciation of investments, before applicable deferred income tax credits of
$21.4, at June 30, 2006 included gross unrealized gains and (losses) of
$123.3 and ($184.6), respectively.
For the six months ended June 30, 2006 and 2005, net unrealized depreciation
of investments, net of deferred income tax credits, amounted to $89.9 and
$34.3, respectively.
4. Pension Plans:
The Corporation has three defined benefit pension plans covering a portion of
its work force. The three plans are the Old Republic International Salaried
Employees Restated Retirement Plan (the Old Republic Plan), the Bituminous
Casualty Corporation Retirement Income Plan (the Bituminous Plan) and the Old
Republic National Title Group Pension Plan (the Title Plan). The plans are
defined benefit plans pursuant to which pension payments are based primarily
on years of service and employee compensation near retirement. It is the
Corporation's policy to fund the plans' costs as they accrue. Plan assets are
comprised principally of bonds, common stocks and short-term investments.
The measurement dates used to determine pension measurements are December 31
for the Old Republic Plan and the Bituminous Plan and September 30 for the
Title Plan.
The components of estimated net periodic pension cost for the plans consisted
of the following:
Quarters Ended Six Months Ended
June 30, June 30,
-------------------------- ---------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Service cost................................................... $ 2.3 $ 2.1 $ 4.6 $ 4.2
Interest cost.................................................. 3.2 3.0 6.4 6.1
Expected return on plan assets................................. (3.6) (3.6) (7.3) (7.3)
Recognized loss................................................ .8 .5 1.6 1.1
----------- ----------- ----------- -----------
Net cost....................................................... $ 2.6 $ 2.0 $ 5.3 $ 4.1
=========== =========== =========== ===========
The companies made a cash contribution of $.3 to their pension plans in the
second quarter of 2006 and expect to make additional cash or non-cash
contributions to their pension plans in the second half of 2006 of
approximately $6.0.
Effective January 1, 2005, both the Old Republic Plan and the Bituminous Plan
were closed to new employees hired after December 31, 2004. The Title Plan
was already closed to new employees. There were no changes to the benefits
for employees/beneficiaries already in the Plans.
Also effective January 1, 2005, the Old Republic International Employees
Savings and Stock Ownership Plan ("ESSOP") became a 401K plan. All aspects of
the ESSOP remained unchanged, except that employee contributions are now made
on a pretax rather than post-tax basis.
10
5. Information About Segments of Business:
The Corporation conducts its operations through three major regulatory
segments, namely its General Insurance (property and liability insurance),
Mortgage Guaranty and Title Insurance Groups. The Company includes the
results of its small life & health insurance business with those of its
corporate and minor service operations. Each of the Corporation's segments
underwrites and services only those insurance coverages which may be written
by it pursuant to state insurance regulations and corporate charter
provisions. Segment results exclude net realized investment gains or losses
as these are aggregated in consolidated totals. The contributions of Old
Republic's insurance industry segments to consolidated totals are shown in
the following table.
Quarters Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
General Insurance Group:
Net premiums earned................................................ $ 473.0 $ 461.3 $ 933.0 $ 892.4
Net investment income and other income ............................ 58.5 51.8 115.4 103.3
----------- ----------- ----------- -----------
Total revenues before realized gains............................ $ 531.5 $ 513.2 $ 1,048.4 $ 995.8
=========== =========== =========== ===========
Income before taxes (credits) and realized investment gains........ $ 105.2 $ 86.4 $ 202.3 $ 171.3
=========== =========== =========== ===========
Income tax expense (credits) on above (1).......................... $ 32.8 $ (19.0) $ 62.6 $ 7.7
=========== =========== =========== ===========
Mortgage Guaranty Group:
Net premiums earned................................................ $ 110.2 $ 108.5 $ 219.2 $ 213.9
Net investment income and other income ............................ 20.8 21.7 43.0 43.3
----------- ----------- ----------- -----------
Total revenues before realized gains............................ $ 131.0 $ 130.3 $ 262.3 $ 257.3
=========== =========== =========== ===========
Income before taxes and realized investment gains.................. $ 63.7 $ 67.9 $ 123.8 $ 132.5
=========== =========== =========== ===========
Income tax expense on above ....................................... $ 21.1 $ 22.8 $ 40.9 $ 44.4
=========== =========== =========== ===========
Title Insurance Group:
Net premiums earned................................................ $ 180.4 $ 175.7 $ 374.6 $ 335.7
Title, escrow and other fees....................................... 66.7 85.9 126.1 157.7
----------- ----------- ----------- -----------
Sub-total....................................................... 247.2 261.7 500.7 493.4
Net investment income and other income ............................ 6.6 6.5 13.4 13.1
----------- ----------- ----------- -----------
Total revenues before realized gains............................ $ 253.8 $ 268.2 $ 514.2 $ 506.6
=========== =========== =========== ===========
Income before taxes and realized investment gains ................. $ 12.1 $ 22.8 $ 19.7 $ 35.6
=========== =========== =========== ===========
Income tax expense on above........................................ $ 3.8 $ 7.8 $ 6.2 $ 12.0
=========== =========== =========== ===========
Consolidated Revenues:
Total revenues of above Company segments........................... $ 916.4 $ 911.8 $ 1,825.0 $ 1,759.8
Other sources (2).................................................. 30.6 22.7 63.2 48.9
Consolidated net realized investment gains......................... 8.1 12.8 15.7 20.8
Elimination of intersegment revenues (3)........................... (6.4) (2.4) (12.1) (4.3)
----------- ----------- ----------- -----------
Consolidated revenues........................................... $ 948.9 $ 944.9 $ 1,891.8 $ 1,825.2
=========== =========== =========== ===========
Consolidated Income Before Taxes:
Total income before taxes and realized investment
gains of above Company segments................................. $ 181.2 $ 177.2 $ 345.9 $ 339.6
Other sources - net (2)............................................ (2.9) (2.6) (3.3) (4.3)
Consolidated net realized investment gains......................... 8.1 12.8 15.7 20.8
----------- ----------- ----------- -----------
Consolidated income before income taxes......................... $ 186.4 $ 187.5 $ 358.3 $ 356.0
=========== =========== =========== ===========
Consolidated Income Tax Expense:
Total income tax expense of above Company segments (1)............. $ 57.9 $ 11.5 $ 109.9 $ 64.2
Other sources - net (2)............................................ (1.0) (.8) (1.0) (2.0)
Income tax expense on consolidated
net realized investment gains............................... 2.8 4.5 5.4 7.2
----------- ----------- ----------- -----------
Consolidated income tax expense................................. $ 59.7 $ 15.2 $ 114.3 $ 69.4
=========== =========== =========== ===========
11
June 30, December 31,
2006 2005
------------------- ------------------
Consolidated Assets:
General....................................................................... $ 8,381.7 $ 8,178.9
Mortgage...................................................................... 2,101.0 2,211.8
Title......................................................................... 749.1 776.3
Other - net (2)............................................................... 420.5 376.0
------------------- ------------------
Consolidated ................................................................. $ 11,652.5 $ 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 the second quarter and
six months ended June 30, 2005 as discussed in note 7(a).
(2) Represents amounts for Old Republic's holding company parent, minor internal
services subsidiaries, and a small life and health insurance operation.
(3) Represents consolidation eliminating adjustments.
6. Commitments and Contingent Liabilities:
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 and Ohio. 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 the other
states as well but, at this stage in the litigation, the Company cannot
estimate the 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 seeks certification of a nationwide class of
consumers who were allegedly required to pay for private mortgage insurance
at a cost greater than RMIC's "best available rate". The action alleges that
the decision to insure their loans at a higher rate was based on the
consumers' credit scores and constituted an "adverse action" within the
meaning, and in violation of the Fair Credit Reporting Act, that requires
notice, allegedly not given, to the consumers. The action seeks statutory and
punitive damages, as well as other costs. RMIC intends to defend vigorously
against the action, but at this stage in the litigation the Company cannot
estimate the costs it may incur as the litigation proceeds to its conclusion.
RMIC is proceeding with its defense.
7. Income Taxes:
(a) The Company obtained a favorable resolution on its claim for a Federal
income tax refund pertaining to the three years ended December 31, 1990. As a
result, a combined recovery of income taxes and related accumulated interest
of $57.9 was recorded in the second quarter of 2005. The net of tax effect on
this recovery resulted in a non-recurring addition to net income of $45.9 in
the second quarter and six months ended June 30, 2005.
(b) 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
non-interest bearing U.S. Treasury Tax and Loss Bonds in an amount equal to
the tax benefit derived from deducting any portion of the Company's statutory
contingency reserves. 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
12
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. 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.
June 30, December 31, June 30,
2006 2005 2005
-------------- -------------- --------------
Cash and invested assets:
Previous classification............................................ $ 7,981.4 $ 7,939.9 $ 7,762.2
After reclassification............................................. 7,512.9 7,394.1 7,216.4
Change......................................................... (468.4) (545.7) (545.7)
Total other assets:
Previous classification............................................ 3,671.1 3,603.2 3,282.1
After reclassification............................................. 4,139.6 4,149.0 3,827.9
Change......................................................... $ 468.4 $ 545.7 $ 545.7
============== ============== ==============
Six Months Ended Years Ended
June 30, December 31,
-------------------------------- --------------------------------
2006 2005 2005 2004
-------------- -------------- -------------- --------------
Cash flows from operating activities:
Previous classification........................... $ 248.2 $ 371.2 $ 880.0 $ 828.3
After reclassification............................ 325.5 324.7 833.6 775.5
Change........................................ 77.3 (46.4) (46.4) (52.8)
Cash flows from investing activities:
Previous classification........................... (195.0) (324.6) (589.9) (734.1)
After reclassification............................ (272.3) (278.1) (543.5) (681.3)
Change........................................ $ (77.3) $ 46.4 $ 46.4 $ 52.8
============== ============== ============== ==============
13
OLD REPUBLIC INTERNATIONAL CORPORATION
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
Six Months Ended June 30, 2006 and 2005
($ 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 2.3% of consolidated revenues
for the six months ended June 30, 2006 and 2.3% of consolidated assets as of
June 30, 2006, is included within the corporate and other caption of this
financial 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 characterized 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
--------------------------------------------------------------------------------
Second quarter and first half 2006 earnings were constrained by the
accelerated recognition of stock option expenses of $4.1 ($2.6 after tax or one
cent per diluted share). The additional charge stems from second quarter option
grants to employees who meet certain age and service criteria, typically
long-term employees who are ages 57 or older. Under the recently issued
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment", the
values attributed to such options must be expensed immediately.
On the other hand, second quarter and first half 2005 earnings were
enhanced by the posting of 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 stemmed from a favorable resolution of the Company's claim for a
permanent Federal income tax refund applicable to the three years ended December
31, 1990.
14
Consolidated Results
The major components of Old Republic's consolidated operating revenues and
income were as follows for the periods being reported upon:
Quarters Ended June 30, Six Months Ended June 30,
---------------------------------------- ---------------------------------------
2006 2005 Change 2006 2005 Change
----------- ----------- ----------- ----------- ---------- ----------
Operating revenues:
General insurance......................... $ 531.5 $ 513.2 3.6% $ 1,048.4 $ 995.8 5.3%
Mortgage guaranty......................... 131.0 130.3 .6 262.3 257.3 1.9
Title insurance........................... 253.8 268.2 -5.3 514.2 506.6 1.5
Corporate and other....................... 24.2 20.3 51.0 44.5
----------- ----------- ----------- ----------- ---------- ----------
Total.................................. $ 940.7 $ 932.1 .9% $ 1,876.1 $ 1,804.4 4.0%
=========== =========== =========== =========== ========== ==========
Pretax operating income (loss):
General insurance......................... $ 105.2 $ 86.4 21.7% $ 202.3 $ 171.3 18.1%
Mortgage guaranty......................... 63.7 67.9 -6.1 123.8 132.5 -6.6
Title insurance........................... 12.1 22.8 -46.8 19.7 35.6 -44.5
Corporate and other....................... (2.9) (2.6) (3.3) (4.3)
----------- ----------- ----------- ----------- ---------- ----------
Sub total.............................. 178.2 174.6 2.0 342.6 335.2 2.2
----------- ----------- ----------- ----------- ---------- ----------
Realized investment gains (losses):
From sales................................ 8.1 12.9 15.7 26.0
From impairments.......................... - (.1) - (5.2)
----------- ----------- ----------- ----------
Net realized investment gains.......... 8.1 12.8 15.7 20.8
----------- ----------- ----------- ----------- ---------- ----------
Consolidated pretax income.................. 186.4 187.5 -.6 358.3 356.0 .7
Income taxes........................... 59.7 15.2 293.1 114.3 69.4 64.6
----------- ----------- ----------- ----------- ---------- ----------
Net income.................................. $ 126.6 $ 172.3 -26.5% $ 244.0 $ 286.6 -14.8%
=========== =========== =========== =========== ========== ==========
Consolidated underwriting ratio:
Benefits and claims ratio.............. 44.1% 43.6% 43.7% 43.7%
Expense ratio.......................... 43.8 44.0 45.1 44.3
----------- ----------- ----------- ----------
Composite ratio................... 87.9% 87.6% 88.8% 88.0%
=========== =========== =========== ==========
Components of diluted
net income per share:
Net operating income:
Before non-recurring tax benefit........ $ 0.52 $ 0.51 2.0% $ 1.01 $ 0.98 3.1%
2005 non-recurring tax benefit.......... - 0.20 - 0.20
----------- ----------- ----------- ----------- ---------- ----------
Total................................... 0.52 0.71 -26.8 1.01 1.18 -14.4
Net realized investment gains............. 0.02 0.03 0.04 0.06
----------- ----------- ----------- ----------- ---------- ----------
Net income................................ $ 0.54 $ 0.74 -27.0% $ 1.05 $ 1.24 -15.3%
=========== =========== =========== =========== ========== ==========
Consolidated results are provided in terms of both operating and net income
to highlight the effect of realized investment gain or loss recognition on
period-to-period comparisons. Recognition of such gains or losses can be highly
discretionary and arbitrary due to such factors as the timing of individual
securities sales, recognition of losses from write-downs of impaired securities,
tax-planning considerations, and changes in investment management judgments
relative to the direction of securities markets or the future prospects of
individual investees or industry sectors.
General Insurance Results
The General Insurance Group's operating performance continued at high
levels for the latest quarter and year-to-date periods. Key indicators of that
performance follow:
Quarters Ended June 30, Six Months Ended June 30,
--------------------------------------- ----------------------------------------
2006 2005 Change 2006 2005 Change
---------- ----------- ---------- ----------- ---------- -----------
Net premiums earned........................ $ 473.0 $ 461.3 2.5% $ 933.0 $ 892.4 4.5%
Net investment income...................... 53.7 47.8 12.3 106.6 95.7 11.5
Pretax operating income.................... $ 105.2 $ 86.4 21.7% $ 202.3 $ 171.3 18.1%
========== =========== ========== =========== ========== ===========
Claims ratio............................... 65.6% 67.5% 65.0% 67.2%
Expense ratio.............................. 23.4 24.0 24.6 24.2
---------- ----------- ----------- ----------
Composite ratio.......................... 89.0% 91.5% 89.6% 91.4%
========== =========== =========== ==========
Earned premium growth of 2.5 percent in this year's second quarter fell
short of expectations. For the first half of the year, net premiums earned grew
by 4.5 percent. For the first six months of 2006, the Company experienced double
digit premium growth among its trucking, and home and extended warranty
coverages while nearly all other lines reflected few or no increases. General
insurance underwriting margins, however, remained at highly satisfactory levels
due to the relative stability of overall claim and productions costs. Net
investment income climbed at low double digit rates, benefiting from the
combination of a greater invested asset base and rising yields on fixed maturity
securities.
15
Mortgage Guaranty Results
Old Republic's Mortgage Guaranty Group posted moderately lower
year-over-year pretax operating earnings in the second quarter and first half of
2006. Key indicators of this segment's performance follow:
Quarters Ended June 30, Six Months Ended June 30,
--------------------------------------- ----------------------------------------
2006 2005 Change 2006 2005 Change
---------- ----------- ---------- ----------- ---------- -----------
Net premiums earned........................ $ 110.2 $ 108.5 1.5% $ 219.2 $ 213.9 2.5%
Net investment income...................... 17.6 17.4 1.2 36.8 35.0 5.2
Pretax operating income.................... $ 63.7 $ 67.9 -6.1% $ 123.8 $ 132.5 -6.6%
========== =========== ========== =========== ========== ===========
Claims ratio............................... 35.6% 31.5% 37.2% 31.9%
Expense ratio.............................. 22.6 22.0 23.1 22.5
---------- ----------- ----------- ----------
Composite ratio.......................... 58.2% 53.5% 60.3% 54.4%
========== =========== =========== ==========
Mortgage Guaranty premium revenue trends for this year's first half
reflected the combination of slightly improved business persistency, lower
overall mortgage originations, and a sharp decline in bulk insurance production.
The higher composite underwriting ratio for 2006 periods was largely driven by
higher claim costs. The rise in claim costs stemmed primarily from higher paid
claims as well as expectations of greater claim frequency for the traditional
primary business. Lower underwriting profit margins evidenced by this year's
higher composite ratio were partially offset by a slight increase in net
investment income.
Title Insurance Results
Old Republic's Title Insurance segment registered significant drops in
profitability for the 2006 periods reported upon. Key indicators of that
performance follow:
Quarters Ended June 30, Six Months Ended June 30,
--------------------------------------- ----------------------------------------
2006 2005 Change 2006 2005 Change
---------- ----------- ---------- ----------- ---------- -----------
Net premiums and fees earned............... $ 247.2 $ 261.7 -5.5% $ 500.7 $ 493.4 1.5%
Net investment income...................... 6.5 6.4 1.7 13.3 12.7 4.2
Pretax operating income.................... $ 12.1 $ 22.8 -46.8% $ 19.7 $ 35.6 -44.5%
========== =========== ========== =========== ========== ===========
Claims ratio............................... 5.9% 5.9% 6.0% 5.9%
Expense ratio.............................. 91.7 87.7 92.6 89.4
---------- ----------- ----------- ----------
Composite ratio.......................... 97.6% 93.6% 98.6% 95.3%
========== =========== =========== ==========
Title premium and fee revenues dropped by 5.5 percent in this year's second
quarter but rose by 1.5 percent in the first half. For both 2006 periods, profit
margins in underwriting/service operations deteriorated significantly.
Substantially all of the margin compression occurred in the segment's direct
operations, most of which are concentrated in the Western United States.
Revenues in that region dropped by 26.6 percent in this year's second quarter
and 25.1 percent in the first half. The resulting production levels in that
region have been much lower than necessary to support the related operating
expense structure. As a consequence of the relatively greater expense load, the
segment posted a much higher composite underwriting ratio in this year's second
quarter and first half. Slight net investment income growth in this segment was
insufficient to offset the substantial reduction in underwriting/service
profitability in 2006 to date.
Corporate and Other Operations
Old Republic's small life and health business, and the net corporate
service costs of the parent holding company and internal services subsidiaries
produced combined pretax losses of $2.9 and $3.3 in the second quarter and first
six months of 2006, respectively. Life and health pretax income was affected
adversely by greater life insurance claim costs in both periods of 2006. Overall
net corporate expenses, however, were moderately lower year-over-year.
16
Cash, Invested Assets and Shareholders' Equity
The following table shows the changes in consolidated cash and invested
assets as well as shareholders' equity, as of the dates shown:
% Change
------------------------
June December June June `06/ June `06/
2006 2005 2005 Dec `05 June `05
---------- ---------- ---------- ---------- ----------
Cash and invested assets:
Total: As reported, with securities at market.......... $ 7,512.9 $ 7,394.1 $ 7,216.4 1.6% 4.1%
With securities at cost......................... 7,574.6 7,317.3 7,006.8 3.5 8.1
Per share: As reported, with securities at market...... 32.66 32.21 31.56 1.4 3.5
With securities at cost.................... 32.93 31.87 30.65 3.3 7.4
Shareholders' equity:
Total: As reported, with securities at market.......... 4,130.6 4,024.0 4,068.9 2.6 1.5
With securities at cost......................... 4,170.4 3,973.9 3,932.6 4.9 6.0
Per share: As reported, with securities at market...... 17.96 17.53 17.80 2.5 .9
With securities at cost.................... $ 18.13 $ 17.31 $ 17.20 4.7% 5.4%
========== ========== ========== ========== ==========
The investment portfolio reflects a current allocation of approximately 85
percent in fixed-maturity securities and 8 percent in equities. As in the past,
it contains little or no exposure to real estate investments, mortgage-backed
securities, derivatives, junk bonds, private placements or mortgage loans. The
latest periods' changes in shareholders' equity, as reported, reflects
principally additions from earnings in excess of dividend payments, offset by a
decline in the value of investment securities carried at market values.
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, 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. 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.
June 30, December 31, June 30,
2006 2005 2005
-------------- -------------- --------------
Cash and invested assets:
Previous classification............................................ $ 7,981.4 $ 7,939.9 $ 7,762.2
After reclassification............................................. 7,512.9 7,394.1 7,216.4
Change........................................................ (468.4) (545.7) (545.7)
Total other assets:
Previous classification............................................ 3,671.1 3,603.2 3,282.1
After reclassification............................................. 4,139.6 4,149.0 3,827.9
Change........................................................ $ 468.4 $ 545.7 $ 545.7
============== ============== ==============
Six Months Ended Years Ended
June 30, December 31,
-------------------------------- --------------------------------
2006 2005 2005 2004
-------------- -------------- -------------- --------------
Cash flows from operating activities:
Previous classification............................ $ 248.2 $ 371.2 $ 880.0 $ 828.3
After reclassification............................. 325.5 324.7 833.6 775.5
Change........................................ 77.3 (46.4) (46.4) (52.8)
Cash flows from investing activities:
Previous classification............................ (195.0) (324.6) (589.9) (734.1)
After reclassification............................. (272.3) (278.1) (543.5) (681.3)
Change........................................ $ (77.3) $ 46.4 $ 46.4 $ 52.8
============== ============== ============== ==============
17
--------------------------------------------------------------------------------
TECHNICAL MANAGEMENT ANALYSIS
--------------------------------------------------------------------------------
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 2 of the notes to consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). A
discussion regarding the provisions of FIN 48 is included in note 1 of the notes
to consolidated financial statements.
FINANCIAL POSITION
The Company's financial position at June 30, 2006 reflected increases in
assets and common shareholders' equity of .9% and 2.6%, respectively, when
compared to the immediately preceding year-end. Cash and invested assets
represented 64.5% and 64.1% of consolidated assets as of June 30, 2006 and
December 31, 2005, respectively. Consolidated operating cash flow was positive
at $325.5 in the first six months of 2006 compared to $324.7 in the same period
of 2005. As of June 30, 2006, the invested asset base increased 1.8% to $7,357.3
principally as a result of positive operating cash flow offset by a decline in
the fair value of fixed maturity and equity investments.
During the first six months of 2006 and 2005, the Corporation committed
substantially all investable funds to short to intermediate-term fixed maturity
securities. At both June 30, 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 June 30, 2006, the Company
had $3.7 of fixed maturity investments in default as to principal and/or
interest.
Relatively high short-term maturity investment positions continued to be
maintained as of June 30, 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.
18
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)
------------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2006 2005
------------------ ------------------
Aaa.................................................................................. 32.3% 32.6%
Aa................................................................................... 18.7 18.4
A.................................................................................... 27.6 27.9
Baa.................................................................................. 20.0 20.2
------------------ ------------------
Total investment grade...................................................... 98.6 99.1
All other (2)........................................................................ 1.4 .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.
------------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Non-Investment Grade Fixed Maturity Securities
------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
----------------------------------------
Gross
Amortized Unrealized
Cost Losses
----------------- ----------------
Fixed Maturity Securities by Industry Concentration:
Retail.......................................................................... $ 13.2 $ 1.3
Finance......................................................................... 17.5 1.3
Service......................................................................... 20.5 .6
Consumer Durables............................................................... 10.2 .1
Other (includes 2 industry groups).............................................. 9.0 -
----------------- ----------------
Total.................................................................. $ 70.6 (3) $ 3.5
================= ================
(3) Represents 1.1% of the total fixed maturity securities portfolio.
------------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities
------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
----------------------------------------
Gross
Amortized Unrealized
Cost Losses
----------------- ----------------
Fixed Maturity Securities by Industry Concentration:
Municipals...................................................................... $ 1,525.2 $ 44.3
Utilities....................................................................... 507.7 22.7
Consumer Non-durables........................................................... 266.5 10.1
Industrial...................................................................... 235.0 8.4
Other (includes 17 industry groups) ............................................ 2,216.6 83.0
----------------- ----------------
Total.................................................................. $ 4,751.2 (4) $ 168.7
================= ================
(4) Represents 74.5% of the total fixed maturity securities portfolio.
19
------------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities
------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
----------------------------------------
Gross Unrealized
Cost Losses
----------------- -----------------
Equity Securities by Industry Concentration:
Insurance....................................................................... $ 38.6 $ 2.6
Health Care..................................................................... 18.6 1.3
Consumer Non-durables........................................................... 15.7 1.1
Banking......................................................................... 18.5 .8
Other (6 industry groups)....................................................... 30.3 1.3
----------------- -----------------
Total.................................................................. $ 121.8 (5) $ 7.4 (6)
================= =================
(5) Represents 22.8% of the total equity securities portfolio.
(6) Represents 1.4% of the cost of the total equity securities portfolio, while
gross unrealized gains represent 13.7% of the portfolio.
------------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Maturity Ranges For All Fixed Maturity Securities
------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
------------------------------------------------------------------
Amortized Cost
of Fixed Maturity Securities Gross Unrealized Losses
------------------------------- -------------------------------
Non- Non-
Investment Investment
All Grade Only All Grade Only
-------------- ------------- -------------- -------------
Maturity Ranges:
Due in one year or less............................ $ 486.1 $ 2.9 $ 3.5 $ -
Due after one year through five years.............. 1,659.8 57.3 54.3 2.2
Due after five years through ten years............. 2,665.2 10.3 114.2 1.3
Due after ten years................................ 10.7 - .2 -
-------------- ------------- -------------- -------------
Total.......................................... $ 4,821.9 $ 70.6 $ 172.2 $ 3.5
============== ============= ============== =============
------------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses
------------------------------------------------------------------------------------------------------------------------------------
June 30, 2006
------------------------------------------------------------------
Amount of Gross Unrealized Losses
------------------------------------------------------------------
Total Gross
Less than 20% to 50% More than Unrealized
20% of Cost of Cost 50% of Cost Loss
------------- ------------- -------------- -------------
Number of Months in Loss Position:
Fixed Maturity Securities:
One to six months.............................. $ 37.1 $ - $ - $ 37.1
Seven to twelve months......................... 81.3 - - 81.3
More than twelve months........................ 53.7 - - 53.7
------------- ------------- -------------- -------------
Total................................. $ 172.2 $ - $ - $ 172.2
============= ============= ============== =============
Equity Securities:
One to six months.............................. $ 7.4 $ - $ - $ 7.4
Seven to twelve months......................... - - - -
More than twelve months........................ - - - -
------------- ------------- -------------- -------------
Total................................. $ 7.4 $ - $ - $ 7.4
============= ============= ============== =============
Number of Issues in Loss Position:
Fixed Maturity Securities:
One to six months.............................. 460 - - 460
Seven to twelve months......................... 482 - - 482
More than twelve months........................ 307 - - 307
------------- -------------- -------------- --------------
Total................................. 1,249 - - 1,249 (7)
============= ============== ============== ==============
Equity Securities:
One to six months.............................. 24 - - 24
Seven to twelve months......................... - - - -
More than twelve months........................ - 1 - 1
------------- -------------- -------------- --------------
Total................................. 24 1 - 25 (7)
============= ============== ============== ==============
20
(7) At June 30, 2006 the number of issues in an unrealized loss position
represent 70.1% as to fixed maturities, and 30.5% 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 (June 30, 2006
in the previous 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
------------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2006 2005
------------------ -----------------
Maturity Ranges:
Due in one year or less..................................................... 12.1% 10.9%
Due after one year through five years....................................... 42.9 41.5
Due after five years through ten years...................................... 44.8 46.9
Due after ten years through fifteen years................................... .2 .7
Due after fifteen years..................................................... - -
------------------ -----------------
Total................................................................... 100.0% 100.0%
================== =================
Average Maturity................................................................. 4.5 Years 4.7 Years
================== =================
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 June 30, 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%.
------------------------------------------------------------------------------------------------------------------------------------
Composition of Unrealized Gains (Losses)
------------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2006 2005
------------------ -----------------
Fixed Maturity Securities:
Amortized cost............................................................ $ 6,376.2 $ 6,323.7
Estimated fair value...................................................... 6,238.7 6,331.6
------------------ -----------------
Gross unrealized gains.................................................... 34.8 79.5
Gross unrealized losses................................................... (172.2) (71.5)
------------------ -----------------
Net unrealized gains (losses)......................................... $ (137.4) $ 7.9
================== =================
Equity Securities:
Cost...................................................................... $ 533.4 $ 500.9
Estimated fair value...................................................... 599.3 552.4
------------------ -----------------
Gross unrealized gains.................................................... 73.3 55.1
Gross unrealized losses................................................... (7.4) (3.6)
------------------ -----------------
Net unrealized gains.................................................. $ 65.8 $ 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 $474.4
in dividends from its subsidiaries in 2006 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. $18.8 of commercial paper was outstanding at June 30, 2006.
Old Republic's total capitalization of $4,272.7 at June 30, 2006 consisted
of debt of $142.1 and common shareholders' equity of $4,130.6. Changes in the
common shareholders' equity account reflect primarily the retention of earnings
in excess of dividend requirements as well as changes in the value of
investments carried at market values. Old Republic has paid cash dividends to
21
its shareholders without interruption since 1942, and has increased the annual
rate in each of the past 24 years. The annual dividend rate is typically
reviewed and approved by the Board of Directors in the first quarter of each
year. In establishing each year's cash dividend rate the Corporation does not
follow a strict formulaic approach and favors a gradual rise in the annual
dividend rate that is largely reflective of long-term consolidated operating
earnings trends. Accordingly, each year's dividend rate is set judgmentally in
consideration of such key factors as the dividend paying capacity of the
Corporation's insurance subsidiaries, the trends in average annual statutory and
GAAP earnings for the six most recent calendar years, and the long-term
expectations for the Corporation's consolidated business. At its February, 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
June 30, 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.
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
2006 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:
% Change
from prior
General Mortgage Title Other Total period
---------- ---------- ---------- ---------- --------- ------------
Years Ended December 31:
2003.............................. $ 1,379.5 $ 400.9 $ 1,103.8 $ 51.6 $ 2,936.0 21.1%
2004.............................. 1,623.0 403.2 1,025.2 64.6 3,116.1 6.1
2005.............................. 1,805.2 429.5 1,081.8 70.3 3,386.9 8.7
Six Months Ended June 30:
2005.............................. 892.4 213.9 493.4 36.6 1,636.5 8.6
2006.............................. 933.0 219.2 500.7 39.2 1,692.2 3.4
Quarters Ended June 30:
2005.............................. 461.3 108.5 261.7 16.0 847.6 8.6
2006.............................. $ 473.0 $ 110.2 $ 247.2 $ 17.8 $ 848.4 .1%
========== ========== ========== ========== ========= ============
Earned premiums in the General Insurance Group grew by 2.5% and 4.5% in the
second quarter and first six months of 2006, respectively, as a result of
additional business produced in a reasonably stable underwriting environment.
Mortgage guaranty premium revenue trends for the first six months of 2006
reflect slightly improved business persistency, lower overall mortgage
originations, and a sharp decline in bulk insurance production. Title Group
premium and fee revenues decreased 5.5% in the second quarter of 2006, but grew
by 1.5% in the first six months of 2006 due to reduced real estate transaction
volume substantially occurring in the segment's direct operations, most of which
are concentrated in the Western United States.
22
The percentage allocation of net premiums earned for major insurance
coverages in the General Insurance Group was as follows:
Type of Coverage
-----------------------------------------------------------------------------------
Comm. Inland
Auto. Marine
(mostly Workers' Financial and General
trucking) Comp. Indemnity Property Liability Other
----------- ----------- ---------- ---------- ---------- ---------
Years Ended December 31:
2003................................. 39.5% 20.0% 11.7% 12.2% 5.3% 11.3%
2004................................. 37.9 21.8 11.8 11.3 5.8 11.4
2005................................. 39.2 21.9 10.3 11.1 5.4 12.1
Six Months Ended June 30:
2005................................. 38.8 21.3 11.6 10.9 5.5 11.9
2006................................. 39.8 21.0 10.8 10.7 5.8 11.9
Quarters Ended June 30:
2005................................. 38.9 20.3 12.2 10.8 5.1 12.7
2006................................. 39.9% 19.6% 10.5% 10.6% 6.8% 12.6%
============ =========== ========== ========== =========== =========
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:
2003........................................................ $ 37,255.8 $ 6,806.6 $ 5,802.8 $ 49,865.2
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
Six Months Ended June 30:
2005........................................................ 10,032.4 5,764.8 43.4 15,840.7
2006........................................................ 8,353.1 4,238.8 140.7 12,732.8
Quarters Ended June 30:
2005........................................................ 5,326.8 2,465.2 3.5 7,795.7
2006........................................................ $ 4,460.6 $ 981.9 $ 89.4 $ 5,532.0
============= ============ ============ ============
Net Risk In Force
-------------------------------------------------------------
Traditional
Primary Bulk Other Total
------------- ------------ ------------ ------------
As of December 31:
2003........................................................ $ 15,329.5 $ 802.2 $ 493.4 $ 16,625.1
2004........................................................ 15,452.2 834.8 580.9 16,868.0
2005........................................................ 14,711.2 1,758.8 586.1 17,056.2
As of June 30:
2005........................................................ 15,126.5 1,203.9 576.2 16,906.7
2006........................................................ $ 14,502.0 $ 1,891.8 $ 587.8 $ 16,981.7
============= ============ ============ ============
Analysis of Traditional Primary Risk in Force:
FICO Unscored/
By Fair Isaac & Company ("FICO") Scores: FICO less FICO 620 greater Unavail-
than 620 to 680 than 680 able
------------ ------------ ------------ ------------
As of December 31:
2003................................................ 8.5% 29.2% 48.8% 13.5%
2004................................................ 8.6 31.1 51.4 8.9
2005................................................ 8.3 31.8 53.1 6.8
As of June 30:
2005................................................ 8.5 31.6 52.4 7.5
2006................................................ 8.3% 32.6% 54.2% 4.9%
============ ============ ============ ============
LTV
By Loan to Value ("LTV") Ratio: LTV less LTV LTV Greater
than 85 85 to 90 90 to 95 than 95
------------ ------------ ------------ ------------
As of December 31:
2003................................................ 6.4% 37.3% 43.8% 12.5%
2004................................................ 5.7 36.8 42.0 15.5
2005................................................ 5.4 37.7 39.1 17.8
As of June 30:
2005................................................ 5.5 37.0 40.6 16.9
2006................................................ 5.2% 37.7% 37.7% 19.4%
============ ============ ============ ============
23
By Type of Loan Documentation: Full Reduced
Documentation Documentation
----------------- -----------------
As of December 31:
2003........................................................................ 94.4% 5.6%
2004........................................................................ 93.2 6.8
2005........................................................................ 90.6 9.4
As of June 30:
2005........................................................................ 92.0 8.0
2006........................................................................ 90.2% 9.8%
================= =================
Premium and Persistency Trends
Earned Premiums Persistency
---------------------------- -----------------------------
Traditional
Direct Net Primary Bulk (1)
------------ ------------ ------------ ------------
Years Ended December 31:
2003.................................................. $ 467.3 $ 400.9 46.0% 31.8%
2004.................................................. 483.6 403.2 64.5 55.7
2005.................................................. 508.0 429.5 65.5 59.5
Six Months Ended June 30:
2005.................................................. 252.7 213.9 66.6 55.0
2006.................................................. 258.8 219.2 68.1% 69.1%
============ ============
Quarters Ended June 30:
2005.................................................. 128.1 108.5
2006.................................................. $ 129.8 $ 110.2
============ ============
----------------------
(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:
Independent
Direct Title Agents &
Operations Other
-------------- ---------------
Years Ended December 31:
2003................................................................................ 40.0% 60.0%
2004................................................................................ 38.1 61.9
2005................................................................................ 37.1 62.9
Six Months Ended June 30:
2005................................................................................ 39.2 60.8
2006................................................................................ 32.2 67.8
Quarters Ended June 30:
2005................................................................................ 39.9 60.1
2006................................................................................ 34.7% 65.3%
============== ===============
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.
Invested Assets at Cost Market Invested
--------------------------------------------------------------------- Value Assets at
Corporate Adjust- Market
General Mortgage Title and Other Total ment Value
----------- ---------- ---------- ----------- ----------- --------- ------------
As of December 31:
2003................. $ 3,798.2 $ 1,381.4 $ 556.9 $ 177.1 $ 5,913.6 $ 360.3 $ 6,273.8
2004................. 4,217.8 1,501.9 595.2 295.0 6,610.1 262.2 6,872.2
2005................. 4,694.8 1,515.4 616.8 326.4 7,153.5 76.6 7,230.2
As of June 30:
2005................. 4,409.2 1,440.9 566.1 445.0 6,861.3 209.6 7,070.9
2006................. $ 4,869.1 $ 1,515.4 $ 594.2 $ 440.1 $ 7,418.9 $ (61.6) $ 7,357.3
=========== ========== ========== =========== =========== ========= ============
24
Net Investment Income Yield at
--------------------------------------------------------------------- ------------------------
Corporate
General Mortgage Title and Other Total Cost Market
---------- ---------- ---------- ------------ ----------- ---------- ---------
Years Ended
December 31:
2003................. $ 175.0 $ 65.7 $ 23.5 $ 14.9 $ 279.2 4.9% 4.6%
2004................. 183.4 67.7 25.5 14.0 290.8 4.6 4.4
2005................. 197.0 70.1 26.0 16.9 310.1 4.5 4.4
Six Months Ended
June 30:
2005................. 95.7 35.0 12.7 7.6 151.2 4.5 4.3
2006................. 106.6 36.8 13.3 8.4 165.3 4.5 4.5
Quarters Ended
June 30:
2005................. 47.8 17.4 6.4 4.1 75.8 4.5 4.4
2006................. $ 53.7 $ 17.6 $ 6.5 $ 4.6 $ 82.6 4.5% 4.5%
========== ========== ========== ============ =========== ========== =========
Consolidated net investment income grew by 8.9% and 9.3% for the second
quarter and first six months of 2006, respectively, when compared to the same
2005 periods. 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 a lower yield environment during
the past several years.
Revenues: Net Realized Gains
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Rather, these policies aim to
assure a stable source of income from interest and dividends, protection of
capital, and provision of sufficient liquidity to meet insurance underwriting
and other obligations as they become payable in the future. Dispositions of
fixed maturity securities arise mostly from scheduled maturities and early
calls; for the first six months of 2006 and 2005, 83.8% and 73.5%, respectively,
of all such dispositions resulted from these occurrences. Dispositions of equity
securities at a realized gain or loss reflect such factors as ongoing
assessments of issuers' business prospects, rotation among industry sectors, and
tax planning considerations. Additionally, the amount of net realized gains and
losses registered in any one accounting period are affected by the
aforementioned assessments of securities' values for other than temporary
impairment. As a result of the interaction of all these factors and
considerations, net realized investment gains or losses can vary significantly
from period-to-period, and in the Company's view are not indicative of any
particular trend or result in its basic insurance underwriting business.
The following table reflects the composition of net realized gains or
losses for the periods shown. 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 (Losses)
on Disposition of: Impairment Losses on:
---------------------------------------- -----------------------------------------
Equity Equity
securities securities
Fixed and miscell- Fixed and miscell- Net
maturity aneous maturity aneous realized
securities investments Total securities investments Total gains
---------- ------------ --------- ----------- ------------- -------- ----------
Years Ended
December 31:
2003............... $ 4.6 $ 31.1 $ 35.7 $ - $ (16.4) $ (16.4) $ 19.3
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
Six Months Ended
June 30:
2005............... 3.0 23.0 26.0 - (5.2) (5.2) 20.8
2006............... 1.6 14.0 15.7 - - - 15.7
Quarters Ended
June 30:
2005............... 2.7 10.2 12.9 - (.1) (.1) 12.8
2006............... $ .4 $ 7.7 $ 8.1 $ - $ - $ - $ 8.1
========== ============ ========= =========== ============= ======== ==========
25
Expenses: Benefits and Claims
In order to achieve a necessary matching of revenues and expenses, the
Company records the benefits, claims and related settlement costs that have been
incurred during each accounting period. Such costs are affected by the amount of
paid claims and the adequacy of reserve estimates established for current and
prior years' claim occurrences.
The establishment of claim reserves by the Company's insurance subsidiaries
is a reasonably complex and dynamic process influenced by a large variety of
factors. These factors principally include past experience applicable to the
anticipated costs of various types of claims, continually evolving and changing
legal theories emanating from the judicial system, recurring accounting,
statistical, and actuarial studies, the professional experience and expertise of
the Company's claim departments' personnel or attorneys and independent claim
adjusters, ongoing changes in claim frequency or severity patterns such as those
caused by natural disasters, illnesses, accidents, work-related injuries, and
changes in general and industry-specific economic conditions. Consequently, the
reserve-setting process relies on the opinions of a large number of persons, on
the application and interpretation of historical precedent and trends, on
expectations as to future developments, and on management's judgment in
interpreting all such factors. At any point in time, the Company is therefore
exposed to possibly higher than anticipated claim costs due to all of these
factors, and to the evolution, interpretation, and expansion of tort law, as
well as the effects of unexpectedly adverse jury verdicts. All reserves are thus
based on a large number of assumptions and resulting estimates which are
periodically reviewed and evaluated in the light of emerging claim experience
and changing circumstances. The resulting changes in estimates are recorded in
operations of the periods during which they are made. The Company believes that
its overall reserving practices have been consistently applied over many years.
For at least the past ten years, previously established aggregate reserves have
produced reasonable estimates of the cumulative ultimate net costs of claims
incurred. However, no representation is made that ultimate net claim and related
costs will not develop in future years to be greater or lower than currently
established reserve estimates.
Most of Old Republic's consolidated claim and related expense reserves stem
from its general insurance business. At June 30, 2006, such reserves accounted
for 89.3% and 83.0% of consolidated gross and net of reinsurance reserves,
respectively, while similar reserves at December 31, 2005 accounted for 89.1%
and 82.5% of the respective consolidated amounts. The following table shows a
breakdown of gross and net of reinsurance claim reserve estimates for major
types of insurance coverages as of those dates:
June 30, 2006 December 31, 2005
-------------------------- --------------------------
Gross Net Gross Net
---------- ----------- ----------- -----------
Claim and Loss Adjustment Expense Reserves:
Commercial automobile (mostly trucking)............................ $ 943.1 $ 756.7 $ 878.4 $ 692.9
Workers' compensation.............................................. 1,853.9 965.0 1,775.0 915.1
General liability.................................................. 1,037.1 437.2 991.3 418.1
Other coverages.................................................... 601.3 387.4 597.5 387.8
Unallocated loss adjustment expense reserves....................... 147.2 93.6 159.2 92.9
---------- ----------- ----------- -----------
Total general insurance reserves 4,582.8 2,640.1 4,401.7 2,507.0
Mortgage guaranty.................................................. 219.3 218.5 214.7 213.7
Title.............................................................. 273.0 273.0 268.8 268.8
Life and health.................................................... 30.0 21.9 26.5 19.9
Unallocated loss adjustment expense reserves -
other coverages................................................. 28.7 28.7 28.0 28.0
---------- ----------- ----------- -----------
Total claim and loss adjustment expense reserves............. $ 5,134.1 $ 3,182.5 $ 4,939.8 $ 3,037.6
========== =========== =========== ===========
Asbestosis and environmental claim reserves included
in the above general insurance reserves:
Amount...................................................... $ 169.8 $ 132.6 $ 170.7 $ 132.2
========== =========== =========== ===========
% of total general insurance reserves....................... 3.7% 5.0% 3.9% 5.3%
========== =========== =========== ===========
Old Republic's General Insurance business is composed of a large variety of
lines or classes of commercial insurance; it has negligible exposure to personal
lines such as homeowners or private passenger automobile insurance that exhibit
wide diversification of risks, significant frequency of claim occurrences, and
high degrees of statistical credibility. Most of the General Insurance Group's
claim reserves stem from liability insurance coverages for commercial customers.
Liability claims typically require more extended periods of investigation and at
times protracted litigation before they are finally settled, and thus tend to
exhibit loss development and payment patterns that stretch over relatively long
periods of time.
The Company establishes point estimates for most reserves on an insurance
coverage line-by-line basis for individual subsidiaries, sub-classes, or
individual accounts and blocks of business that have similar attributes.
Actuarially or otherwise derived ranges of reserve levels are not utilized as
such in setting these reserves, and, accordingly, the reserves listed in the
above table represent the Company's point estimates at each reporting date. The
overall reserve level at any point in time therefore represents the compilation
of a very large number of reported ("case") reserve estimates and the results of
26
a variety of formula calculations intended to cover claims and related costs not
as yet reported or emerged ("IBNR"). Case reserves are based on continually
evolving assessments of the facts available to the Company during the claim
settlement process. Long-term, disability-type workers' compensation reserves
are discounted to present value based on interest rates that range from 3.5% to
4.0%. Formula calculations are utilized to provide for IBNR claim costs as well
as additional costs that can arise from such factors as monetary and social
inflation, changes in claims administration processes, changes in reinsurance
ceded and recoverability levels, and expected trends in claim costs and related
ratios. Typically, such formulas take into account so-called link ratios that
represent prior years' patterns of incurred or paid loss trends between
succeeding years, or past experience relative to progressions of the number of
claims reported over time and ultimate average costs per claim. Reserves
pertaining to large individual commercial insurance accounts that exhibit
sufficient statistical credibility, and that may be subject to retrospective
premium rating plans or the utilization of varying levels or types of
self-insured retentions are established on an account by account basis using
case reserves and applicable formula-driven methods. For certain so-called
long-tail categories of insurance such as excess liability or excess workers'
compensation, officers and directors' liability, and commercial umbrella
liability relative to which claim development patterns are particularly long,
more volatile, and immature in their early stages of development, the Company
judgmentally establishes the most current accident years' loss reserves on the
basis of expected loss ratios. As actual claims data emerges in succeeding
years, the original accident year loss ratio assumptions are validated or
otherwise adjusted sequentially through the application of statistical or
actuarial projection techniques such as the Bornhuetter/Ferguson method which
utilizes data from the more mature experience of prior years.
Except for a small portion that emanates from ongoing primary insurance
operations, a large majority of the asbestosis and environmental ("A&E") claim
reserves posted by Old Republic stem mainly from its participations in assumed
reinsurance treaties and insurance pools. Substantially all such participations
were discontinued fifteen or more years ago and have since been in run-off
status. With respect to the primary portion of gross A&E reserves, Old Republic
administers the related claims through its claims personnel as well as outside
attorneys, and posted reserves reflect its best estimates of ultimate claim
costs. Claims administration for the assumed portion of the Company's A&E
exposures is handled by the claims departments of unrelated primary or ceding
reinsurance companies. While the Company performs periodic reviews of a portion
of claim files so managed, the overall A&E reserves it establishes respond to
the paid claim and case reserve activity reported to the Company as well as
available industry statistical data such as so-called survival ratios. Such
ratios represent the number of years' average paid losses for the three or five
most recent calendar years that are encompassed by an insurer's A&E reserve
level at any point in time. According to this simplistic appraisal of an
insurer's A&E loss reserve level, Old Republic's average five year survival
ratios stood at 6.8 years (gross) and 10.0 years (net of reinsurance) as of June
30, 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 asbestosis and environmental claims have averaged 3.3% of General
Insurance Group net incurred losses for the five years ended December 31, 2005.
Mortgage Guaranty claim reserves are determined on the basis of the carried
risk on reported loan defaults and on an estimate of defaulted loans that have
yet to be reported. The majority of defaults reported to the Company are cured
by the borrower either by making the necessary number of mortgage payments to
bring the loan current, by refinancing the mortgage loan, or by selling the
property in an amount sufficient to cover the outstanding mortgage debt.
Estimates of claim frequency, which are based on historical trends and on
judgments as to current and future economic conditions, are applied according to
the level of the reported default. Claim severity is estimated based on
historical claim payments including the impact of loss mitigation strategies and
potential salvage recoveries. Once reported, the time required to cure a default
or settle a claim can be significant, often running years from the date of
original default and through changing economic conditions. As a result, mortgage
guaranty loss reserve estimates take into account a large number of variables
including trends in claim severity, potential salvage recoveries, expected cure
rates for reported loan defaults at various stages of default, and judgments
relative to future employment levels, housing market activity, and mortgage loan
demand and extensions.
Title Insurance and related escrow service loss and loss adjustment expense
reserves are established to cover the estimated settlement costs of known as
well as claims incurred but not reported, concurrently with the recognition of
premium and escrow service revenues. Reserves for known claims are based on an
assessment of the facts available to the Company during the settlement process.
Reserves for claims incurred but not reported are established on the basis of
past experience and evaluations of such variables as changes and trends in the
types of policies issued, changes in real estate markets and interest rate
environments, and changed levels of loan refinancings, all of which can have a
bearing on the emergence, number, and ultimate cost of claims.
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 known and
IBNR claims.
Substantially all of the Company's reserves for IBNR claims relate to its
general insurance business. As of June 30, 2006 and December 31, 2005, the
Company's general insurance segment carried reserves of $934.1 and $873.6,
respectively, to cover claims incurred but not as yet reported as well as for
the possible adverse development of known case reserves. As noted above, the
aggregate of these provisions, known collectively as IBNR reserves, results from
27
the application of many formulas and reserve-setting approaches that are
sensitive to the wide variety of already enumerated factors. Should these
reserves for IBNR claims be understated by 10% for a deficiency of $93.4, or
3.5% of the Company's net general insurance reserves as of June 30, 2006 and
$87.3, or 3.5% as of the prior year end balance sheet date, the impact on the
Company's income statement would be to reduce pretax income by such amounts. One
year developments of general insurance reserves posted as of each of the 1995
through 2004 year ends have reflected uniformly positive results. Cumulative
developments ranging from 10 years to one year for the same year ends have
produced both redundancies and (deficiencies) that have ranged between 7.2% and
(5.8%) and have averaged .6%.
Certain events could affect adversely the Company's reserve levels and its
future operating results and financial condition. With respect to Old Republic's
general insurance business, such events or exposures would include but not be
limited to catastrophic workers' compensation claims caused by a terrorist
attack or a natural disaster such as an earthquake, legislated retroactive
incurrence of previously denied or settled claims, the levying of major guaranty
fund assessments by various states based on the costs of insurance company
failures apportioned against remaining and financially secure insurers, the
future failure of one or more significant assuming reinsurers that would void or
reduce the Company's reinsurance recoverable for losses paid or in reserve, and
greater than expected involuntary market assessments, such as those caused by
forced participation in assigned risk and similar involuntary market plans, all
of which cannot be reasonably estimated prior to their emergence.
In management's opinion, geographic concentrations of assureds' employees
in the path of an earthquake or acts of terrorism represent the most significant
catastrophic risks to Old Republic's General insurance segment. These risks
would largely impact the workers' compensation line since primary insurers such
as the Company must, by regulation, issue unlimited liability policies. While
Old Republic obtains a degree of protection through its reinsurance program as
to earthquake exposures, and, until December 31, 2007 through the Terrorism Risk
Insurance Extension Act of 2005, there is no assurance that recoveries
thereunder would be sufficient to offset the costs of a major calamity nor
eliminate its possible major impact on operating results and financial
condition. Old Republic has availed itself of modeling techniques to evaluate
the possible magnitude of earthquake or terrorist induced claim costs for its
most exposed coverage of workers' compensation. Such models, however, have not
been sufficiently validated by past occurrences, and rely on a large variety and
number of assumptions. As a result, they may not be predictive of possible
claims from future events.
Mortgage guaranty net claim reserve levels could be affected adversely by
several factors, including 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 that could expose the
Company to greater loss on resale of properties obtained through foreclosure
proceedings.
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.
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.
In all of the above regards, current GAAP accounting polices do not permit
the Company's reserving practices to anticipate or provide for claims arising
from future catastrophic events before they occur.
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:
General Mortgage Title Consolidated
-------------- ------------- ----------- -------------
Years Ended December 31:
2003............................................. 67.6% 22.7% 5.8% 37.9%
2004............................................. 65.9 35.5 5.8 42.0
2005............................................. 66.9 37.2 6.0 43.3
Six Months Ended June 30:
2005............................................. 67.2 31.9 5.9 43.7
2006............................................. 65.0 37.2 6.0 43.7
Quarters Ended June 30:
2005............................................. 67.5 31.5 5.9 43.6
2006............................................. 65.6% 35.6% 5.9% 44.1%
============== ============= =========== =============
The general insurance portion of the 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, together
with elements of reduced loss severity and frequency. The mortgage guaranty
28
claim ratios reflect higher paid losses, as well as expectations of greater
claim frequency for traditional primary business. The title insurance loss
ratios remain in the low single digits due to a continuation of favorable trends
in claims frequency and severity for business underwritten. The consolidated
benefits and claims ratio reflects the changing effects of period-to-period
contributions of each segment to consolidated results, and this ratio's
variances within each segment.
The percentage of net claims, benefits and related settlement expenses
measured against premiums earned by General Insurance Group major coverage were
as follows:
Type of Coverage
-----------------------------------------------------------------------------------
Comm. Inland
Auto. Marine
(mostly Workers' Financial and General
trucking) Comp. Indemnity Property Liability Other
----------- ----------- ---------- ---------- ---------- ---------
Years Ended December 31:
2003............................... 70.4% 81.2% 51.0% 59.1% 89.5% 52.2%
2004............................... 66.5 72.4 47.6 56.2 108.6 59.3
2005............................... 67.2 78.9 48.9 52.1 97.4 58.6
Six Months Ended June 30:
2005............................... 69.8 72.6 56.7 53.3 102.4 55.7
2006............................... 74.0 76.0 45.1 52.5 51.5 52.2
Quarters Ended June 30:
2005............................... 69.0 74.5 60.8 53.1 106.5 51.0
2006............................... 75.9% 78.8% 46.2% 53.3% 36.3% 51.1%
=========== ========== ========== ========== ========== ==========
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 Traditional
Primary Bulk (2) Primary Bulk (2)
--------------- --------------- ----------------- ---------------
Years Ended December 31:
2003.................................... $ 22,339 $ 29,293 3.95% 4.76%
2004.................................... 23,920 19,885 4.11 4.59
2005.................................... 24,255 20,639 4.67 3.67
Six Months Ended June 30:
2005.................................... 24,056 22,340 3.82 3.25
2006.................................... 25,550 18,873 4.08% 3.24%
================= ===============
Quarters Ended June 30:
2005.................................... 23,711 24,103
2006.................................... $ 24,940 $ 20,234
=============== ===============
(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 NC CA OH PA MN SC
------ ------ ------- ------ ------ ------- ------- ------ ------ -------
As of December 31:
2003............... 3.5% 4.6% 4.9% 4.0% 4.7% 2.8% 6.9% 3.8% 2.5% 4.9%
2004............... 3.2 5.0 5.6 3.8 4.9 2.1 7.6 4.4 3.5 5.0
2005............... 3.1 5.7 5.9 4.2 4.9 1.8 8.3 4.7 4.0 5.4
As of June 30:
2005............... 2.4 4.6 5.4 3.8 4.5 1.6 7.4 4.1 3.5 4.6
2006............... 2.2% 4.4% 5.5% 4.1% 4.3% 2.0% 7.5% 4.3% 4.6% 4.5%
====== ====== ======= ====== ====== ======= ======= ====== ====== =======
(3) As determined by risk in force. These 10 states represent approximately
50% of total risk in force as of June 30, 2006.
29
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:
2003............................................. 26.2% 24.8% 84.6% 48.5%
2004............................................. 24.8 25.6 90.5 47.3
2005............................................. 24.6 22.4 88.2 45.2
Six Months Ended June 30:
2005............................................. 24.2 22.5 89.4 44.3
2006............................................. 24.6 23.1 92.6 45.1
Quarters Ended June 30:
2005............................................. 24.0 22.0 87.7 44.0
2006............................................. 23.4% 22.6% 91.7% 43.8%
============== ============= =========== =============
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 slight increases in the 2006 Mortgage Guaranty Group ratios reflects
higher stock option compensation expenses.
The increase in the Title Insurance Group's second quarter and first six
months 2006 expense ratios results from decreased revenues from direct
operations, most of which are concentrated in the Western United States, to a
level lower than necessary to support the related 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:
2003.............................................. 93.8% 47.5% 90.4% 86.4%
2004.............................................. 90.7 61.1 96.3 89.3
2005.............................................. 91.5 59.6 94.2 88.5
Six Months Ended June 30:
2005.............................................. 91.4 54.4 95.3 88.0
2006.............................................. 89.6 60.3 98.6 88.8
Quarters Ended June 30:
2005.............................................. 91.5 53.5 93.6 87.6
2006.............................................. 89.0% 58.2% 97.6% 87.9%
============== ============= =========== =============
Expenses: Income Taxes
The effective consolidated income tax rates were 32.1% and 31.9% in the
second quarters and first six months of 2006, respectively, and 8.1% and 19.5%
for similar periods of 2005, respectively. The 2005 effective tax rates were
reduced and net earnings were enhanced by tax and related interest recoveries of
$45.9, or 20 cents per share, in the second quarter 2005 for 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 current
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.
30
--------------------------------------------------------------------------------
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, also may 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.
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.
31
OLD REPUBLIC INTERNATIONAL CORPORATION
--------------------------------------------------------------------------------
Item 3 - 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.
Old Republic's market risk exposures at June 30, 2006, have not materially
changed from those identified in the Company's 2005 Annual Report on Form 10-K.
Item 4 - Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's principal executive officer and its principal financial
officer have evaluated the Company's disclosure controls and procedures as of
the end of the period covered by this quarterly report. Based upon their
evaluation, the principal executive officer and principal financial officer have
concluded that the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective for the above referenced evaluation period.
Changes in Internal Control Over Financial Reporting
During the three month period ended June 30, 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
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.
32
OLD REPUBLIC INTERNATIONAL CORPORATION
FORM 10-Q
PART II - OTHER INFORMATION
--------------------------------------------------------------------------------
Item 1A - Risk Factors
----------------------
There have been no material changes with respect to the risk factors disclosed
in the Company's Annual Report on Form 10-K for the year ended December 31,
2005.
Item 4 - Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
(a) The annual meeting of registrant's shareholders was held on May 26, 2006.
(b) Proxies for the meeting were solicited by management pursuant to Regulation
14A under the Security Exchange Act of 1934. There was no solicitation in
opposition to management's nominees for directors as listed in the proxy
statement and all such nominees were elected.
(c) At the meeting, the shareholders voted on the following matters:
1. The election of four Class 1 directors. There were at least 128,235,365
affirmative votes for each director and no more than 83,467,701 votes
withheld for any single director.
2. The Old Republic International Corporation 2006 Incentive Compensation
Plan. There were 131,969,466 shares voted for the plan, 60,662,583
shares voted against the plan, and 780,418 shares that voted to
abstain. Broker non-votes totaled 18,290,598.
Item 6 - Exhibits
-----------------
(a) Exhibits
31.1 Certification by Aldo C. Zucaro, Chief Executive Officer, pursuant
to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by Karl W. Mueller, Chief Financial Officer,
pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Aldo C. Zucaro, Chief Executive Officer, pursuant
to Section 1350, Chapter 63 of Title 18, United States Code, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by Karl W. Mueller, Chief Financial Officer, pursuant
to Section 1350, Chapter 63 of Title 18, United States Code, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
33
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Old Republic International Corporation
------------------------------------------------
(Registrant)
Date: August 8, 2006
------------------
------------------------------------------------
Karl W. Mueller
Senior Vice President and
Chief Financial Officer
34
EXHIBIT INDEX
Exhibit
No. Description
-------------- --------------------------------------------------------------
31.1 Certification by Aldo C. Zucaro, Chief Executive Officer,
pursuant to Rule 13a-14(a) and 15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by Karl W. Mueller, Chief Financial Officer,
pursuant to Rule 13a-14(a) and 15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Aldo C. Zucaro, Chief Executive Officer,
pursuant to Section 1350, Chapter 63 of Title 18, United
States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification by Karl W. Mueller, Chief Financial Officer,
pursuant to Section 1350, Chapter 63 of Title 18, United
States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
35