UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934(FEE REQUIRED)
For the fiscal year ended: December 31, 2005 OR
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_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
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Commission File Number: 001-10607
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OLD REPUBLIC INTERNATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of each class on Which Registered
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7% Subordinated Debentures Due June 15, 2007 New York Stock Exchange
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Common Stock/$1 par value New York Stock Exchange
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes:_X_/ No:___
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes:___/No:_X_
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes: _X_/ No:___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one).
Large accelerated filer (X) Accelerated filer ( ) Non-accelerated filer ( )
Indicate by check mark whether the registrant is a shell company (as defined in
Exchange Act Rule 12b-2). Yes:___ / No:_X_
The aggregate market value of the registrant's voting Common Stock held by
non-affiliates of the registrant (assuming, for purposes of this calculation
only, that the registrant's directors and executive officers, the registrant's
various employee benefit plans and American Business & Personal Insurance
Mutual, Inc. and its subsidiaries are all affiliates of the registrant), based
on the closing sale price of the registrant's common stock on June 30, 2005, the
last day of the registrant's most recently completed second fiscal quarter, was
$4,294,079,923.
The registrant had 229,597,096 shares of Common Stock outstanding as of February
2, 2006.
Documents incorporated by reference:
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The following documents are incorporated by reference into that part of this
Form 10-K designated to the right of the document title.
Title Part
Proxy statement for the
2006 Annual Meeting of Shareholders III, Items 10, 11, 12, 13 and 14
Exhibits as specified in
exhibit index (page 74) IV, Item 15
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There are 75 pages in this report
PART I
Item 1-Business
(a) General Description of Business. Old Republic International Corporation is a
Chicago-based insurance holding company whose subsidiaries conduct business
through three major segments. These segments are organized as the Old Republic
General Insurance (property and liability), Mortgage Guaranty, and Title
Insurance Groups and references herein to such groups apply to the Company's
subsidiaries engaged in these respective segments of business. A small life and
health insurance business is included under the corporate and other caption. In
this report, "Old Republic", "the Corporation", or "the Company" refers to Old
Republic International Corporation and its subsidiaries as the context requires.
Financial Information Relating to Segments of Business (1)
The contributions to net revenues and income (loss) before taxes of each
Old Republic segment are set forth below for the years shown, together with
their respective assets at the end of each year. The information below should be
read in conjunction with the consolidated financial statements, the notes
thereto, and the "Management Analysis of Financial Position and Results of
Operations" appearing elsewhere herein.
($ in Millions)
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Years Ended December 31,
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Net Revenues (2)
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2005 2004 2003 2002 2001
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General.................................... $ 2,017.6 $ 1,822.5 $ 1,572.7 $ 1,376.7 $ 1,195.0
Mortgage Guaranty.......................... 516.0 489.9 498.6 467.1 436.0
Title...................................... 1,108.6 1,051.8 1,128.0 836.5 648.9
Corporate & Other - Net (3)................ 98.6 79.3 66.9 62.0 63.6
Consolidated Realized
Investment Gains.......................... 64.9 47.9 19.3 13.9 29.7
------------ ----------- ----------- ----------- -----------
Consolidated............................. $ 3,805.9 $ 3,491.6 $ 3,285.8 $ 2,756.4 $ 2,373.4
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($ in Millions)
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Years Ended December 31,
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Income (Loss) Before Taxes
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2005 2004 2003 2002 2001
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General.................................... $ 350.0 $ 333.0 $ 258.9 $ 182.1 $ 141.5
Mortgage Guaranty.......................... 243.7 224.5 276.4 267.7 261.9
Title...................................... 88.7 62.5 129.6 97.6 75.0
Corporate & Other - Net (3)................ (.1) (17.2) (4.5) (.7) (1.5)
Consolidated Realized
Investment Gains.......................... 64.9 47.9 19.3 13.9 29.7
------------ ----------- ----------- ----------- -----------
Consolidated............................. $ 747.3 $ 650.9 $ 679.7 $ 560.7 $ 506.6
============ =========== =========== =========== ===========
($ in Millions)
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Assets at December 31,
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2005 2004 2003 2002 2001
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General.................................... $ 8,178.9 $ 7,222.8 $ 6,603.5 $ 5,876.5 $ 5,451.9
Mortgage Guaranty.......................... 2,211.8 2,205.9 2,080.1 1,921.2 1,731.6
Title...................................... 776.3 753.0 720.5 619.9 536.0
Corporate & Other - Net (3)................ 376.0 388.9 308.0 297.6 200.5
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Consolidated............................. $ 11,543.2 $ 10,570.8 $ 9,712.3 $ 8,715.4 $ 7,920.2
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(1) Reference is made to the table in Note 6 of the Notes to Consolidated
Financial Statements, incorporated herein by reference, which shows the
contribution of each subcategory to the consolidated net revenues and
income or loss before income taxes of Old Republic's insurance industry
segments.
(2) Revenues consist of net premiums, fees, net investment and other income
earned; realized investment gains are shown in total for all groups
combined since the investment portfolio is managed as a whole.
(3) Represents amounts for Old Republic's holding company parent, minor
internal services subsidiaries, and a small life and health insurance
operation.
2
The insurance business is distinguished from most others in that the prices
(premiums) charged for various coverages are set without certainty of the
ultimate benefit and claim costs that will emerge or be incurred, often many
years after issuance of a policy. This basic fact casts Old Republic's business
as a long-term undertaking which is managed with a primary focus on the
achievement of favorable underwriting results over time. In addition to
operating income stemming from Old Republic's basic underwriting and related
services functions, significant revenues are obtained from investable funds
generated by those functions as well as from retained shareholders' capital. In
managing investable funds the Company aims to assure stability of income from
interest and dividends, protection of capital, and sufficient liquidity to meet
insurance underwriting and other obligations as they become payable in the
future. Securities trading and the realization of capital gains are not
objectives. The investment philosophy is therefore best categorized as
emphasizing value, credit quality, and relatively long-term holding periods. The
Company's ability to hold both fixed maturity and equity securities for long
periods of time is enabled by the scheduling of maturities in contemplation of
an appropriate matching of assets and liabilities.
In light of the above factors, the Company's affairs are managed for the
long run, without regard to the arbitrary strictures of quarterly or even annual
reporting periods that American industry must observe. In Old Republic's view,
short reporting time frames do not comport well with the long-term nature of
much of its business, driven as it is by a basic 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 frames are likely to
encompass one or two economic and/or underwriting cycles, and provide
appropriate time intervals for such cycles to run their course and for reserved
claim costs to be quantified with greater finality and effect.
General Insurance Group
Through its General Insurance Group subsidiaries, the Corporation assumes
risks and provides related risk management services that encompass a large
variety of property and liability insurance coverages. Old Republic does not
have a meaningful exposure to personal lines of insurance such as homeowners and
private automobile coverages, and does not insure significant amounts of
commercial buildings and related property. Approximately 84% of the
Corporation's general insurance business is produced through independent agency
and brokerage channels, while the remaining 16% is obtained through direct
production facilities.
Liability Coverages: Commercial automobile (mostly trucks) full coverage
protection, workers' compensation and general liability (including the general
liability portion of commercial package policies) are the major classes of
insurance underwritten for businesses and public entities such as
municipalities. Within these classes of insurance, Old Republic focuses on a
number of industries, most prominently the transportation (trucking and general
aviation), construction, forest products, and energy industries.
Over the years, Old Republic has diversified its General Insurance Group
business. This diversification has been achieved through a combination of
internal growth, the establishment of new subsidiaries, and through selective
mergers with other companies. For 2005, production of commercial automobile
direct insurance premiums accounted for approximately 33.7% of consolidated
direct premiums written by the General Insurance Group, while workers'
compensation and general liability direct insurance premiums amounted to 24.5%
and 13.5%, respectively, of such consolidated totals.
Among other liability coverages, Old Republic indemnifies corporations'
financial exposures to directors' and officers' ("D&O") liability as well as
those stemming from errors and omissions ("E&O") liability. In the past twenty
years, the Corporation has developed a presence in the general aviation
insurance industry, providing coverage for hull and liability exposures as well
as such additional areas as airport facilities and flying schools.
Other Coverages: Old Republic's property insurance business incorporates
mostly commercial physical damage insurance on trucking risks. A small volume of
business is represented by fire and other physical perils for commercial
properties. In addition to the aforementioned D&O and E&O financial indemnity
coverages, the Corporation also covers fidelity, surety and credit exposures for
a wide range of business enterprises. Fidelity and surety policies are issued
through some 9,000 independent agents by the Old Republic Surety Group. Surety
bonds, such as those covering public officials, license and permit
authorizations and contract bonds covering both public and private works, are
typically written for exposures of less than $500,000. Fidelity bonds are also
extended to small to medium-sized risks. Old Republic Insured Credit Services,
Inc. has underwritten loan and retail installment sales credit indemnity
insurance since 1955 through commercial banks, thrifts and other lending
institutions. This coverage provides a limited indemnity to lenders on a variety
of consumer loans and installment sales contracts.
Extended warranty coverages for new and used automobiles, as well as home
warranty policies covering appliances and other mechanical systems in pre-owned
homes are marketed by Old Republic through its own employees and selected
independent agents. Travel insurance is produced through independent travel
agents in the United States and Canada. The coverages provided under these
policies, some of which are also underwritten by one of the Company's life
insurance subsidiaries, include trip delay and trip cancellation protection for
insureds.
3
Mortgage Guaranty Group
Private mortgage insurance protects mortgage lenders and investors from
default related losses on residential mortgage loans made primarily to
homebuyers who make down payments of less than 20% of the home's purchase price.
The Mortgage Guaranty Group insures only first mortgage loans, primarily on
residential properties incorporating one-to-four family dwelling units.
There are two principal types of private mortgage insurance coverage:
"primary" and "pool". Primary mortgage insurance provides mortgage default
protection on individual loans and covers a stated percentage of the unpaid loan
principal, delinquent interest, and certain expenses associated with the default
and subsequent foreclosure. In lieu of paying the stated coverage percentage,
the Corporation may pay the entire claim amount, take title to the mortgaged
property, and subsequently sell the property to mitigate its loss. Pool
insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions. This insurance provides coverage that
ranges up to 100% of the net loss on each individual loan included in the pool,
subject to provisions regarding deductibles, caps on individual exposures, and
aggregate stop loss provisions which limit aggregate losses to a specified
percentage of the total original balances of all loans in the pool.
Traditional primary insurance is issued on an individual loan basis to
mortgage bankers, brokers, commercial banks and savings institutions through a
network of Company-managed underwriting sites located throughout the country.
Traditional primary loans are individually reviewed (except for loans insured
under delegated approval programs) and priced according to filed premium rates.
In underwriting traditional primary business, the Corporation generally adheres
to the underwriting guidelines published by the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"),
purchasers of many of the loans the Corporation insures. Delegated underwriting
programs allow approved lenders to commit the Corporation to insure loans
provided they adhere to predetermined underwriting guidelines. In 2005,
delegated underwriting approvals accounted for approximately 64% of the
Corporation's new traditional primary insurance written.
Bulk and other insurance is issued on groups of loans to mortgage banking
customers through a centralized risk assessment and underwriting department.
These groups of loans are priced in the aggregate, on a bid or negotiated basis.
Coverage for insurance issued in this manner can be provided through primary
insurance policies (loan level coverage) or pool insurance policies (aggregate
coverage). The Corporation considers transactions designated as bulk insurance
to be exposed to higher risk (as determined by characteristics such as
origination channel, loan amount, credit quality, and loan documentation) than
those designated as other insurance.
Before insuring any loans, the Corporation issues to each approved customer
a master policy outlining the terms and conditions under which coverage will be
provided. Primary business is then executed via the issuance of a
commitment/certificate for each loan submitted and approved for insurance. In
the case of business providing pool coverage, a separate pool insurance policy
is issued covering the particular loans applicable to each transaction.
As to all types of mortgage insurance products, the amount of premium
charge depends on loan-to-value ratios, the level of coverage being provided,
the type of loan instrument (whether fixed rate/fixed payment or an adjustable
rate/adjustable payment), documentation type, and whether or not the insured
property is categorized as an investment or owner occupied property. Coverage is
non-cancelable by the Company (except in the case of non-payment of premium or
certain master policy violations) and premiums are paid under single, annual, or
monthly payment plans. Single premiums are paid at loan closing and provide
coverage for the entire coverage term. Annual and monthly premiums are renewable
on their anniversary dates with the premium charge determined on the basis of
the original or outstanding loan amount. Substantially all of the Corporation's
insurance in force as of December 31, 2005 has been written under monthly
premium plans.
Title Insurance Group
The title insurance business consists primarily of the issuance of policies
to real estate purchasers and investors based upon searches of the public
records, which contain information concerning interests in real property. The
policy insures against losses arising out of defects, liens and encumbrances
affecting the insured title and not excluded or excepted from the coverage of
the policy. For the year ended December 31, 2005, approximately 37% of the
Company's consolidated title premium and related fee income stemmed from direct
operations (which include branch offices of its title insurers and wholly owned
subsidiaries of the Company), while the remaining 63% emanated from independent
title agents and underwritten title companies.
There are two basic types of title insurance policies: lenders' policies
and owners' policies. Both are issued for a onetime premium. Most mortgages made
in the United States are extended by mortgage bankers, savings and commercial
banks, state and federal agencies, and life insurance companies. The financial
institutions secure title insurance policies to protect their mortgagees'
interest in the real property. This protection remains in effect for as long as
the mortgagee has an interest in the property. A separate title insurance policy
may be issued to the owner of the real estate. An owner's policy of title
insurance protects an owner's interest in the title to the property.
The premiums charged for the issuance of title insurance policies vary with
the policy amount and the type of policy issued. The premium is collected in
full when the real estate transaction is closed, there being no recurring fee
thereafter. In many areas, premiums charged on subsequent policies on the same
4
property may be reduced, depending generally upon the time elapsed between
issuance of the previous policies and the nature of the transactions for which
the policies are issued. Most of the charge to the customer relates to title
services rendered in conjunction with the issuance of a policy rather than to
the possibility of loss due to risks insured against. Accordingly, the cost of
service performed by a title insurer relates for the most part to the prevention
of loss rather than to the assumption of the risk of loss. Claim losses that do
occur result primarily from title search and examination mistakes, fraud,
forgery, incapacity, missing heirs and escrow processing errors.
In connection with its title insurance operations, Old Republic also
provides escrow closing and construction disbursement services, as well as real
estate information products and services pertaining to real estate transfers and
loan transactions.
Corporate and Other Operations
Corporate and other operations include the accounts of a small life and
health insurance business as well as those of the parent holding company and
several internal services subsidiaries that perform investment management,
payroll, administrative and minor marketing services.
The Corporation's small life and health business registered 2005 and 2004
net premium revenues of $70.3 million and $64.6 million, respectively. This
business is conducted in both the United States and Canada and consists mostly
of limited product offerings sold through financial intermediaries such as
finance companies, automobile dealers, travel agents, and marketing channels
that are also utilized in some of Old Republic's general insurance operations.
Production of term life insurance, accounting for net premiums earned of
approximately $19.5 million in 2005 and $18.9 million in 2004, was terminated
and placed in run off mode as of year end 2004. As a result of the changed
circumstances, it was concluded that previously deferred acquisition costs could
no longer be amortized for their full amount over the product's expected run-off
years. Accordingly, 2004 operations were charged in the sum of $10.5 million to
reflect revised estimates of deferrable costs.
5
Consolidated Underwriting Statistics
The following table reflects underwriting statistics covering: premiums and
related loss, expense, and policyholders' dividend ratios for the major
coverages underwritten in the General, Mortgage Guaranty and Title insurance
groups:
($ in Millions)
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Years Ended December 31,
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2005 2004 2003 2002 2001
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General Insurance Group:
Overall Experience:
Net Premiums Earned..................... $ 1,805.2 $ 1,623.0 $ 1,379.5 $ 1,184.1 $ 1,000.2
Claim Ratio............................. 66.6% 65.8% 66.5% 72.0% 74.8%
Policyholders' Dividend Benefit......... .3 .1 1.1 - -
Expense Ratio .......................... 24.6 24.8 26.2 27.1 27.8
----------- ----------- ------------ ------------ -----------
Composite Ratio......................... 91.5% 90.7% 93.8% 99.1% 102.6%
=========== =========== ============ ============ ===========
Experience By Major Coverages:
Commercial Automobile
(Principally Trucking):
Net Premiums Earned .................... $ 707.9 $ 616.3 $ 545.6 $ 508.0 $ 457.7
Claim Ratio............................. 67.1% 66.5% 70.4% 78.4% 82.4%
=========== =========== ============ ============ ===========
Workers' Compensation:
Net Premiums Earned .................... $ 396.5 $ 353.9 $ 277.2 $ 226.2 $ 173.9
Claim Ratio............................. 78.2% 71.9% 75.9% 93.7% 90.0%
Policyholders' Dividend Benefit......... .7% .5% 5.3% (.5%) (1.0%)
=========== =========== ============ ============ ===========
Financial Indemnity: (1)
Net Premiums Earned .................... $ 186.3 $ 191.4 $ 161.8 $ 104.1 $ 72.3
Claim Ratio............................. 48.9% 47.5% 50.9% 40.9% 38.8%
=========== =========== ============ ============ ===========
Inland Marine and Property: (2)
Net Premiums Earned .................... $ 200.0 $ 184.5 $ 169.0 $ 151.9 $ 128.1
Claim Ratio............................. 51.4% 56.0% 58.9% 51.4% 59.1%
=========== =========== ============ ============ ===========
General Liability:
Net Premiums Earned .................... $ 96.8 $ 94.4 $ 72.6 $ 55.3 $ 53.7
Claim Ratio............................. 97.1% 108.6% 89.3% 67.5% 70.8%
=========== =========== ============ ============ ===========
Other Coverages: (3)
Net Premiums Earned .................... $ 219.2 $ 185.2 $ 156.4 $ 136.6 $ 114.8
Claim Ratio............................. 58.6% 59.3% 52.2% 66.9% 68.5%
=========== =========== ============ ============ ===========
Mortgage Guaranty Group:
Net Premiums Earned..................... $ 429.5 $ 403.2 $ 400.9 $ 376.2 $ 353.1
Claim Ratio............................. 37.2% 35.5% 22.7% 14.1% 16.1%
Expense Ratio........................... 22.4 25.6 24.8 32.3 27.5
----------- ----------- ------------ ------------ -----------
Composite Ratio......................... 59.6% 61.1% 47.5% 46.4% 43.6%
=========== =========== ============ ============ ===========
Title Insurance Group: (4)
Net Premiums Earned..................... $ 757.2 $ 714.0 $ 749.9 $ 524.8 $ 382.7
Combined Net Premiums
& Fees Earned....................... $ 1,081.8 $ 1,025.2 $ 1,103.8 $ 813.4 $ 625.3
Claim Ratio............................. 6.0% 5.8% 5.8% 5.0% 4.0%
Expense Ratio........................... 88.2 90.5 84.6 85.6 87.2
----------- ----------- ------------ ------------ -----------
Composite Ratio......................... 94.2% 96.3% 90.4% 90.6% 91.2%
=========== =========== ============ ============ ===========
All Coverages Consolidated:
Net Premiums & Fees Earned.............. $ 3,386.9 $ 3,116.1 $ 2,936.0 $ 2,423.9 $ 2,029.5
Claim and Benefit Ratio................. 43.3% 42.0% 37.9% 40.2% 42.4%
Expense Ratio........................... 45.2 47.3 48.5 47.9 46.5
----------- ----------- ------------ ------------ -----------
Composite Ratio......................... 88.5% 89.3% 86.4% 88.1% 88.9%
=========== =========== ============ ============ ===========
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Any necessary reclassifications of prior year data are reflected in the above
table to conform to current presentation.
(1) Consists principally of fidelity, surety, consumer credit indemnity, and
executive indemnity (directors & officers and errors & omissions)
coverages.
(2) Consists principally of commercial multi-peril, and inland marine
coverages.
(3) Consists principally of home and automobile warranty, aviation, and travel
accident coverages.
(4) Title claim, expense, and composite ratios are calculated on the basis of
combined net premiums and fees earned.
6
Variations in claim ratios are typically caused by changes in the frequency
and severity of claims incurred, changes in premium rates and the level of
premium refunds, and periodic changes in claim and claim expense reserve
estimates resulting from ongoing reevaluations of reported and incurred but not
reported claims and claim expenses. The Company can therefore experience
period-to-period volatility in the underwriting results for individual coverages
as demonstrated in the above table. As a result of the Company's basic
underwriting focus in the management of its business, it has attempted to dampen
this volatility and thus ensure a higher degree of overall underwriting
stability by diversifying the coverages it offers and industries it serves.
The claim ratios include loss adjustment expenses where appropriate.
Policyholders' dividends, which apply principally to workers' compensation
insurance, are a reflection of changes in loss experience for individual or
groups of policies, rather than overall results, and should be viewed in
conjunction with loss ratio trends.
The general insurance claims ratio has reflected favorable trends since
reaching a peak in 1999. The downtrend in this major cost factor reflects
largely the pricing and risk selection improvements effected since 2001. General
Insurance Group loss ratios for workers' compensation and liability insurance
coverages in particular may reflect greater variability due to chance events in
any one year, changes in loss costs emanating from participation in involuntary
markets (i.e. insurance assigned risk pools and associations in which
participation is basically mandatory), and added provisions for loss costs not
recoverable from assuming reinsurers which may experience financial difficulties
from time to time. The Company generally underwrites concurrently workers'
compensation, commercial automobile (liability and physical damage), and general
liability insurance coverages for a large number of customers. Accordingly, an
evaluation of trends in premiums, claims and dividend ratios for these
individual coverages should be considered in the light of such a concurrent
underwriting approach. With respect to commercial automobile coverages, the
claims ratio experienced a general decline stemming primarily from the pricing
and risk selection improvements made in recent years, while better results in
workers' compensation are due to improved pricing in general as well as stronger
growth of business subject to captive reinsurance, retrospective premium, or
self-insured deductible programs that are intended to produce lower net loss
ratios. The 2003 workers' compensation dividend benefit rose primarily due to
the conversion of a large account to self-insured status which led to an
increase in policyholder dividend costs and a contra-reduction in incurred
losses. The claims ratio for a relatively small book of general liability
coverages has tended to be highly volatile, usually rising due to the impact of
higher claims emergence and greater than anticipated severity, mostly from
legacy asbestos and environmental claims exposures.
Mortgage guaranty claim ratios have risen in the three most recent years,
from historically low levels posted in 2002 and 2001. The higher claim ratios
are reflective of greater loss provisions due to rising paid loss trends and net
reserve additions driven by higher expectations of estimated claim frequency and
severity.
The title insurance claim ratio has been in the low single digits in each
of the past several years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. A
moderate uptrend in the four years ended December 31, 2005 stems from a rise in
the net provision for ultimate claim costs from the historically low levels
achieved in 2001 and 2000 in particular.
The consolidated claims, expense, and composite ratios reflect all the
above factors and the changing period-to-period contributions of each segment to
consolidated results.
General Insurance Claim Reserves
The Corporation's property and liability insurance subsidiaries establish
claim reserves which consist of estimates to settle: a) reported claims; b)
claims which have been incurred as of each balance sheet date but have not as
yet been reported ("IBNR") to the insurance subsidiaries; and c) the direct
costs, (fees and costs which are allocable to individual claims) and indirect
costs (such as salaries and rent applicable to the overall management of claim
departments) to administer known and IBNR claims. Such claim reserves, except as
to classification in the Consolidated Balance Sheets in terms of gross and
reinsured portions, are reported for financial and regulatory reporting purposes
at amounts that are substantially the same.
The establishment of claim reserves by the Corporation's insurance
subsidiaries is a reasonably complex and dynamic process influenced by a large
variety of factors. These factors include past experience applicable to the
anticipated costs of various types of claims, continually evolving and changing
legal theories emanating from the judicial system, recurring accounting,
statistical, and actuarial studies, the professional experience and expertise of
the Company's claim departments' personnel or outside attorneys and independent
claims adjusters, ongoing changes in claim frequency or severity patterns such
as those caused by natural disasters, illnesses, accidents, work-related
injuries, and changes in general and industry-specific economic conditions.
Consequently, the reserve-setting process relies on management's judgments and
the opinions of a large number of persons, on the application and interpretation
of historical precedent and trends, and on expectations as to future
developments. At any point in time, the Company is exposed to possibly higher
than anticipated claim costs due to the aforementioned factors, and to the
evolution, interpretation, and expansion of tort law, as well as the effects of
unexpected jury verdicts.
In establishing claim reserves, the possible increase in future loss
settlement costs caused by inflation is considered implicitly, along with the
many other factors cited above. Reserves are generally set to provide for the
ultimate cost of all claims. With regard to workers' compensation reserves,
however, the ultimate cost of long-term disability or pension-type claims is
7
discounted to present value based on interest rates ranging from 3.5% to 4.0%.
The Company, where applicable, uses only such discounted reserves in evaluating
the results of its operations, in pricing its products and settling
retrospective and reinsured accounts, in evaluating policy terms and experience,
and for other general business purposes. Solely to comply with reporting rules
mandated by the Securities and Exchange Commission, however, Old Republic has
made statistical studies of applicable workers' compensation reserves to obtain
estimates of the amounts by which claim and claim adjustment expense reserves,
net of reinsurance, have been discounted. These studies have resulted in
estimates of such amounts at approximately $138.3 million, $139.3 million and
$142.9 million, as of December 31, 2005, 2004 and 2003, respectively. It should
be noted, however, that these differences between discounted and non-discounted
(terminal) reserves are, fundamentally, of an informational nature, and are not
indicative of an effect on operating results for any one or series of years for
the above-noted reasons.
Early in 2001, the Federal Department of Labor revised the Federal Black
Lung Program regulations. The revisions basically require a reevaluation of
previously settled, denied, or new occupational disease claims in the context of
newly devised, more lenient standards when such claims are resubmitted.
Following a number of challenges and appeals by the insurance and coal mining
industries, the revised regulations were, for the most part, upheld in June,
2002 and are to be applied prospectively. Since the final quarter of 2001, black
lung claims filed or refiled pursuant to these anticipated and now final
regulations have increased, though the volume of new claim reports has abated in
the past three years. The vast majority of claims filed to date against Old
Republic pertain to business underwritten through loss sensitive programs that
permit the charge of additional or refund of return premiums to wholly or
partially offset changes in estimated claim costs, or to business underwritten
as a service carrier on behalf of various industry-wide involuntary market (i.e.
assigned risk) pools. A much smaller portion pertains to business produced on a
traditional risk transfer basis. The Company has established applicable reserves
for claims as they have been reported and for claims not as yet reported on the
basis of its historical experience as well as assumptions relative to the effect
of the revised regulations. Inasmuch as a variety of challenges are likely as
the revised regulations are implemented through the actual claim settlement
process, the potential impact on reserves, gross and net of reinsurance or
retrospective premium adjustments, resulting from such regulations cannot as yet
be estimated with reasonable certainty.
Old Republic's reserve estimates also include provisions for indemnity and
settlement costs for various asbestosis and environmental impairment ("A&E")
claims that have been filed in the normal course of business against a number of
its insurance subsidiaries. Many such claims relate to policies issued prior to
1985, including many issued during a short period between 1981 and 1982 pursuant
to an agency agreement canceled in 1982. Over the years, the Corporation's
property and liability insurance subsidiaries have typically issued general
liability insurance policies with face amounts ranging between $1.0 million and
$2.0 million and rarely exceeding $10.0 million. Such policies have, in turn,
been subject to reinsurance cessions which have typically reduced the
Corporation's retentions to $.5 million or less as to each claim. Old Republic's
exposure to A&E claims cannot, however, be calculated by conventional insurance
reserving methods for a variety of reasons, including: a) the absence of
statistically valid data inasmuch as such claims typically involve long
reporting delays and very often uncertainty as to the number and identity of
insureds against whom such claims have arisen or will arise; and b) the
litigation history of such or similar claims for insurance industry members that
has produced court decisions that have been inconsistent with regard to such
questions as to when an alleged loss occurred, which policies provide coverage,
how a loss is to be allocated among potentially responsible insureds and/or
their insurance carriers, how policy coverage exclusions are to be interpreted,
what types of environmental impairment or toxic tort claims are covered, when
the insurer's duty to defend is triggered, how policy limits are to be
calculated, and whether clean-up costs constitute property damage. In recent
times, the Executive Branch and/or the Congress of the United States have
proposed or considered changes in the legislation and rules affecting the
determination of liability for environmental and asbestosis claims. As of
December 31, 2005, however, there is no solid evidence to suggest that possible
future changes might mitigate or reduce some or all of these claim exposures.
Because of the above issues and uncertainties, estimation of reserves for losses
and allocated loss adjustment expenses for A&E claims in particular is much more
difficult or impossible to quantify with a high degree of precision.
Accordingly, no representation can be made that the Corporation's reserves for
such claims and related costs will not prove to be overstated or understated in
the future. At December 31, 2005, Old Republic's aggregate indemnity and loss
adjustment expense reserves specifically identified with A&E exposures amounted
to approximately $170.7 million gross, and $132.2 million net of reinsurance.
Based on average annual claims payments during the five most recent calendar
years, such reserves represented 7.4 years (gross) and 10.4 years (net) of
average annual claims payments. Fluctuations in this ratio between years can be
caused by the inconsistent pay out patterns associated with these types of
claims. For the five years ended December 31, 2005, incurred A&E claim and
related loss settlement costs have averaged 3.3% of average annual General
Insurance Group claims and related settlement costs.
Over the years, the subject of property and liability insurance claim
reserves has been written about and analyzed extensively by a large number of
professionals and regulators. Accordingly, the above discussion summary should,
of necessity, be regarded as a basic outline of the subject and not as a
definitive presentation. The Company believes that its overall reserving
practices have been consistently applied over many years, and that its aggregate
reserves have generally resulted in reasonable approximations of the ultimate
net costs of claims incurred. However, no representation is made that ultimate
net claim and related costs will not develop in future years to be greater or
lower than currently established reserve estimates.
8
The following table shows the evolving redundancies or deficiencies for
reserves established as of December 31, of each of the years 1995 through 2005.
In reviewing this tabular data, it should be noted that prior periods' loss
payment and development trends may not be repeated in the future due to the
large variety of factors influencing the reserving and settlement processes
outlined herein above. The reserve redundancies or deficiencies shown for all
years are not necessarily indicative of the effect on reported results of any
one or series of years since cumulative retrospective premium and commission
adjustments employed in various parts of the Company's business may partially
offset such effects. The moderately deficient development of reserves at
year-ends 1998 to 2001 and the reduced levels of redundancies shown for
year-ends 1995 to 1997, pertain mostly to claims incurred in 1995 and prior
accident years, generally for business written in the 1980's. (See "Consolidated
Underwriting Statistics" above, and "Reserves, Reinsurance, and Retrospective
Adjustments" elsewhere herein).
($ in Millions)
----------------------------------------------------------------------------------------------------------------------------------
(a) As of December 31: 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(b) Liability(1) for unpaid claims
and claim adjustment and claim
adjustment expenses(2): $2,414 $2,182 $1,964 $1,802 $1,678 $1,661 $1,699 $1,742 $1,846 $1,829 $1,821
===============================================================================================
(c) Paid (cumulative) as of (3):
---------------------------
One year later - % 23.7% 24.3% 23.9% 23.8% 23.8% 22.7% 23.0% 21.5% 18.6% 20.2%
Two years later - - 38.6 39.2 38.1 38.0 37.6 36.4 35.8 31.8 30.6
Three years later - - - 49.1 48.7 47.3 47.0 45.8 43.8 40.9 39.1
Four years later - - - - 55.1 54.2 53.3 52.1 50.5 45.8 45.0
Five years later - - - - - 59.1 58.4 56.8 55.1 50.7 48.3
Six years later - - - - - - 62.4 60.9 58.9 54.6 52.4
Seven years later - - - - - - - 64.4 62.6 58.1 56.1
Eight years later - - - - - - - - 65.9 61.8 59.3
Nine years later - - - - - - - - - 65.1 62.8
Ten years later - % - % - % - % - % - % - % - % - % - % 66.0%
===============================================================================================
(d) Liability reestimated (i.e.,
cumulative payments plus
reestimated ending liability)
As of (4):
----------------------------
One year later - % 97.6% 97.2% 98.6% 99.6% 97.3% 96.1% 96.2% 93.3% 94.2% 95.9%
Two years later - - 97.0 98.2 101.3 98.1 94.9 93.3 89.2 88.5 91.5
Three years later - - - 99.7 102.7 100.1 96.5 93.0 87.0 83.9 86.8
Four years later - - - - 105.8 102.2 98.0 95.1 87.1 82.4 82.6
Five years later - - - - - 105.6 100.7 96.5 89.2 82.5 81.6
Six years later - - - - - - 104.2 99.4 90.6 84.7 82.3
Seven years later - - - - - - - 103.0 93.6 86.1 84.7
Eight years later - - - - - - - - 97.0 89.3 86.1
Nine years later - - - - - - - - - 92.8 89.5
Ten years later - % - % - % - % - % - % - % - % - % - % 93.0%
===============================================================================================
(E) Redundancy (deficiency)(5)
for each year-end at (a): - % 2.4% 3.0% .3% -5.8% -5.6% -4.2% -3.0% 3.0% 7.2% 7.0%
===============================================================================================
Average for all year-ends
at (a): .6%
========
----------
(1) Amounts are reported net of reinsurance.
(2) Excluding unallocated loss adjustment expense reserves.
(3) Percent of most recent reestimated liability (line d). Decreases in paid
loss percentages may at times reflect the reassumption by the Company of
certain previously ceded loss reserves from assuming reinsurers through
commutations of then existing reserves.
(4) Percent of beginning liability (line b) for unpaid claims and claim
adjustment expenses.
(5) Beginning liability less the most current liability reestimated (line d) as
a percent of beginning liability (line b).
9
The following table shows an analysis of changes in aggregate reserves for
the Company's property and liability insurance claims and allocated claim
adjustment expenses for each of the years shown:
($ in Millions)
-----------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------------------------------------------
2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
------- ------- ------- ------- -------- ------- ------- ------- ------- ------- --------
(a) Beginning net reserves........... $2,182 $1,964 $1,802 $1,678 $ 1,661 $1,699 $1,742 $1,846 $1,829 $1,821 $ 1,768
-----------------------------------------------------------------------------------------
Incurred claims and claim expenses:
-----------------------------------
(b) Current year provision........... 1,191 1,070 893 814 749 690 734 728 713 668 684
(c) Change in prior years' provision. (52) (55) (25) (7) (44) (66) (66) (123) (105) (74) (92)
-----------------------------------------------------------------------------------------
(d) Total incurred................... 1,138 1,014 868 807 704 623 668 604 608 593 592
-----------------------------------------------------------------------------------------
Claim payments on:
-----------------
(e) Current year events.............. 402 332 277 260 269 258 298 322 275 243 207
(f) Prior years' events.............. 504 463 428 423 418 402 412 385 316 342 332
-----------------------------------------------------------------------------------------
(g) Total payments................... 907 796 706 683 687 661 710 708 591 585 539
-----------------------------------------------------------------------------------------
(h) Ending net reserves (a + d - g).. 2,414 2,182 1,964 1,802 1,678 1,661 1,699 1,742 1,846 1,829 1,821
(i) Unallocated loss adjustment
expense reserves.............. 92 87 83 78 76 73 71 73 73 71 69
(j) Reinsurance recoverable on
claim reserves................ 1,894 1,632 1,515 1,363 1,261 1,235 1,238 1,190 1,232 1,296 1,311
-----------------------------------------------------------------------------------------
(k) Gross claim reserves (h + i + j). $4,401 $3,902 $3,562 $3,244 $ 3,016 $2,969 $3,009 $3,005 $3,151 $3,197 $ 3,202
=========================================================================================
(b) Investments. In common with other insurance organizations, Old Republic
invests most funds provided by operations in income-producing investment
securities. All investments must comply with applicable insurance laws and
regulations which prescribe the nature, form, quality, and relative amounts of
investments which may be made by insurance companies. Generally, these laws and
regulations permit insurance companies to invest within varying limitations in
state, municipal and federal government obligations, corporate obligations,
preferred and common stocks, certain types of real estate, and first mortgage
loans. Old Republic's investment policies are also influenced by the terms of
the insurance coverages written, by its expectations as to the timing of claim
and benefit payments, and by income tax considerations. The following tables
show invested assets at the end of the last five years, together with investment
income for such years:
Consolidated Investments
($ in Millions)
December 31,
------------------------------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ------------ ------------ ----------- ------------
Available for Sale
Fixed Maturity
Securities:
U.S. & Canadian Governments........... $ 1,259.2 $ 1,135.3 $ 993.4 $ 976.2 $ 869.0
Tax-Exempt............................ 1,975.2 1,574.0 1,277.2 - -
Utilities............................. 923.0 876.4 828.5 - -
Corporate............................. 2,719.8 2,870.0 2,641.8 2,196.2 1,741.2
------------ ------------ ------------ ----------- ------------
6,877.4 6,455.9 5,741.1 3,172.4 2,610.2
Equity Securities........................ 552.4 459.0 513.5 513.5 391.6
Short-term Investments................... 275.3 388.6 403.9 253.8 298.5
Miscellaneous Investments................ 62.7 54.4 53.2 - -
------------ ------------ ------------ ----------- ------------
Total available for sale.............. 7,768.0 7,358.1 6,711.8 3,939.9 3,300.4
------------ ------------ ------------ ----------- ------------
Held to Maturity
Fixed Maturity Securities:
Utilities............................. - - - 754.4 777.6
Tax-Exempt............................ - - - 1,299.7 1,333.4
Redeemable Preferred Stocks........... - - - - .7
------------ ------------ ------------ ----------- ------------
- - - 2,054.1 2,111.8
------------ ------------ ------------ ----------- ------------
Other Investments........................ 8.0 13.4 8.5 57.4 60.8
------------ ------------ ------------ ----------- ------------
Total held to maturity................ 8.0 13.4 8.5 2,111.6 2,172.7
------------ ------------ ------------ ----------- ------------
Total Investments........................ $ 7,776.0 $ 7,371.6 $ 6,720.4 $ 6,051.5 $ 5,473.1
============ ============ ============ =========== ============
10
Sources of Consolidated Investment Income
($ in Millions)
Years Ended December 31,
------------------------------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ------------ ------------ ----------- ------------
Fixed Maturity Securities:
Taxable............................... $ 219.4 $ 214.0 $ 202.7 $ 193.5 $ 189.5
Tax-Exempt............................ 64.7 53.1 53.7 59.5 61.7
------------ ------------ ------------ ----------- ------------
284.1 267.2 256.4 253.1 251.3
------------ ------------ ------------ ----------- ------------
Equity Securities........................ 9.4 14.3 14.6 12.4 7.9
------------ ------------ ------------ ----------- ------------
Other Investment Income:
Interest on Short-term Investments.... 15.9 5.7 4.5 6.0 15.8
Sundry................................ 5.4 6.8 6.8 5.2 6.1
------------ ------------ ------------ ----------- ------------
21.3 12.5 11.4 11.3 22.0
------------ ------------ ------------ ----------- ------------
Gross Investment Income.................. 315.0 294.1 282.5 276.9 281.3
Less: Investment Expenses (1)......... 4.9 3.2 3.2 4.2 6.5
------------ ------------ ------------ ----------- ------------
Net Investment Income.................... $ 310.1 $ 290.8 $ 279.2 $ 272.6 $ 274.7
============ ============ ============ =========== ============
----------
(1) Investment expenses consist primarily of personnel costs, investment
management and custody service fees and includes interest incurred on funds
held of $.7, $.3, $.1, $.3 and $1.4 for the years ended December 31, 2005,
2004, 2003, 2002, and 2001, respectively.
For many years, Old Republic's investment policy has been to acquire and
retain primarily investment grade, publicly traded, fixed maturity securities.
Accordingly, the Corporation's exposure to so-called "junk bonds", private
placements, real estate, mortgage loans, and derivatives is immaterial or
non-existent. Management considers investment-grade securities to be those rated
by Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors
Service, Inc. ("Moody's") that fall within the top four rating categories, or
securities which are not rated but have characteristics similar to securities so
rated. The Company had $3.2 of bond or note investments in default as to
principal and/or interest at December 31, 2005 and none as of December 31, 2004.
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Old Republic reviews the status
and market value changes of each of its investments on at least a quarterly
basis during the year, and estimates of other than temporary impairments in the
portfolio's value are evaluated and established at each quarterly balance sheet
date. In management's opinion, the Company's high quality and diversified
portfolio, which consists largely of publicly traded securities, has been a
basic reason for the absence of major impairment provisions in the periods
reported upon. The combination of gains and losses on sales of securities and
such provisions or write-downs of securities are reflected as realized gains and
losses in the income statement. Dispositions of securities result principally
from scheduled maturities of bonds and notes and sales of fixed income and
equity securities available for sale. The Company's invested assets as of
December 31, 2005 have been classified largely as "available for sale" pursuant
to the existing investment policy.
The independent credit quality ratings and maturity distribution for Old
Republic's consolidated fixed maturity investments, excluding short-term
investments, at the end of the last five years are shown in the following
tables. These investments, $6.8 billion and $6.4 billion at December 31, 2005
and 2004, respectively, represented approximately 60% and 61%, respectively, of
consolidated assets, and 91% and 96%, respectively, of consolidated liabilities
as of such dates.
--------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (1)
--------------------------------------------------------------------------------------------------------------------------------
December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
-----------------------------------------------------------------
(% of total portfolio)
Aaa.................................................... 37.9% 32.6% 29.7% 30.9% 31.0%
Aa..................................................... 17.0 19.5 19.1 24.3 28.2
A...................................................... 25.7 27.5 32.0 31.4 29.5
Baa.................................................... 18.6 19.8 18.5 10.8 8.9
-----------------------------------------------------------------
Total investment grade............................. 99.2 99.4 99.3 97.4 97.6
All others (2)......................................... .8 .6 .7 2.6 2.4
-----------------------------------------------------------------
Total.............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
=================================================================
----------
(1) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(2) "All others" includes non-investment grade or non-rated small issues of
tax-exempt bonds.
11
--------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
--------------------------------------------------------------------------------------------------------------------------------
December 31,
-----------------------------------------------------------------
2005 2004 2003 2002 2001
-----------------------------------------------------------------
(% of total portfolio)
Maturity Ranges:
Due in one year or less................................ 10.5% 12.5% 11.0% 13.4% 11.4%
Due after one year through five years.................. 40.9 42.9 50.0 55.9 50.7
Due after five years through ten years................. 47.9 43.5 37.7 29.9 36.7
Due after ten years through fifteen years.............. .7 1.1 1.3 .8 1.2
Due after fifteen years................................ - - - - -
-----------------------------------------------------------------
100.0% 100.0% 100.0% 100.0% 100.0%
=================================================================
Average Maturity in Years............................. 4.8 4.7 4.5 3.9 4.3
=================================================================
--------------------------------------------------------------------------------------------------------------------------------
(c) Marketing. Commercial automobile (trucking), workers' compensation and
general liability insurance underwritten for business enterprises and public
entities is marketed primarily through independent insurance agents and brokers
with the assistance of Old Republic's trained sales, underwriting, actuarial,
and loss control personnel. The remaining property and liability commercial
insurance written by Old Republic is obtained through insurance agents or
brokers who are independent contractors and generally represent other insurance
companies, and by direct sales. No single source accounted for over 10% of Old
Republic's premium volume in 2005.
Traditional primary mortgage insurance is marketed primarily through a
direct sales force which calls on mortgage bankers, brokers, commercial banks,
savings institutions and other mortgage originators. No sales commissions or
other forms of remuneration are paid to the lending institutions or others for
the procurement or development of business.
The Mortgage Guaranty segment's ten largest customers were responsible for
approximately 44.2%, 41.8% and 37.3% of traditional primary new insurance
written in 2005, 2004, and 2003, respectively. The largest single customer
accounted for 11.5% of traditional primary new insurance written in 2005
compared to 11.7% and 7.2% in 2004 and 2003, respectively.
A substantial portion of the Company's title insurance business is referred
to it by title insurance agents, builders, lending institutions, real estate
developers, realtors, and lawyers. Title insurance and related real estate
settlement products are sold through 272 Company offices and through agencies
and underwritten title companies in Puerto Rico, the District of Columbia and
all 50 states. The issuing agents are authorized to issue commitments and title
insurance policies based on their own search and examination, or on the basis of
abstracts and opinions of approved attorneys. Policies are also issued through
independent title companies (not themselves title insurers) pursuant to
underwriting agreements. These agreements generally provide that the agency or
underwritten company may cause title policies of the Company to be issued, and
the latter is responsible under such policies for any payments to the insured.
Typically, the agency or underwritten title company deducts the major portion of
the title insurance charge to the customer as its commission for services.
During 2005, approximately 63% of title insurance premiums and fees were
accounted for by policies issued by agents and underwritten title companies.
Title insurance premium and fee revenue is closely related to the level of
activity in the real estate market. The volume of real estate activity is
affected by the availability and cost of financing, population growth, family
movements and other factors. Also, the title insurance business is seasonal.
During the winter months, new building activity is reduced and, accordingly, the
Company produces less title insurance business relative to new construction
during such months than during the rest of the year. The most important factors,
insofar as Old Republic's title business is concerned, however, are the rates of
activity in the resale and refinance markets for residential properties.
The personal contacts, relationships, and reputations of Old Republic's key
executives are a vital element in obtaining and retaining much of its business.
Many of the Company's customers produce large amounts of premiums and therefore
warrant substantial levels of top executive attention and involvement. In this
respect, Old Republic's mode of operation is similar to that of professional
reinsurers and commercial insurance brokers, and relies on the marketing,
underwriting, and management skills of relatively few key people for large parts
of its business.
Several types of insurance coverages underwritten by Old Republic, such as
consumer credit indemnity, title, and mortgage guaranty insurance, are affected
in varying degrees by changes in national economic conditions. During periods of
economic recession or rising interest rates, operating and/or claim costs
pertaining to such coverages tend to rise disproportionately to revenues and
generally result in reduced levels of profitability.
12
At least one Old Republic general insurance subsidiary is licensed to do
business in each of the 50 states, the District of Columbia, Puerto Rico, Virgin
Islands, Guam, and each of the Canadian provinces; mortgage insurance
subsidiaries are licensed in 50 states and the District of Columbia; title
insurance operations are licensed to do business in 50 states, the District of
Columbia, Puerto Rico and Guam. Consolidated direct premium volume distributed
among the various geographical regions shown was as follows for the past five
years:
-------------------------------------------------------------------------------------------------------------------------------
Geographical Distribution of Consolidated Direct Premiums Written
-------------------------------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
United States:
Northeast................................. 9.0% 8.9% 9.3% 8.4% 7.4%
Mid-Atlantic.............................. 10.2 9.6 9.7 8.3 7.9
Southeast................................. 19.6 18.6 17.6 17.7 17.9
Southwest................................. 11.8 11.8 12.1 12.8 13.7
East North Central........................ 13.5 14.6 14.9 14.8 14.6
West North Central........................ 12.7 12.7 12.2 13.0 13.8
Mountain.................................. 7.6 7.5 7.5 7.9 8.5
Western................................... 13.0 14.0 14.6 14.9 14.0
Foreign (Principally Canada)................ 2.6 2.3 2.1 2.2 2.2
----------- ----------- ----------- ----------- -----------
Total................................ 100.0% 100.0% 100.0% 100.0% 100.0%
=========== =========== =========== =========== ===========
(d) Reserves, Reinsurance, and Retrospective Adjustments. Old Republic's
insurance subsidiaries establish reserves for unearned premiums, reported
claims, claims incurred but not reported, and claim adjustment expenses, as
required in the circumstances. Such reserves are based on regulatory accounting
requirements and generally accepted accounting principles. In accordance with
insurance industry practices, claim reserves are based on estimates of the
amounts that will be paid over a period of time and changes in such estimates
are reflected in the financial statements of the periods when they occur. See
"General Insurance Claim Reserves" herein.
To maintain premium production within its capacity and limit maximum losses
and risks for which it might become liable under its policies, Old Republic, as
is the practice in the insurance industry, may cede a portion or all of its
premiums and liabilities on certain classes of insurance, individual policies,
or blocks of business to other insurers and reinsurers. Although the ceding of
insurance does not generally discharge an insurer from its direct liability to a
policyholder, it is industry practice to establish the reinsured part of risks
as the liability of the reinsurer. Old Republic also employs retrospective
premium adjustments and risk-sharing arrangements for parts of its business in
order to minimize losses for which it might become liable under its insurance
policies, and to afford its customers or producers a degree of participation in
the risks and rewards associated with such business. Under retrospective
arrangements, Old Republic collects additional premiums if losses are greater
than originally anticipated and refunds a portion of original premiums if loss
costs are lower. Pursuant to risk-sharing arrangements, the Company adjusts
production costs or premiums retroactively to likewise reflect deviations from
originally expected loss costs. The amount of premium, production and other
retrospective adjustments which may be made is either limited or unlimited
depending on the Company's evaluation of risks and related contractual
arrangements. To the extent that any reinsurance companies, retrospectively
rated risks, or producers might be unable to meet their obligations under
existing reinsurance, retrospective insurance and production agreements, Old
Republic would be liable for the defaulted amounts. In these regards, however,
the Company generally protects itself by withholding funds, by securing
indemnity agreements, by obtaining surety bonds, or by otherwise collateralizing
such obligations through irrevocable letters of credit, cash, or securities.
Reinsurance recoverable asset balances represent amounts due from or
credited by assuming reinsurers for paid and unpaid claims and policy reserves.
Such reinsurance balances as are recoverable from non-admitted foreign and
certain other reinsurers such as captive insurance companies owned by assureds
or business producers, as well as similar balances or credits arising from
policies that are retrospectively rated or subject to assureds' high deductible
retentions are substantially collateralized by letters of credit, securities,
and other financial instruments. Old Republic evaluates on a regular basis the
financial condition of its assuming reinsurers and assureds who purchase its
retrospectively rated or high deductible policies. Estimates of unrecoverable
amounts are included in the Company's net claim and claim expense reserves since
reinsurance, retrospectively rated and self-insured deductible policies and
contracts do not relieve Old Republic from its direct obligations to assureds or
their beneficiaries.
Old Republic's reinsurance practices with respect to portions of its
business also result from its desire to bring its sponsoring organizations and
customers into some degree of joint venture or risk sharing relationship. The
Corporation may, in exchange for a ceding commission, reinsure up to 100% of the
underwriting risk, and the premium applicable to such risk, to insurers owned by
or affiliated with lending institutions, financial and other intermediaries
whose customers are insured by Old Republic, or individual customers who have
formed captive insurance companies. The ceding commissions received compensate
Old Republic for performing the direct insurer's functions of underwriting,
actuarial, claim settlement, loss control, legal, reinsurance, and
administrative services to comply with local and federal regulations, and for
providing appropriate risk management services.
Remaining portions of Old Republic's business are reinsured in most
instances with independent insurance or reinsurance companies pursuant to excess
of loss agreements. Except as noted in the following paragraph, reinsurance
protection on property and liability operations generally limits the net loss on
13
most individual claims to a maximum of (in whole dollars): $1,800,000 for
workers' compensation; $1,800,000 for commercial auto liability; $1,800,000 for
general liability; $3,800,000 for executive protection (directors & officers and
errors & omissions); $1,000,000 for aviation; and $1,000,000 for property
coverages. Substantially all the mortgage guaranty insurance risk is retained,
with the exposure on any one risk currently averaging approximately $22,900,
though portions of the business are also ceded to captive reinsurers on an
excess of loss basis in most instances. Title insurance risk assumptions are
currently limited to a maximum of $100.0 million as to any one policy. The vast
majority of title policies issued, however, carry exposures of $500,000 or less.
Due to worldwide reinsurance capacity and related cost constraints,
effective January 1, 2002, the Corporation began retaining exposures for all,
but most predominantly workers' compensation liability insurance coverages in
excess of $40.0 million that were previously assumed by unaffiliated reinsurers
for up to $100.0 million. Effective January 1, 2003, reinsurance ceded limits
were raised to the $100.0 million level, and as of January 1, 2005, they have
been further increased to $200.0 million. Pursuant to regulatory requirements,
however, all workers' compensation primary insurers such as the Company remain
liable for unlimited amounts in excess of reinsured limits. Other than the
substantial concentration of workers' compensation losses caused by the
September 11, 2001 terrorist attack on America, to the best of the Company's
knowledge there had not been a similar accumulation of claims in a single
location from a single occurrence prior to that event. Nevertheless, the
possibility continues to exist that non-reinsured losses could, depending on a
wide range of severity and frequency assumptions, aggregate several hundred
million dollars to an insurer such as the Company in the event a catastrophe,
such as caused by an earthquake, lead to the death or injury of a large number
of employees concentrated in a single facility such as a high rise building.
As a result of the September 11, 2001 terrorist attack on America, the
reinsurance industry eliminated coverage from substantially all contracts for
claims arising from acts of terrorism. Primary insurers such as the Company
thereby became fully exposed to such claims. Late in 2002, the Terrorism Risk
Insurance Act of 2002 (the "TRIA") was signed into law, immediately establishing
a temporary federal reinsurance program administered by the Secretary of
Treasury. The program applies to insured commercial property and casualty losses
resulting from an act of terrorism, as defined in the TRIA. Congress extended
and modified the program in late 2005 through the Terrorism Risk Insurance
Extension Act of 2005 (the "TRIEA"). The temporary program will now sunset on
December 31, 2007 if not extended or replaced by similar legislation. The TRIA
automatically voided all policy exclusions which were in effect for terrorism
related losses and obligated insurers to offer terrorism coverage with most
commercial property and casualty insurance lines. The TRIEA revised the
definition of "property and casualty insurance" to exclude commercial
automobile, burglary and theft, surety, professional liability and farm owners
multi-peril insurance. Although insurers are permitted to charge an additional
premium for terrorism coverage, insureds may reject the coverage. Under TRIEA,
the program's protection is not triggered for losses arising from an act of
terrorism after March 31, 2006 until the industry first suffers losses of $50
billion in the aggregate in 2006. The program trigger amount increases to $100
billion for 2007. Once the program trigger is met, the program will pay 90% of
an insurer's terrorism losses that exceed that individual insurer's deductible.
The federal share drops to 85% for 2007. The insurer's deductible is 17.5% of
direct earned premium on property and casualty insurance for 2006 and increases
to 20% for 2007. Insurers may reinsure that portion of the risk they retain
under the program, but the reinsurance market has not displayed a widespread
willingness to accept such risks. To date, coverage for acts of terrorism are
excluded from substantially all the Corporation's reinsurance treaties and are
effectively retained by it subject to any recovery that would be collected under
the temporary federal reinsurance program.
(e) Competition. The insurance business is highly competitive and Old Republic
competes with many stock and mutual insurance companies. Many of these
competitors offer more insurance coverages and have substantially greater
financial resources than the Corporation. The rates charged for many of the
insurance coverages in which the Corporation specializes, such as workers'
compensation insurance, other property and liability insurance and title
insurance, are primarily regulated by the states and are also subject to
extensive competition among major insurance organizations. The basic methods of
competition available to Old Republic, aside from rates, are service to
customers, expertise in tailoring insurance programs to the specific needs of
its clients, efficiency and flexibility of operations, personal involvement by
its key executives, and, as to title insurance, accuracy and timely delivery of
evidences of title issued. Mortgage insurance companies also compete by
providing contract underwriting services to lenders, enabling the latter to
improve the efficiency of their operations by outsourcing all or part of their
mortgage loan underwriting processes. For certain types of coverages, including
loan credit indemnity and mortgage guaranty insurance, the Company also competes
in varying degrees with the Federal Housing Administration ("FHA") and the
Veterans Administration ("VA"). In these regards, the Corporation's insurance
subsidiaries compete with the FHA and VA by offering different coverages and by
establishing different requirements relative to such factors as interest rates,
closing costs, and loan processing charges. The Corporation believes its
experience and expertise have enabled it to develop a variety of specialized
insurance programs and related services for its customers, and to secure state
insurance departments' approval of these programs.
(f) Government Regulation. In common with all insurance companies, the
Corporation's insurance subsidiaries are subject to the regulation and
supervision of the jurisdictions in which they do business. The method of such
regulation varies, but, generally, regulation has been delegated to state
insurance commissioners who are granted broad administrative powers relating to:
the licensing of insurers and their agents; the nature of and limitations on
investments; approval of policy forms; reserve requirements; and trade
practices. In addition to these types of regulation, many classes of insurance,
including most of the Corporation's insurance coverages, are subject to rate
regulations which require that rates be reasonable, adequate, and not unfairly
discriminatory.
14
The Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation have various qualifying requirements for private mortgage
guaranty insurers which write mortgage insurance on loans acquired by the FNMA
and FHLMC from mortgage lenders. These requirements call for compliance with the
applicable laws and regulations of the insurer's domiciliary state and those
states in which it conducts business, maintenance of minimum total
policyholders' surplus of $5.0 million, and maintenance of contingency reserves
in accordance with applicable state laws. The requirements also contain
guidelines pertaining to captive reinsurance transactions.
The majority of states have also enacted insurance holding company laws
which require registration and periodic reporting by insurance companies
controlled by other corporations licensed to transact business within their
respective jurisdictions. Old Republic's insurance subsidiaries are subject to
such legislation and are registered as controlled insurers in those
jurisdictions in which such registration is required. Such legislation varies
from state to state but typically requires periodic disclosure concerning the
corporation which controls the registered insurers, or ultimate holding company,
and all subsidiaries of the ultimate holding company, and prior approval of
certain intercorporate transfers of assets (including payments of dividends in
excess of specified amounts by the insurance subsidiary) within the holding
company system. Each state has established minimum capital and surplus
requirements to conduct an insurance business. All of the Company's subsidiaries
meet or exceed these requirements, which vary from state to state.
(g) Employees. As of December 31, 2005, Old Republic employed approximately
6,525 persons on a full time basis. A majority of eligible full time employees
participate in various pension plans which provide annuity benefits payable upon
retirement. Eligible employees are also covered by hospitalization and major
medical insurance, group life insurance, and various savings, profit sharing,
and deferred compensation plans. The Company considers its employee relations to
be good.
(h) Website access. The Company files various reports with the U.S. Securities
and Exchange Commission ("SEC"), including its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements,
and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act. The Company's filings are available for viewing
and/or copying at the SEC's Public Reference Room located at 450 Fifth Street,
NW., Washington, DC 20549. Information regarding the operation of the Public
Reference Room can be obtained by calling 1-800-SEC-0330. The Company's reports
are also available by visiting the SEC's Internet website (http://www.sec.gov)
and accessing its EDGAR database to view or print copies of the electronic
versions of the Company's reports. Additionally, the Company's reports can be
obtained, free of charge, by visiting its Internet website
(http://www.oldrepublic.com), selecting Financial Data and the EDGAR Filings
hyperlink to access the SEC's EDGAR database to view or print copies of the
electronic versions of the Company's reports. The contents of the Company's
Internet website are not intended to be, nor shall they be considered
incorporated by reference into any of the reports the Company files with the
SEC.
Item 1A- Risk Factors
Risk factors are uncertainties and events over which the Company has
limited or no control and which can have a materially adverse effect on the
business, the results of operations or the financial condition of the Company
and its subsidiaries. The Company and its business segments are subject to a
variety of risk factors and, within each business segment, each type of
insurance coverage may be exposed to a variety of risk factors. The following
sections set forth management's evaluation of the most prevalent material risk
factors for the Company as a whole and within each business segment. There may
be risks which management does not presently consider material or which are not
presently known to management that may later prove to be material risk factors
as well.
Parent Company
--------------
Dividend Dependence and Liquidity
---------------------------------
The Company is an insurance holding company with no operations of its own.
Its principal assets consist of the business conducted by its insurance
subsidiaries. It relies upon dividends from such subsidiaries in order to pay
the interest and principal on its debt obligations, dividends to its
shareholders and corporate expenses. The ability of the insurance subsidiaries
to declare and pay dividends is subject to regulations under state laws that
limit dividends based on the amount of adjusted unassigned surplus and require
the subsidiaries to maintain minimum amounts of capital, surplus and reserves.
Dividends in excess of the ordinary limitations can only be declared and paid
with prior regulatory approval, of which there can be no assurance. The
inability of the insurance subsidiaries to pay dividends in an amount sufficient
to meet debt service and cash dividends on stock, as well as other cash
requirements of the Company could result in liquidity issues for Old Republic.
Investment Risks
----------------
The Company's invested assets and those of its subsidiaries are centrally
managed through a wholly-owned asset management subsidiary. Most of the
investments consist of fixed-maturity securities. Changes in interest rates
directly affect the income from, and the market value of fixed-maturity
investments and could reduce the value of the Company's investment portfolio and
adversely affect the Company's, and its subsidiaries', results of operations and
financial condition. A smaller percentage of total investments are in indexed
funds and actively managed equities. A change in general economic conditions,
15
the stock market, or many other external factors could adversely affect the
value of those investments and, in turn, the Company's, or its subsidiaries'
results and financial condition. Further, the Company manages its fixed-maturity
investments by taking into account the maturities of such securities and the
anticipated liquidity needs of the Company and its subsidiaries. Should the
Company suddenly experience greater than anticipated liquidity needs for any
reason, it could face a liquidity risk that may adversely affect its financial
condition or operating results.
Risk Factors Common to All Subsidiaries
---------------------------------------
Excessive Losses and Loss Expenses
----------------------------------
Although the Company's three major business segments encompass different
types of insurance, the greatest risk factor common to all insurance coverages
is excessive losses due to unanticipated claims frequency, severity or a
combination of both. Many of the factors affecting the frequency and severity of
claims depend upon the type of insurance coverage, but others are shared in
common. Severity and frequency can be affected by unexpectedly adverse outcomes
in claims litigation, often as a result of unanticipated jury verdicts, changes
in court-made law, adverse court interpretations of insurance policy provisions
resulting in increased liability or new judicial theories of liability, together
with unexpectedly high costs of defending claims.
Inadequate Reserves
-------------------
Reserves are the amounts that an insurance company sets aside for its
anticipated policy liabilities. Claim reserves are an estimate of liability for
unpaid claims and claims defense and adjustment expenses, and cover both
reported as well as incurred, but not yet reported claims. It is not possible to
calculate precisely what these liabilities will amount to in advance and,
therefore, the reserves represent a best estimate at any point in time. Such
estimates are based upon known historical loss data and expectations of future
trends in claims frequency, severity, interest rates and other considerations
which in turn are affected by a large variety of factors over which insurers
have little or no control. Reserve estimates are periodically reviewed in light
of known developments and, where necessary, adjusted and refined as
circumstances may warrant. Nevertheless, the reserve-setting process is
inherently uncertain. If for any of these reasons reserve estimates prove to be
inadequate, the Company's subsidiaries can be forced to increase their reported
liabilities; such an occurrence could result in a materially adverse impact on
their results of operations and financial condition.
Inadequate Pricing
------------------
Premium rates are generally determined on the basis of historical data for
claims frequency and severity as well as related production and other expense
patterns. In the event ultimate claims and expenses exceed historically
projected levels, premium rates are likely to prove insufficient. Premium rate
inadequacy may not become evident quickly and may require time to correct.
Inadequate premiums, much like excessive losses, if material, can adversely
affect the Company's business, operating results and financial condition.
Liquidity Risk
--------------
As indicated above, the Company manages its fixed-maturity investments with
a view toward matching the maturities of those investments with the anticipated
liquidity needs of its subsidiaries for the payment of claims and expenses. If a
subsidiary suddenly experienced greater-than-anticipated liquidity needs for any
reason, it could require an injection of funds that might not necessarily be
available to the Company to meet its obligations at a point in time.
Regulatory Environment
----------------------
The Company's insurance businesses are subject to extensive governmental
regulation in all of the state and similar jurisdictions in which they operate.
These regulations relate to such matters as licensing requirements, types of
insurance products that may be sold, premium rates, marketing practices, capital
and surplus requirements, investment limitations, underwriting limitations,
dividend payment limitations, transactions with affiliates, accounting
practices, taxation and other matters. While most of the regulation is at the
state level, the federal government has increasingly expressed an interest in
regulating the insurance business and has injected itself through the
Graham-Leach-Bliley Act, the Patriot Act, financial services regulation, changes
in the Internal Revenue Code and other legislation. All of these regulations
raise the costs of conducting an insurance business through increased compliance
expenses. Furthermore, as existing regulations evolve through administrative and
court interpretations, and as new regulations are adopted, there can be no way
of predicting what impact these changes will have on the Company's businesses in
the future, and the impact could adversely affect the Company's profitability
and limit its growth.
Competition
-----------
Each of the Company's lines of insurance business is highly competitive and
is likely to remain so for the foreseeable future. Moreover, existing
competitors and the capital markets have brought an influx of capital and
newly-organized entrants into the industry in recent years, and changes in laws
have allowed financial institutions, like banks and savings and loans, to sell
16
insurance products. Increases in competition threaten to reduce demand for the
Company's insurance products, reduce its market share, reduce its growth, reduce
its profitability and generally adversely affect its results of operations and
financial condition.
Rating Downgrades
-----------------
The competitive positions of insurance companies, in general, have come to
depend increasingly on independent ratings of their financial strength and
claims-paying ability. The rating agencies base their ratings on criteria they
establish regarding an insurer's financial strength, operating performance,
strategic position and ability to meet its obligations to policyholders. A
significant downgrade in the ratings of any of the Company's major
policy-issuing subsidiaries could negatively impact their ability to compete for
new business and retain existing business and, as a result, adversely affect
their results of operations and financial condition.
Financial Institutions Risk
---------------------------
The Company's subsidiaries have significant business relationships with
financial institutions, particularly national banks. The subsidiaries are the
beneficiaries of a considerable amount of security in the form of letters of
credit which they hold as collateral securing the obligations of insureds and
certain reinsurers. Some of the banks themselves have subsidiaries that reinsure
the Company's business. Other banks are depositories holding large sums of money
in escrow accounts established by the Company's title subsidiaries. There is
thus a risk of concentrated financial exposures in one or more such banking
institution. If any of these institutions fail or are unable to honor their
credit obligations, or if escrowed funds become lost or tied up due to the
failure of a bank, the result could be adverse to the Company's business,
results of operations and financial condition.
In addition to the foregoing, the following are risk factors that are
particular to each of the Company's three major business segments.
General Insurance Group
-----------------------
Catastrophic Losses
-------------------
While the Company limits the property exposures it writes, the casualty or
liability insurance it underwrites creates an exposure to claims arising out of
catastrophes. The two principal catastrophe exposures are earthquakes and acts
of terrorism in areas where there are large concentrations of employees of an
insured employer or other individuals who could potentially be injured and
assert claims against an insured.
Following the September 11, 2001 terrorist attack, the reinsurance industry
eliminated coverage from substantially all reinsurance contracts for claims
arising from acts of terrorism. The Terrorism Risk Insurance Act of 2002
("TRIA") subsequently passed by the U. S. Congress required primary insurers to
offer coverage for certified acts of terrorism under most commercial property
and casualty insurance policies. Although TRIA established a temporary federal
reinsurance program through December 31, 2005, a program which has recently been
extended for two more years but with reduced coverage, primary insurers like the
Company's general insurance subsidiaries retain significant exposure for
terrorist act-related losses.
Long-Tailed Losses
------------------
Coverage for general liability is considered long-tailed coverage. Written
in most cases on an "occurrence" basis, it often takes longer for the claims to
be reported and become known, adjusted and settled than it does for property
claims, for example, which are generally considered short-tailed. The extremely
long-tailed aspect of such claims as pollution, asbestos, silicosis, manganism
(welding rod fume exposure), black lung, lead paint and other toxic tort claims,
coupled with uncertain and sometimes variable judicial rulings on coverage and
policy allocation issues and the possibility of legislative actions, makes
reserving for these exposures highly uncertain. While the Company believes that
it has reasonably estimated its liabilities for such exposures to date, and that
its exposures are relatively modest, there is a risk of materially adverse
developments in both known and as as-yet-unknown claims.
Workers' Compensation Coverage
------------------------------
Workers' compensation coverage is the second largest line of insurance
written within the Company. The frequency and severity of claims under, and the
adequacy of reserves for workers' compensation claims and expenses can all be
significantly influenced by such risk factors as future wage inflation in states
that index benefits, the speed with which injured employees are able to return
to work in some capacity, the cost and rate of inflation in medical treatments,
the types of medical procedures and treatments, the cost of prescription
medications, the frequency with which closed claims reopen for additional or
related medical issues, the mortality of injured workers with lifetime benefits
and medical treatments, the use of health insurance to cover some of the
expenses, the assumption of some of the expenses by states' second injury funds,
the use of cost containment practices like preferred provider networks, and the
opportunities to recover against third parties through subrogation. Adverse
developments in any of these factors, if significant, could have a materially
adverse effect on the Company's operating results and financial condition.
17
Reinsurance
-----------
Reinsurance is a contractual arrangement whereby one insurer (the
reinsurer) assumes some or all of the risk exposure written by another insurer
(the reinsured). The Company uses reinsurance to manage its risks both in terms
of the amount of coverage it is able to write, the amount it is able to retain
for its own account, and the price at which it is able to write it. The
availability of reinsurance and its price, however, are determined in the
reinsurance market by conditions beyond the Company's control.
Reinsurance does not relieve the reinsured company of its primary liability
to its insureds in the event of a loss. It merely reimburses the reinsured
company. The ability and willingness of reinsurers to honor their obligations
represent credit risks inherent in reinsurance transactions. The Company
addresses these risks by limiting its reinsurance to those reinsurers it
considers the best credit risks. In recent years, however, there has been an
ever-decreasing number of reinsurers considered to be acceptable risks by the
Company.
There can be no assurance that the Company will be able to find the desired
or even adequate amounts of reinsurance at favorable rates from acceptable
reinsurers in the future. If unable to do so, the Company would be forced to
reduce the volume of business it writes or retain increased amounts of liability
exposure. Because of the declining number of reinsurers the Company finds
acceptable, there is a risk that too much reinsurance risk may become
concentrated in too few reinsurers. Each of these results could adversely affect
the Company's business, results of operations and financial condition.
Insureds as Credit Risks
------------------------
A significant amount of the Company's liability and workers' compensation
business, particularly for large commercial insureds, is written on the basis of
risk-sharing underwriting methods utilizing large deductibles, captive insurance
risk retentions, or other arrangements whereby the insureds effectively retain
and fund varying and at times significant amounts of their losses. Their
financial strength and ability to pay are carefully evaluated as part of the
underwriting process and monitored periodically thereafter, and their retained
exposures are estimated and collateralized based on pertinent credit analysis
and evaluation. Because the Company is primarily liable for losses incurred
under its policies, the possible failure or inability of insureds to honor their
retained liability represents a credit risk. Any subsequently developing
shortage in the amount of collateral held would also be a risk, as would the
failure or inability of a bank to honor a letter of credit issued as collateral.
These risk factors could have a material adverse impact on the Company's results
of operations and financial condition.
Guaranty Funds and Residual Markets
-----------------------------------
In nearly all states, licensed property and casualty insurers are required
to participate in guaranty funds through assessments covering a portion of
insurance claims against impaired or insolvent property and casualty insurers.
Any increase in the number or size of impaired companies would likely result in
an increase in the Company's share of such assessments.
Many states have established second-injury funds that compensate injured
employees for aggravation of prior injuries or conditions. These second-injury
funds are funded by assessments or premium surcharges.
Residual market or pooling arrangements exist in many states to provide
various types of insurance coverage to those that are otherwise unable to find
private insurers willing to insure them. All licensed property and casualty
insurers writing such coverage voluntarily are required to participate in these
residual market or pooling mechanisms.
A material increase in any of these assessments or charges could adversely
affect the Company's results of operations and financial condition.
Prior Approval of Rates
-----------------------
Most of the lines of insurance underwritten by the Company are subject to
prior regulatory approval of premium rates in a majority of the states. The
process of securing regulatory approval can be time consuming and can impair the
Company's ability to effect necessary rate increases in an expeditious manner.
Furthermore, there is a risk that the regulators will not approve a requested
increase, particularly in regard to workers' compensation insurance with respect
to which rate increases often confront strong opposition from local business and
political interests.
Mortgage Guaranty Group
-----------------------
Housing and Mortgage Lending Markets
------------------------------------
Any significant development which adversely affects the housing and related
mortgage lending markets could be a risk factor for the Company's mortgage
insurance subsidiaries. Rising mortgage interest rates, increases in
unemployment or recessions and the general health of the national or regional
economies are all factors that could result in a decline of new business. A
significant downturn in the economy and rising unemployment could also result in
an increase in mortgage defaults and, in turn, an increase in claims under the
18
subsidiaries' policies. The affordability and rate of housing price escalation
are also factors because mortgage insurance generally applies only to mortgage
loans with loan-to-value ratios exceeding 80%.
On the other hand, low interest rates can also be a risk factor inasmuch as
they can threaten persistency of coverage. Declining rates can encourage
mortgage refinance activity. When a mortgage loan insured by the Company is
refinanced, there is a risk the lender will replace the Company's coverage with
coverage written by another mortgage insurer or, alternatively, that coverage
may no longer be necessary in the event that price appreciation of the property
has served to reduce the loan-to-value ratio below 80%. Each of these factors,
if significant enough, could have a materially adverse affect on the business,
results of operations and financial condition of the Company's mortgage guaranty
subsidiaries.
Competition
-----------
Competition is always a risk factor and comes not only from the seven other
mortgage insurers which comprise the industry, but also from
government-sponsored enterprises ("GSE"), such as Fannie Mae and Freddie Mac,
and the insured mortgage lenders themselves. The market for mortgage insurance
exists primarily because the GSE's require it on traditional primary business.
These institutions establish the levels of required coverage, the underwriting
standards for the loans they will purchase and the loss mitigation efforts that
must be followed on insured loans. Changes in any of these respects can result
in a reduction of the Mortgage Guaranty Group's business or an increase in its
claim costs.
Lender consolidation has resulted in fewer lenders originating a greater
share of all mortgage loans. In 2005, 44% of all mortgage loans were purchased
or originated by the top 5 nationwide lenders. Consequently, mortgage insurance
business is increasingly becoming controlled by a small number of nationwide
mortgage lenders, some of which have reduced the number of mortgage insurers
they do business with, thus increasing competition among the insurers.
Increasingly, mortgage lenders have organized their own captive reinsurers
as a means of extending their business to the underwriting of mortgage guaranty
risks. Through such captives they provide quota share or excess of loss
reinsurance protection to the mortgage guaranty insurers such as the Company's
subsidiaries in this segment. This involvement is a competitive risk factor
inasmuch as it reduces the amount of business that the Company could otherwise
retain.
Other competitive risk factors faced by the Company's Mortgage Guaranty
Group stem from certain alternative risk management techniques utilized by
mortgage lenders. These include:
* the use of so-called piggy-back or 80-10-10 type mortgage loan extensions
whose effect is to eliminate the need for mortgage guaranty insurance by
structuring the mortgage note as an 80% loan-to-value first mortgage;
* the retention of mortgage loans on an uninsured basis in the lender's
portfolio of assets;
* the use of alternative mortgage insurance programs such as those afforded
by the Federal Housing and Veterans Administrations; and
* capital markets utilizing alternative credit enhancements.
Litigation and Regulation
-------------------------
The possibly adverse effect of litigation and regulation are ever present
risk factors. Captive reinsurance and other risk-participating structures with
mortgage lenders have been challenged in recent years as potential violations of
the Real Estate Settlement Procedures Act ("RESPA"). From time to time, the U.S.
Department of Housing and Urban Development has considered adopting RESPA
regulations which would have adversely impacted mortgage insurance by requiring
that the premiums be combined with all other settlement service charges in a
single package fee. Adverse litigation or regulatory developments could have a
materially adverse effect on the Company's mortgage guaranty business, results
of operations and financial condition.
Title Insurance Group
---------------------
Housing and Mortgage Lending Markets
------------------------------------
The fortunes of title insurance are even more directly tied to the level of
real estate activity than are those of mortgage insurance. The principal risk
factor for title insurance is a decline in residential real estate activity. The
major factors that can impact real estate activity adversely include:
* high or rising mortgage interest rates;
* high or rising unemployment;
19
* any downturn in a regional or the national economy, any reduction in the
availability or affordability of housing, as well as, any precipitous
decline in housing prices;
* any reduction in mortgage refinancing activity; and
* any reduction in the availability of mortgage funding.
A significant adverse development among any of these risk factors could
have a materially adverse effect on the Company's title insurance business,
results of operations and financial condition.
Competition
-----------
Business comes to title insurers primarily by referral from real estate
agents, lenders, developers and other settlement providers. The sources of
business lead to a great deal of competition among title insurers. Although the
top five title insurance companies account for about 90% of industry-wide
premium volume, there are numerous smaller companies representing the remainder
at the regional and local levels. The smaller companies are an ever-present
competitive risk in the regional and local markets where their business
connections can give them a competitive edge. Moreover, there is almost always
competition among the major companies for key employees, especially those who
are engaged in the production side of the business.
Regulation and Litigation
-------------------------
Regulation is also a risk factor for title insurers. The title insurance
industry has recently been, and continues to be, under intense regulatory
scrutiny in a number of states with respect to pricing practices, and possible
RESPA violations and unlawful rebating practices. The regulatory investigations
could lead to industry-wide reductions in premium rates and escrow fees, the
inability to get rate increases when necessary, as well as to changes that could
adversely affect the Company's ability to compete for or retain business or
raise the costs of additional regulatory compliance.
As with the Company's other business segments, litigation poses a risk
factor. Recent litigation in a number of states seeks class certification in
actions against a number of title insurers alleging violations of rate
applications in those states with respect to title insurance issued in certain
mortgage refinancing transactions.
Other Risks
-----------
Inadequate title searches are among the risk factors faced by the entire
industry. If a title search is conducted thoroughly and accurately, there should
theoretically never be a claim. When the search is less than thorough or
complete, title defects can go undetected and claims result.
To a lesser extent, fraud is also a risk factor for all title companies --
sometimes in the form of an agent's or an employee's defalcation of escrowed
funds, sometimes in the form of fraudulently issued title insurance policies.
Item 1B-Unresolved Staff Comments
None
Item 2-Properties
The principal executive offices of the Company are located in the Old
Republic Building in Chicago, Illinois. This Company-owned building contains
151,000 square feet of floor space of which approximately 56% is occupied by Old
Republic, and the remainder is leased to others. In addition to the
Company-owned principal executive offices, a subsidiary of the Title Insurance
Group partially occupies its owned headquarters building. This building contains
110,000 square feet of floor space of which approximately 75% is occupied by the
Old Republic National Title Insurance Company. The remainder of the building is
leased to others. Eleven smaller buildings are owned by Old Republic and its
subsidiaries in various parts of the country and are primarily used for its
business. The carrying value of all owned buildings and related land at December
31, 2005 was approximately $38.8 million.
Certain other operations of the Company and its subsidiaries are directed
from leased premises. See Note 4(b) of the Notes to Consolidated Financial
Statements for a summary of all material lease obligations.
Item 3-Legal Proceedings
(a) Legal proceedings against the Company arise in the normal course of
business and usually pertain to claim matters related to insurance policies and
contracts issued by its insurance subsidiaries. Other legal proceedings are
discussed below.
Purported class actions have been filed in state courts in Ohio and Florida
20
against the Company's principal title insurance subsidiary, Old Republic
National Title Insurance Company ("ORNTIC"). Substantially similar lawsuits have
been filed against other unaffiliated title insurance companies in New York and
Florida. Plaintiffs allege that, pursuant to rate schedules filed by ORNTIC with
insurance regulators, ORNTIC was required to, but failed to give consumers a
reissue credit on the premiums charged for title insurance covering mortgage
refinancing transactions. The actions seek damages and declaratory and
injunctive relief. ORNTIC intends to defend vigorously against these actions,
but at this early stage in the litigation the Company cannot estimate the costs
it may incur as the actions proceed to their conclusions.
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 other private mortgage insurers in different Federal District Courts.
The action against RMIC seeks certification of a nationwide class of consumers
who were allegedly required to pay for private mortgage insurance at a cost
greater than RMIC's "best available rate". The action alleges that the decision
to insure their loans at a higher rate was based on the consumers' credit scores
and constituted an "adverse action" within the meaning, and in violation of the
Fair Credit Reporting Act, that requires notice, allegedly not given, to the
consumers. The action seeks statutory and punitive damages, as well as other
costs. RMIC intends to defend vigorously against the action, but at this early
stage in the litigation the Company cannot estimate the costs it may incur as
the litigation proceeds to its conclusion.
(b) Examinations of the Company are performed periodically by the Internal
Revenues Service ("IRS") and other taxing authorities. Currently, the IRS is not
conducting an examination on any of the Corporation's tax returns.
Item 4-Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5-Market for the Registrant's Common Equity, Related Security Holder
Matters and Issuer Purchases of Equity Securities
The Company's common stock is traded on the New York Stock Exchange under
the symbol "ORI". The high and low closing prices as reported on the New York
Stock Exchange, and cash dividends declared for each quarterly period during the
past two years were as follows:
Closing Price
------------------------------ Cash
High Low Dividends
------------ ----------- -----------
1st quarter 2004..................................................... $ 21.75 $ 18.78 $ .090
2nd quarter 2004..................................................... 20.30 17.10 .104
3rd quarter 2004..................................................... 20.02 18.08 .104
4th quarter 2004..................................................... $ 20.63 $ 18.52 $ .104
============ =========== ===========
1st quarter 2005..................................................... $ 20.10 $ 18.41 $ .104
2nd quarter 2005..................................................... 20.39 17.85 .136
3rd quarter 2005..................................................... 21.34 20.02 .136
4th quarter 2005..................................................... 22.44 19.88 .136
Special Dec. 2005..................................................... $ - $ - $ .800 (1)
============ =========== ==========
----------
(1) In December, 2005 a special cash dividend of $.800 per share (adjusted for a
concurrent 25% stock dividend of the Company's common stock) was declared
and paid.
As of January 31, 2006, there were 3,005 registered holders of the
Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial
Statements for a description of certain regulatory restrictions on the payment
of dividends by Old Republic's insurance subsidiaries. Closing prices have been
restated, as necessary, to reflect all stock dividends and splits declared
through December 31, 2005.
The Company made no common stock repurchases during the fourth quarter 2005
under its common stock repurchase plan.
21
Item 6-Selected Financial Data
Years Ended December 31,
---------------------------------------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------ ------------
FINANCIAL POSITION ($ millions):
Cash and Invested Assets (1)............ $ 7,939.9 $ 7,519.5 $ 6,849.2 $ 6,168.2 $ 5,586.7
Other Assets............................ 3,603.2 3,051.3 2,863.0 2,547.1 2,333.4
Total Assets..................... 11,543.2 10,570.8 9,712.3 8,715.4 7,920.2
Liabilities, Other than Debt............ 7,376.4 6,562.1 6,020.9 5,417.9 4,977.1
Debt.................................... 142.7 143.0 137.7 141.5 159.0
Total Liabilities................ 7,519.1 6,705.1 6,158.6 5,559.5 5,136.1
Preferred Stock......................... - - - - .3
Common Shareholders' Equity............. 4,024.0 3,865.6 3,553.6 3,155.8 2,783.7
Total Capitalization (2)......... $ 4,166.7 $ 4,008.6 $ 3,691.3 $ 3,297.4 $ 2,943.1
============ ============ ============ ============ ============
----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS ($ millions):
Net Premiums and Fees Earned............ $ 3,386.9 $ 3,116.1 $ 2,936.0 $ 2,423.9 $ 2,029.5
Net Investment and Other Income......... 354.0 327.5 330.5 318.5 314.1
Realized Investment Gains............... 64.9 47.9 19.3 13.9 29.7
Net Revenues.................... 3,805.9 3,491.6 3,285.8 2,756.4 2,373.4
Benefits, Claims, and
Settlement Expenses................... 1,465.4 1,307.9 1,112.8 974.8 860.5
Underwriting and Other Expenses......... 1,593.0 1,532.7 1,493.2 1,220.8 1,006.2
Pretax Income...................... 747.3 650.9 679.7 560.7 506.6
Income Taxes........................... 195.9 215.9 219.9 167.7 159.7
Net Income......................... $ 551.4 $ 435.0 $ 459.8 $ 392.9 $ 346.9
============ ============ ============ ============ ============
---------------------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA: (3)
Net Income:
Basic (4).............................. $ 2.40 $ 1.91 $ 2.02 $ 1.74 $ 1.55
============ ============ ============ ============ ============
Diluted ............................... $ 2.37 $ 1.89 $ 2.01 $ 1.73 $ 1.54
============ ============ ============ ============ ============
Dividends: Cash - Regular................ $ .512 $ .402 $ .356 $ .336 $ .314
- Special (5)............ .800 - .534 - -
------------ ------------ ------------ ------------ ------------
- Total.................. $ 1.312 $ .402 $ .890 $ .336 $ .314
============ ============ ============ ============ ============
Stock......................... 25% -% 50% -% -%
============ ============ ============ ============ ============
Book Value............................... $ 17.53 $ 16.94 $ 15.65 $ 13.96 $ 12.48
============ ============ ============ ============ ============
Common Shares (thousands):
Outstanding............................ 229,575 228,204 227,007 226,122 223,082
============ ============ ============ ============ ============
Average: Basic........................ 229,487 228,177 226,936 226,079 223,045
============ ============ ============ ============ ============
Diluted...................... 232,108 230,759 229,128 227,904 225,614
============ ============ ============ ============ ============
----------
(1) Consists of cash, investments and investment income due and accrued.
(2) Total capitalization consists of debt, preferred stock, and common
shareholders' equity.
(3) All per share statistics herein have been restated to reflect all stock
dividends or splits declared through December 31, 2005.
(4) Calculated after deduction of minor amounts of preferred stock cash
dividends.
(5) Special cash dividends of $.800 and $.534 per share were paid in December
2005 and 2003, respectively.
22
Item 7-Management Analysis of Financial Position and Results of Operations
($ in Millions, Except Share Data)
--------------------------------------------------------------------------------
OVERVIEW
--------------------------------------------------------------------------------
This management analysis of financial position and results of operations
pertains to the consolidated accounts of Old Republic International Corporation
("Old Republic" or "the Company"). The Company conducts its business through
three major segments, namely, its General (property and liability), Mortgage
Guaranty, and Title insurance segments. A small life and health insurance
business, accounting for approximately 2.1% of consolidated revenues for the
year ended December 31, 2005 and 2.2% of consolidated assets as of December 31,
2005, is included within the corporate and other caption. The consolidated
accounts are presented on the basis of generally accepted accounting principles
("GAAP"). This management analysis should be read in conjunction with the
consolidated financial statements and the footnotes appended to them.
The insurance business is distinguished from most others in that the prices
(premiums) charged for various coverages are set without certainty of the
ultimate benefit and claim costs that will emerge or be incurred, often many
years after issuance of a policy. This basic fact casts Old Republic's business
as a long-term undertaking which is managed with a primary focus on the
achievement of favorable underwriting results over time. In addition to
operating income stemming from Old Republic's basic underwriting and related
services functions, significant revenues are obtained from investable funds
generated by those functions as well as from retained shareholders' capital. In
managing investable funds the Company aims to assure stability of income from
interest and dividends, protection of capital, and sufficient liquidity to meet
insurance underwriting and other obligations as they become payable in the
future. Securities trading and the realization of capital gains are not
objectives. The investment philosophy is therefore best categorized as
emphasizing value, credit quality, and relatively long-term holding periods. The
Company's ability to hold both fixed maturity and equity securities for long
periods of time is enabled by the scheduling of maturities in contemplation of
an appropriate matching of assets and liabilities.
In light of the above factors, the Company's affairs are managed for the
long run, without regard to the arbitrary strictures of quarterly or even annual
reporting periods that American industry must observe. In Old Republic's view,
short reporting time frames do not comport well with the long-term nature of
much of its business, driven as it is by a strong focus on the fundamental
underwriting and related service functions of the Company. Management believes
that Old Republic's operating results and financial condition can best be
evaluated by observing underwriting and overall operating performance trends
over succeeding five to ten year intervals. Such time intervals are likely to
encompass one or two economic and/or underwriting cycles, and provide
appropriate time frames for such cycles to run their course and for reserved
claim costs to be quantified with greater finality and effect.
--------------------------------------------------------------------------------
EXECUTIVE SUMMARY
--------------------------------------------------------------------------------
Old Republic has experienced growth in consolidated revenues in each of the
past five years. During this period, trends in operating income and net income
have been affected by varying levels of realized gains on investments and other
non-recurring items. Net operating and net income for 2005 include a
non-recurring recovery of income taxes and related accumulated interest of $57.9
($45.9 net of tax or 20 cents per share). The recovery, received early in the
year, stems 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.
Consolidated pretax earnings for 2004 were affected adversely by certain
non-recurring expenses of $38.3 consisting of: stock option compensation charges
of $5.6, representing the expense of a vesting acceleration of stock option
costs; title litigation settlement costs of $22.2; and a write down of $10.5 for
previously deferred life insurance acquisition costs. The post-tax effect of
these 2004 charges was $29.0, or 13 cents per share.
23
The major components of Old Republic's consolidated operating revenues and
income were as follows for the periods shown:
Years Ended December 31,
-----------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
Operating revenues:
General insurance............................. $ 2,017.6 $ 1,822.5 $ 1,572.7 $ 1,376.6 $ 1,195.0
Mortgage guaranty ............................ 516.0 489.9 498.6 467.1 436.0
Title insurance............................... 1,108.6 1,051.8 1,128.0 836.5 648.9
Corporate and other........................... 98.6 79.3 66.9 62.0 63.6
----------- ----------- ----------- ----------- -----------
Total...................................... $ 3,741.0 $ 3,443.7 $ 3,266.5 $ 2,742.4 $ 2,343.7
=========== =========== =========== =========== ===========
Pretax operating income (loss):
General insurance ............................ $ 350.0 $ 333.0 $ 258.9 $ 182.1 $ 141.5
Mortgage guaranty ............................ 243.7 224.5 276.4 267.7 261.9
Title insurance............................... 88.7 62.5 129.6 97.6 75.0
Corporate and other........................... (.1) (17.2) (4.5) (.7) (1.5)
Realized investment gains (losses):
From sales ................................... 74.1 53.2 35.7 33.0 36.5
From impairments ............................. (9.2) (5.2) (16.4) (19.0) (6.7)
----------- ----------- ----------- ----------- -----------
Net realized gains......................... 64.9 47.9 19.3 13.9 29.7
----------- ----------- ----------- ----------- -----------
Consolidated pretax income ...................... 747.3 650.9 679.7 560.7 506.6
Income taxes.................................. 195.9 215.9 219.9 167.7 159.7
----------- ----------- ----------- ----------- -----------
Net income....................................... $ 551.4 $ 435.0 $ 459.8 $ 392.9 $ 346.9
=========== =========== =========== =========== ===========
Consolidated composite ratio:
Benefits and claims .......................... 43.3% 42.0% 37.9% 40.2% 42.4%
Expenses ..................................... 45.2 47.3 48.5 47.9 46.5
----------- ----------- ----------- ----------- -----------
Composite ratio............................ 88.5% 89.3% 86.4% 88.1% 88.9%
=========== =========== =========== =========== ===========
Components of diluted earnings per share:
Net operating income before non-
recurring income tax benefit ............. $ 1.99 $ 1.75 $ 1.95 $ 1.63 $ 1.46
Non-recurring income tax benefit ............. .20 - - .05 -
----------- ----------- ----------- ----------- -----------
Net operating income ......................... 2.19 1.75 1.95 1.68 1.46
Net realized investment gains ................ .18 .14 .06 .05 .08
----------- ----------- ----------- ----------- -----------
Net income ................................... $ 2.37 $ 1.89 $ 2.01 $ 1.73 $ 1.54
=========== =========== =========== =========== ===========
Consolidated results are provided in terms of both operating and net income
to highlight the effect of 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.
During the final quarters of 2005 and 2004, the Company liquidated
approximately 55 percent and 50 percent, respectively, of its then actively
managed equity investment portfolios. As a result, above average net realized
investment gains of $40.3 and $25.2, respectively, were registered in these
periods. A significant portion of the sales proceeds were redirected toward
index-style investment portfolios. Approximately 87 percent and 40 percent of
total equity investments at December 31, 2005 and 2004, respectively, were
committed to such indexed portfolios, and the remaining 13 percent and 60
percent, respectively, represented actively managed equity investment
portfolios.
24
General Insurance Results
Key indicators of Old Republic's General Insurance operating performance
follow:
Years Ended December 31,
-------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------- ------------- -------------- -------------- --------------
Net premiums earned ............... $ 1,805.2 $ 1,623.0 $ 1,379.5 $ 1,184.1 $ 1,000.2
Net investment income.............. 197.0 183.4 175.0 172.5 175.7
Pretax operating income............ $ 350.0 $ 333.0 $ 258.9 $ 182.1 $ 141.5
============== ============= ============== ============== ==============
Benefits and claims ratio ......... 66.9% 65.9% 67.6% 72.0% 74.8%
Expense ratio ..................... 24.6 24.8 26.2 27.1 27.8
-------------- ------------- -------------- -------------- --------------
Composite ratio ................. 91.5% 90.7% 93.8% 99.1% 102.6%
============== ============= ============== ============== ==============
General Insurance earned premium growth for the past five years reflects
the positive pricing and risk selection changes effected during the past few
years, as well as additional business produced in an environment marked by
reasonably stable underwriting discipline on the part of many competitors. Old
Republic's underwriting results continued to benefit from relatively stable
overall claims ratios, and firm production and administrative expense control.
Claim costs attributable to hurricane damages added less than one percentage
point to the composite ratio for 2005 as Old Republic's business is concentrated
on liability rather than property coverages. The slight decline in underwriting
results during 2005 by comparison to the same period in 2004 was more than
offset by an increase in net investment income. The composite underwriting ratio
represents the most widely accepted indicator of underwriting performance in the
industry, and Old Republic has now registered a favorable general insurance
composite ratio below 100 percent for 15 consecutive quarters through year end
2005.
Mortgage Guaranty Results
Old Republic's Mortgage Guaranty Group has performed within expectations in
recent years. Key indicators of this segment's operating performance follow:
Years Ended December 31,
-------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------- ------------- -------------- -------------- --------------
Net premiums earned .............. $ 429.5 $ 403.2 $ 400.9 $ 376.2 $ 353.1
Net investment income............. 70.1 67.7 65.7 65.8 63.3
Pretax operating income............ $ 243.7 $ 224.5 $ 276.4 $ 267.7 $ 261.9
============== ============= ============== ============== ==============
Claims ratio ...................... 37.2% 35.5% 22.7% 14.1% 16.1%
Expense ratio ..................... 22.4 25.6 24.8 32.3 27.5
-------------- ------------- -------------- -------------- --------------
Composite ratio ................. 59.6% 61.1% 47.5% 46.4% 43.6%
============== ============= ============== ============== ==============
The Company's Mortgage Guaranty segment reflected renewed growth of pretax
operating income in 2005 mainly from its underwriting/service functions; the
8.6% increase compares to a decline of 18.8% in 2004 and an increase of 3.2% in
2003. Growth in net premiums earned for 2005 was principally due to greater bulk
business premiums as well as a higher average rate on traditional primary
business production. For each of the two most recent years, the benefits of
rising traditional primary business persistency have largely been offset by a
combination of lower origination volumes and greater reinsurance cessions. The
composite underwriting ratio for the past five years has been affected
negatively by a fairly persistent rise in the claims ratio, while a reasonably
consistent decline in the expense ratio has been a positive offsetting factor.
The higher claims ratios are reflective of greater loss provisions due to rising
paid loss trends and net reserve additions driven by higher expectations of
estimated claim frequency and severity.
25
Title Insurance Results
Key indicators of Old Republic's Title Insurance operating performance
follow:
Years Ended December 31,
-------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
-------------- -------------- -------------- -------------- --------------
Net premiums and fees earned...... $ 1,081.8 $ 1,025.2 $ 1,103.8 $ 813.4 $ 625.3
Net investment income............. 26.0 25.5 23.5 22.5 22.7
Pretax operating income............ $ 88.7 $ 62.5 $ 129.6 $ 97.6 $ 75.0
============== ============== ============== ============== ==============
Claims ratio ...................... 6.0% 5.8% 5.8% 5.0% 4.0%
Expense ratio ..................... 88.2 90.5 84.6 85.6 87.2
-------------- -------------- -------------- -------------- --------------
Composite ratio ................. 94.2% 96.3% 90.4% 90.6% 91.2%
============== ============== ============== ============== ==============
Title insurance premiums and fees increased by 5.5% in 2005, declined by
7.1% in 2004, and rose by 35.7% in 2003. The decline in 2004 and modest growth
achieved in 2005 are generally reflective of a significant drop in mortgage
refinance activity beginning in mid-2003. The composite ratios of claims and
expenses to premiums and fees earned reflect a declining trend between 2001 and
2003, mostly as a result of a lower expense ratio driven by a rising revenue
line. The higher composite ratio for 2004 was affected by the aforementioned
litigation settlement costs as well as the lower revenue base. The 2.1
percentage point improvement in the composite ratio for 2005 was the result of a
drop in the expense ratio largely due to the absence of the litigation
settlement costs offset by a slight increase in the claims ratio.
Corporate and Other Operations
Combined results for Old Republic's small life and health insurance
business and corporate services reflected pretax operating deficits of $.1,
$17.2 and $4.5 in 2005, 2004 and 2003, respectively. Results for 2005 are
reflective of holding company expenses and debt service costs, net internal
service costs, income on short-term investment holdings, and higher earnings
from Old Republic's small book of life and accident and health business.
Combined results for 2004 were penalized by a pretax charge of $10.5 for
previously deferred term-life acquisition costs.
Cash, Invested Assets, and Shareholder's Equity
The following table shows the growth in consolidated cash and invested
assets and shareholders' equity, along with the related per share amounts as of
the dates shown:
December 31,
-------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------- -------------- -------------- -------------- --------------
Cash and invested assets:
Total................................. $ 7,939.9 $ 7,519.5 $ 6,849.2 $ 6,168.2 $ 5,586.7
Per share............................. 34.59 32.95 30.17 27.28 25.04
Shareholders' equity:
Total: as reported ................... 4,024.0 3,865.6 3,553.6 3,155.8 2,783.7
at cost ....................... 3,973.9 3,695.0 3,319.4 3,033.3 2,680.6
Per share: as reported ............... 17.53 16.94 15.65 13.96 12.48
at cost ................... $ 17.31 $ 16.19 $ 14.62 $ 13.41 $ 12.02
============= ============== ============== ============== ==============
Total annual return (*):
Book return 11.2% 10.8% 18.6% 14.5% 16.4%
Market return 10.3% 1.8% 41.8% 2.2% -10.7%
============= ============== ============== ============== ==============
(*) Total book return represents the sum of each year's dividend yield as a
percentage of book value per share at the beginning of the year, plus the
year's percentage change in such book value. Total market return represents
the sum of the annual percentage change in the closing price per share and
each year's cash dividend as a percentage of the closing price at the
preceding year-end.
Each of the Company's major segments have registered positive operating
cash flow during the past five years. Consolidated operating cash flow amounted
to $880.0 for 2005 versus $828.3 for 2004, $720.2 for 2003, $638.2 for 2002, and
$490.2 for 2001.
Old Republic's high quality investment portfolio reflects a current
allocation of approximately 88 percent in fixed-income investments and 7 percent
in equities. As has been the case for many years, it contains little or no
exposure to real estate investments, mortgage-backed securities, derivatives,
junk bonds, private placements or mortgage loans.
26
The rise in the shareholders' equity account has resulted mostly from
earnings retained in excess of cash dividends paid to shareholders, and from
adjustments in the value of investments carried at market values. Equity per
share as reported is inclusive of unrealized gains or losses on investments
whereas the cost basis is exclusive of such gains and losses.
--------------------------------------------------------------------------------
MANAGEMENT ANALYSIS
--------------------------------------------------------------------------------
CHANGES IN ACCOUNTING POLICIES
During December, 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R")
"Share-Based Payment". FAS 123R requires entities to recognize the cost of
employee services received in exchange for awards of equity instruments based on
the grant-date fair value of those awards. The effective date of this
pronouncement is the first annual reporting period that begins after June 15,
2005. The Company believes that the reduction to fully diluted earnings per
share will be immaterial when the modified prospective transition method is
used.
FINANCIAL POSITION
The Company's financial position at December 31, 2005 reflected increases
in assets, liabilities and common shareholders' equity of 9.2%, 12.1% and 4.1%,
respectively, when compared to the immediately preceding year-end. Cash and
invested assets represented 68.8% and 71.1% of consolidated assets as of
December 31, 2005 and December 31, 2004, respectively. Consolidated operating
cash flow was positive at $880.0 in 2005 compared to $828.3 in 2004, with each
of the Company's major segments contributing to this result. As of December 31,
2005, the invested asset base increased 5.6% to $7,939.9 principally as a result
of positive operating cash flow offset by a decline in the fair value of fixed
maturity and equity investments.
During 2005 and 2004, the Corporation committed substantially all
investable funds to short to intermediate-term fixed maturity securities. At
both December 31, 2005 and 2004, approximately 99% of the Company's investments
consisted of marketable securities, including $545.7 and $499.3, respectively,
of U.S. Treasury tax and loss bonds held by its mortgage guaranty subsidiaries
for deferred tax purposes. Old Republic continues to adhere to its long-term
policy of investing primarily in investment grade, marketable securities.
Investable funds have not been directed to so-called "junk bonds" or types of
securities categorized as derivatives. At December 31, 2005, the Company had
$3.2 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 December 31, 2005. Such positions reflect a large variety of
seasonal and intermediate-term factors including current operating needs,
expected operating cash flows, quarter-end cash flow seasonality, and investment
strategy considerations. Accordingly, the future level of short-term investments
will vary and respond to the interplay of these factors and may, as a result,
increase or decrease from current levels.
The Company does not own or utilize derivative financial instruments for
the purpose of hedging, enhancing the overall return of its investment
portfolio, or reducing the cost of its debt obligations. With regard to its
equity portfolio, the Company does not own any options nor does it engage in any
type of option writing. Traditional investment management tools and techniques
are employed to address the yield and valuation exposures of the invested assets
base. The long-term fixed maturity investment portfolio is managed so as to
limit various risks inherent in the bond market. Credit risk is addressed
through asset diversification and the purchase of investment grade securities.
Reinvestment rate risk is reduced by concentrating on non-callable issues, and
by taking asset-liability matching considerations into account. Purchases of
mortgage and asset backed securities, which have variable principal prepayment
options, are generally avoided. Market value risk is limited through the
purchase of bonds of intermediate maturity. The combination of these investment
management practices is expected to produce a more stable long-term fixed
maturity investment portfolio that is not subject to extreme interest rate
sensitivity and principal deterioration. The market value of the Company's
long-term fixed maturity investment portfolio is sensitive, however, to
fluctuations in the level of interest rates, but not materially affected by
changes in anticipated cash flows caused by any prepayments. The impact of
interest rate movements on the long-term fixed maturity investment portfolio
generally affects net unrealized gains or losses. As a general rule, rising
interest rates enhance currently available yields but typically lead to a
reduction in the fair value of existing fixed maturity investments. By contrast,
a decline in such rates reduces currently available yields but usually serves to
increase the fair value of the existing fixed maturity investment portfolio. All
such changes in fair value are reflected, net of deferred income taxes, directly
in the shareholders' equity account, and as a separate component of the
statement of comprehensive income. Given the Company's inability to forecast or
control the movement of interest rates, Old Republic sets the maturity spectrum
of its fixed maturity securities portfolio within parameters of estimated
liability payouts, and focuses the overall portfolio on high quality
investments. By so doing, Old Republic believes it is reasonably assured of its
ability to hold securities to maturity as it may deem necessary in changing
environments, and of ultimately recovering their aggregate cost.
Possible future declines in fair values for Old Republic's bond and stock
portfolios would affect negatively the common shareholders' equity account at
any point in time, but would not necessarily result in the recognition of
realized investment losses. The Company reviews the status and market value
27
changes of each of its investments on at least a quarterly basis during the
year, and estimates of other than temporary impairments in the portfolio's value
are evaluated and established at each quarterly balance sheet date. In reviewing
investments for other than temporary impairment, the Company, in addition to a
security's market price history, considers the totality of such factors as the
issuer's operating results, financial condition and liquidity, its ability to
access capital markets, credit rating trends, most current audit opinion,
industry and securities markets conditions, and analyst expectations to reach
its conclusions. Sudden market value declines caused by such adverse
developments as newly emerged or imminent bankruptcy filings, issuer default on
significant obligations, or reports of financial accounting developments that
bring into question the validity of previously reported earnings or financial
condition, are recognized as realized losses as soon as credible publicly
available information emerges to confirm such developments. Accordingly, the
recognition of losses from other than temporary value impairments is subject to
a great deal of judgment as well as turns of events over which the Company can
exercise little or no control. In the event the Company's estimate of other than
temporary impairments is insufficient at any point in time, future periods' net
income would be affected adversely by the recognition of additional realized or
impairment losses, but its financial condition would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses.
The following tables show certain information relating to the Company's
fixed maturity and equity portfolios as of the dates shown:
-------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (1)
-------------------------------------------------------------------------------------------------------------------------------
December 31,
----------------------------------------
2005 2004
------------------ ------------------
Aaa......................................................................... 37.9% 32.6%
Aa.......................................................................... 17.0 19.5
A........................................................................... 25.7 27.5
Baa......................................................................... 18.6 19.8
------------------ ------------------
Total investment grade............................................. 99.2 99.4
All other (2)............................................................... .8 .6
------------------ ------------------
Total.............................................................. 100.0% 100.0%
================== ==================
(1) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(2) "All other" includes non-investment or non-rated small issues of tax-exempt
bonds.
-------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Non-Investment Grade Fixed Maturity Securities
-------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
-------------------------------
Gross
Amortized Unrealized
Cost Losses
------------ -------------
Fixed Maturity Securities by Industry Concentration:
Consumer Durables..................................................................... $ 10.2 $ 1.9
Finance............................................................................... 10.3 1.0
------------ -------------
Total........................................................................ $ 20.5 (3) $ 2.9
============ =============
(3) Represents .3 percent of the total fixed maturity securities portfolio.
28
--------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities
--------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
--------------------------------
Gross
Amortized Unrealized
Cost Losses
------------- ------------
Fixed Maturity Securities by Industry Concentration:
Municipals....................................................................... $ 1,140.3 $ 16.2
Utilities........................................................................ 420.1 8.7
Finance.......................................................................... 158.2 5.4
Service.......................................................................... 171.3 5.0
Other (includes 17 industry groups) ............................................. 1,821.5 33.0
------------- ------------
Total................................................................... $ 3,711.6 (4) $ 68.6
============= ============
(4) Represents 54.0 percent of the total fixed maturity securities portfolio.
--------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities
--------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
--------------------------------
Gross
Unrealized
Cost Losses
------------- ------------
Equity Securities by Industry Concentration:
Health Care...................................................................... $ 17.9 $ 1.1
Consumer Non-durables............................................................ 25.2 .9
Banking.......................................................................... 19.4 .3
Basic............................................................................ 6.5 .3
Other (7 industry groups)........................................................ 29.2 .7
------------- ------------
Total................................................................... $ 98.3 (5) $ 3.6 (6)
============= ============
(5) Represents 19.6 percent of the total equity securities portfolio.
(6) Represents .7 percent of the cost of the total equity securities portfolio,
while gross unrealized gains represent 11.0 percent of the portfolio.
--------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Maturity Ranges For All Fixed Maturity Securities
--------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
------------------------------------------------------------------------
Amortized Cost
of Fixed Maturity Securities Gross Unrealized Losses
--------------------------------- --------------------------------
Non-Investment Non-Investment
All Grade Only All Grade Only
------------- ------------- ------------ -------------
Maturity Ranges:
Due in one year or less...................... $ 348.6 $ - $ 2.3 $ -
Due after one year through five years........ 1,293.8 20.5 30.3 2.9
Due after five years through ten years....... 2,088.9 - 38.7 -
Due after ten years.......................... .8 - - -
------------- ------------- ------------ -------------
Total.................................... $ 3,732.2 $ 20.5 $ 71.5 $ 2.9
============= ============= ============ =============
29
--------------------------------------------------------------------------------------------------------------------------------
Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses
--------------------------------------------------------------------------------------------------------------------------------
December 31, 2005
-----------------------------------------------------------------------
Amount of Gross Unrealized Losses
-----------------------------------------------------------------------
Total Gross
Less than 20% 20% to 50% More than 50% Unrealized
of Cost of Cost of Cost Loss
------------- ------------- ------------- -------------
Number of Months in Loss Position:
Fixed Maturity Securities:
One to six months................... $ 34.6 $ - $ - $ 34.6
Seven to twelve months.............. 16.6 - - 16.6
More than twelve months............. 20.3 - - 20.3
------------- ------------- ------------- -------------
Total...................... $ 71.5 $ - $ - $ 71.5
============= ============= ============= =============
Equity Securities:
One to six months................... $ 3.5 $ - $ - $ 3.5
Seven to twelve months.............. - - - -
More than twelve months............. - - - -
------------- ------------- ------------- -------------
Total...................... $ 3.5 $ - $ - $ 3.6
============= ============= ============= =============
Number of Issues in Loss Position:
Fixed Maturity Securities:
One to six months................... 617 - - 617
Seven to twelve months.............. 193 - - 193
More than twelve months............. 136 - - 136
------------- ------------- ------------- -------------
Total...................... 946 - - 946 (7)
============= ============= ============= =============
Equity Securities:
One to six months................... 24 - - 24
Seven to twelve months.............. - - - -
More than twelve months............. - 1 - 1
------------- ------------- ------------- -------------
Total...................... 24 1 - 25 (7)
============= ============= ============= =============
The aging of issues with unrealized losses employs closing market price
comparisons with an issue's original cost. The percentage reduction from
original cost reflects the decline as of a specific point in time (December 31,
2005 in the above table) and, accordingly, is not indicative of a security's
value having been consistently below its cost at the percentages and throughout
the periods shown.
(7) At December 31, 2005 the number of issues in an unrealized loss position
represent 52.2 percent as to fixed maturities, and 27.8 percent as to
equity securities of the total number of such issues held by the Company.
--------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
--------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2005 2004
--------------- ----------------
Maturity Ranges:
Due in one year or less....................................................... 10.5% 12.5%
Due after one year through five years......................................... 40.9 42.9
Due after five years through ten years........................................ 47.9 43.5
Due after ten years through fifteen years..................................... .7 1.1
Due after fifteen years....................................................... - -
--------------- ----------------
Total..................................................................... 100.0% 100.0%
=============== ================
Average Maturity................................................................... 4.8 Years 4.7 Years
=============== ================
Duration (8)....................................................................... 4.3 4.1
=============== ================
(8) Duration is used as a measure of bond price sensitivity to interest rate
changes. A duration of 4.3 as of December 31, 2005 implies that a 100 basis
point parallel increase in interest rates from current levels would result
in a possible decline in the market value of the long-term fixed maturity
investment portfolio of approximately 4.3 percent.
30
-----------------------------------------------------------------------------------------------------------------------------
Composition of Unrealized Gains (Losses)
-----------------------------------------------------------------------------------------------------------------------------
December 31,
--------------------------------------
2005 2004
--------------- ----------------
Fixed Maturity Securities:
Amortized cost............................................................. $ 6,869.5 $ 6,273.2
Estimated fair value....................................................... 6,877.4 6,455.9
--------------- ----------------
Gross unrealized gains..................................................... 79.5 194.5
Gross unrealized losses.................................................... (71.5) (11.8)
--------------- ----------------
Net unrealized gains .................................................. $ 7.9 $ 182.7
=============== ================
Equity Securities:
Cost....................................................................... $ 500.9 $ 396.8
Estimated fair value....................................................... 552.4 459.0
--------------- ----------------
Gross unrealized gains..................................................... 55.1 68.6
Gross unrealized losses.................................................... (3.6) (6.4)
--------------- ----------------
Net unrealized gains................................................... $ 51.5 $ 62.2
=============== ================
Among other major assets, substantially all of the Company's receivables
are not past due. Reinsurance recoverable balances on paid or estimated unpaid
losses are deemed recoverable from solvent reinsurers or have otherwise been
reduced by allowances for estimated amounts unrecoverable. Deferred policy
acquisition costs are estimated by taking into account the variable costs of
producing specific types of insurance policies, and evaluating their
recoverability on the basis of recent trends in claims costs. The Company's
deferred policy acquisition cost balances have not fluctuated substantially from
period-to-period and do not represent significant percentages of assets or
shareholders' equity.
The parent holding company meets its liquidity and capital needs
principally through dividends paid by its subsidiaries. The insurance
subsidiaries' ability to pay cash dividends to the parent company is generally
restricted by law or subject to approval of the insurance regulatory authorities
of the states in which they are domiciled. The Company can receive up to $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 of which $18.8 was outstanding at December 31, 2005.
Old Republic's total capitalization of $4,166.7 at December 31, 2005
consisted of debt of $142.7 and common shareholders' equity of $4,024.0. Changes
in the common shareholders' equity account for the three most recent years
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 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
March, 2005 meeting the Board of Directors approved a quarterly cash dividend
rate of 13.6 cents per share, up from 10.4 cents per share, subject to the usual
quarterly authorizations. In December 2005, the Board approved the payment of a
special cash dividend of 80 cents per share.
At its March, 2004 meeting, the Company's Board of Directors authorized the
reacquisition of up to $250.0 of common shares as market conditions warrant
during the two year period from that date; no stock had as yet been acquired
through December 31, 2005 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.
31
The following table shows certain information relating to the Company's
contractual obligations as of December 31, 2005:
Payments Due by Period
----------------------------------------------------------------------------------
Less than 1 - 3 3 - 5 More than 5
Total 1 Year Years Years Years
------------ ------------- ------------- ------------ -------------
Contractual Obligations:
-----------------------
Debt.................................. $ 142.7 $ 19.7 $ 121.4 $ .7 $ .8
Interest on Debt...................... 21.5 9.4 5.8 1.8 4.3
Operating Leases...................... 132.6 37.7 56.1 23.3 15.4
Pension Benefits Contributions (1).... 31.8 3.1 9.1 3.9 15.6
Claim & Claim Expense
Reserves (2)....................... 3,037.6 725.4 663.9 298.3 1,349.9
------------ ------------- ------------- ------------ -------------
Total............................ $ 3,366.4 $ 795.4 $ 856.4 $ 328.3 $ 1,386.2
============ ============= ============= ============ =============
(1) Represents estimated funding of contributions for the Old Republic
International Salaried Employees Restated Retirement Plan (the Old Republic
Plan), Bituminous Casualty Corporation Retirement Income Plan (the Bitco
Plan), and the Old Republic National Title Group Pension Plan (the Title
Plan). Funding of the plans is dependent on a number of factors including
actual performance versus actuarial assumptions made at the time of the
actuarial valuations, as well as, maintaining certain funding levels
relative to regulatory requirements.
(2) Amounts are reported net of reinsurance. As discussed herein with respect
to the nature of loss reserves and the estimating process utilized in their
establishment, the Company's loss reserves do not have a contractual
maturity date. Estimated loss payments are based primarily on historical
claim payment patterns, are subject to change due to a wide variety of
factors, and cannot be predicted with certainty. Actual future loss
payments may differ materially from the current estimates shown in the
table above.
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 37 percent
of consolidated title business revenues. Such premiums are generally recognized
as income at the escrow closing date which approximates the policy effective
date. Fee income related to escrow and other closing services is recognized when
the related services have been performed and completed. The remaining 63 percent
of consolidated title premium and fee revenues is produced by independent title
agents and underwritten title companies. Rather than making estimates that could
be subject to significant variance from actual premium and fee production, the
Company recognizes revenues from those sources upon receipt. Such receipts can
reflect a three to four month lag relative to the effective date of the
underlying title policy, and are offset concurrently by production expenses and
claim reserve provisions.
The major sources of Old Republic's earned premiums and fees for the
periods shown were as follows:
% Change
from prior
General Mortgage Title Other Total period
---------- ---------- ---------- ---------- --------- ------------
Years Ended December 31:
2001.............................. $ 1,000.2 $ 353.1 $ 625.3 $ 50.6 $ 2,029.5 16.9%
2002.............................. 1,184.1 376.2 813.4 50.1 2,423.9 19.4
2003.............................. 1,379.5 400.9 1,103.8 51.6 2,936.0 21.1
2004.............................. 1,623.0 403.2 1,025.2 64.6 3,116.1 6.1
2005.............................. $ 1,805.2 $ 429.5 $ 1,081.8 $ 70.3 $ 3,386.9 8.7%
========== ========== ========== ========== ========= ============
Earned premiums in the General Insurance Group grew by 11.2%, 17.6%, and
16.5% in 2005, 2004, and 2003, respectively, as a result of additional business
produced in a reasonably stable underwriting environment. Mortgage guaranty
premium income reflects moderately improving persistency trends for traditional
primary mortgage insurance offset by a combination of lower origination volumes
and greater reinsurance cessions. 2005 net premiums earned rose due to bulk
business growth as well as a higher average premium rate on new traditional
32
primary business production. Title Group premium and fee revenues increased in
2005 due to higher real estate transaction volume. Reduced title revenues in
2004 are mostly reflective of a substantial drop in mortgage refinancing
activity, while 2003 results reflected favorable market conditions for the sale
of new and used homes, and, most importantly, strong mortgage refinancing
activity that was driven by a fairly consistent drop in mortgage rates.
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:
2001................................. 45.7% 17.4% 7.2% 12.8% 5.4% 11.5%
2002................................. 43.0 19.1 8.7 12.9 4.7 11.6
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%
============ =========== ========== ========== ========== ========
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:
2001................................................... $ 25,085.4 $ 2,614.4 $ 3,675.3 $ 31,375.1
2002................................................... 30,809.6 5,130.0 7,555.5 43,495.1
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
============= ============ ============ =============
Net Risk In Force
--------------------------------------------------------------
Traditional
Primary Bulk Other Total
------------- ----------- ------------ ------------
As of December 31:
2001................................................... $ 15,043.5 $ 167.0 $ 336.9 $ 15,547.4
2002................................................... 15,367.6 513.0 450.7 16,331.3
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
============= =========== ============ ============
Analysis of Traditional Primary Risk in Force:
FICO Unscored/
By Fair Isaac & Company ("FICO") Scores (1): FICO less FICO 620 greater Unavail-
than 620 to 680 than 680 able
------------ ------------ ------------ ------------
As of December 31:
2001................................................ -% -% -% -%
2002................................................ - - - -
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%
============ ============ ============ ============
----------
(1) Scores were unavailable for a substantial number of policies in force prior
to 2003.
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:
2001............................................... 5.7% 37.6% 48.8% 7.9%
2002............................................... 6.0 37.3 47.0 9.7
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%
============ ============ ============ ============
33
By Type of Loan Documentation: Full Reduced
Documentation Documentation
----------------- -----------------
As of December 31:
2001......................................................................... 99.4% .6%
2002......................................................................... 96.7 3.3
2003......................................................................... 94.4 5.6
2004......................................................................... 93.2 6.8
2005......................................................................... 90.6% 9.4%
================= =================
Premium and Persistency Trends
Earned Premiums Persistency
---------------------------- -----------------------------
Traditional
Direct Net Primary Bulk (2)
------------ ------------ ------------ -------------
Years Ended December 31:
2001.................................................. $ 390.9 $ 353.1 65.3% -%
2002.................................................. 432.4 376.2 59.1 71.7
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%
============ ============ ============ ============
----------
(2) Due to the relative immaturity of the bulk business, the above trends may
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:
2001................................................................................ 47.4% 52.6%
2002................................................................................ 43.7 56.3
2003................................................................................ 40.0 60.0
2004................................................................................ 38.1 61.9
2005................................................................................ 37.1% 62.9%
============== ===============
Revenues: Net Investment Income
Net investment income is affected by trends in interest and dividend yields
for the types of securities in which the Company's funds are invested during
individual reporting periods. The following tables reflect the segmented and
consolidated invested asset bases as of the indicated dates, and the investment
income earned and resulting yields on such assets. In calculating yields,
non-interest bearing U.S. Treasury tax and loss bonds, held by the Company's
mortgage guaranty subsidiaries for deferred tax purposes, are necessarily
excluded from the invested asset base. Since the Company can exercise little
control over market values, yields are evaluated on the basis of investment
income earned in relation to the amortized cost of the underlying invested
assets, though yields based on the market values of such assets are also shown
in the statistics below.
Invested Assets at Cost Market Invested
--------------------------------------------------------------------- Value Assets at
Corporate Adjust- Market
General Mortgage Title and Other Total ment Value
----------- ---------- ---------- ----------- ----------- --------- ------------
As of December 31:
2001................. $ 3,198.8 $ 1,542.3 $ 423.9 $ 150.1 $ 5,315.0 $ 219.7 $ 5,534.8
2002................. 3,446.0 1,700.9 489.6 226.9 5,863.4 305.5 6,169.0
2003................. 3,798.2 1,827.9 556.9 177.1 6,360.1 360.3 6,720.4
2004................. 4,217.8 2,001.2 595.2 295.0 7,109.4 262.2 7,371.6
2005................. $ 4,694.8 $ 2,061.2 $ 616.8 $ 326.4 $ 7,699.3 $ 76.6 $ 7,776.0
=========== ========== ========== =========== =========== ========= ============
34
Net Investment Income Yield at
--------------------------------------------------------------------- ------------------------
Corporate
General Mortgage Title and Other Total Cost Market
---------- ---------- ---------- ------------ ----------- ---------- ---------
Years Ended
December 31:
2001................. $ 175.7 $ 63.3 $ 22.7 $ 12.8 $ 274.7 5.7% 5.5%
2002................. 172.5 65.8 22.5 11.7 272.6 5.2 5.0
2003................. 175.0 65.7 23.5 14.9 279.2 4.9 4.6
2004................. 183.4 67.7 25.5 14.0 290.8 4.6 4.4
2005................. $ 197.0 $ 70.1 $ 26.0 $ 16.9 $ 310.1 4.5% 4.4%
========== ========== ========== ============ =========== ========== =========
Consolidated net investment income grew by 6.6%, 4.2% and 2.4% in 2005,
2004 and 2003, respectively. For each of the past three years, this revenue
source was affected by a rising invested asset base caused by positive
consolidated operating cash flows, by a concentration of investable assets in
interest-bearing securities, and by changes in market yields. Yield trends
reflect the relatively short maturity of Old Republic's fixed maturity
securities portfolio as well as continuation of a lower yield environment during
the past several years.
Revenues: Net Realized Gains
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. Rather, these policies aim to
assure a stable source of income from interest and dividends, protection of
capital, and provision of sufficient liquidity to meet insurance underwriting
and other obligations as they become payable in the future. Dispositions of
fixed maturity securities arise mostly from scheduled maturities and early
calls; in 2005, 2004, and 2003, 68.6%, 80.7% and 70.0%, 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:
2001............... $ (2.9) $ 39.4 $ 36.5 $ (1.2) $ (5.5) $ (6.7) $ 29.7
2002............... 3.8 29.1 33.0 (5.0) (14.0) (19.0) 13.9
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
========== ============ ========= =========== ============= ======== ============
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
35
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 December 31, 2005, such reserves
accounted for 89.1% and 82.5% of consolidated gross and net of reinsurance
reserves, respectively, while similar reserves at December 31, 2004 accounted
for 88.6% and 82.1% of the respective consolidated amounts. The following table
shows a breakdown of gross and net of reinsurance claim reserve estimates for
major types of insurance coverages as of those dates:
December 31,
---------------------------------------------------------
2005 2004
-------------------------- --------------------------
Gross Net Gross Net
---------- ----------- ----------- -----------
Claim and Loss Adjustment Expense Reserves:
Commercial automobile (mostly trucking)............................ $ 878.4 $ 692.9 $ 788.6 $ 635.9
Workers' compensation.............................................. 1,775.0 915.1 1,607.0 814.0
General liability.................................................. 991.3 418.1 808.7 350.5
Other coverages.................................................... 597.5 387.8 576.0 382.1
Unallocated loss adjustment expense reserves....................... 159.2 92.9 122.0 87.2
---------- ----------- ----------- -----------
Total general insurance reserves 4,401.7 2,507.0 3,902.4 2,269.7
Mortgage guaranty.................................................. 214.7 213.7 200.5 199.1
Title.............................................................. 268.8 268.8 252.5 252.5
Life and health.................................................... 26.5 19.9 22.6 16.9
Unallocated loss adjustment expense reserves -
other coverages................................................. 28.0 28.0 25.4 25.4
---------- ----------- ----------- -----------
Total claim and loss adjustment expense reserves............. $ 4,939.8 $ 3,037.6 $ 4,403.5 $ 2,763.8
========== =========== =========== ===========
Asbestosis and environmental claim reserves included
in the above general insurance reserves:
Amount...................................................... $ 170.7 $ 132.2 $ 118.9 $ 97.1
========== =========== =========== ===========
% of total general insurance reserves....................... 3.9% 5.3% 3.0% 4.3%
========== =========== =========== ===========
Old Republic's General Insurance business is composed of a large variety of
lines or classes of commercial insurance; it has negligible exposure to personal
lines such as homeowners or private passenger automobile insurance that exhibit
wide diversification of risks, significant frequency of claim occurrences, and
high degrees of statistical credibility. Most of the General Insurance Group's
claim reserves stem from liability insurance coverages for commercial customers.
Liability claims typically require more extended periods of investigation and at
times protracted litigation before they are finally settled, and thus tend to
exhibit loss development and payment patterns that stretch over relatively long
periods of time.
The Company establishes point estimates for most reserves on an insurance
coverage line-by-line basis for individual subsidiaries, sub-classes, or
individual accounts and blocks of business that have similar attributes.
Actuarially or otherwise derived ranges of reserve levels are not utilized as
such in setting these reserves, and, accordingly, the reserves listed in the
above table represent the Company's point estimates at each reporting date. The
overall reserve level at any point in time therefore represents the compilation
of a very large number of reported ("case") reserve estimates and the results of
a variety of formula calculations intended to cover claims and related costs not
as yet reported or emerged ("IBNR"). Case reserves are based on continually
evolving assessments of the facts available to the Company during the claim
settlement process. Long-term, disability-type workers' compensation reserves
are discounted to present value based on interest rates that range from 3.5
percent to 4.0 percent. Formula calculations are utilized to provide for IBNR
claim costs as well as additional costs that can arise from such factors as
monetary and social inflation, changes in claims administration processes,
changes in reinsurance ceded and recoverability levels, and expected trends in
claim costs and related ratios. Typically, such formulas take into account
so-called link ratios that represent prior years' patterns of incurred or paid
loss trends between succeeding years, or past experience relative to
progressions of the number of claims reported over time and ultimate average
costs per claim. Reserves pertaining to large individual commercial insurance
accounts that exhibit sufficient statistical credibility, and that may be
subject to retrospective premium rating plans or the utilization of varying
levels or types of self-insured retentions are established on an account by
account basis using case reserves and applicable formula-driven methods. For
certain so-called long-tail categories of insurance such as excess liability or
excess workers' compensation, officers and directors' liability, and commercial
umbrella liability relative to which claim development patterns are particularly
long, more volatile, and immature in their early stages of development, the
Company judgmentally establishes the most current accident years' loss reserves
on the basis of expected loss ratios. As actual claims data emerges in
succeeding years, the original accident year loss ratio assumptions are
36
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 7.4 years (gross) and 10.4 years (net of reinsurance) as of
December 31, 2005 and 6.2 years (gross) and 9.6 years (net of reinsurance) as of
December 31, 2004. Fluctuations in this ratio between years can be caused by the
inconsistent pay out patterns associated with these types of claims. Incurred
net losses for asbestosis and environmental claims have averaged 3.3 percent 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 December 31, 2005 and 2004, the Company's
general insurance segment carried reserves of $873.6 and $735.2, respectively,
to cover claims incurred but not as yet reported as well as for the possible
adverse development of known case reserves. As noted above, the aggregate of
these provisions, known collectively as IBNR reserves, results from the
application of many formulas and reserve-setting approaches that are sensitive
to the wide variety of already enumerated factors. Should these reserves for
IBNR claims be understated by 10 percent for a deficiency of $87.3, or 3.5
percent of the Company's net general insurance reserves as of year end 2005 and
$73.5, or 3.2 percent as of the prior year end balance sheet date, the impact on
the Company's income statement would be to reduce pretax income by such amounts.
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.
37
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:
2001............................................. 74.8% 16.1% 4.0% 42.4%
2002............................................. 72.0 14.1 5.0 40.2
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%
============== ============= =========== =============
The general insurance portion of the claims ratio has reflected a
reasonably consistent downtrend since 1999. The reduction in this major cost
factor reflects largely pricing and risk selection improvements that have been
applied since 2001, together with elements of reduced loss severity and
frequency. The mortgage guaranty claims ratio has trended higher since the
second quarter of 2003 reflecting increases in claim provisions principally due
to such factors as higher loss payments and expectations of higher severity and
frequency of claims. The lower 2002 mortgage guaranty claims ratio resulted from
a decline in claim provisions driven principally by a drop in expected claim
severity. The most recent year-over-year claim ratio comparisons reflect
continued upward pressure in paid loss trends, claim frequency and severity
patterns. The title insurance loss ratios have been in the low single digits in
each of the past five years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. The
moderate uptrend in title insurance loss ratios since 2002 stems from a rise in
the net provision for ultimate claim costs from the historically low level
achieved in 2001. 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.
38
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:
2001............................... 82.5% 89.0% 39.0% 59.5% 71.0% 68.5%
2002............................... 78.4 93.2 41.1 51.5 67.6 66.9
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%
=========== ========== =========== =========== ========== ==========
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:
2001.................................... $ 19,221 $ - 2.84% .33%
2002.................................... 20,693 - 3.43 3.28
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%
=============== =============== ================= ===============
(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 NJ
------ ------ ------- ------ ------ ------- ------- ------ ------ -------
As of December 31:
2001............... 3.4% 3.2% 2.9% 2.9% 3.0% 3.1% 3.8% 2.5% 1.9% 3.4%
2002............... 3.6 3.9 3.9 3.3 4.0 2.9 4.9 3.3 2.1 3.8
2003............... 3.5 4.6 4.9 4.0 4.7 2.8 6.9 3.8 2.5 4.5
2004............... 3.2 5.0 5.6 3.8 4.9 2.1 7.6 4.4 3.5 4.2
2005............... 3.1% 5.7% 5.9% 4.2% 4.9% 1.8% 8.3% 4.7% 4.0% 4.1%
====== ====== ======= ====== ====== ======= ======= ====== ====== =======
(3) As determined by risk in force. These 10 states represent approximately
50% of total risk in force as of December 31, 2005.
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:
2001............................................. 27.8% 27.5% 87.2% 46.5%
2002............................................. 27.1 32.3 85.6 47.9
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%
============== ============= =========== =============
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.
39
The Mortgage Guaranty segment's expense ratio decreased in 2003 due to
greater efficiencies gained in the distribution and servicing of its products;
the increase in this ratio for 2002 was due to the posting of special operating
charges aggregating $20.5. These charges stemmed from the cessation of the
development and marketing of a loan portfolio evaluation service aimed at
existing and potential mortgage guaranty insurance customers, and a reassessment
of certain class action litigation exposures. The 2003 ratio also benefited from
the resolution of the aforementioned class action litigation at a cost
approximately $5.0 less than the related reserves recorded in 2002. The increase
in 2004 resulted from higher stock option compensation expenses offset by
recovery of certain prior years' litigation costs. The decline in the 2005 ratio
reflects the absence of this segments' share of the aforementioned 2004 stock
option costs, as well as a combination of lower contract underwriting costs,
reductions in variable sales expenses, and continued attention to operating
efficiencies.
Increased title sales volume led to lower expense ratios in 2005, 2003 and
2002. The increase in the 2004 expense ratio results from the aforementioned
final settlement of consumer and regulatory litigation costs affecting Old
Republic's California title insurance subsidiary.
Expenses: Total
The composite ratios of the above net claims, benefits and underwriting
expenses that reflect the sum total of all the factors enumerated above have
been as follows:
General Mortgage Title Consolidated
-------------- ------------- ----------- -------------
Years Ended December 31:
2001.............................................. 102.6% 43.6% 91.2% 88.9%
2002.............................................. 99.1 46.4 90.6 88.1
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%
============== ============= =========== =============
Expenses: Income Taxes
The effective consolidated income tax rates were 26.2% in 2005, 33.2% in
2004, and 32.4% in 2003. The effective tax rate was reduced by 6.2 percentage
points in 2005, and net earnings were enhanced by tax and related interest
recoveries of $57.9 ($45.9 net of tax, or 20 cents per share), due to the
favorable resolution of tax issues applicable to the three years ended December
31, 1990. Excluding the effects of these tax and related interest recoveries,
the effective tax rates remained relatively consistent with those of the
corresponding prior periods. Such rates reflect primarily the varying
proportions of pretax operating income derived from partially tax-sheltered
investment income (principally state and municipal tax-exempt interest) on the
one hand, and the combination of fully taxable investment income, realized
investment gains or losses, and underwriting and service income, on the other
hand.
OTHER INFORMATION
Reference is here made to "Information About Segments of Business"
appearing elsewhere herein.
Historical data pertaining to the operating results, liquidity, and other
performance indicators applicable to an insurance enterprise such as Old
Republic are not necessarily indicative of results to be achieved in succeeding
years. In addition to the factors cited below, the long-term nature of the
insurance business, seasonal and annual patterns in premium production and
incidence of claims, changes in yields obtained on invested assets, changes in
government policies and free markets affecting inflation rates and general
economic conditions, and changes in legal precedents or the application of law
affecting the settlement of disputed and other claims can have a bearing on
period-to-period comparisons and future operating results.
Some of the statements made in this report, as well as oral statements or
commentaries made by the Company's management in conference calls following
earnings releases, can constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Of necessity,
any such forward-looking statements, commentaries, or inferences, involve
assumptions, uncertainties, and risks that may affect the Company's future
performance. With regard to Old Republic's General insurance segment, its
results can be affected in particular by the level of market competition, which
is typically a function of available capital and expected returns on such
capital among competitors, the levels of interest and inflation rates, and
periodic changes in claim frequency and severity patterns caused by natural
disasters, weather conditions, accidents, illnesses, work-related injuries, and
unanticipated external events. Mortgage Guaranty and Title insurance results can
be impacted by similar factors and, most particularly, by changes in national
and regional housing demand and values, the availability and cost of mortgage
loans, employment trends, and default rates on mortgage loans. Additionally,
mortgage guaranty results, in particular, may also be affected by various
risk-sharing arrangements with business producers as well as the risk management
and pricing policies of government sponsored enterprises. Life and health
insurance earnings can be affected by the levels of employment and consumer
spending, variations in mortality and health trends, and changes in policy
lapsation rates. At the parent holding company level, operating earnings or
losses are generally reflective of the amount of debt outstanding and its cost,
interest income on temporary holdings of short-term investments, and
period-to-period variations in the costs of administering the Company's
widespread operations.
40
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.
7A-Quantitative and Qualitative Disclosure About Market Risk
The information called for by Item 7A is found under the heading "Financial
Position" in Part II, Item 7 of this report.
41
Item 8-Financial Statements and Supplementary Data
Listed below are the financial statements included herein:
OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES
Page No.
--------
Consolidated Balance Sheets ........................................ 43
Consolidated Statements of Income................................... 44
Consolidated Statements of Comprehensive Income..................... 45
Consolidated Statements of Preferred Stock and
Common Shareholders' Equity...................................... 46
Consolidated Statements of Cash Flows............................... 47
Notes to Consolidated Financial Statements.......................... 48 - 67
Report of Independent Registered Public Accounting Firm............. 68
42
Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets
($ in Millions)
---------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2005 2004
------------- -------------
Assets
Investments:
Available for sale:
Fixed maturity securities (at fair value) (cost: $6,869.5 and $6,273.2)............ $ 6,877.4 $ 6,455.9
Equity securities (at fair value) (cost: $500.9 and $396.8)......................... 552.4 459.0
Short-term investments (at fair value which approximates cost)...................... 275.3 388.6
Miscellaneous investments........................................................... 62.7 54.4
------------- -------------
Total........................................................................... 7,768.0 7,358.1
Other investments................................................................... 8.0 13.4
------------- -------------
Total investments............................................................... 7,776.0 7,371.6
------------- -------------
Other Assets:
Cash................................................................................ 68.3 60.5
Securities and indebtedness of related parties...................................... 16.4 14.0
Accrued investment income........................................................... 95.5 87.3
Accounts and notes receivable....................................................... 803.4 590.1
Reinsurance balances and funds held................................................. 81.0 92.5
Reinsurance recoverable: Paid losses................................................ 59.4 53.3
Policy and claim reserves.................................. 2,107.8 1,793.2
Deferred policy acquisition costs................................................... 240.0 232.3
Sundry assets....................................................................... 294.9 275.6
------------- -------------
3,767.1 3,199.2
------------- -------------
Total Assets.................................................................... $ 11,543.2 $ 10,570.8
============= =============
----------------------------------------------------------------------------------------------------------------------------------
Liabilities, Preferred Stock, and Common Shareholders' Equity
Liabilities:
Losses, claims and settlement expenses.............................................. $ 4,939.8 $ 4,403.5
Unearned premiums................................................................... 1,039.3 903.1
Other policyholders' benefits and funds............................................. 188.8 175.9
------------- -------------
Total policy liabilities and accruals........................................... 6,167.9 5,482.6
Commissions, expenses, fees and taxes............................................... 227.2 235.9
Reinsurance balances and funds...................................................... 307.0 157.8
Federal income tax payable: Current................................................. 129.3 8.4
Deferred................................................ 421.6 554.5
Debt................................................................................ 142.7 143.0
Sundry liabilities.................................................................. 123.1 122.7
Commitments and contingent liabilities..............................................
------------- -------------
Total Liabilities............................................................... 7,519.1 6,705.1
------------- -------------
Preferred Stock:
Convertible preferred stock (1)..................................................... - -
------------- -------------
Common Shareholders' Equity:
Common stock (1).................................................................... 229.5 185.4
Additional paid-in capital.......................................................... 288.6 270.4
Retained earnings................................................................... 3,444.9 3,240.1
Accumulated other comprehensive income ............................................. 60.8 179.5
Treasury stock (at cost) (1)........................................................ - (10.0)
------------- -------------
Total Common Shareholders' Equity............................................... 4,024.0 3,865.6
------------- -------------
Total Liabilities, Preferred Stock and Common Shareholders' Equity.............. $ 11,543.2 $ 10,570.8
============= =============
(1) At December 31, 2005 and 2004, there were 75,000,000 shares of $0.01 par
value preferred stock authorized, of which no shares were outstanding. As
of the same dates, there were 500,000,000 shares of common stock, $1.00 par
value, authorized, of which 229,575,404 in 2005 and 231,786,409 in 2004
were issued and outstanding. At December 31, 2005 and 2004, there were
100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of
which no shares were issued. Common shares classified as treasury stock
were 0 and 3,581,978 as of December 31, 2005 and 2004, respectively.
See accompanying Notes to Consolidated Financial Statements.
--------------------------------------------------------------------------------
43
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Income
($ in Millions, Except Share Data)
---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------
2005 2004 2003
---------------- ---------------- ----------------
Revenues:
Net premiums earned.......................................... $ 3,062.3 $ 2,804.8 $ 2,582.1
Title, escrow, and other fees................................ 324.6 311.2 353.9
---------------- ---------------- ----------------
Total premiums and fees.................................. 3,386.9 3,116.1 2,936.0
Net investment income........................................ 310.1 290.8 279.2
Other income................................................. 43.9 36.7 51.2
---------------- ---------------- ----------------
Total operating revenues................................. 3,741.0 3,443.7 3,266.5
Realized investment gains.................................... 64.9 47.9 19.3
---------------- ---------------- ----------------
Total revenues........................................... 3,805.9 3,491.6 3,285.8
---------------- ---------------- ----------------
Benefits, Claims and Expenses:
Benefits, claims, and settlement expenses.................... 1,460.1 1,305.6 1,097.6
Dividends to policyholders................................... 5.3 2.2 15.1
Underwriting, acquisition, and other expenses................ 1,583.4 1,523.8 1,484.9
Interest and other charges................................... 9.5 8.9 8.2
---------------- ---------------- ----------------
Total expenses........................................... 3,058.5 2,840.7 2,606.0
---------------- ---------------- ----------------
Income before income taxes .................................. 747.3 650.9 679.7
---------------- ---------------- ----------------
Income Taxes:
Currently payable............................................ 263.0 183.4 168.0
Deferred (Credits)........................................... (67.1) 32.5 51.9
---------------- ---------------- ----------------
Total................................................... 195.9 215.9 219.9
---------------- ---------------- ----------------
Net Income................................................... $ 551.4 $ 435.0 $ 459.8
================ ================ ================
Net Income Per Share:
Basic:................................................... $ 2.40 $ 1.91 $ 2.02
================ ================ ================
Diluted:................................................. $ 2.37 $ 1.89 $ 2.01
================ ================ ================
Average shares outstanding: Basic........................ 229,487,273 228,177,278 226,936,856
================ ================ ================
Diluted...................... 232,108,491 230,759,540 229,128,669
================ ================ ================
Dividends Per Common Share:
Cash: Regular............................................ $ .512 $ .402 $ .356
Special............................................ .800 - .534
---------------- ---------------- ----------------
Total.............................................. $ 1.312 $ .402 $ .890
================ ================ ================
Stock.................................................... 25% -% 50%
================ ================ ================
See accompanying Notes to Consolidated Financial Statements.
--------------------------------------------------------------------------------
44
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
($ in Millions)
--------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
-------------------------------------------------------------
2005 2004 2003
----------------- ----------------- -----------------
Net income as reported....................................... $ 551.4 $ 435.0 $ 459.8
----------------- ----------------- -----------------
Other comprehensive income (loss):
Foreign currency translation adjustment................... 2.9 7.3 13.9
----------------- ----------------- -----------------
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period......... (120.5) (49.9) 191.2
Less: elimination of pretax realized gains
included in income as reported...................... 64.9 47.9 19.3
----------------- ----------------- -----------------
Pretax unrealized gains (losses) on securities
carried at market value............................. (185.4) (97.8) 171.9
Deferred income taxes (credits) ....................... (64.9) (34.2) 60.1
----------------- ----------------- -----------------
Net unrealized gains (losses) on securities............. (120.5) (63.5) 111.7
----------------- ----------------- -----------------
Minimum Pension Liability:
Minimum pension liability............................... (1.7) (1.5) -
Deferred income tax credits ............................ (.6) (.5) -
----------------- ----------------- -----------------
Minimum pension liability, net of tax credits........... (1.1) (.9) -
----------------- ----------------- -----------------
Net adjustments.............................................. (118.7) (57.2) 125.7
----------------- ----------------- -----------------
Comprehensive income......................................... $ 432.6 $ 377.7 $ 585.5
================= ================= =================
See accompanying Notes to Consolidated Financial Statements.
--------------------------------------------------------------------------------
45
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Preferred Stock
and Common Shareholders' Equity
($ in Millions)
---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Convertible Preferred Stock:
Balance, end of year.......................................... $ - $ - $ -
============== ============== ==============
Common Stock:
Balance, beginning of year.................................... $ 185.4 $ 184.4 $ 123.7
Stock dividend............................................. 45.9 - 61.4
Dividend reinvestment plan................................. - - -
Exercise of stock options.................................. .9 .9 .4
Stock awards............................................... - - -
Treasury stock restored to unissued status................. (2.8) - (1.2)
-------------- -------------- --------------
Balance, end of year.......................................... $ 229.5 $ 185.4 $ 184.4
============== ============== ==============
Additional Paid-in Capital:
Balance, beginning of year.................................... $ 270.4 $ 245.5 $ 253.1
Dividend reinvestment plan................................. 2.0 .8 1.5
Exercise of stock options.................................. 18.1 15.3 9.9
Stock option compensation.................................. 4.8 8.7 2.2
Stock awards............................................... .2 - -
Treasury stock restored to unissued status................. (7.1) - (21.4)
-------------- -------------- --------------
Balance, end of year.......................................... $ 288.6 $ 270.4 $ 245.5
============== ============== ==============
Retained Earnings:
Balance, beginning of year.................................... $ 3,240.1 $ 2,896.8 $ 2,700.5
Net income................................................. 551.4 435.0 459.8
Dividends on common stock: cash ........................... (300.7) (91.6) (201.9)
stock........................... (45.9) - (61.4)
-------------- -------------- --------------
Balance, end of year.......................................... $ 3,444.9 $ 3,240.1 $ 2,896.8
============== ============== ==============
Accumulated Other Comprehensive Income:
Balance, beginning of year.................................... $ 179.5 $ 236.8 $ 111.0
Foreign currency translation adjustments................... 2.9 7.3 13.9
Net unrealized gains (losses) on securities................ (120.5) (63.5) 111.7
Minimum pension liability, net of tax credits.............. (1.1) (.9) -
-------------- -------------- --------------
Balance, end of year.......................................... $ 60.8 $ 179.5 $ 236.8
============== ============== ==============
Treasury Stock:
Balance, beginning of year.................................... $ (10.0) $ (10.0) $ (32.6)
Acquired during the year................................... - - -
Restored to unissued status................................ 10.0 - 22.6
-------------- -------------- --------------
Balance, end of year.......................................... $ - $ (10.0) $ (10.0)
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
--------------------------------------------------------------------------------
46
Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows
($ in Millions)
---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Cash flows from operating activities:
Net income....................................................... $ 551.4 $ 435.0 $ 459.8
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred policy acquisition costs.............................. (7.2) (9.4) (21.6)
Premiums and other receivables................................. (212.7) (33.4) (34.6)
Unpaid claims and related items................................ 273.9 262.8 192.1
Other policyholders' benefits and funds........................ 96.2 82.8 92.9
Income taxes................................................... 53.9 56.5 36.4
Reinsurance balances and funds................................. 154.3 (10.5) (24.9)
Realized investment gains...................................... (64.9) (47.9) (19.3)
Accounts payable, accrued expenses and other................... 34.9 92.5 39.5
-------------- -------------- --------------
Total............................................................ 880.0 828.3 720.2
-------------- -------------- --------------
Cash flows from investing activities:
Fixed maturity securities:
Maturities and early calls.................................... 818.7 625.8 704.3
Sales......................................................... 375.2 149.6 302.0
Sales of:
Equity securities............................................. 325.8 334.0 211.0
Other investments............................................. 12.9 12.7 7.6
Fixed assets for company use.................................. 5.7 .9 1.0
Cash and short-term investments of subsidiary acquired........... 1.2 2.5 -
Purchases of:
Fixed maturity securities..................................... (1,818.8) (1,604.1) (1,428.9)
Equity securities............................................. (380.8) (250.3) (119.0)
Other investments............................................. (5.2) (1.9) (4.0)
Fixed assets for company use.................................. (37.6) (20.1) (22.1)
Investments in affiliates..................................... (10.1) (1.4) -
Net decrease (increase) in short-term investments............... 118.9 15.5 (149.6)
Other-net........................................................ 4.0 2.6 1.3
-------------- -------------- --------------
Total............................................................ (589.9) (734.1) (496.2)
-------------- -------------- --------------
Cash flows from financing activities:
Issuance of debentures and notes................................. 1.0 - -
Issuance of common shares........................................ 18.4 14.6 9.7
Repayments of term loans......................................... - - (1.0)
Redemption of debentures and notes............................... (1.4) (.6) (2.8)
Dividends on common shares....................................... (300.7) (91.6) (201.9)
Other-net........................................................ .2 (3.1) (17.9)
-------------- -------------- --------------
Total............................................................ (282.4) (80.8) (214.0)
-------------- -------------- --------------
Increase (decrease) in cash ....................................... 7.7 13.3 9.9
Cash, beginning of year.......................................... 60.5 47.2 37.2
-------------- -------------- --------------
Cash, end of year................................................ $ 68.3 $ 60.5 $ 47.2
============== ============== ==============
Supplemental cash flow information:
Cash paid during the year for: Interest ......................... $ 9.4 $ 8.7 $ 8.7
============== ============== ==============
Income Taxes...................... $ 138.4 $ 156.5 $ 180.6
============== ============== ==============
See accompanying Notes to Consolidated Financial Statements.
--------------------------------------------------------------------------------
47
Old Republic International Corporation and Subsidiaries
Notes to Consolidated Financial Statements
($ in Millions, Except as Otherwise Indicated)
--------------------------------------------------------------------------------
Old Republic International Corporation is a Chicago-based insurance holding
company with subsidiaries engaged mainly in the general (property and
liability), mortgage guaranty and title insurance businesses. In this report,
"Old Republic", "the Corporation", or "the Company" refers to Old Republic
International Corporation and its subsidiaries as the context requires. The
aforementioned insurance segments are organized as the Old Republic General
Insurance, Mortgage Guaranty and Title Insurance Groups, and references herein
to such groups apply to the Company's subsidiaries engaged in the respective
segments of business. Note 6 shows summary results for the Company's business
segments.
Note 1-Summary of Significant Accounting Policies-The significant accounting
policies employed by Old Republic International Corporation and its subsidiaries
are set forth in the following summary.
(a) Consolidation Practices-The consolidated financial statements include the
accounts of the Corporation and those of its major insurance underwriting and
service subsidiaries. All significant intercompany accounts and transactions
have been eliminated in consolidation.
(b) Accounting Principles-The Corporation's insurance underwriting subsidiaries
maintain their records in conformity with accounting practices prescribed or
permitted by state insurance regulatory authorities. In consolidating such
subsidiaries, adjustments have been made to conform their accounts with
generally accepted accounting principles. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(c) Investments-The Company may classify its invested assets in terms of those
assets relative to which it either (1) has the positive intent and ability to
hold until maturity, (2) has available for sale or (3) has the intention of
trading. As of December 31, 2005 and 2004, the Company's invested assets were
classified as "available for sale."
Fixed maturity securities classified as "available for sale" and other
preferred and common stocks (equity securities) are included at fair value with
changes in such values, net of deferred income taxes, reflected directly in
shareholders' equity. Fair values for fixed maturity securities and equity
securities are based on quoted market prices or estimates using values obtained
from independent pricing services as applicable.
The Company reviews the status and market value changes of each of its
investments on at least a quarterly basis during the year, and estimates of
other than temporary impairments in the portfolio's value are evaluated and
established at each quarterly balance sheet date. In reviewing investments for
other than temporary impairment, the Company, in addition to a security's market
price history, considers the totality of such factors as the issuer's operating
results, financial condition and liquidity, its ability to access capital
markets, credit rating trends, most current audit opinion, industry and
securities markets conditions, and analyst expectations to reach its
conclusions. Sudden market value declines caused by such adverse developments as
newly emerged or imminent bankruptcy filings, issuer default on significant
obligations, or reports of financial accounting developments that bring into
question the validity of previously reported earnings or financial condition,
are recognized as realized losses as soon as credible publicly available
information emerges to confirm such developments. Accordingly, the recognition
of losses from other-than-temporary value impairments is subject to a great deal
of judgment as well as turns of events over which the Company can exercise
little or no control. In the event the Company's estimate of other than
temporary impairments is insufficient at any point in time, future periods' net
income would be adversely affected by the recognition of additional realized or
impairment losses, but its financial position would not necessarily be affected
adversely inasmuch as such losses, or a portion of them, could have been
recognized previously as unrealized losses. The Company recognized other than
temporary impairments of investments in the amounts of $9.2, $5.2, and $16.4 for
the years ended December 31, 2005, 2004 and 2003, respectively.
48
The amortized cost and estimated fair values of fixed maturity securities
are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------- ------------ -------------
Fixed Maturity Securities:
December 31, 2005:
U.S. & Canadian Governments.............. $ 1,245.0 $ 18.2 $ 4.0 $ 1,259.2
Tax-exempt............................... 1,976.4 15.0 16.2 1,975.2
Utilities................................ 924.2 13.1 14.3 923.0
Corporate................................ 2,723.7 33.1 36.9 2,719.8
------------ ------------- ------------ -------------
$ 6,869.5 $ 79.5 $ 71.5 $ 6,877.4
============ ============= ============ =============
December 31, 2004:
U.S. & Canadian Governments.............. $ 1,107.7 $ 28.3 $ .8 $ 1,135.3
Tax-exempt............................... 1,538.6 38.4 2.9 1,574.0
Utilities................................ 850.2 29.0 2.7 876.4
Corporate................................ 2,776.6 98.7 5.2 2,870.0
------------ ------------- ------------ -------------
$ 6,273.2 $ 194.5 $ 11.8 $ 6,455.9
============ ============= ============ =============
The amortized cost and estimated fair value at December 31, 2005, by
contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Estimated
Amortized Fair
Cost Value
--------------- --------------
Fixed Maturity Securities:
Due in one year or less.................................................... $ 721.1 $ 721.2
Due after one year through five years...................................... 2,810.0 2,826.3
Due after five years through ten years..................................... 3,291.7 3,273.8
Due after ten years........................................................ 46.5 56.0
--------------- --------------
$ 6,869.5 $ 6,877.4
=============== ==============
Bonds and other investments carried at $224.8 as of December 31, 2005 were
on deposit with governmental authorities by the Corporation's insurance
subsidiaries to comply with insurance laws.
A summary of the Company's equity securities follows:
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- ------------- ------------- --------------
December 31, 2005:
Equity securities.......................... $ 500.9 $ 55.1 $ 3.6 $ 552.4
============== ============= ============= ==============
December 31, 2004:
Equity securities.......................... $ 396.8 $ 68.6 $ 6.4 $ 459.0
============== ============= ============= ==============
Investment income is reported net of allocated expenses and includes
appropriate adjustments for amortization of premium and accretion of discount on
fixed maturity securities acquired at other than par value. Dividends on equity
securities are credited to income on the ex-dividend date. Realized investment
gains and losses, which are comprised of sales of securities and provisions or
write-downs of securities, are reflected as revenues in the income statement and
are determined on the basis of amortized value at date of sale for fixed
maturity securities, and cost in regard to equity securities; such bases apply
to the specific securities sold. Unrealized investment gains and losses, net of
any deferred income taxes, are recorded directly as a component of accumulated
other comprehensive income in shareholders' equity.
49
The following table reflects the Company's gross unrealized losses and fair
value, aggregated by category and length of time that individual securities have
been in an unrealized loss position employing closing market price comparisons
with an issuer's original cost at December 31, 2005 and 2004:
12 Months or Less Greater than 12 Months Total
------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------- ----------- ----------- ---------- ---------- -----------
December 31, 2005:
Fixed Maturity Securities:
U.S & Canadian Governments........... $ 312.9 $ 2.9 $ 72.5 $ .8 $ 385.4 $ 3.7
Tax-exempt........................... 969.6 12.2 154.4 4.0 1,124.0 16.2
Corporates........................... 1,773.8 36.1 377.2 15.4 2,151.0 51.5
---------- ----------- ----------- ---------- ---------- -----------
3,056.3 51.2 604.2 20.3 3,660.6 71.5
Equity Securities...................... 94.6 3.5 - - 94.6 3.6
---------- ----------- ----------- ---------- ---------- -----------
Total.................................. $ 3,151.0 $ 54.8 $ 604.2 $ 20.3 $ 3,755.3 $ 75.1
========== =========== =========== ========== ========== ===========
December 31, 2004:
Fixed Maturity Securities:
U.S & Canadian Governments........... $ 209.7 $ .8 $ - $ - $ 209.7 $ .8
Tax-exempt........................... 307.7 2.4 33.1 .5 340.8 2.9
Corporates........................... 634.4 6.0 73.6 2.0 708.0 8.0
---------- ----------- ----------- ---------- ---------- -----------
1,151.9 9.2 106.7 2.5 1,258.6 11.8
Equity Securities...................... 44.0 6.3 .7 .1 44.7 6.4
---------- ----------- ----------- ---------- ---------- -----------
Total.................................. $ 1,195.9 $ 15.6 $ 107.4 $ 2.6 $ 1,303.4 $ 18.2
========== =========== =========== ========== ========== ===========
At December 31, 2005, the Company held 946 fixed maturity and 25 equity
securities in an unrealized loss position, representing 52.2 percent as to fixed
maturities and 27.8 percent as to equity securities of the total number of such
issues held by the Company. Of the 946 fixed maturity securities, 136 had been
in a continuous unrealized loss position for greater than 12 months. The
unrealized losses on these securities are primarily attributable to the rising
interest rate environment as opposed to a decline in credit quality of the
issuer.
At December 31, 2005, the Corporation and its subsidiaries had no
non-income producing fixed maturity securities except for U.S. Treasury Tax and
Loss Bonds in the amount of $545.7 required to be held by its mortgage insurance
subsidiaries for the payment of deferred income taxes. In January, 2006, $122.5
of such tax and loss bonds were redeemed.
The following table reflects the composition of net investment income, net
realized gains or losses, and the net change in unrealized investment gains or
losses for each of the years shown:
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Investment income from:
Fixed maturity securities.................................... $ 284.1 $ 267.2 $ 256.4
Equity securities............................................ 9.4 14.3 14.6
Short-term investments....................................... 15.9 5.7 4.5
Other sources................................................ 5.4 6.8 6.8
-------------- -------------- --------------
Gross investment income................................... 315.0 294.1 282.5
Investment expenses (1)...................................... 4.9 3.2 3.2
-------------- -------------- --------------
Net investment income..................................... $ 310.1 $ 290.8 $ 279.2
============== ============== ==============
Realized gains (losses) on:
Fixed maturity securities:
Gains................................................... $ 5.8 $ 5.2 $ 9.0
Losses.................................................. (4.0) (.5) (4.4)
-------------- -------------- --------------
Net..................................................... 1.7 4.6 4.6
-------------- -------------- --------------
Equity securities & other long-term investments.............. 63.1 43.2 14.6
-------------- -------------- --------------
Total..................................................... 64.9 47.9 19.3
Income taxes................................................. 22.6 17.0 6.7
-------------- -------------- --------------
Net realized gains........................................ $ 42.2 $ 30.9 $ 12.5
============== ============== ==============
(Table continued on next page.)
50
(Table continued from previous page.)
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Changes in unrealized investment gains (losses) on:
Fixed maturity securities:
Held to maturity (2)...................................... $ - $ - $ (117.5)
============== ============== ==============
Available for sale........................................ $ (174.7) $ (94.3) $ 94.0
Less: Deferred income taxes (credits).................... (61.1) (33.0) 32.9
-------------- -------------- --------------
Net changes in unrealized investment gains (losses)....... $ (113.5) $ (61.3) $ 61.1
============== ============== ==============
Equity securities & other long-term investments.............. $ (10.7) $ (3.5) $ 77.8
Less: Deferred income taxes (credits)........................ (3.7) (1.2) 27.2
-------------- -------------- --------------
Net changes in unrealized investment gains (losses)....... $ (6.9) $ (2.2) $ 50.6
============== ============== ==============
----------
(1) Investment expenses consist of personnel costs and investment management
and custody service fees, as well as interest incurred on funds held of
$.7, $.3 and $.1 for the years ended December 31, 2005, 2004 and 2003,
respectively.
(2) Deferred income taxes do not apply since these securities are carried at
amortized cost. During the first quarter of 2003, the Company reclassified
its fixed maturity securities categorized as held to maturity to the
available for sale classification, which resulted in recognizing $117.5 of
unrealized investment gains imbedded in such securities at December 31,
2002.
(d) Revenue Recognition -Pursuant to GAAP applicable to the insurance industry,
revenues are associated with the related benefits, claims, and expenses.
Substantially all general insurance premiums are reflected in income on a
pro-rata basis. Earned but unbilled premiums are generally taken into income on
the billing date, while adjustments for retrospective premiums, commissions and
similar charges or credits are accrued on the basis of periodic evaluations of
current underwriting experience and contractual obligations. Nearly all of the
Company's mortgage guaranty premiums stem from monthly installment policies.
Accordingly, such premiums are generally written and earned in the month
coverage is effective. With respect to annual or single premium policies, earned
premiums are recognized on a pro-rata basis over the terms of the policies.
Title premium and fee revenues stemming from the Company's direct operations
(which includes branch offices of its title insurer and wholly owned
subsidiaries of the Company) represent approximately 37 percent of such
consolidated title business revenues. Such premiums are generally recognized as
income at the escrow closing date which approximates the policy effective date.
Fee income related to escrow and other closing services is recognized when the
related services have been performed and completed. The remaining 63 percent of
consolidated title premium and fee revenues are title premiums produced by
independent title agents and underwritten title companies. Rather than making
estimates that could be subject to significant variance from actual premium
production, the Company recognizes revenues from those sources upon receipt.
Such receipts can reflect a three to four month lag relative to the effective
date of the underlying title policy, and are offset concurrently by production
expenses and claim reserve provisions.
(e) Deferred Policy Acquisition Costs-The Corporation's insurance subsidiaries,
other than title companies, defer certain costs which vary with and are
primarily related to the production of business. Deferred costs consist
principally of commissions, premium taxes, marketing, and policy issuance
expenses. With respect to most coverages, deferred acquisition costs are
amortized on the same basis as the related premiums are earned or,
alternatively, over the periods during which premiums will be paid. To the
extent that future policy revenues on existing policies are not adequate to
cover related costs and expenses, deferred policy acquisition costs are charged
to earnings. A write down of previously deferred acquisition costs applicable to
a discontinued life product amounted to $10.5 during the fourth quarter of 2004.
The following table summarizes deferred policy acquisition costs and
related data for the years shown:
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Deferred, beginning of year.................................... $ 232.3 $ 221.9 $ 197.8
-------------- -------------- --------------
Acquisition costs deferred:
Commissions - net of reinsurance........................... 219.1 209.4 178.6
Premium taxes.............................................. 75.5 69.9 58.2
Salaries and other marketing expenses...................... 92.6 91.5 102.5
-------------- -------------- --------------
Sub-total.............................................. 387.4 370.9 339.3
Amortization charged to income................................. (379.8) (360.5) (315.2)
-------------- -------------- --------------
Change for the year.................................... 7.6 10.4 24.0
-------------- -------------- --------------
Deferred, end of year.......................................... $ 240.0 $ 232.3 $ 221.9
============== ============== ==============
51
(f) Unearned Premiums-Unearned premium reserves are generally calculated by
application of pro-rata factors to premiums in force. At December 31, 2005 and
2004, unearned premiums consisted of the following:
December 31,
-----------------------------------------
2005 2004
--------------- ---------------
General Insurance Group .................................................... $ 993.3 $ 860.2
Mortgage Guaranty Group..................................................... 45.9 42.9
--------------- ---------------
Total................................................................... $ 1,039.3 $ 903.1
=============== ===============
(g) Losses, Claims and Settlement Expenses-The establishment of claim reserves
by the Company's insurance subsidiaries is a reasonably complex and dynamic
process influenced by a large variety of factors. These factors include past
experience applicable to the anticipated costs of various types of claims,
continually evolving and changing legal theories emanating from the judicial
system, recurring accounting, statistical, and actuarial studies, the
professional experience and expertise of the Company's claim departments'
personnel or attorneys and independent adjusters retained to handle individual
claims, the effect of inflationary trends on future claim settlement costs, and
ongoing changes in claim frequency or severity patterns such as those caused by
natural disasters, illnesses, accidents, work-related injuries, or changes in
economic conditions. Consequently, the reserve-setting process relies on the
judgments and opinions of a large number of persons, on the application and
interpretation of historical precedent and trends, and on expectations as to
future developments. At any point in time, the Company and the insurance
industry are exposed to possibly higher than anticipated claim costs due to the
aforementioned factors, and to the evolution, interpretation, and expansion of
tort law, as well as the effects of unexpected jury verdicts.
All reserves are necessarily based on estimates which are periodically
reviewed and evaluated in the light of emerging claim experience and changing
circumstances. The resulting changes in estimates are recorded in operations of
the periods during which they are made. Return and additional premiums and
policyholders' dividends, all of which tend to be affected by development of
claims in future years, may offset, in whole or in part, developed claim
redundancies or deficiencies for certain coverages such as workers'
compensation, portions of which are written under loss sensitive programs that
provide for such adjustments. The Company believes that its overall reserving
practices have been consistently applied over many years, and that its aggregate
net reserves have produced reasonable estimates of the ultimate net costs of
claims incurred. However, no representation is made that ultimate net claim and
related costs will not be greater or lower than previously established reserves.
General Insurance Group reserves are established to provide for the
ultimate expected cost of settling unpaid losses and claims reported at each
balance sheet date. Such reserves are based on continually evolving assessments
of the facts available to the Company during the settlement process which may
stretch over long periods of time. Long-term disability-type workers'
compensation reserves are discounted to present value based on interest rates
ranging from 3.5% to 4.0%. Losses and claims incurred but not reported, as well
as expenses required to settle losses and claims are established on the basis of
a large number of formulas that take into account various criteria, including
historical cost experience and anticipated costs of servicing reinsured and
other risks. Estimates of possible recoveries from salvage or subrogation
opportunities are considered in the establishment of such reserves as
applicable. As part of overall claim and claim expense reserves, the point
estimates incorporate amounts to cover net estimates of unusual claims such as
those emanating from asbestosis and environmental ("A&E") exposures as discussed
below. Such reserves can affect claim costs and related loss ratios for such
insurance coverages as general liability, commercial automobile (truck),
workers' compensation and property.
Early in 2001, the Federal Department of Labor revised the Federal Black
Lung Program regulations. The revisions basically require a re-evaluation of
previously settled, denied, or new occupational disease claims in the context of
newly devised, more lenient standards when such claims are resubmitted.
Following a number of challenges and appeals by the insurance and coal mining
industries, the revised regulations were, for the most part, upheld in June,
2002 and are to be applied prospectively. Since the final quarter of 2001 black
lung claims filed or refiled pursuant to these anticipated and now final
regulations have increased, though the volume of new claim reports has abated in
the last three years. The vast majority of claims filed to date against Old
Republic pertain to business underwritten through loss sensitive programs that
permit the charge of additional or refund of return premiums to wholly or
partially offset changes in estimated claim costs, or to business underwritten
as a service carrier on behalf of various industry-wide involuntary market (i.e.
assigned risk) pools. A much smaller portion pertains to business produced on a
traditional risk transfer basis. The Company has established applicable reserves
for claims as they have been reported and for claims not as yet reported on the
basis of its historical experience as well as assumptions relative to the effect
of the revised regulations. Inasmuch as a variety of challenges are likely as
the revised regulations are implemented through the actual claim settlement
process, the potential impact on reserves, gross and net of reinsurance or
retrospective premium adjustments, resulting from such regulations cannot as yet
be estimated with reasonable certainty.
Old Republic's reserve estimates also include provisions for indemnity and
settlement costs for various asbestosis and environmental impairment ("A&E")
claims that have been filed in the normal course of business against a number of
its insurance subsidiaries. Many such claims relate to policies issued prior to
1985, including many issued during a short period between 1981 and 1982 pursuant
to an agency agreement canceled in 1982. Over the years, the Corporation's
property and liability insurance subsidiaries have typically issued general
liability insurance policies with face amounts ranging between $1.0 and $2.0 and
rarely exceeding $10.0. Such policies have, in turn, been subject to reinsurance
cessions which have typically reduced the Corporation's retentions to $.5 or
less as to each claim.
52
Old Republic's exposure to A&E claims cannot be calculated by conventional
insurance reserving methods for a variety of reasons, including: a) the absence
of statistically valid data inasmuch as such claims typically involve long
reporting delays and very often uncertainty as to the number and identity of
insureds against whom such claims have arisen or will arise; and b) the
litigation history of such or similar claims for insurance industry members has
produced court decisions that have been inconsistent with regard to such
questions as when an alleged loss occurred, which policies provide coverage, how
a loss is to be allocated among potentially responsible insureds and/or their
insurance carriers, how policy coverage exclusions are to be interpreted, what
types of environmental impairment or toxic tort claims are covered, when the
insurer's duty to defend is triggered, how policy limits are to be calculated,
and whether clean-up costs constitute property damage. In recent times, the
Executive Branch and/or the Congress of the United States have proposed or
considered changes in the legislation and rules affecting the determination of
liability for environmental and asbestosis claims. As of December 31, 2005,
however, there is no solid evidence to suggest that possible future changes
might mitigate or reduce some or all of these claim exposures. Because of the
above issues and uncertainties, estimation of reserves for losses and allocated
loss adjustment expenses for A&E claims in particular is much more difficult or
impossible to quantify with a high degree of precision. Accordingly, no
representation can be made that the Corporation's reserves for such claims and
related costs will not prove to be overstated or understated in the future. At
December 31, 2005 and 2004, Old Republic's aggregate indemnity and loss
adjustment expense reserves specifically identified with A&E exposures amounted
to approximately $170.7 and $118.9 gross, respectively, and $132.2 and $97.1 net
of reinsurance, respectively. Old Republic's average five year survival ratios
stood at 7.4 years (gross) and 10.4 years (net of reinsurance) as of December
31, 2005 and 6.2 years (gross) and 9.6 years (net of reinsurance) as of December
31, 2004. Fluctuations in this ratio between years can be caused by the
inconsistent pay out patterns associated with these types of claims.
Mortgage guaranty loss reserves are based on calculations that take into
account the number of reported insured mortgage loan defaults as of each balance
sheet date, as well as experience-based estimates of loan defaults that have
occurred but have not as yet been reported. Further, the resulting loss reserve
estimates take into account a large number of variables including trends in
claim severity, potential salvage recoveries, expected cure rates for reported
loan defaults at various stages of default, and judgments relative to future
employment levels, housing market activity, and mortgage loan demand and
extensions.
Title insurance and related escrow service loss and loss adjustment expense
reserves are established to cover the estimated settlement costs of known as
well as claims incurred but not reported, concurrently with the recognition of
premium and escrow service revenues. Reserves for known claims are based on an
assessment of the facts available to the Company during the settlement process.
Reserves for claims incurred but not reported are established on the basis of
past experience and evaluations of such variables as changes and trends in the
types of policies issued, changes in real estate markets and interest rate
environments, and changed levels of loan refinancings, all of which can have a
bearing on the emergence, number, and ultimate cost of claims.
In addition to the above reserve elements, the Company establishes reserves
for loss settlement costs that are not directly related to individual claims.
Such reserves are based on prior years' cost experience and trends, and are
intended to cover the unallocated costs of claim departments' administration of
known and IBNR claims.
The following table shows an analysis of changes in aggregate reserves for
the Company's losses, claims and settlement expenses for each of the years
shown:
Years Ended December 31,
------------------------------------------------
2005 2004 2003
------------- ------------- -------------
Gross reserves at beginning of year................................ $ 4,403.5 $ 4,022.7 $ 3,676.8
Less: reinsurance losses recoverable ............................. 1,639.6 1,522.5 1,370.7
------------- ------------- -------------
Net reserves at beginning of year ........................ 2,763.8 2,500.1 2,306.0
------------- ------------- -------------
Incurred claims and claim adjustment expenses:
Provisions for insured events of the current year................ 1,504.5 1,348.7 1,159.2
Change in provision for insured events of prior years............ (43.9) (43.1) (60.8)
------------- ------------- -------------
Total incurred claims and claim adjustment expenses....... 1,460.7 1,305.7 1,098.4
------------- ------------- -------------
Payments:
Claims and claim adjustment expenses attributable to
insured events of the current year............................. 484.6 403.6 337.4
Claims and claim adjustment expenses attributable to
insured events of prior years.................................. 702.1 638.2 566.9
------------- ------------- -------------
Total payments............................................ 1,186.8 1,041.9 904.3
------------- ------------- -------------
Amount of reserves for unpaid claims and claim adjustment
expenses at the end of each year, net of reinsurance
losses recoverable............................................... 3,037.6 2,763.8 2,500.1
Reinsurance losses recoverable..................................... 1,902.1 1,639.6 1,522.5
------------- ------------- -------------
Gross reserves at end of year...................................... $ 4,939.8 $ 4,403.5 $ 4,022.7
============= ============= =============
53
For the three most recent calendar years, the above table indicates that
the one-year development of consolidated reserves at the beginning of each year
produced average favorable annual developments of about 2.0%. The Company
believes that the factors most responsible, in varying and continually changing
degrees, for such redundancies or deficiencies included differences in
originally estimated salvage and subrogation recoveries, in sales and prices of
homes that can reduce claim costs upon the sale of foreclosed properties, in
levels of loan refinancing activity that can reduce the period of time over
which a policy remains at risk, in lower than expected frequencies of claims
incurred but not reported, in the effect of reserve discounts applicable to
workers' compensation claims, in higher than expected severity of litigated
claims in particular, in governmental or judicially imposed retroactive
conditions in the settlement of claims such as noted above in regard to black
lung disease claims, in greater than anticipated inflation rates applicable to
repairs and the medical portion of claims in particular, and in higher than
expected claims incurred but not reported due to the slower and highly volatile
emergence patterns applicable to certain types of claims such as those stemming
from litigated, assumed reinsurance, or the A&E types of claims noted above.
(h) Income Taxes-The Corporation and most of its subsidiaries file a
consolidated tax return and provide for income taxes payable currently. Deferred
income taxes included in the accompanying consolidated financial statements will
not necessarily become payable/recoverable in the future. The Company uses the
asset and liability method of calculating deferred income taxes. This method
calls for the establishment of a deferred tax, calculated at currently enacted
tax rates that are applied to the cumulative temporary differences between
financial statement and tax bases of assets and liabilities.
The provision for combined current and deferred income taxes reflected in
the consolidated statements of income does not bear the usual relationship to
income before income taxes as the result of permanent and other differences
between pretax income and taxable income determined under existing tax
regulations. The more significant differences, their effect on the statutory
income tax rate, and the resulting effective income tax rates are summarized
below:
Years Ended December 31,
------------------------------------------------
2005 2004 2003
------------- -------------- -------------
Statutory tax rate................................................ 35.0% 35.0% 35.0%
Tax rate increases (decreases):
Tax-exempt interest ........................................ (2.6) (2.4) (2.3)
Dividends received exclusion................................ (.2) (.5) (.5)
Other items - net (1) ...................................... (6.0) 1.1 .2
------------- -------------- -------------
Effective tax rate................................................ 26.2% 33.2% 32.4%
============= ============== =============
(1) During 2004, the Company recorded a pretax charge of $22.9 in response
to a court ruling against Old Republic Title Company. Of that amount,
approximately $11.8 was non-deductible, resulting in an increase in the
effective tax rate of 0.6 percentage points. Tax and related interest recoveries
of $57.9 ($45.9 net of tax) were recorded in the second quarter of 2005 due to
the favorable resolution of tax issues applicable to the three years ended
December 31, 1990. This adjustment reduced the 2005 effective tax rate by
approximately 6.2 percentage points.
The tax effects of temporary differences that give rise to significant
portions of the Company's net deferred tax assets (liabilities) are as follows
at the dates shown:
December 31,
------------------------------------------------
2005 2004 2003
------------- -------------- -------------
Deferred Tax Assets:
Losses, claims, and settlement expenses....................... $ 176.5 $ 177.1 $ 161.5
Other timing differences...................................... 15.8 23.9 25.5
------------- -------------- -------------
Total deferred tax assets (1)............................. 192.3 201.0 187.1
------------- -------------- -------------
Deferred Tax Liabilities:
Unearned premium reserves..................................... 29.5 30.1 33.2
Deferred policy acquisition costs............................. 77.7 75.7 72.3
Mortgage guaranty insurers' contingency reserves.............. 468.5 545.8 499.4
Fixed maturity securities adjusted to cost.................... 6.8 7.4 8.2
Net unrealized investment gains............................... 26.9 91.9 126.2
Title plants and records...................................... 4.4 4.4 4.4
------------- -------------- -------------
Total deferred tax liabilities............................ 614.0 755.5 743.9
------------- -------------- -------------
Net deferred tax liabilities.............................. $ 421.6 $ 554.5 $ 556.8
============= ============== =============
----------
(1) The Company has evaluated its deferred tax assets as of each of these dates
and has concluded that no valuation allowance is warranted.
Pursuant to special provisions of the Internal Revenue Code pertaining to
mortgage guaranty insurers, a contingency reserve (established in accordance
with insurance regulations designed to protect policyholders against
extraordinary volumes of claims) is deductible from gross income. The tax
benefits obtained from such deductions must, however, be invested in a special
type of non-interest bearing U.S. Treasury Tax and Loss Bonds which aggregated
54
$545.7 at December 31, 2005. For Federal income tax purposes, amounts deducted
from the contingency reserve are taken into gross statutory taxable income in
the period in which they are released. Contingency reserves may be released when
incurred losses exceed thresholds established under state law or regulation,
upon special request and approval by state insurance regulators, or in any
event, upon the expiration of ten years. The Company released contingency
reserves of $350.0 during the fourth quarter of 2005 and consequently, $122.5 of
U.S. Treasury Tax and Loss Bonds were redeemed during January 2006.
In April, 2004 the IRS issued a so-called "30 Day Letter" to the Company as
a result of a recently completed examination of tax returns for years 1998 to
2000 (see note 4(c), Commitments and Contingent Liabilities - General for
further information).
(i) Property and Equipment-Property and equipment is generally depreciated or
amortized over the estimated useful lives of the assets, (2 to 27 years),
substantially by the straight-line method. Depreciation and amortization
expenses related to property and equipment were $19.0, $18.2, and $16.2 in 2005,
2004, and 2003, respectively. Expenditures for maintenance and repairs are
charged to income as incurred, and expenditures for major renewals and additions
are capitalized.
(j) Title Plants and Records-Title plants and records are carried at original
cost or appraised value at the date of purchase. Such values represent the cost
of producing or acquiring interests in title records and indexes and the
appraised value of purchased subsidiaries' title records and indexes at dates of
acquisition. The cost of maintaining, updating, and operating title records is
charged to income as incurred. Title records and indexes are ordinarily not
amortized unless events or circumstances indicate that the carrying amount of
the capitalized costs may not be recoverable.
(k) Goodwill-Goodwill resulting from business combinations is no longer
amortizable against operations but must be tested annually for possible
impairment of its continued value ($93.1 and $92.2 at December 31, 2005 and
2004, respectively). No impairment charges were required for any period
presented.
(l) Employee Benefit Plans- The Corporation has three pension plans covering a
portion of its work force. The three plans are the Old Republic International
Salaried Employees Restated Retirement Plan (the Old Republic Plan), the
Bituminous Casualty Corporation Retirement Income Plan (the Bituminous Plan) and
the Old Republic National Title Group Pension Plan (the Title Plan). The plans
are defined benefit plans pursuant to which pension payments are based primarily
on years of service and employee compensation near retirement. It is the
Corporation's policy to fund the plans' costs as they accrue. These plans were
closed to new participants as of December 31, 2004.
Plan assets are comprised principally of bonds, common stocks and
short-term investments. The dates used to determine pension measurements are
December 31 for the Old Republic Plan and the Bituminous Plan, and September 30
for the Title Plan.
The changes in the projected benefit obligation are as follows at the above
measurement dates:
2005 2004 2003
------------- -------------- -------------
Projected benefit obligation at beginning of year................. $ 214.4 $ 195.8 $ 161.6
------------- -------------- -------------
Increases (decreases) during the year attributable to:
Service cost................................................... 8.5 7.7 5.8
Interest cost.................................................. 12.2 11.5 11.0
Actuarial losses............................................... 4.4 7.6 26.4
Benefits paid.................................................. (8.7) (8.3) (9.1)
------------- -------------- -------------
Net increase for year............................................. 16.5 18.5 34.2
------------- -------------- -------------
Projected benefit obligation at end of year....................... $ 230.9 $ 214.4 $ 195.8
============= ============== =============
The changes in the fair value of net assets available for plan benefits as
of the above measurement dates are as follows:
2005 2004 2003
------------- -------------- -------------
Fair value of net assets available for plan benefits
at beginning of the year....................................... $ 185.7 $ 175.0 $ 156.6
------------- -------------- -------------
Increases (decreases) during the year attributable to:
Actual return on plan assets................................... 10.8 13.5 17.4
Sponsor contributions.......................................... 8.0 5.7 10.1
Benefits paid.................................................. (8.7) (8.3) (9.1)
Administrative expenses........................................ (.1) (.1) (.1)
------------- -------------- -------------
Net increase for year............................................. 9.8 10.7 18.3
------------- -------------- -------------
Fair value of net assets available for plan benefits
at the end of the year......................................... $ 195.6 $ 185.7 $ 175.0
============= ============== =============
55
A reconciliation of the funded status of the plans as of the above
measurement dates is as follows:
2005 2004
------------- -------------
Plan assets less than projected benefit obligations.................................... $ (35.3) $ (28.6)
Prior service cost not yet recognized in net periodic
pension cost........................................................................ - .1
Unrecognized net loss.................................................................. 53.4 47.3
------------- -------------
Pension asset recognized in the consolidated balance sheet............................. $ 18.1 $ 18.7
============= =============
Amounts recognized in the statement of financial position as of the above
measurement dates consist of the following:
Pension Benefits
------------------------------
2005 2004
------------- -------------
Prepaid benefit cost................................................................... $ 32.1 $ 29.6
Accrued benefit cost................................................................... (17.2) (12.4)
Additional minimum pension liability................................................... 3.2 1.5
------------- -------------
Net amount recognized.................................................................. $ 18.1 $ 18.7
============= =============
The following information is being provided for the Old Republic Plan whose
accumulated benefit obligation exceeds plan assets as of December 31:
2005 2004
------------- -------------
Projected benefit obligations.......................................................... $ 73.9 $ 66.1
Accumulated benefit obligations........................................................ 64.1 59.9
Fair value of plan assets.............................................................. 46.9 47.4
The weighted-average asset allocations of the Plans as of the above
measurement dates are as follows:
Plan Assets
------------------------------- Investment Policy Asset
2005 2004 Allocation % Range Target
------------- ------------- -------------------------------------
Equity securities: 30% to 70%
Common shares of Company stock.......... - % - %
Other................................... 48.9 47.8
Debt securities.............................. 43.7 47.8 30% to 70%
Other (including short-term and
accrued interest and dividends)............ 7.4 4.4 1% to 20%
------------- -------------
Total.............................. 100.0% 100.0%
============= =============
The Corporation's three plans adhere to the same investment policy pursuant
to which the Corporation's general assets are managed. Asset/liability matching
techniques, diversification, and high quality investments are stressed. Lower
quality issuers and derivatives are avoided. Non-callable, U.S. government and
investment grade corporate fixed income securities of intermediate maturities
are purchased to meet the plans' obligations out to ten years. Holdings of
equity securities, which are primarily comprised of value oriented index funds,
are preferred investment vehicles to meet the longer term obligations of the
plans. Some funds are employed for diversification purposes. Short-term
securities are held to cover current plan obligations and anticipated expenses.
Investment policy asset allocation range targets, listed above, are applicable
to each plan, and allow for modest changes in investment strategy as financial
market conditions warrant.
The components of aggregate annual net periodic pension costs that take
into account the above measurement dates consisted of the following:
2005 2004 2003
------------- ------------- -------------
Service cost......................................................... $ 8.5 $ 7.7 $ 5.8
Interest cost........................................................ 12.2 11.5 11.0
Expected return on plan assets....................................... (14.7) (14.4) (14.1)
Recognized loss...................................................... 2.4 2.3 2.9
------------- ------------- -------------
Net cost............................................................. $ 8.5 $ 7.1 $ 5.7
============= ============= =============
56
The projected benefit obligations for the plans were determined using the
following weighted-average assumptions as of the above measurement dates:
2005 2004
------------- -------------
Settlement discount rates.............................................................. 5.67% 5.93%
Rates of compensation increase......................................................... 3.59% 3.54%
Long-term rates of return on plans' assets............................................. 7.74% 8.38%
The net periodic benefit cost for the Plans were determined using the
following weighted-average assumptions, for the plan years taking into account
the above measurement dates:
2005 2004
------------- -------------
Settlement discount rates.............................................................. 5.93% 6.00%
Rates of compensation increase......................................................... 3.54% 3.38%
Long-term rates of return on plans' assets............................................. 8.09% 8.37%
The assumed settlement discount rates were determined by matching the
current estimate of each Plan's projected cash outflows against spot rate yields
on a portfolio of high quality bonds as of their respective measurement date. To
develop the expected long-term rate of return on assets assumption, the Plans
considered the historical returns and the future expectations for returns for
each asset class, as well as the target asset allocation of the pension
portfolios.
The accumulated benefit obligation for the Plans was $202.6 and $187.1 for
the 2005 and 2004 plan years taking into account the above measurement dates,
respectively.
The benefits expected to be paid as of December 31, 2005 for the next 10
years are as follows: 2006: $9.2; 2007: $10.0; 2008: $10.7; 2009: $10.8; 2010:
$11.9; and for the five years after 2010: $74.1.
The companies are expecting to make cash or non-cash contributions to their
pension plans in calendar year 2006 of approximately $3.1.
The Corporation has a number of profit sharing and other incentive
compensation programs for the benefit of a substantial number of its employees.
The costs related to such programs are summarized below:
Years Ended December 31,
------------------------------------------------
2005 2004 2003
------------- ------------- -------------
Employees Savings and Stock Ownership Plan........................... $ 6.5 $ 5.6 $ 5.3
Other profit sharing plans........................................... 9.3 8.3 7.2
Deferred and incentive compensation.................................. $ 29.1 $ 32.1 $ 31.2
============= ============= =============
The Company sponsors an Employees Savings and Stock Ownership Plan (ESSOP)
in which a majority of its employees participate. The ESSOP initially acquired
its stock of the Company in 1987 and prior years. All such shares have been
released over the years, and current Company contributions are directed to the
open market purchase of its shares. Dividends on released shares are allocated
to participants as earnings. The Company's annual contributions are based on a
formula that takes growth in net operating income per share over consecutive
five year periods into account. As of December 31, 2005, there were 11,378,766
Old Republic common shares owned by the ESSOP, all of which were released and
allocated to employees' account balances. There are no repurchase obligations in
existence.
(m) Escrow Funds-Segregated cash deposit accounts and the offsetting liabilities
for escrow deposits in connection with Title Insurance Group real estate
transactions in the same amounts ($1,426.3 and $1,171.0 at December 31, 2005 and
2004, respectively) are not included as assets or liabilities in the
accompanying consolidated balance sheets as the escrow funds are not available
for regular operations.
57
(n) Earnings Per Share-Consolidated basic earnings per share excludes the
dilutive effect of common stock equivalents and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
actually outstanding for the year. Diluted earnings per share are similarly
calculated with the inclusion of common stock equivalents. The following tables
provide a reconciliation of net income and number of shares used in basic and
diluted earnings per share calculations.
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
--------------- --------------- --------------
Numerator:
Net Income ............................................. $ 551.4 $ 435.0 $ 459.8
Less: Convertible preferred stock dividends............. - - -
--------------- --------------- --------------
Numerator for basic earnings per share -
income available to common stockholders............. 551.4 435.0 459.8
Effect of dilutive securities:
Convertible preferred stock dividends............... - - -
--------------- --------------- --------------
Numerator for diluted earnings per share -
income available to common stockholders
after assumed conversions.......................... $ 551.4 $ 435.0 $ 459.8
=============== =============== ==============
Denominator:
Denominator for basic earnings per share -
weighted-average shares............................ 229,487,273 228,177,278 226,936,856
Effect of dilutive securities:
Stock options....................................... 2,621,218 2,582,262 2,186,524
Convertible preferred stock......................... - - 5,289
--------------- --------------- --------------
Dilutive potential common shares.................... 2,621,218 2,582,262 2,191,813
--------------- --------------- --------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions................................ 232,108,491 230,759,540 229,128,669
=============== =============== ==============
Basic earnings per share (1)........................... $ 2.40 $ 1.91 $ 2.02
=============== =============== ==============
Diluted earnings per share (1)......................... $ 2.37 $ 1.89 $ 2.01
=============== =============== ==============
----------
(1) All per share statistics have been restated to reflect all stock dividends
or splits declared through December 31, 2005.
(o) Concentration of Credit Risk-Excluding U.S. government fixed maturity
securities, the Company is not exposed to material concentrations of credit
risks as to any one issuer.
(p) Stock Option Compensation-The Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 148 ("FAS 148")
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of FAS No. 123" for periods starting after December 15, 2002. As of
April 1, 2003, the Company adopted the requirements of FAS 148 utilizing the
prospective method. Under this method, stock-based compensation expense is
recognized for awards granted after the beginning of the fiscal year of
adoption, as such awards become vested. For all other stock option awards
outstanding, the Company continues to use the intrinsic value method permitted
under existing accounting pronouncements. The following table shows a comparison
of net income and related per share information as reported, and on a pro forma
basis on the assumption that the estimated value of stock options was treated as
compensation cost for all years shown. In estimating the compensation cost of
options, the fair value of options has been calculated using the Black-Scholes
option pricing model. Expense recognition of stock options granted in 2005, 2004
and 2003 reduced earnings by $3.0 or 1 cent per share in 2005, $5.6 or 2 cents
per share in 2004, and $1.4 or less than 1 cent per share in 2003.
58
Years Ended December 31,
--------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Option pricing/weighted average assumptions:
Risk-free interest rates...................................... 4.62% 4.06% 4.36%
Dividend yield................................................ 3.82% 2.68% 3.12%
Common stock market
price volatility factors................................... .26 .26 .26
Expected option life.......................................... 10 years 10 years 10 years
Comparative data:
Net income:
As reported................................................ $ 551.4 $ 435.0 $ 459.8
Add: Stock based compensation expense included
in reported income, net of related tax effects........ 3.0 5.6 1.4
Deduct: Total stock-based employee compensation
expense determined under the fair value based
method for all awards, net of related tax effects...... 8.6 11.0 4.6
-------------- -------------- --------------
Pro forma basis............................................ $ 545.7 $ 429.5 $ 456.5
============== ============== ==============
Basic earnings per share:
As reported................................................ $ 2.40 $ 1.91 $ 2.02
Pro forma basis............................................ 2.38 1.88 2.01
Diluted earnings per share:
As reported................................................ 2.37 1.89 2.01
Pro forma basis............................................ $ 2.35 $ 1.86 $ 1.99
============== ============== ==============
A summary of the status of the Corporation's stock options as of December
31, 2005, 2004 and 2003, and changes in outstanding options during the years
then ended follows:
As of and for the Years Ended December 31,
--------------------------------------------------------------------------------
2005 2004 2003
------------------------ ----------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ---------- ---------- --------- ---------- -----------
Outstanding at beginning of year ....... 11,602,443 $ 15.00 10,468,096 $ 13.64 8,991,325 $ 13.17
Granted................................. 2,057,500 18.44 2,525,625 19.33 2,313,750 14.37
Exercised............................... 1,249,709 13.04 1,149,432 11.91 790,538 10.30
Forfeited and canceled ................. 144,064 17.01 241,846 15.81 46,441 14.78
---------- ---------- ----------
Outstanding at end of year.............. 12,266,170 15.76 11,602,443 15.00 10,468,096 13.64
========== ========== ==========
Exercisable at end of year.............. 7,725,233 $ 14.31 7,465,064 $ 13.58 4,725,208 $ 11.98
========== ========== ========== ========= ========== ===========
Weighted average fair value of
options granted during the year (1). $ 4.34 per share $ 5.42 per share $ 3.81 per share
========== ========== ==========
(1) Based on the Black-Scholes option pricing model and the assumptions
outlined in the table above.
59
A summary of stock options outstanding and exercisable at December 31, 2005
follows:
Options Outstanding Options Exercisable
------------------------------------------ -------------------------
Weighted - Average
--------------------------- Weighted
Year(s) Number Remaining Average
Of Out- Contractual Exercise Number Exercise
Ranges of Exercise Prices Grant Standing Life Price Exercisable Price
-------------------------------- -------- ----------- ------------ ----------- ----------- ----------
$ 9.51......................... 1997 577,713 1.00 $ 9.51 575,324 $ 9.51
$15.49......................... 1998 1,185,356 2.00 15.49 906,266 15.49
$ 9.37 to $10.40............... 1999 605,410 3.00 10.40 596,720 10.40
$ 6.40 to $ 7.23............... 2000 474,425 4.00 6.40 450,128 6.40
$14.36......................... 2001 1,455,254 5.00 14.36 1,349,230 14.36
$16.85......................... 2002 1,754,226 6.00 16.85 1,215,125 16.85
$14.37......................... 2003 1,746,711 7.00 14.37 1,720,910 14.37
$19.32 to $20.02............... 2004 2,422,325 8.00 19.33 662,341 19.33
$18.41 to $20.87............... 2005 2,044,750 9.00 $ 18.44 249,189 $ 18.44
----------- =========== ----------- ==========
Total..................... 12,266,170 7,725,233
=========== ===========
The maximum number of options available for future issuance as of December
31, 2005, is approximately 1,508,354 shares.
During December, 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 - Revised ("FAS 123R")
"Share-Based Payment". FAS 123R requires entities to recognize the cost of
employee services received in exchange for awards of equity instruments based on
the grant-date fair value of those awards. The effective date of this
pronouncement is the first annual, reporting period that begins after June 15,
2005. The Company believes that the reduction to fully diluted earnings per
share will be immaterial when the modified prospective transition method is
used.
(q) Statement Presentation-Amounts shown in the consolidated financial
statements and applicable notes are stated (except as otherwise indicated and as
to share data) in millions, which amounts may not add to totals shown due to
truncation. Necessary reclassifications are made in prior periods' financial
statements whenever appropriate to conform to the most current presentation. The
Company has revised the statements of cash flows to present the net change in
short-term investments as a separate component of cash flows from investing
activities.
Note 2-Debt-Consolidated debt of Old Republic and its subsidiaries is summarized
below:
December 31,
-------------------------------------------------------
2005 2004
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ----------- -----------
Commercial paper due within 180 days with an
average yield of 4.48% and 2.50%, respectively....... $ 18.8 $ 18.8 $ 18.9 $ 18.9
Debentures maturing in 2007 at 7.0%...................... 114.9 118.2 114.9 123.6
Other miscellaneous debt................................. 8.8 8.8 9.0 9.0
---------- ----------- ----------- -----------
Total Debt...................................... $ 142.7 $ 145.9 $ 143.0 $ 151.7
========== =========== =========== ===========
The Company has access to the commercial paper market for up to $150.0 of
which $131.0 remains unused as of December 31, 2005. The carrying amount of the
Company's commercial paper borrowings approximates its fair value. The fair
value of publicly traded debt is based on its quoted market price.
Scheduled maturities of the above debt at December 31, 2005 are as follows:
2006: $19.7; 2007: $121.0; 2008: $.3; 2009: $.3; 2010: $.3; 2011 and after: $.8.
During 2005, 2004 and 2003, $9.5, $8.7 and $8.8, respectively, of interest
expense on debt was charged to consolidated operations.
60
Note 3-Shareholders' Equity - All common and preferred share data herein has
been retroactively adjusted as applicable for stock dividends or splits declared
through December 31, 2005.
(a) Preferred Stock-The following table shows certain information pertaining to
the Corporation's preferred shares issued and outstanding:
Convertible
-------------
Preferred Stock Series: Series G(1)
-------------
Annual cumulative dividend rate per share.............................................. $ (1)
Conversion ratio of preferred into common shares ...................................... 1 for .95
Conversion right begins................................................................ Anytime
Redemption and liquidation value per share............................................. (1)
Redemption beginning in year........................................................... (1)
Total redemption value (millions)...................................................... (1)
Vote per share......................................................................... one
Shares outstanding:
December 31, 2004.................................................................... 0
December 31, 2005.................................................................... 0
=============
----------
(1) The Corporation has authorized up to 1,000,000 shares of Series G
Convertible Preferred Stock for issuance pursuant to the Corporation's
Stock Option Plan. Series G had been issued under the designation "G-2". As
of December 31, 2003, all Series "G-2" had been converted into shares of
common stock. In 2001, the Corporation created a new designation, "G-3",
from which no shares have been issued as of December 31, 2005. Management
believes this designation will be the source of possible future issuances
of Series G stock. Except as otherwise stated, Series "G-2" and Series
"G-3" are collectively referred to as Series "G". Each share of Series G
pays a floating rate dividend based on the prime rate of interest. At
December 31, 2005, the annual dividend rate for Series G-3 would have been
65 cents per share. Each share of Series G is convertible at any time,
after being held six months, into 0.95 shares of Common Stock (See Note
3(c)). Unless previously converted, Series G shares may be redeemed at the
Corporation's sole option five years after their issuance.
(b) Cash Dividend Restrictions-The payment of cash dividends by the Corporation
is principally dependent upon the amount of its insurance subsidiaries'
statutory policyholders' surplus available for dividend distribution. The
insurance subsidiaries' ability to pay cash dividends to the Corporation is in
turn generally restricted by law or subject to approval of the insurance
regulatory authorities of the states in which they are domiciled. These
authorities recognize only statutory accounting practices for determining
financial position, results of operations, and the ability of an insurer to pay
dividends to its shareholders. Based on 2005 data, the maximum amount of
dividends payable to the Corporation by its insurance and a small number of
non-insurance company subsidiaries during 2006 without the prior approval of
appropriate regulatory authorities is approximately $474.4.
(c) Stock Option Plan-The Corporation has stock option plans for certain
eligible key employees. The plan in effect since 1992 was amended in 2002 for
grants made in 2002 prior to the plan's expiration, and the granting of new
options in May, 2002. A new plan was adopted and approved by the shareholders in
May, 2002 to cover grants made in 2003 and thereafter. The combination of
options awarded at the date of grant and previously issued options still
outstanding at such date, may not exceed 6% of the Old Republic common stock
then issued and outstanding. The exercise price of options is equal to the
market price of the Corporation's stock at the date of grant, and the term of
the options is generally ten years from such date. Options granted in 2001 and
prior years under the 1992 plan may be exercised to the extent of 10% of the
number of options covered thereby on and after the date of grant, and
cumulatively to the extent of an additional 10% on and after each of the first
through ninth subsequent calendar years. Options granted in 2002 and thereafter
may be exercised to the extent of 10% of the number of options covered thereby
on and after the date of grant, and cumulatively to the extent of an additional
15%, 20%, 25% and 30% on and after the second through fifth calendar years,
respectively.
In the event the closing market price of Old Republic's common stock
reaches a pre-established value ("the vesting acceleration price"), options
granted in 2001 and prior years may be exercised cumulatively to the extent of
10% of the number of shares covered by the grant for each year of employment by
the optionee. For grants in 2002 and 2003, optionees become vested on an
accelerated basis to the extent of the greater of 10% of the options granted
times the number of years of employment, or the sum of the optionee's already
vested grant plus 50% of the remaining unvested grant. There is no vesting
acceleration for 2004 and subsequent years' grants.
The option plans enable optionees to, alternatively, exercise their options
that have vested through December 31, 2004, into Series "G" Convertible
Preferred Stock. The exercise of options into such Preferred Stock reduces by 5%
the number of equivalent common shares which would otherwise be obtained from
the exercise of options into common shares.
(d) Common Stock-There were 500,000,000 shares of common stock authorized at
December 31, 2005. At the same date, there were 100,000,000 shares of Class "B"
common stock authorized, though none were issued or outstanding. Class "B"
common shares have the same rights as common shares except for being entitled to
1/10th of a vote per share. In December, 2005 and May, 2003, the Company
canceled 3,581,979, and 2,404,638 common shares, respectively, previously
reported as treasury stock and restored them to unissued status; this had no
61
effect on total shareholders' equity or the financial position of the Company.
(e) Undistributed Earnings-At December 31, 2005, the equity of the Corporation
in the undistributed earnings, determined in accordance with generally accepted
accounting principles, and in the net unrealized investment gains (losses) of
its subsidiaries amounted to $3,060.8 and $50.5, respectively. Dividends
declared during 2005, 2004 and 2003, to the Corporation by its subsidiaries
amounted to $287.2, $186.3 and $174.6, respectively.
(f) Statutory Data-The policyholders' surplus and net income (loss), determined
in accordance with statutory accounting practices, of the Corporation's
insurance company subsidiaries was as follows at the dates and for the periods
shown:
Policyholders' Surplus Net Income (Loss)
-------------------------- -----------------------------------------
December 31, Years Ended December 31,
-------------------------- -----------------------------------------
2005 2004 2005 2004 2003
----------- ----------- ----------- ----------- -----------
General Insurance Group................. $ 1,899.1 $ 1,688.7 $ 312.4 $ 243.5 $ 175.7
Mortgage Guaranty Group................. 369.4 224.5 93.4 208.4 233.9
Title Insurance Group................... 172.6 166.2 43.3 51.7 42.7
Other (1)............................... 55.6 49.3 3.0 (2.9) (2.8)
Combined (2)............................ $ 2,483.6 $ 2,109.0 $ 452.1 $ 500.7 $ 449.5
=========== =========== =========== =========== ===========
(1) Represents amounts for Old Republic's small life and health operation.
(2) After elimination of intercompany investments.
Note 4-Commitments and Contingent Liabilities:
(a) Reinsurance and Retention Limits-In order to maintain premium production
within their capacity and to limit maximum losses for which they might become
liable under policies they've underwritten, Old Republic's insurance
subsidiaries, as is the common practice in the insurance industry, may cede all
or a portion of their premiums and liabilities on certain classes of business to
other insurers and reinsurers. Although the ceding of insurance does not
ordinarily discharge an insurer from liability to a policyholder, it is industry
practice to establish the reinsured part of risks as the liability of the
reinsurer. Old Republic also employs retrospective premium and risk-sharing
arrangements for parts of its business in order to reduce underwriting losses
for which it might become liable under insurance policies it issues. To the
extent that any reinsurance companies, assured or producer might be unable to
meet their obligations under existing reinsurance, retrospective insurance and
production agreements, Old Republic would be liable for the defaulted amounts.
As deemed necessary, reinsurance ceded to other companies is secured by letters
of credit, cash, and/or securities.
Except as noted in the following paragraph, reinsurance protection on
property and liability operations generally limits the net loss on most
individual claims to a maximum of (in thousands): $1,800 for workers'
compensation; $1,800 for commercial auto liability; $1,800 for general
liability; $3,800 for executive protection (directors & officers and errors &
omissions); $1,000 for aviation; and $1,000 for property coverages.
Substantially all the mortgage guaranty insurance risk is retained, with the
exposure on any one risk currently averaging approximately $22, though portions
of the business are also ceded to captive reinsurers on an excess of loss basis
in most instances. Title insurance risk assumptions are currently limited to a
maximum of $100,000 as to any one policy. The vast majority of title policies
issued, however, carry exposures of $500 or less.
Due to worldwide reinsurance capacity and related cost constraints,
effective January 1, 2002, the Corporation began retaining exposures for all,
but most predominantly workers' compensation liability insurance coverages in
excess of $40.0 that were previously assumed by unaffiliated reinsurers for up
to $100.0. Effective January 1, 2003 reinsurance ceded limits were raised to the
$100.0 level, and as of January 1, 2005, they have been further increased to
$200.0. Pursuant to regulatory requirements, however, all workers' compensation
primary insurers such as the Company remain liable for unlimited amounts in
excess of reinsured limits. Other than the substantial concentration of workers'
compensation losses caused by the September 11, 2001 terrorist attack on
America, to the best of the Company's knowledge there had not been a similar
accumulation of claims in a single location from a single occurrence prior to
that event. Nevertheless, the possibility continues to exist that non-reinsured
losses could, depending on a wide range of severity and frequency assumptions,
aggregate several hundred million dollars to an insurer such as the Company in
the event a catastrophe such as caused by an earthquake leading to the death or
injury of a large number of employees concentrated in a single facility such as
a high rise building.
As a result of the September 11, 2001 terrorist attack on America, the
reinsurance industry eliminated coverage from substantially all contracts for
claims arising from acts of terrorism. Primary insurers such as the Company
thereby became fully exposed to such claims. Late in 2002, the Terrorism Risk
Insurance Act of 2002 (the "TRIA") was signed into law, immediately establishing
a temporary federal reinsurance program administered by the Secretary of
Treasury. The program applies to insured commercial property and casualty losses
resulting from an act of terrorism, as defined in the TRIA. Congress extended
and modified the program in late 2005 through the Terrorism Risk Insurance
Extension Act of 2005 (the "TRIEA"). The temporary program will now sunset on
December 31, 2007 if not extended or replaced by similar legislation. The TRIA
automatically voided all policy exclusions which were in effect for terrorism
related losses and obligated insurers to offer terrorism coverage with most
commercial property and casualty insurance lines. The TRIEA revised the
definition of "property and casualty insurance" to exclude commercial
automobile, burglary and theft, surety, professional liability and farm owners
multi-peril insurance. Although insurers are permitted to charge an additional
premium for terrorism coverage, insureds may reject the coverage. Under TRIEA,
the program's protection is not triggered for losses arising from an act of
62
terrorism after March 31, 2006 until the industry first suffers losses of $50
billion in the aggregate in 2006. The program trigger amount increases to $100
billion for 2007. Once the program trigger is met, the program will pay 90% of
an insurer's terrorism losses that exceed that individual insurer's deductible.
The federal share drops to 85% for 2007. The insurer's deductible is 17.5% of
direct earned premium on property and casualty insurance for 2006 and increases
to 20% for 2007. Insurers may reinsure that portion of the risk they retain
under the program, but the reinsurance market has not displayed a widespread
willingness to accept such risks. To date, coverage for acts of terrorism are
excluded from substantially all the Corporation's reinsurance treaties and are
effectively retained by it subject to any recovery that would be collected under
the temporary federal reinsurance program.
Reinsurance ceded by the Corporation's insurance subsidiaries in the
ordinary course of business is typically placed on an excess of loss basis.
Under excess of loss reinsurance agreements, the companies are generally
reimbursed for losses exceeding contractually agreed-upon levels. Quota share
reinsurance is most often effected between the Company's insurance subsidiaries
and industry-wide assigned risk plans or captive insurers owned by assureds.
Under quota share reinsurance, the Company remits to the assuming entity an
agreed upon percentage of premiums written and is reimbursed for applicable
underwriting expenses and claims costs.
Reinsurance recoverable asset balances represent amounts due from or
credited by assuming reinsurers for paid and unpaid claims and premium reserves.
Such reinsurance balances that are recoverable from non-admitted foreign and
certain other reinsurers such as captive insurance companies owned by assureds,
as well as similar balances or credits arising from policies that are
retrospectively rated or subject to assureds' high deductible retentions are
substantially collateralized by letters of credit, securities, and other
financial instruments. Old Republic evaluates on a regular basis the financial
condition of its assuming reinsurers and assureds who purchase its
retrospectively rated or self-insured deductible policies. Estimates of
unrecoverable amounts totaling $36.8 as of December 31, 2005 and $45.6 as of
December 31, 2004 are included in the Company's net claim and claim expense
reserves since reinsurance, retrospectively rated, and self-insured deductible
policies and contracts do not relieve Old Republic from its direct obligations
to assureds or their beneficiaries.
At December 31, 2005, the Company's ten largest reinsurers represented
approximately 63% of reinsurance recoverable on paid and unpaid losses of which
31.8% of the total was due from American Re-Insurance Company. Of the balance
due from these ten reinsurers, 75.8% was recoverable from A or better rated
reinsurance companies, 15.0% from insurance assigned risk pools, and 9.1% from
captive reinsurance companies.
The following information relates to reinsurance and related data for the
General Insurance and Mortgage Guaranty Groups for the three years ended
December 31, 2005. For years 2003 to 2005, reinsurance transactions of the Title
Insurance Group and small life and health insurance operation have not been
material.
Property and liability insurance companies are required to annualize
certain policy premiums in their regulatory financial statements though such
premiums may not be contractually due as of each balance sheet date. The
annualization process relies on a large number of estimates, and has the effect
of increasing direct, ceded, and net premiums written, and of grossing up
corresponding balance sheet premium balances and liabilities such as unearned
premium reserves. The accrual of these estimates has no effect on net premiums
earned or GAAP net income. During 2005, the Company further refined certain
premium annualization estimates and concurrently reclassified various related
premium balances. In the following table, the sum total of these adjustments had
the effect of increasing general insurance direct premiums written by $66.3,
premiums written ceded by $43.2, and net premiums written by $23.1. As of year
end 2005, net premiums receivable were increased by $131.6, unearned premium
reserves by $23.1, and various other liabilities by $108.5.
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
General Insurance Group
Written premiums: Direct................................. $ 2,424.9 $ 2,228.1 $ 1,936.4
Assumed ............................... 37.9 34.8 36.4
Ceded.................................. $ 573.5 $ 561.8 $ 512.5
============== ============== ==============
Earned premiums: Direct................................. $ 2,291.9 $ 2,140.9 $ 1,837.6
Assumed ............................... 35.9 30.2 33.3
Ceded.................................. $ 522.6 $ 548.1 $ 491.5
============== ============== ==============
Claims ceded............................................. $ 469.0 $ 395.7 $ 348.2
============== ============== ==============
(Table continued on next page.)
63
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Mortgage Guaranty Group
Written premiums: Direct................................. $ 511.7 $ 479.4 $ 473.2
Assumed................................ .1 .2 .3
Ceded.................................. $ 79.3 $ 81.3 $ 67.5
============== ============== ==============
Earned premiums: Direct................................. $ 508.0 $ 483.6 $ 467.3
Assumed................................ .8 1.0 1.2
Ceded.................................. $ 79.3 $ 81.4 $ 67.7
============== ============== ==============
Claims ceded............................................. $ .5 $ .6 $ .3
============== ============== ==============
Mortgage guaranty insurance in force as of
December 31: Direct................................. $ 102,919.7 $ 104,351.1 $ 99,566.2
Assumed................................ 2,196.3 2,840.3 4,902.5
Ceded.................................. $ 6,467.2 $ 5,944.1 $ 5,116.5
============== ============== ==============
(b) Leases-Some of the Corporation's subsidiaries maintain their offices in
leased premises. Some of these leases provide for the payment of real estate
taxes, insurance, and other operating expenses. Rental expenses for operating
leases amounted to $39.9, $38.8 and $36.2 in 2005, 2004 and 2003, respectively.
These expenses relate primarily to building leases of the Company. A number of
the Corporation's subsidiaries also lease other equipment for use in their
businesses. At December 31, 2005, aggregate minimum rental commitments (net of
expected sub-lease receipts) under noncancellable operating leases are
summarized as follows: 2006: $37.7; 2007: $32.4; 2008: $23.6; 2009: $14.9; 2010:
$8.4; 2011 and after: $15.4.
(c) General-In the normal course of business, the Corporation and its
subsidiaries are subject to various contingent liabilities, including possible
income tax assessments resulting from tax law interpretations or issues raised
by taxing or regulatory authorities in their regular examinations, catastrophic
claims occurrences not indemnified by reinsurers such as noted at 4(a) above, or
failure to collect all amounts on its investments, or balances due from assureds
and reinsurers. Other than the item discussed in the following paragraph, the
Corporation does not have a basis for anticipating any significant losses or
costs to result from any known or existing contingencies.
In April, 2004 the Internal Revenue Service ("IRS") issued a so-called "30
Day Letter" to the Company as a result of a recently completed examination of
tax returns for years 1998 to 2000. In substance, the letter alleges that
certain claim reserve deductions taken through year end 2000 were overstated and
thus served to reduce taxable income for those years. After reviewing the IRS'
calculations, the Company concluded that its claim reserves were calculated
consistently and provided a fair and reasonable estimate of its unpaid losses.
The Company vigorously defended the validity of the claim reserve deductions
taken in its tax returns, and the matter was assigned to an IRS Appeals Officer
for resolution. By letter dated July 5, 2005, the IRS Appeals Office confirmed
an agreement reached with the Company whereby tax years 1988 through 2000 have
been closed without adjustment to the claim reserve deductions as originally
filed in the corresponding tax returns.
(d) Legal Proceedings- Legal proceedings against the Company arise in the normal
course of business and usually pertain to claim matters related to insurance
policies and contracts issued by its insurance subsidiaries. Other legal
proceedings are discussed below.
Purported class actions have been filed in state courts in Ohio and Florida
against the Company's principal title insurance subsidiary, Old Republic
National Title Insurance Company ("ORNTIC"). Substantially similar lawsuits have
been filed against other unaffiliated title insurance companies in New York and
Florida. Plaintiffs allege that, pursuant to rate schedules filed by ORNTIC with
insurance regulators, ORNTIC was required to, but failed to give consumers a
reissue credit on the premiums charged for title insurance covering mortgage
refinancing transactions. The actions seek damages and declaratory and
injunctive relief. ORNTIC intends to defend vigorously against these actions,
but at this early stage in the litigation the Company cannot estimate the costs
it may incur as the actions proceed to their conclusions.
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 other private mortgage insurers in different Federal District Courts.
The action against RMIC seeks certification of a nationwide class of consumers
who were allegedly required to pay for private mortgage insurance at a cost
greater than RMIC's "best available rate". The action alleges that the decision
to insure their loans at a higher rate was based on the consumers' credit scores
and constituted an "adverse action" within the meaning, and in violation of the
Fair Credit Reporting Act, that requires notice, allegedly not given, to the
consumers. The action seeks statutory and punitive damages, as well as other
costs. RMIC intends to defend vigorously against the action, but at this early
stage in the litigation the Company cannot estimate the costs it may incur as
the litigation proceeds to its conclusion.
64
Note 5-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated
quarterly operating data for the two years ended December 31, 2005 is presented
below.
In the opinion of management, all adjustments consisting of normal
recurring adjustments necessary for a fair statement of quarterly results have
been reflected in the data which follows. It is also management's opinion,
however, that quarterly operating data for insurance enterprises such as the
Company is not indicative of results to be achieved in succeeding quarters or
years. The long-term nature of the insurance business, seasonal and cyclical
factors affecting premium production, the fortuitous nature and, at times,
delayed emergence of claims, and changes in yields on invested assets are some
of the factors necessitating a review of operating results, changes in
shareholders' equity, and cash flows for periods of several years to obtain a
proper indicator of performance trends. The data below should be read in
conjunction with the "Management Analysis of Financial Position and Results of
Operations":
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------------- ------------- ------------- ------------
Year Ended December 31, 2005:
Operating Summary:
Net premiums, fees, and other income................ $ 796.8 $ 856.1 $ 872.8 $ 904.7
Net investment income and realized gains (losses)... 83.6 88.6 81.7 121.0
Total revenues...................................... 880.6 944.9 954.7 1,025.9
Benefits, claims, and expenses...................... 712.0 757.4 774.8 814.4
Net income ......................................... $ 114.3 $ 172.3 $ 121.6 $ 143.1
============= ============= ============= ============
Net income per share: Basic......................... $ .50 $ .75 $ .53 $ .62
Diluted....................... $ .49 $ .74 $ .52 $ .61
============= ============= ============= ============
Average shares outstanding:
Basic............................................ 228,351,494 228,629,783 229,021,348 229,511,029
============= ============= ============= ============
Diluted.......................................... 230,861,205 231,190,413 232,037,923 232,587,552
============= ============= ============= ============
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------------- ------------- ------------- ------------
Year Ended December 31, 2004:
Operating Summary:
Net premiums, fees, and other income................ $ 736.2 $ 790.8 $ 805.2 $ 820.3
Net investment income and realized gains (losses)... 86.1 76.1 75.0 101.4
Total revenues...................................... 822.4 867.1 880.3 921.8
Benefits, claims, and expenses...................... 664.2 689.8 717.8 768.6
Net income ......................................... $ 106.4 $ 119.0 $ 109.1 $ 100.4
============= ============= ============= ============
Net income per share: Basic......................... $ .47 $ .52 $ .48 $ .44
Diluted....................... $ .46 $ .52 $ .47 $ .43
============= ============= ============= ============
Average shares outstanding:
Basic............................................ 227,453,446 227,654,171 227,909,225 228,195,623
============= ============= ============= ============
Diluted.......................................... 230,630,581 230,273,604 230,521,839 230,943,065
============= ============= ============= ============
Note 6-Information About Segments of Business - The Corporation's major business
segments are organized as the General Insurance (property and liability
insurance), Mortgage Guaranty and Title Insurance Groups. Effective with the
second quarter of 2004 the Company has included the results of its small life &
health insurance business with those of its corporate and minor service
operations; prior period data has been reclassified accordingly. Each of the
Corporation's segments underwrites and services only those insurance coverages
which may be written by it pursuant to state insurance regulations and corporate
charter provisions. Segment results exclude realized investment gains or losses
and impairments, and these are aggregated in consolidated totals. The
contributions of Old Republic's insurance industry segments to consolidated
totals are shown in the following table.
The Corporation does not derive over 10% of its consolidated revenues from
any one customer. Revenues and assets connected with foreign operations are not
significant in relation to consolidated totals.
The General Insurance Group provides property and liability insurance
primarily to commercial clients. Old Republic does not have a meaningful
participation in personal lines of insurance. Commercial automobile (principally
trucking) insurance is the largest type of coverage underwritten by the General
Insurance Group, accounting for approximately 33.7% of the Group's direct
premiums written in 2005. The remaining premiums written by the General
Insurance Group are derived largely from a wide variety of coverages, including
workers' compensation, general liability, loan credit indemnity, general
aviation, directors and officers indemnity, fidelity and surety indemnities, and
home and auto warranties.
65
Private mortgage insurance produced by the Mortgage Guaranty Group protects
mortgage lenders and investors from default related losses on residential
mortgage loans made primarily to homebuyers who make down payments of less than
20% of the home's purchase price. The Mortgage Guaranty Group insures only first
mortgage loans, primarily on residential properties having one-to-four family
dwelling units. The Mortgage Guaranty segment's ten largest customers were
responsible for approximately 44.2%, 41.8% and 37.3% of traditional primary new
insurance written in 2005, 2004 and 2003, respectively. The largest single
customer accounted for 11.5% of traditional primary new insurance written in
2005 compared to 11.7% and 7.2% in 2004 and 2003, respectively.
The title insurance business consists primarily of the issuance of policies
to real estate purchasers and investors based upon searches of the public
records which contain information concerning interests in real property. The
policy insures against losses arising out of defects, loans and encumbrances
affecting the insured title and not excluded or excepted from the coverage of
the policy.
The accounting policies of the segments parallel those described in the
summary of significant accounting policies pertinent thereto.
Segment Reporting
---------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
-------------- -------------- ---------------
General Insurance:
Net premiums earned.................................................. $ 1,805.2 $ 1,623.0 $ 1,379.5
Net investment income and other income .............................. 212.4 199.5 193.2
-------------- -------------- ---------------
Total revenues before realized gains (losses)..................... $ 2,017.6 $ 1,822.5 $ 1,572.7
============== ============== ===============
Income before taxes and realized investment gains (losses)........... $ 350.0 $ 333.0 $ 258.9
============== ============== ===============
Income tax expense (1)............................................... $ 62.9 $ 104.3 $ 75.1
============== ============== ===============
Segment assets - at year end......................................... $ 8,178.9 $ 7,222.8 $ 6,603.5
============== ============== ===============
Mortgage Guaranty:
Net premiums earned.................................................. $ 429.5 $ 403.2 $ 400.9
Net investment income and other income .............................. 86.5 86.6 97.7
-------------- -------------- ---------------
Total revenues before realized gains (losses)..................... $ 516.0 $ 489.9 $ 498.6
============== ============== ===============
Income before taxes and realized investment gains (losses)........... $ 243.7 $ 224.5 $ 276.4
============== ============== ===============
Income tax expense .................................................. $ 81.1 $ 75.2 $ 94.1
============== ============== ===============
Segment assets - at year end......................................... $ 2,211.8 $ 2,205.9 $ 2,080.1
============== ============== ===============
Title Insurance:
Net premiums earned.................................................. $ 757.2 $ 714.0 $ 749.9
Title, escrow and other fees......................................... 324.6 311.2 353.9
-------------- -------------- ---------------
Sub-total.......................................................... 1,081.8 1,025.2 1,103.8
Net investment income and other income .............................. 26.7 26.5 24.1
-------------- -------------- ---------------
Total revenues before realized gains (losses)..................... $ 1,108.6 $ 1,051.8 $ 1,128.0
============== ============== ===============
Income before taxes and realized investment gains (losses)(2)........ $ 88.7 $ 62.5 $ 129.6
============== ============== ===============
Income tax expense .................................................. $ 30.1 $ 25.9 $ 43.1
============== ============== ===============
Segment assets - at year end......................................... $ 776.3 $ 753.0 $ 720.5
============== ============== ===============
66
Reconciliations of Segmented Amounts to Consolidated Totals
--------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
----------------------------------------------------
2005 2004 2003
--------------- --------------- ---------------
Consolidated Revenues:
Total revenues of above Company segments........................ $ 3,642.3 $ 3,364.3 $ 3,199.5
Other sources (3)............................................... 122.5 83.5 72.2
Consolidated net realized investment gains...................... 64.9 47.9 19.3
Elimination of intersegment revenues (4)........................ (23.9) (4.1) (5.2)
--------------- --------------- ---------------
Consolidated revenues........................................ $ 3,805.9 $ 3,491.6 $ 3,285.8
=============== =============== ===============
Consolidated Income before taxes:
Total income before taxes and realized investment
gains (losses) of above Company segments..................... $ 682.6 $ 620.1 $ 665.0
Other sources - net (3)(5) ..................................... (.1) (17.2) (4.5)
Consolidated net realized investment gains...................... 64.9 47.9 19.3
--------------- --------------- ---------------
Consolidated income before income taxes...................... $ 747.3 $ 650.9 $ 679.7
=============== =============== ===============
Consolidated Income Tax Expense:
Total income tax expense of above Company segments.............. $ 174.2 $ 205.4 $ 212.4
Other sources - net (3) ........................................ (.9) (6.5) .7
Income tax expense on consolidated net realized
investment gains............................................. 22.6 17.0 6.7
--------------- --------------- ---------------
Consolidated income tax expense.............................. $ 195.9 $ 215.9 $ 219.9
=============== =============== ===============
Assets:
Total assets for above Company segments......................... $ 11,167.1 $ 10,181.8 $ 9,404.2
Other assets (3)................................................ 528.5 495.3 378.7
Elimination of intersegment investments (4)..................... (152.4) (106.4) (70.6)
--------------- --------------- ---------------
Consolidated assets.......................................... $ 11,543.2 $ 10,570.8 $ 9,712.3
=============== =============== ===============
----------
In the above tables, net premiums earned on a GAAP basis differ slightly from
statutory amounts due to certain differences in calculations of unearned premium
reserves under each accounting method.
(1) General Insurance tax expense was reduced by $45.9 in 2005 due to a
non-recurring recovery of income taxes and related accumulated interest
stemming 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.
(2) Title Insurance income before taxes and realized investment gains (losses)
was reduced by $22.9 in 2004 due to an increase in previously posted
litigation reserves necessitated by a ruling on January 20, 2005 by the
California Court of Appeals affirming a prior trial court verdict against
Old Republic Title Company.
(3) Represents amounts for Old Republic's holding company parent, minor
internal service subsidiaries, and a small life and health insurance
operation.
(4) Represents consolidation elimination adjustments.
(5) Includes a $10.5 special charge in 2004 resulting from a write down of
previously deferred acquisition costs applicable to a life insurance
product discontinued during the fourth quarter of that year.
67
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
To the Board of Directors and Shareholders of
Old Republic International Corporation:
We have completed an integrated audit of Old Republic International Corporation
and its subsidiaries' 2005 and 2004 consolidated financial statements and of its
internal control over financial reporting as of December 31, 2005 and audits of
its 2004 and 2003 consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Our
opinions, based on our audits, are presented below.
Consolidated financial statements
---------------------------------
In our opinion, the consolidated financial statements listed in the accompanying
index, present fairly, in all material respects, the financial position of Old
Republic International Corporation and its subsidiaries at December 31, 2005 and
2004, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
-----------------------------------------
Also, in our opinion, management's assessment, included in "Management's Report
on Internal Control Over Financial Reporting," appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2005 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 28, 2006
68
Management's Responsibility for Financial Statements
Management is responsible for the preparation of the Company's consolidated
financial statements and related information appearing in this report.
Management believes that the consolidated financial statements fairly reflect
the form and substance of transactions and that the financial statements
reasonably present the Company's financial position and results of operations in
conformity with generally accepted accounting principles. Management also has
included in the Company's financial statement amounts that are based on
estimates and judgments which it believes are reasonable under the
circumstances.
The independent registered public accounting firm has advised that it
audits the Company's consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board and provides an
objective, independent review of the fairness of reported operating results and
financial position.
The Board of Directors of the Company has an Audit Committee composed of
eight non-management Directors. The committee meets periodically with financial
management, the internal auditors and the independent registered public
accounting firm to review accounting, control, auditing and financial reporting
matters.
Item 9-Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
Item 9A-Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's principal executive officer and its principal financial
officer have evaluated the Company's disclosure controls and procedures as of
the end of the period covered by this annual report. Based upon their
evaluation, the principal executive officer and principal financial officer have
concluded that the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective for the above referenced evaluation period.
Changes in Internal Control
During the year ended December 31, 2005, there were no changes in internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of our management, including our principal executive officer and
principal financial officer, we conducted an evaluation of the effectiveness of
our internal control over financial reporting based on the framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
The Company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. The Company's internal
control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Based on our evaluation under the framework in Internal Control -
Integrated Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2005.
PricewaterhouseCoopers LLP, an independent registered public accounting firm,
has audited our management's assessment of the effectiveness of our internal
control over financial reporting as of December 31, 2005. Their report is shown
on page 68 in this Annual Report.
69
Item 9B - Other Information
None.
PART III
Item 10-Directors and Executive Officers of the Registrant
Executive Officers of the Registrant
The following table sets forth certain information as of December 31, 2005,
regarding the senior executive officers of the Company:
Name Age Position
-------------------------- --- -----------------------------------------------------------------------------
Charles S. Boone 52 Senior Vice President - Investments and Treasurer since August, 2001.
James A. Kellogg 54 Senior Vice President/General Insurance and President of Old Republic
Insurance Company since October, 2002.
Spencer LeRoy, III 59 Senior Vice President, General Counsel and Secretary since 1992.
Karl W. Mueller 46 Senior Vice President and Chief Financial Officer since October, 2004. Prior
to joining Old Republic, Mr. Mueller was a partner with the public accounting
firm of KPMG LLP.
Christopher Nard 42 Senior Vice President/Mortgage Guaranty since May, 2005. President since May,
2005 of Republic Mortgage Insurance Company.
Rande K. Yeager 57 Senior Vice President/Title Insurance since March, 2003. President since
March, 2002 of Old Republic National Title Insurance Company.
Aldo C. Zucaro 66 Chief Executive Officer, President, Director and Chairman of the Board since
1990, 1981, 1976 and 1993, respectively.
The term of office of each officer of the Company expires on the date of
the annual meeting of the board of directors, which is generally held in May of
each year. There is no family relationship between any of the executive officers
named above. Each of these named officers, except for Karl W. Mueller, has been
employed in executive capacities with the Company and/or its subsidiaries for
the past five years.
The Company will file with the Commission prior to April 1, 2006 a
definitive proxy statement pursuant to Regulation 14a in connection with its
Annual Meeting of Shareholders to be held on May 26, 2006. A list of Directors
appears on the "Signature" page of this report. Information about the Company's
directors is contained in the Company's definitive proxy statement for the 2006
Annual Meeting of shareholders, which is incorporated by reference herein.
The Company has adopted a code of ethics that applies to its principal
executive officer and principal financial officer. A copy has been filed with
the Commission and appears as Exhibit (14) in the exhibit index under item 15.
The Company has also posted the text of its code of ethics on its Internet
website at www.oldrepublic.com.
Item 11-Executive Compensation
Information with respect to this Item is incorporated herein by reference
to the section entitled "Executive Compensation" in the Company's Proxy
Statement in connection with the Annual Meeting of Shareholders to be held on
May 26, 2006, which will be on file with the Commission by April 1, 2006.
Item 12-Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information with respect to this Item is incorporated herein by reference
to the sections entitled "General Information" and "Principal Holders of
Securities" in the Company's Proxy Statement in connection with the Annual
Meeting of Shareholders to be held on May 26, 2006, which will be on file with
the Commission by April 1, 2006.
Item 13-Certain Relationships and Related Transactions
Information with respect to this Item is incorporated herein by reference
to the section entitled "Principal Holders of Securities" in the Company's Proxy
Statement in connection with the Annual Meeting of Shareholders to be held on
May 26, 2006, which will be on file with the Commission by April 1, 2006.
70
Item 14-Principal Accountant Fees and Services
Information with respect to this Item is incorporated herein by reference
to the section entitled "Board Committees" in the Company's Proxy Statement in
connection with the Annual Meeting of Shareholders to be held on May 26, 2006,
which will be on file with the Commission by April 1, 2006.
PART IV
Item 15-Exhibits and Financial Statement Schedules
Documents filed as a part of this report:
1. Financial statements: See Item 8, Index to Financial Statements.
2. Financial statement schedules will be filed on or before April 15, 2006
under cover of Form 10-K/A.
3. See exhibit index on page 74 of this report.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized (Name, Title or Principal
Capacity, and Date).
(Registrant): Old Republic International Corporation
By : /s/ Aldo C. Zucaro 03/01/06
--------------------------------------------------------------
Aldo C. Zucaro, Chairman of the Board, Date
Chief Executive Officer, President and Director
By : /s/ Karl W. Mueller 03/01/06
--------------------------------------------------------------
Karl W. Mueller, Senior Vice President Date
and Chief Financial Officer
72
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated (Name, Title or
Principal Capacity, and Date).
/s/ Harrington Bischof /s/ William A. Simpson
---------------------------------- -----------------------------------
Harrington Bischof, Director* William A. Simpson, Director*
President of Republic Mortgage
Insurance Company
/s/ Jimmy A, Dew /s/ Arnold L. Steiner
---------------------------------- -----------------------------------
Jimmy A. Dew, Director* Arnold L. Steiner, Director*
Sales Group Manager and Vice Chairman
of Republic Mortgage Insurance Company
/s/ John M. Dixon /s/ Fredricka Taubitz
---------------------------------- -----------------------------------
John M. Dixon, Director* Fredricka Taubitz, Director*
/s/ Peter Lardner /s/ Charles F. Titterton
---------------------------------- -----------------------------------
Peter Lardner, Director* Charles F. Titterton, Director*
/s/ Wilbur S. Legg /s/ Dennis P. Van Mieghem
---------------------------------- -----------------------------------
Wilbur S. Legg, Director* Dennis P. Van Mieghem, Director*
/s/ John W. Popp /s/ William G. White, Jr.
---------------------------------- -----------------------------------
John W. Popp, Director* William G. White, Jr., Director*
* By/s/Aldo C. Zucaro
Attorney-in-fact
Date: February 23, 2006
73
EXHIBIT INDEX
An index of exhibits required by item 601 of Regulation S-K follows:
(3) Articles of incorporation and by-laws.
(A) * Restated Certificate of Incorporation. (Exhibit 3(A) to Registrant's
Annual Report on Form 10-K for 2004).
(B) * By-laws, as amended. (Exhibit 3.2 to Form S-3 Registration Statement
No. 333-43311).
(4) Instruments defining the rights of security holders, including indentures.
(A) * Amended and Restated Rights Agreement dated as of May 15, 1997
between Old Republic International Corporation and First Chicago
Trust Company of New York. (Exhibit 4.1 to Registrant's Form 8-K
filed May 30, 1997).
(B) * Agreement to furnish certain long term debt instruments to the
Securities & Exchange Commission upon request. (Exhibit 4(D) on
Form 8 dated August 28, 1987).
(C) * Form of Indenture dated as of August 15, 1992 between Old Republic
International Corporation and Wilmington Trust Company, as Trustee.
(Exhibit 4(G) to Registrant's Annual Report on Form 10-K for 1993).
(D) * Supplemental Indenture No. 1 dated as of June 16, 1997 supplementing
the Indenture. (Exhibit 4.3 to Registrant's Form 8-A filed June 16,
1997).
(E) * Supplemental Indenture No. 2 dated as of December 31, 1997
supplementing the Indenture. (Exhibit 4(G) to Registrant's Annual
Report on Form 10-K for 1997).
(10) Material contracts.
** (A) * Amended and Restated Old Republic International Corporation
Key Employees Performance Recognition Plan. (Exhibit 10(A) to
Registrant's Annual Report on Form 10-K for 2002).
** (B) * Amended and Restated 1992 Old Republic International
Corporation Non-qualified Stock Option Plan. (Exhibit 10(B) to
Registrant's Annual Report on Form 10-K for 2002).
** (C) Amended and Restated 2002 Old Republic International Corporation
Non-qualified Stock Option Plan.
** (D) * Amended and Restated Old Republic International Corporation
Executives Excess Benefits Pension Plan. (Exhibit 10(E) to
Registrant's Annual Report on Form 10-K for 1997).
** (E) * Form of Indemnity Agreement between Old Republic International
Corporation and each of its directors and certain officers. (Exhibit
10 to Form S-3 Registration Statement No. 33-16836).
** (F) * Directors and officers liability and company reimbursement policy
dated October 6, 1970. (Exhibit 12(A) to Form S-1 Registration
Statement No. 2-41089).
** (G) * Bitco Key Employees Performance Recognition Plan. (Exhibit 10(H) to
Registrant's Annual Report on Form 10-K for 1997).
** (H) * RMIC Corporation/Republic Mortgage Insurance Company Amended and
Restated Key Employees Performance Recognition Plan. (Exhibit 10(I)
to Registrant's Annual Report on Form 10-K for 2000).
** (I) * RMIC Corporation/Republic Mortgage Insurance Company Executives
Excess Benefits Pension Plan. (Exhibit 10(J) to Registrant's Annual
Report on Form 10-K for 2000).
** (J) * Amended and Restated Old Republic Risk Management Key Employee
Recognition Plan. (Exhibit 10(J) to Registrant's Annual Report on
Form 10-K for 2002).
** (K) * Old Republic National Title Group Incentive Compensation Plan.
(Exhibit 10(K) to Registrant's Annual Report on Form 10-K for 2003).
(14) * Code of Ethics for the Principal Executive Officer and Senior
Financial Officer. (Exhibit 14 to Registrant's Annual Report on
Form 10-K for 2003).
74
(Exhibit Index, Continued)
(21) Subsidiaries of the registrant.
(23) Consent of PricewaterhouseCoopers LLP.
(24) Powers of attorney.
(28) Consolidated Schedule P (To be filed by amendment).
(31.1) Certification by A.C. Zucaro, Chief Executive Officer, pursuant to
Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of
the Sarbannes-Oxley Act of 2002.
(31.2) Certification by Karl W. Mueller, Chief Financial Officer, pursuant
to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302
of the Sarbannes-Oxley Act of 2002.
(32.1) Certification by A.C. Zucaro, Chief Executive Officer, pursuant to
Section 350, Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbannes-Oxley Act of 2002.
(32.2) Certification by Karl W. Mueller, Chief Financial Officer,
pursuant to Section 1350, Chapter 63 of Title 18, United States
Code, as adopted pursuant to Section 906 of the Sarbannes-Oxley Act
of 2002.
(99.1) * Old Republic International Corporation Audit Committee Charter.
(Exhibit 99.1 of Registrant's Form 8-K filed February 27, 2006).
(99.2) * Old Republic International Corporation Nominating Committee Charter.
(Exhibit 99.2 to Registrant's Annual Report on Form 10-K for 2003).
(99.3) * Old Republic International Corporation Compensation Committee
Charter. (Exhibit 99.2 of Registrant's Form 8-K filed February 27,
2006).
(99.4) * Code of Business Conduct and Ethics. (Exhibit 99.4 to Registrant's
Annual Report on Form 10-K for 2003).
(99.5) * Corporate Governance Guidelines.(Exhibit 99.5 to Registrant's Annual
Report on Form 10-K for 2003).
----------
* Exhibit incorporated herein by reference.
** Denotes a management or compensatory plan or arrangement required to be
filed as an exhibit pursuant to Item 601 of Regulation S-K.
75