The principal executive offices of the Company are located in the Old Republic Building in Chicago, Illinois. This Company owned building contains 151,000 square feet of floor space of which approximately 54% is occupied by Old Republic, and the remainder is leased to others. In addition to the Company-owned principal executive offices, a subsidiary of the Title Insurance Group partially occupies its headquarters building. This building contains 110,000 square feet of floor space of which approximately 65% is occupied by the Old Republic National Title Insurance Company. The remainder of the building is leased to others. Nine 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 buildings and related land at December 31, 2001 was approximately $19.0 million.
Short-term investment positions reflect a large variety of seasonal and intermediate-term factors including current operating needs, expected operating cash flows, and investment strategy. 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. During 2001 and 2000, the Corporation committed most investable funds in short to intermediate-term fixed maturity securities and equity securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; investable funds have not been directed to so-called "junk bonds" or types of securities categorized as derivatives. Old Republic's commitment to equity securities during 2001 increased in relation to the related invested balance at year-end 2000 due to portfolio additions and net unrealized gains. At December 31, 2001, the Company had no fixed maturity investments in default as to principal and/or interest.
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. Traditional investment management tools and techniques are employed to address the yield and valuation exposures of its 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 controlled by concentrating on non-callable issues, and by taking asset-liability matching practices 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 tenets 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 realized gains or losses when securities are sold. With a market value of approximately $4,783.9, the long-term fixed maturity investment portfolio has an average maturity of 4.3 years and an indicated duration of 3.8. This implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the market value of the long-term fixed maturity investment portfolio of approximately 3.7%, or $178.1. With regard to its $389.8 common stock portfolio,
The parent holding company generally meets its liquidity and capital needs through dividends paid by its subsidiaries and the issuance of short-term debt. The insurance subsidiaries' ability to pay cash dividends to the parent company, however, is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. During 2001, the Company used a part of available cash flow to redeem a portion of its commercial paper outstanding, thereby reducing consolidated debt by approximately $79.0.
Net investment income grew by 0.3% and 4.1% in 2001 and 2000, respectively, and was down 3.6% in 1999. For each of the past three years, this revenue source was affected by positive consolidated operating cash flows, by a concentration of investable assets in interest-bearing fixed maturity securities, and by changes in market yields. Between 1999 and mid-year 2000, the Company used mostly internally generated funds for the aforementioned open market purchases of approximately 16.6 million shares of its common stock, thus reducing the size and earning power of its invested assets base. The average annual yield on investments was 5.2%, 5.6% and 5.5% for the years ended December 31, 2001, 2000 and 1999, respectively. These yields reflect at once the relatively short maturity of Old Republic's fixed maturity securities portfolio, an uptrend in yields in 2000, generally flat to declining yields during most of 2001 and 1999, and a moderately greater commitment to equity securities which typically provide lower current yields.
The Company's investment policies are not designed to maximize investment gains. Net investment gains were moderately lower in 2001 than those registered in 2000 and basically level with those posted in 1999. Such net gains were mostly due to discretionary and market driven dispositions or valuations of equity and fixed maturity security holdings. In 2001, 88.7% of total dispositions of securities were represented by contractual maturities and early calls of fixed maturity security holdings; for the years 2000 and 1999 these amounted to 79.9% and 71.0%, respectively.
Expenses: Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 42.4% in 2001, 43.8% in 2000 and 46.8% in 1999. The general insurance portion of the claims ratio improved in 2001 compared to 2000 which also reflected an improvement over 1999. In addition to the effect of a soft pricing environment for most property and liability coverages during the 1990's, greater severity for the most recent loss occurrences was mainly responsible for the higher general insurance claim ratio in 2000 and 1999. The higher ratios were largely driven by commercial automobile (truck) liability insurance coverages, though smaller portions of Old Republic's property and liability business also experienced increases in 1999 when compared to 2001 and 2000. The loss ratio for mortgage guaranty insurance declined in 2000 and 1999; the improvement was mostly attributable to the strong employment and good general economic conditions which led to reasonably stable loan default rates and higher cure rates for loans exhibiting payment difficulties. A small increase in 2001 was largely the result of moderately higher loan default rates. The title insurance loss ratio has been in the low single digits in each of the past three years due to a continuation of favorable trends in claims frequency and severity for business underwritten since 1992 in particular.
Consolidated benefit, claim, and related settlement costs for each of the Company's business segments are affected by the adequacy of reserves established for current and prior years' claim occurrences. Such reserves are recorded on a case by case basis and by means of a large number of formulas and calculations to cover known as well as incurred but not as yet reported claims at each balance sheet date. In the aggregate, the Company's record in establishing such reserves has not indicated deficiencies in the past decade. However, the reserves posted by insurers such as the Company are necessarily based on a wide variety of estimates, can be affected by lagging claim emergence or reporting delays, and their ultimate disposition is subject to a multitude of economic, political, judicial and societal factors that cannot be anticipated or quantified accurately. Accordingly, there can be no guaranty that such reserves will always be on the mark, and any redundancies or deficiencies would be recorded in the periods during which they emerge and are quantified.
Pre-Tax and Net Income: Consolidated income before taxes increased by 18.2% and 34.5% in 2001 and 2000, respectively, and declined by 32.1% in 1999. General insurance results improved significantly in 2001 and 2000 compared to 1999 due to better underwriting experience. The mortgage guaranty segment reflected rising earnings in each of the last three years due to increased premium revenues that generated higher income from underwriting operations, and higher investment income from a greater invested asset base. Title insurance earnings were higher in 2001 compared to 2000 and 1999; this reflected the previously noted revenue and expense trends. Life and disability operations registered decreased earnings in 2001 and slightly increased earnings in 2000, whereas 1999 earnings benefited from the revision of certain actuarial factors used in calculating various life and health reserves and deferred acquisition costs. The net benefit of these revisions, the majority of which applied to 1999 premium revenues, amounted to approximately $4.8; this was partially offset by underwriting losses in Old Republic's Canadian travel accident coverages.
The effective consolidated income tax rates were 31.7% in 2001, 30.7% in 2000 and 29.3% in 1999. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from partially tax-sheltered investment income (principally tax-exempt interest) on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand.
Historical data pertaining to the operating performance, liquidity, and other financial matters applicable to an insurance enterprise such as Old Republic are not necessarily indicative of results to be achieved in succeeding years. In addition to the factors cited below, the long-term nature of the insurance business, seasonal and annual patterns in premium production and incidence of claims, changes in yields obtained on invested assets, changes in government policies and free markets affecting inflation rates and general economic conditions, and changes in legal precedents or the application of law affecting the settlement of disputed claims can have a bearing on period-to-period comparisons and future operating results.
Any forward-looking commentaries speak only as of their dates. Old Republic undertakes no obligation to publicly update or revise such comments, whether as a result of new information, future events or otherwise, and accordingly they may not be unduly relied upon.
Consolidated Balance Sheets ...................................... 23-24 Consolidated Statements of Income................................. 25 Consolidated Statements of Comprehensive Income................... 26 Consolidated Statements of Preferred Stock and Common Shareholders' Equity.................................... 27 Consolidated Statements of Cash Flows............................. 28 Notes to Consolidated Financial Statements........................ 29-50 Report of Independent Accountants................................. 51
Bonds and other investments carried at $145.5 as of December 31, 2001 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
- ---------- (1) Due to the adoption of a revised Accounting Practices and Procedures Manual ("Codification"), unearned premium reserves were increased by $110.9. This had no effect on earned premiums for the General Insurance Group.
The Company has previously issued directly or assumed as a reinsurer certain insurance policies generally categorized as financial guarantees. The major types of guarantees pertain to (a) state, municipal and other general or special revenue bonds and (b) variable interest rate guarantees. The types of risks involved include failure by the bond issuer to make timely payment of principal and interest, changes in interest rates, and changes in the future value of fixed assets. The degree of risk pertaining to these insurance products is largely dependent on the effects of general economic cycles and changes in the credit worthiness of issuers whose obligations have been guaranteed. Premium written is limited to renewal business written prior to 1998.
The data in the table above, incorporates Old Republic's estimates of 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, and during a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. Over the years, the Corporation's 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.
Individual insurance companies and others who have evaluated the potential costs of litigating and settling A&E claims have noted with increasing concern the possibility that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, could likely undermine seriously the financial condition of the property and liability insurance industry. The Corporation is of the view that the substantial public policy issues and the diverse insurance coverage issues presented by A&E claims are unlikely to be resolved by the appellate level courts in the near future. In recent times, the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting the determination of liability for environmental claims. As of December 31, 2001, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
The Corporation's mix of coverages, industries served, and long-standing objective of assuring wide dispersion of risks in selected geographical areas, have likely minimized claim exposures related to the September 11, 2001 terrorist attack on America. The income statement for the year ending December 31, 2001 nonetheless includes pre-tax charges aggregating $4.0 to cover the possibility of isolated property, workers' compensation, trip delay and life insurance claims.
Life insurance companies domiciled in the United States and qualifying as life insurers for tax purposes are taxed under special provisions of the Internal Revenue Code. As a result of legislation, 1983 and prior years' tax deferred earnings (cumulatively $13.3 at December 31, 2001) credited to the former memorandum "policyholders' surplus account" will generally not be taxed unless they are subsequently distributed to shareholders. The Company does not presently anticipate any distribution or payment of taxes on such earnings in the future.
Included in the plans' assets are Common Shares of the Company valued at $6.1 and $7.0 as of December 31, 2001 and 2000, respectively.
(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 ($582.3 and $529.7 at December 31, 2001 and 2000, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(o) Cash Flows-For purposes of the Consolidated Statements of Cash Flows, the Company considers short-term investments, consisting of money market funds, certificates of deposit, and commercial paper with original maturities of less than 90 days to be cash equivalents. These securities are carried at cost which approximates fair value.
(p) Concentration of Credit Risk-Excluding U.S. government fixed maturity securities, the Company is not exposed to any significant concentration of credit risk.
(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 rounding. Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to the most current presentation.
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, 2001.
(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 2001 data, the maximum amount of dividends payable to the Corporation by its insurance and a small number of non-insurance company subsidiaries during 2002 without the prior approval of appropriate regulatory authorities is approximately $199.5.
(e) Undistributed Earnings-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 respective subsidiaries at December 31, 2001 amounted to $1,948.6 and $103.3, respectively. Dividends declared during 2001, 2000 and 1999, to the Corporation by its subsidiaries amounted to $120.3, $119.6 and $178.9, respectively.
Except as noted in the following paragraph, reinsurance protection on property and liability operations generally limits the net loss on any one risk to a maximum of (in thousands): workers' compensation-$1,000; auto liability-$1,000; general liability-$1,000; and property coverages-$300. Substantially all the mortgage guaranty insurance business is retained, with the exposure on any one risk currently averaging approximately $29. Title insurance risk assumptions, based on the title insurance subsidiaries' financial resources, are limited to a maximum of $25,000 as to any one policy. The maximum amount of ordinary life insurance retained on any one life by the Life Insurance Group is $300.
Due to worldwide reinsurance capacity and related cost constraints, effective January 1, 2002, the Corporation will retain exposures for all, but most predominantly workers' compensation liability insurance, coverages in excess of $40.0 that were previously assumed by unaffiliated reinsurers. Further, as of the same date, coverage for acts of terrorism will be excluded from substantially all the Corporation's reinsurance treaties and effectively retained by it. There is no assurance that the U.S. Congress will approve legislation to mitigate the impact of possible losses caused by acts of terrorism, though in conjunction with industry rating organizations, the Corporation's insurance subsidiaries are in process of eliminating such coverage from affected policies other than workers' compensation.
(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. Management does not anticipate any significant losses or costs to result from any known or existing contingencies.
(d) Legal Proceedings- Legal proceedings against the Company arise in the normal course of business and generally pertain to claim matters related to insurance policies and contracts issued by the Corporation's insurance subsidiaries.
The Federal Department of Labor has revised the Federal Black Lung Program regulations effective January 19, 2001. These new regulations, which require a re-evaluation of some previously settled or denied occupational disease claims, were challenged by the insurance and coal mining industries in a lawsuit filed in the United States District Court for the District of Columbia. The challenge was summarily dismissed by the Court and an appeal has been filed by the insurance and coal mining industries before the United States Court of Appeals, and is currently pending. At this time, the outcome of this challenge is uncertain and the potential impact on gross and net of reinsurance reserves or retrospective rating policies due to the revised regulations is not measurable.
Note 6- Information About Segments of Business - The Corporation's business segments are organized as the General Insurance (property and liability insurance), Mortgage Guaranty, Title Insurance and Life Insurance Groups. The contributions of Old Republic's insurance industry segments to consolidated revenues and operating results, and certain balance sheet data pertaining thereto are shown in the following tables on the basis of generally accepted accounting principles ("GAAP"). 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.
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 38.2% of the Group's direct premiums written in 2001. 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 guaranty, and surety bonds. The General Insurance Group's operations have been expanded over the years to insure certain specialty lines such as directors' and officers' liability and errors and omissions liability insurance, to cover owners and operators of private aircraft for hull and liability exposures, and to provide automobile and home warranties.
The Life Insurance Group markets and writes consumer credit life and disability insurance primarily through automobile dealers. Old Republic has also written various conventional life and disability/accident and health insurance coverages for many years, principally through banks and other financial services institutions. Ordinary term life insurance is sold through independent agents and brokers for relatively large face amounts, in both the United States and Canada.
- ---------- 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. (a) Including unallocated investment income derived from invested capital and surplus funds. (b) Represents results of holding company parent, consolidation eliminating adjustments, and general corporate expenses, as applicable.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, preferred stock and common shareholders' equity and cash flows present fairly, in all material respects, the financial position of Old Republic International Corporation and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, 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 auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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.