The housing market is heavily influenced by overall economic conditions and government policies. Initiatives undertaken by various governmental agencies could ease barriers to home ownership and help instill consumer confidence. Regulatory changes and reform of government-sponsored entities could impact lending standards or the processes and procedures used by the Company. The current real estate environment, including interest rates and general economic activity, typically influence the demand for real estate. Any of these factors would likely impact the Company's results of operations.
On October 20, 2014, the Federal Housing Finance Agency ("FHFA"), which regulates the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), announced that Fannie Mae and Freddie Mac were negotiating guidelines with mortgage lenders that resulted in less strict lending requirements and lower barriers to mortgage loans for borrowers who are seeking access to home loans. The FHFA noted in its announcement that it intended to clarify the rules that allow Fannie Mae and Freddie Mac to require mortgage lenders to repurchase troubled loans. The FHFA also sought to increase the supply of credit available, particularly to creditworthy lower and middle-income families, by collaborating with mortgage lenders to provide guidelines for mortgage loans with down payments as low as 3.0%. In December 2014, both Fannie Mae and Freddie Mac officially approved 97.0% loan-to-value products (3.0% down payment mortgages). The Fannie Mae program is targeted to first-time home buyers and became available to lenders in December 2014. The Freddie Mac program became available to lenders on March 23, 2015 and is available to both first-time home buyers and other qualified borrowers with limited down payment savings.
The MBA January 19, 2017 Mortgage Finance Forecast (“MBA Forecast”) projects 2017 purchase activity to increase 10.3% to $1,092 billion and refinance activity to decrease 47.7% to $471 billion, resulting in a decrease in total mortgage originations of 17.3% to $1,563 billion, all from 2016 levels. In 2016, purchase activity accounted for 52.4% of all mortgage originations and is projected to represent 69.9% of all mortgage originations in 2017.
In October 2016, National Investors Holdings, LLC ("NIH"), a subsidiary of the Company, acquired all of the outstanding shares of University Title Company (“University”), a title insurance agency doing business in the state of Texas. NIH paid $10 million plus a $918,000 adjustment for University’s net cash position at closing to the shareholders of University. The acquisition was partially financed with loan proceeds from a Business/Commercial Loan Agreement and related Promissory Note (collectively, the “Loan Agreement”) with a bank, pursuant to which the bank loaned the Company the principal amount of $6 million. The Company paid off all amounts due under the Loan Agreement in December 2016, and therefore has no liabilities related to the Loan Agreement as of December 31, 2016.
If one or more of the variables or assumptions used changed such that the Company’s recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased three loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2016 would be as follows:
Despite the variability of such estimates, management believes that, based on historical claims experience and actuarial analysis, the Company’s reserve is adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2016. The ultimate settlement of claims will likely vary from the reserve estimates included in the Company’s Consolidated Financial Statements. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. There are no known claims that are expected to have a material adverse effect on the Company’s financial position or operating results.
Premium revenues from certain agency operations include accruals for transactions which have settled but have not been reported as of the balance sheet date. These accruals are based on estimates of the typical lag time between settlement of real estate transactions and the agent’s reporting of these transactions to the Company. Reporting lag times vary by market. In certain markets, the lag time may be very short, but in others, can be as high as 100 days. The Company reviews and adjusts lag time estimates periodically, using historical experience and other factors, and reflects any adjustments in the result of operations in the period in which new information becomes available.
Securities held principally for resale in the near term are classified as trading securities and recorded at fair value. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading or held-to-maturity are classified as available-for-sale and reported at estimated fair value with unrealized gains and losses, net of tax, adjusted for other-than-temporary declines in estimated fair value, reported as accumulated other comprehensive income. As of December 31, 2016 and 2015, all of the Company’s invested securities were classified as available-for-sale. Realized gains and losses on the sales of investments are determined using the specific identification method.
During the quarter ended March 31, 2016, the North Carolina Title Insurance Rating Bureau, which establishes premium rates for title insurance in North Carolina, and of which Investors Title Insurance Company is a member, filed updated premium rates that took effect on April 1, 2016. The revised rates positively impacted premiums by approximately $3,950,000 for 2016.
Agency net premiums written increased 4.7% in 2016 to $88,032,194 compared with $84,075,155 in 2015, and decreased 2.1% in 2015 compared with $85,906,524 in 2014. The increase in 2016 agency premiums was primarily attributable to higher levels of real estate activity from existing agents, overall higher home prices, and the addition of new title insurance agents in the Company’s southeast and Texas markets. The decrease in 2015 agency premiums was primarily attributable to a decrease in the amount of premiums written for the Company by one agent in the Texas market, partially offset by increases in premiums in most states in which the Company operates due to higher average real estate prices and increased real estate activity.
Other revenues primarily include other fee income, trust income, management services income, exchange services income, and income related to the Company’s equity method investments. Other revenues were $10,944,108, $10,309,230 and $8,627,935 in 2016, 2015 and 2014, respectively. Other revenues increased in 2016 compared with 2015 primarily due to increases in title fees, exchange services income and management services income, partially offset by a decrease in earnings of unconsolidated affiliates. Other revenues increased in 2015 compared with 2014 primarily due to increases in earnings of unconsolidated affiliates, title fees and exchange services income, partially offset by a decline in trust and investment management services income.
As the Company generates cash from operations, it is invested in accordance with the Company’s investment policy and corporate goals. The Company’s investment policy has been designed to balance multiple goals, including the assurance of a stable source of income from interest and dividends, the preservation of principal, and the provision of liquidity sufficient to meet insurance underwriting and other obligations as they become payable in the future. Securities purchased may include a combination of taxable bonds, tax-exempt bonds and equity securities. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment.
On a combined basis, the after-tax profit margins were 14.1%, 9.9% and 7.8% in 2016, 2015 and 2014, respectively. The Company continually strives to enhance its competitive strengths and market position, including ongoing initiatives to manage its operating expenses.
Salaries, Employee Benefits and Payroll Taxes: Personnel costs include base salaries, benefits and bonuses paid to employees. Salaries, employee benefits and payroll taxes were $31,372,099, $28,041,213 and $25,218,225 for 2016, 2015 and 2014, respectively. Salaries and related costs increased by approximately 11.9% in 2016 from 2015 and increased 11.2% in 2015 from 2014. The increase in 2016 compared with 2015 was primarily related to higher levels of incentive compensation, inflationary increases in salaries and benefits, payroll expenses associated with Texas title agency University Title, which was acquired in the fourth quarter, and increases in staffing levels to accommodate higher volume. The increase in 2015 compared with 2014 was primarily related to inflationary increases in salaries and benefits, higher staffing levels to support ongoing software development activities and higher levels of incentive compensation. On a consolidated basis, salaries and employee benefits as a percentage of total revenues were 22.7%, 22.0% and 20.5% in 2016, 2015 and 2014, respectively.
Business Development: Business development expenses primarily include marketing and travel-related expenses. Business development expenses increased to $2,511,699 in 2016 compared with $2,373,270 in 2015 and $2,333,491 in 2014, primarily due to increases in travel and marketing expenses.
Commissions: Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. In 2016, commissions to agents increased 2.4% to $63,643,321 compared with $62,174,301 in 2015, and decreased 5.3% in 2015 compared with $65,632,353 in 2014. Commissions increased in 2016 compared with 2015 primarily due to higher agent premiums written. Commissions decreased in 2015 compared with 2014 primarily due to a shift in premiums to geographic areas with lower average commission rates. Commission rates vary by market due to local practice, competition and state regulations. Commission expense as a percentage of net premiums written by agents was 72.3%, 74.0% and 76.4% in 2016, 2015 and 2014, respectively.
The decrease in the loss provision rate in 2016 from the 2015 level resulted in approximately $4,619,000 less in reserves than would have been recorded at the higher 2015 level. Loss provision ratios are subject to variability and are reviewed and adjusted as experience develops.
Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $2,725,953, $3,367,494 and $3,912,716 in 2016, 2015 and 2014, respectively.
Reserve for Claims: At December 31, 2016, the total reserve for claims was $35,305,000. Of that total, approximately $4,405,000 was reserved for specific claims, and approximately $30,900,000 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.
Premium and Retaliatory Taxes: Title insurance companies are generally not subject to state income or franchise taxes. However, in most states they are subject to premium and retaliatory taxes, as defined by statute. Premium and retaliatory tax rates vary from state to state; accordingly, the total premium and retaliatory tax incurred is dependent upon the geographical mix of insurance revenues. Premium and retaliatory taxes as a percentage of net premiums written were 1.8%, 1.9% and 1.7% in 2016, 2015 and 2014, respectively.
The Company believes it is more likely than not that the tax benefits associated with recognized impairments and unrecognized losses recorded through December 31, 2016 will be realized. However, this judgment could be impacted by further market fluctuations. Information regarding the components of income tax expense and the items included in the reconciliation of the effective rate with the federal statutory rate can be found in Note 8 to the accompanying Consolidated Financial Statements.
The Company’s current cash requirements include general operating expenses, income taxes, capital expenditures, dividends on its common stock and repurchases of its commons stock. Cash flows from operations have historically been the primary source of financing for expanding operations, whether through organic growth or outside investments.
The Company evaluates nonorganic growth opportunities, such as mergers and acquisitions, from time to time in the ordinary course of business. Because of the episodic nature of these events, related incremental liquidity and capital resource needs can be difficult to predict.
Cash flows from non-operating activities have historically consisted of purchases and proceeds from investing activities, repurchases of common stock and the issuance of dividends. In 2016, the Company had a lower level of investment purchase activity, a lower level of proceeds from investments, a purchase of a subsidiary, a higher level of common stock repurchases and a higher level of dividends paid compared with 2015. In 2015, the Company had a lower level of investment purchase activity, a higher level of proceeds from the sales and maturities of investments, and a higher level of common stock repurchases compared with 2014.
Capital Resources: The amount of capital resources the Company maintains is influenced by state regulation, the need to maintain superior financial ratings from third party rating agencies and other marketing and operational considerations.
The Company's significant sources of funds are dividends and distributions from its subsidiaries, primarily its two title insurance subsidiaries. Cash is received from its subsidiaries in the form of dividends and as reimbursements for operating and other administrative expenses that it incurs. The reimbursements are executed within the guidelines of management agreements between the Company and its subsidiaries.
A strong financial position provides necessary flexibility to fund potential acquisition activity, to invest in the Company's core business, and to minimize the financial impact of potential adverse developments. Adverse developments that generally require additional capital include adverse financial results, changes in statutory accounting requirements by regulators, reserve charges, investment losses or costs incurred to adapt to a changing regulatory environment, including costs related to emerging CFPB regulation of the real estate industry.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326). ASU 2016-13 is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The update broadens the information that an entity must consider in developing its expected credit loss estimates, and is meant to better reflect an entity’s current estimate of all expected credit losses. In addition, this update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The update is effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 updated guidance to improve financial reporting for leasing transactions. The core principle of the guidance is that lessees will be required to recognize assets and liabilities on the balance sheet for all leases with terms of more than twelve months. A lessee would recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from current GAAP, with some targeted improvements. Disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. In transition, both lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption was permitted for all entities upon issuance. The Company is currently evaluating whether or not the recently issued accounting standard will have a material impact on the Company's financial position or results of operations.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 updated guidance to enhance the reporting model for financial instruments. Among the main principles of the guidance applicable to the Company are provisions to: require equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, to be measured at fair value with changes in fair value recognized in net income; simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, noting that when a qualitative assessment indicates that impairment exists that an entity is required to measure the investment at fair value; eliminate the requirement to disclose methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost; require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; require separate presentation of financial assets and financial liabilities by measuring category and form of financial asset on the balance sheet or accompanying notes to the financial statements; and clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The update is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted for the provision requiring entities to recognize the fair value change from instrument-specific credit risk in other comprehensive income for financial liabilities measured using the fair value option in Accounting Standards Codification ("ASC") 825, and can be early adopted for financial statements of annual or interim periods that have not yet been issued or made available for issuance. The Company will be required to apply the update by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption, with the amendments related to equity securities without readily determinable fair values being applied prospectively to equity investments that exist as of the date of adoption. The guidance is expected to have a material impact on the Company’s financial condition and results of operations once effective, primarily resulting from fluctuations in security exchanges or markets.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 updated guidance to improve the comparability of revenue recognition practices for entities that either enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards such as insurance contracts or lease standards. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, this update originally became effective for interim and annual reporting periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. ASU 2015-14 updated guidance to defer the effective date of the standard by one year. Early adoption is not permitted, although public entities are permitted to elect to adopt the amendments on the original effective date. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact.
We have audited the accompanying consolidated balance sheets of Investors Title Company and subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 10, 2017, expressed an unqualified opinion thereon. Our report on internal control over financial reporting refers to the fact that we excluded from the scope of our audit of internal control over financial reporting University Title Company, which was acquired by the Company in October 2016.
Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2016.
Reclassification - Certain 2015 and 2014 amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the 2016 classifications. These reclassifications had no effect on stockholders’ equity or net income as previously reported.
For the purpose of presentation in the Company’s Consolidated Statements of Cash Flows, cash equivalents are highly liquid instruments with remaining original maturities of three months or less. The carrying amount of cash and cash equivalents is a reasonable estimate of fair value due to the short-term maturity at purchase of these instruments.
Securities for which the Company has the intent and ability to hold to maturity are classified as held-to-maturity and reported at cost, adjusted for amortization of premiums or accretion of discounts, and other-than-temporary declines in fair value. Securities held principally for resale in the near term are classified as trading securities and recorded at fair values. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading or held-to-maturity are classified as available-for-sale and reported at fair value with unrealized gains and losses, net of tax and adjusted for other-than-temporary declines in fair value, reported as accumulated other comprehensive income. As of December 31, 2016 and 2015, all investments in securities are classified as available-for-sale. Securities are regularly reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in fair value is other-than-temporary. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include the duration and extent to which the fair value has been less than cost and the Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. Fair values of the majority of investments are based on quoted market prices. Realized gains and losses are determined on the specific identification method. Refer to Note 3 for further information regarding investments in securities and fair value.
Property and equipment are recorded at cost and are depreciated principally under the straight-line method over the estimated useful lives (3 to 25 years) of the respective assets. Maintenance and repairs are charged to operating expenses and improvements are capitalized.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2016 is represented by the reserve for claims. The Company’s reserve for unpaid losses and loss adjustment expenses is established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserve is adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2016. The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and provision for future claims are recognized concurrent with recognition of related premium revenue.
Fees are recognized at the signing of a binding agreement and investment earnings are recognized as they are earned. Exchange services revenues are included in other revenues in the Consolidated Statements of Income.
The Company accounts for share-based compensation in accordance with the fair value based principles required by the Financial Accounting Standards Board (“FASB”). Share-based compensation cost is generally measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee’s requisite service period.
Goodwill represents the excess of cost over fair value of identifiable net assets acquired and assumed in a business combination. The fair value of the Company’s goodwill is principally based on values obtained from a third party valuation service. Goodwill is reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable and at least annually.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718). ASU 2016-09 updated guidance to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The update is effective for annual periods beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact.
The Consolidated Financial Statements have been prepared in conformity with GAAP, which differ in some respects from statutory accounting practices prescribed or permitted in the preparation of financial statements for submission to insurance regulatory authorities.
The Company has designated approximately $53,190,000 and $50,508,000 of retained earnings as of December 31, 2016 and 2015, respectively, as appropriated to reflect the required statutory premium and supplemental reserves. See Note 8 for the tax treatment of the statutory premium reserve.
As of December 31, 2016 and 2015, approximately $88,323,000 and $89,489,000, respectively, of consolidated stockholders’ equity represents net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior insurance department approval. During 2017, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $18,234,000.
Bonds totaling approximately $6,843,000 and $7,159,000 at December 31, 2016 and 2015, respectively, are deposited with the insurance departments of the states in which business is conducted.
The special revenue category for both periods presented includes over 60 individual bonds with revenue sources from a variety of industry sectors.
The following table presents the gross unrealized losses on investment securities and the estimated fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position at December 31, 2016 and 2015:
Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been below cost, the financial condition and prospects of the issuer (including credit ratings and analyst reports) and macro-economic changes. A total of 36 and 30 securities had unrealized losses at December 31, 2016 and December 31, 2015, respectively. Reviews of the values of securities are inherently uncertain and the value of the investment may not fully recover, or may decline in future periods resulting in a realized loss. During 2016, the Company recorded other-than-temporary impairment charges in the amount of $233,941 related to securities. During 2015, the Company recorded other-than-temporary impairment charges in the amount of $751,059 related to securities. During 2014, the Company recorded other-than-temporary impairment charges in the amount of $14,542 related to securities. Other-than-temporary impairment charges are included in net realized gain (loss) on investments in the Consolidated Statements of Income.
The Level 2 category includes fixed maturity investments such as corporate bonds, U.S. government and agency bonds and municipal bonds. Estimated fair value is principally based on market values obtained from a third party pricing service. Factors that are used in determining estimated fair market value include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. The Company receives one quote per security from a third party pricing service, although as discussed below, the Company does consult other pricing resources when confirming that the prices it obtains reflect the estimated fair values of the instruments in accordance with ASC 820, Fair Value Measurements and Disclosures. Generally, quotes obtained from the pricing service for instruments classified as Level 2 are not adjusted and are not binding. As of December 31, 2016 and December 31, 2015, the Company did not adjust any Level 2 fair values.
The Level 3 category only includes the Company’s investments in student loan auction rate securities (“ARS”) because quoted prices are unavailable due to the failed auctions. The Company’s ARS portfolio, which was comprised entirely of an investment grade student loan ARS, was sold during the first quarter of 2016. The par value of this security was $1,000,000 as of December 31, 2015, with approximately 97.0% guaranteed by the U.S. Department of Education.
To help ensure that estimated fair value determinations are consistent with ASC 820, prices from our pricing services go through multiple review processes to ensure appropriate pricing. Pricing procedures and inputs used to price each security include, but are not limited to, the following: unadjusted quoted market prices for identical securities such as stock market closing prices; non-binding quoted prices for identical securities in markets that are not active; interest rates; yield curves observable at commonly quoted intervals; volatility; prepayment speeds; loss severity; credit risks and default rates. The Company reviews the procedures and inputs used by its pricing services, and verifies a sample of the services’ quotes by comparing them to values obtained from other pricing resources. In the event the Company disagrees with a price provided by its pricing services, the respective service reevaluates the price to corroborate the market information and then reviews inputs to the evaluation in light of potentially new market data. The Company believes that these processes and inputs result in appropriate classifications and estimated fair values consistent with ASC 820.
The carrying amounts and estimated fair values of other financial instruments (see previous table for investments carried at estimated fair value) as of December 31, 2016 and 2015 are presented in the following table:
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $17,000 and $141,000, respectively, for 2016, $34,000 and $215,000, respectively, for 2015 and $38,000 and $140,000, respectively, for 2014. Ceded reinsurance is comprised of excess of loss treaties, which outline the conditions in which the reinsurance company will pay claims and protect against losses over certain agreed amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event that the assuming insurance companies are unable to meet their obligations under these contracts. The Company has not paid or recovered any reinsured losses during the three years ended December 31, 2016.
The Company continually refines its reserve estimates as current loss experience develops and credible data emerges. Movements in the reserve related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data. The 2016 calendar year change in the provision relating to prior years resulted mostly from changes to certain actuarial inputs and favorable development in 2016 versus the prior year related primarily to policy years 2009 through 2015. Due to variances between actual and expected loss payments, loss development is subject to significant variability.
The provision for claims as a percentage of net premiums written was 0.2%, 4.0% and 4.8% in 2016, 2015 and 2014, respectively.
Company available pursuant to the plan for the grant of SARs is 250,000 shares.
In 2016, 4,500 SARs vested with a fair value of $132,099.
During the second quarters of 2016, 2015 and 2014, the Company issued share-settled SARs to the directors of the Company. SARs give the holder the right to receive stock equal to the appreciation in the value of shares of stock from the grant date for a specified period of time, and as a result, are accounted for as equity instruments. The fair value of each award is estimated on the date of grant using the Black-Scholes option valuation model with the weighted average assumptions noted in the table shown below. Expected volatilities are based on both the implied and historical volatility of the Company’s stock. The Company uses historical data to project SAR exercises and pre-exercise forfeitures within the valuation model. The expected term of awards represents the period of time that SARs granted are expected to be outstanding. The interest rate assumed for the expected life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted average fair values for the SARs issued during 2016, 2015 and 2014 were $28.75, $31.16 and $28.98, respectively, and were estimated using the weighted average assumptions shown in the table below.
There was approximately $132,000, $138,000 and $121,000 of compensation expense relating to SARs or options vesting on or before December 31, 2016, 2015 and 2014, respectively, included in salaries, employee benefits and payroll taxes in the Consolidated Statements of Income. As of December 31, 2016, there was approximately $32,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s stock award plans. That cost is expected to be recognized over a weighted average period of approximately 3 months.
At December 31, 2016 and 2015, no valuation allowance was recorded. Based upon the Company’s historical results of operations, the existing financial condition of the Company and management’s assessment of all other available information, management believes that it is more likely than not that the benefit of these deferred income tax assets will be realized.
A reconciliation of income tax as computed for the years ended December 31 at the U.S. federal statutory income tax rate of 34.6% for 2016, 34.4% for 2015 and 34.3% for 2014, respectively, to income tax expense follows:
The Company has a 401(k) savings plan. In order to participate in the plan, individuals must have worked at the Company for at least 3 months. In order to be eligible for employer contributions, individuals must be employed for one full year and work at least 1,000 hours annually. The Company makes a 3% Safe Harbor contribution and also has the option annually to make a discretionary profit share contribution. Individuals may elect to make contributions up to the maximum deductible amount as determined by the Internal Revenue Code. Expenses related to the 401(k) plan were approximately $810,000, $741,000 and $676,000 for 2016, 2015 and 2014, respectively.
In addition, during the second quarter of 2004, ITIC entered into nonqualified deferred compensation plan agreements with these executives. The amount accrued for all agreements at December 31, 2016 and 2015 was approximately $8,487,000 and $7,818,000, respectively, which includes postretirement compensation and health benefits, and was calculated based on the terms of the contract. Both the 2016 and 2015 accruals are included in the accounts payable and accrued liabilities line item of the Consolidated Balance Sheets. These executive contracts are accounted for on an individual contract basis. On December 24, 2008, the executive contracts were amended effective January 1, 2009 to bring them into compliance with Section 409A of the Internal Revenue Code, and were amended and restated to provide for an annual cash payment to the officers equal to the amounts the Company would have contributed to their accounts under its 401(k) plan if such contributions were not limited by the federal tax laws, less the amount of any contributions that the Company actually makes to their accounts under the Company’s 401(k) plan.
The Company is required to recognize the funded status (i.e., the difference between the fair value of the assets and the accumulated postretirement benefit obligations of its postretirement benefits) in its Consolidated Balance Sheet, with a corresponding adjustment to accumulated other comprehensive income, net of tax. The net amount in accumulated other comprehensive income is $(165,437), $(109,200) net of tax, for December 31, 2016, and $(173,812), $(114,726) net of tax, for December 31, 2015, and represents the net unrecognized actuarial losses and unrecognized prior service costs. The effects of the funded status on the Company’s Consolidated Balance Sheets at December 31, 2016 and 2015 are presented in the following table:
Agency Relationship. On July 1, 2015, Title Resource Group LLC's wholly owned subsidiary, title insurer Texas American Title Company, acquired the assets of ITCOA, LLC, which does business throughout Texas as Independence Title. In 2016, 2015 and 2014 Independence Title originated 5.4%, 10.3% and 23.6%, respectively, of the net premiums written for the Company. Independence Title is under no legal commitment to remit a minimum amount of premiums to the Company, and could cease doing so at any time.
The Company generates a significant amount of title insurance premiums in Texas, North Carolina and South Carolina. In 2016, 2015 and 2014, North Carolina accounted for 35.5%, 32.8% and 28.4% of total title premiums, respectively. In 2016, 2015 and 2014, Texas accounted for 20.5%, 22.4% and 36.5% of total title premiums, respectively. In 2016, 2015 and 2014, South Carolina accounted for 10.0%, 10.1% and 7.7% of total title premiums, respectively.
In 2016, 2015 and 2014, the Company had one agent that accounted for 5.4%, 10.3% and 23.6% of net premiums written, respectively. This agent was acquired by another title insurer during 2015. Refer to Note 11 for further information.
In October 2016, National Investors Holdings, LLC ("NIH"), a subsidiary of the Company, acquired all of the outstanding shares of University Title Company (“University”), a title insurance agency doing business in the State of Texas. NIH paid $10 million plus a $918,000 adjustment for University’s net cash position at closing to the shareholders of University. The acquisition was partially financed with loan proceeds from a Business/Commercial Loan Agreement and related Promissory Note (collectively, the “Loan Agreement”) with a bank, pursuant to which the bank loaned the Company the principal amount of $6 million. The Company paid off all amounts due under the Loan Agreement in December 2016, and therefore has no liabilities related to the Loan Agreement at December 31, 2016.
In April 2012, ITIC purchased a 70% ownership interest in United Title Agency Co., LLC (“United”) for a purchase price of $1,041,250. In May 2014, ITIC purchased the remaining 30% interest in United for an additional $515,275, making United a wholly owned subsidiary of ITIC. United is a title insurance agency doing business in the State of Michigan.
The following table provides the estimated aggregate amortization expense for each of the five succeeding fiscal years:
The following tables provide changes in the balances of each component of accumulated other comprehensive income, net of tax, for the periods ended December 31, 2016, 2015 and 2014: