In 1993, the Company adopted several changes in accounting policies to comply with Financial Accounting Standards Board (FASB) pronouncements. The resulting adoption of the asset and liability method for calculating deferred income taxes and the recognition of present value liabilities pertaining to post-retirement health benefits under retirement plans maintained by a few Old Republic subsidiaries increased net income by $8.6 or 15 cents per share (14 cents fully diluted) in the first quarter of 1993. Accounting for reinsurance ceded transactions affected the Company's balance sheet but not the consolidated income statement; assets and liabilities at December 31, 1993, were increased by corresponding amounts of approximately $1,524.2 due to the reclassification change for these transactions. Finally, the Company reexamined the classification of its invested assets which led to reporting such assets as either "held to maturity" or "available for sale"; the effect of these classification changes was to increase assets and the liability for deferred taxes by $25.2 and $8.7, respectively, and common shareholders' equity for the net unrealized appreciation of securities newly reclassified at fair value by $16.4 or 32 cents per common share as of December 31, 1993. See Note 1 of the Notes to Consolidated Financial Statements for further details relating to these changes. As permitted by the pertinent FASB pronouncements, prior years' financial statements have not been restated nor reclassified to reflect these changes.
Old Republic's financial position at December 31, 1994 reflected increases in assets of 2.7%, liabilities of 2.0%, and common shareholders' equity of 5.8% when compared to the immediately preceding year-end. At December 31, 1994 and 1993, cash and invested assets represented 62.4% and 61.0% of consolidated assets, respectively. Relatively high short-term investment positions were maintained as of the most recent year-ends to provide necessary liquidity for specific operating needs, and flexibility in investment strategy. Changes in short-term investments reflect a variety of seasonal and intermediate-term factors including seasonal operating cash needs, investment strategy, and expectations as to trends in interest yields. Accordingly, the future level of short-term investments will vary and respond to the dynamics of these factors and may, as a result, increase or decrease from current levels. During 1994 and 1993, the Corporation committed substantially all investable funds in short to intermediate-term fixed maturity securities. In the latter regard, Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; the Corporation has not directed its investable funds to so-called "junk bonds" or derivative types of securities. During 1994, Old Republic also increased its commitment to common stock investments which rose by 37.9% vis-a-vis the related invested balance at year-end 1993. As of December 31, 1994, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in relation to consolidated assets or shareholders' equity.
The Revenue Reconciliation Act of 1990 (the "RRA") provided for a number of changes affecting the taxation of the Corporation and a number of its subsidiaries. Among such changes were the accelerated recognition of salvage and subrogation recoveries, and the deferral of costs associated with the production of life and disability business followed by the subsequent amortization of those costs. The TRA also provided for a number of changes affecting the taxation of the Corporation and a number of its subsidiaries. Among such changes were reductions in corporate tax rates, the discounting of loss reserves, the acceleration of premium income recognition, and the inclusion in taxable income of a portion of certain tax-exempt investment income previously not subject to tax. In addition, the TRA called for the calculation of an alternative minimum tax. The RRA and TRA are likely to result in accelerated payment of federal income taxes. However, most of the additional tax payments are treated as timing differences for financial accounting purposes. Consequently, such payments are expected to have minimal effects on consolidated results of operations and financial position determined in accordance with generally accepted accounting principles.
Reference is here made to "Financial Information Relating to Segments of Business" appearing elsewhere herein.
Old Republic International Corporation and Subsidiaries Notes to Consolidated Financial Statements ($ in Millions, Except as Otherwise Indicated) ----------------------------------------------------------------------------
Note 1-Summary of Significant Accounting Policies-The significant accounting policies employed by Old Republic International Corporation ("Old Republic", "the Company", or "the Corporation") and its subsidiaries are set forth in the following summary. See Note 7 for a discussion of the Company's business segments.
(a) Consolidation Practices-The consolidated financial statements include the accounts of the Corporation and those of its major insurance underwriting and service subsidiaries. Non-consolidated insurance marketing and service subsidiaries are insignificant and are reflected on the equity basis of accounting.
Bonds, notes and redeemable preferred stocks classified as "held to maturity" are generally carried at amortized costs while bonds and notes classified as "available for sale" in addition to other preferred and common stocks (equity securities) are included at fair value. Fair values for fixed maturity securities are based on quoted market prices or estimated using values obtained from independent pricing services as applicable. Mortgage and policy loans (other long-term investments) are carried on the basis of the lower of unpaid principal balances or estimated realizable value. While the aggregate fair value of fixed maturity securities -"held to maturity" at December 31, 1994 was below their carrying values, the Company does not currently expect the realization of such losses from a forced sale of all or part of these securities.
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 stock are credited to income on the ex-dividend date. Realized investment gains and losses 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 stocks; such bases apply to the specific securities sold. Unrealized investment gains and losses, net of any deferred income taxes, are recorded directly in a separate account of shareholders' equity.
With respect to mortgage guaranty insurance (net insurance in force of $30,405.3 and $24,026.1, at December 31, 1994 and 1993, respectively) the Company's reserving policies are set forth below in Note l(g).
(g) Losses, Claims and Settlement Expenses-Reserves are provided for the ultimate expected cost of settling unpaid losses and claims reported at each balance sheet date. Losses and claims incurred but not reported, as well as expenses required to settle losses and claims are established on the basis of various criteria, including historical cost experience and anticipated costs of servicing reinsured and other risks. Long-term disability-type workers' compensation reserves, however, are discounted to present value based on interest rates ranging from 3.5% to 4%.
Effective January 1, 1993 the Company adopted Financial Accounting Standard (FAS) No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" which changes the previous reporting of assets and liabilities relating to reinsured contracts on a net of reinsurance ceded balances basis. As a result, reinsured outstanding losses and unearned premiums are to be reported as assets. Accordingly, at December 31, 1994 and 1993, assets and liabilities were increased by corresponding amounts of approximately $1.5 billion. FAS No. 113 did not have any effect on the Company's results of operations and did not require retroactive application to 1992 and prior years.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to cover normal claim occurrences as well as unusual exposures such as those pertaining to environmental and asbestosis claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 1994 the Corporation's aggregate reserves specifically identified with environmental and asbestosis exposures amounted to approximately $60.4 million gross, and $37.7 million net of reinsurance. Through December 31, 1994 the Corporation's historical indemnity and loss expense payments relative to these exposures have been negligible in the context of loss and loss expense payments made for all types of claims.
Old Republic disagrees with the allegations of liability on virtually all environmental and asbestos-related claims of which it has knowledge on the grounds that exclusions in the policies preclude coverage for nearly all such claims, and that the Corporation never intended to assume such risks. Old Republic's exposure on such claims cannot therefore be calculated by conventional insurance reserving methods for this and 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 the insurance industry has produced court decisions that have been inconsistent with regard to such issues as when the 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.
Insurance industry associations, individual insurance companies, and others who have evaluated the potential costs of litigating and settling environmental and asbestos-type claims have noted with increasing concern the probability that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, would likely bankrupt or undermine seriously the financial condition of the property and liability insurance industry. In the light of this substantial public policy issue, the Corporation is of the view that the courts will not resolve in the near future the litigation gridlock stemming from the non-resolution to date of many environmental and asbestos-related claims. In recent times the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting these types of claims. As of December 31, 1994, however, there is no solid evidence suggesting that forthcoming changes might mitigate or reduce some or all of these claims.
Because of all these issues and uncertainties, estimation of reserves for losses and allocated loss adjustment expenses for the above noted types of claims is extremely difficult or impossible. 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.
(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 pursuant to generally accepted accounting principles will not necessarily become payable/recoverable in the future. Effective January 1, 1993 the Company adopted Financial Accounting Standard (FAS) No. 109 "Accounting for Income Taxes" that required a change to the asset and liability method of calculating deferred income taxes. The cumulative effect of this change resulted in an increase in net income of $13.3, or $.23 per share ($.22 fully diluted) in 1993. This method calls for the establishment of a deferred tax, calculated at currently effective tax rates, for the cumulative temporary differences between financial statement and tax bases of assets and liabilities. Prior to January 1, 1993 deferred income taxes were established for income and expense items reported in the consolidated financial statements in different periods than for tax purposes.
(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 ($198.7 and $219.9 at December 31, 1994 and 1993, 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 savings accounts, money market funds, certificates of deposit, and commercial paper with maturities of less than 90 days to be cash equivalents. These securities are carried at cost which approximates fair value.
Note 3-Debt and Debt Equivalents-Consolidated debt of Old Republic and its subsidiaries is summarized below:
--------- (a) The Company has guaranteed bank loans (balance at December 31, 1994 was $13.8) to a Trust established by the Old Republic Employees Savings and Stock Ownership Plan ("ESSOP"). The loans have been used to fund the purchase of Series "B" and Series "D" Redeemable Preferred Stock from the Company by the trust for the original amount of the loans. The Trust's loan principal repayments (currently scheduled at $6.1 in 1995, $3.9 in 1996, $2.7 in 1997, and $1.0 in 1998) are expected to be met by annual profit sharing contributions by the Corporation and its participating subsidiaries, while interest payments are to be covered by Trust income, including dividends on the Corporation's stock held by the ESSOP. The interest rate on the Trust's loans of $13.8 is set every six months and ranges from 1-1/4% above the prime rate to approximately 75% thereof. See Notes 4a and 4b. (b) Each one thousand dollar convertible debenture maturing in 2002, may be converted at any time into 39.024 common shares.
(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 1994 data, the maximum amount of dividends payable to the Corporation by its insurance and other wholly-owned subsidiaries during 1995 without the prior approval of their respective regulatory authorities is approximately $167.1. However, management does not expect to distribute all such dividends since reinvested earnings are the Corporation's major source of capital to promote its growth and support its obligations to policyholders.
(c) Debt Restrictions-Under the most restrictive covenants, the terms of Old Republic's guaranties relative to loan agreements described in Note 3(a) provide that while loans under such agreements are outstanding, Old Republic will maintain a minimum consolidated tangible net worth (excluding goodwill and net unrealized investment gains or losses, but including title plants and records) of at least $400.0. Such agreements also, among other things, restrict Old Republic from permitting "Debt" to exceed 25% of its consolidated tangible net worth (as adjusted for goodwill and net unrealized investment gains or losses on equity securities) without approval of the lenders.
Under the 1979 plan, the employees' right to exercise their options is accelerated if the Corporation is dissolved or liquidated, merges or consolidates with another company and the Corporation is not the surviving corporation, or more than 50% of the members of the Board of Directors of the Corporation change in any one year unless one or more of the new directors was nominated by the Board of Directors of the Corporation.
In conjunction with the purchase or merger of various companies, the Corporation has assumed the stock option obligations under various qualified and nonqualified stock option plans previously adopted by such companies. These plans were terminated as of the merger dates, and existing options at that date became exercisable into Old Republic common shares at their original price adjusted for the appropriate exchange ratios pertaining to each merger. At December 31, 1994, options for 5,576 shares were outstanding and exercisable under the remaining plan at a price of $10.00 per share. Options for 18,246; 24,568; and 74,440 were exercised for a total consideration of approximately $0.1, $0.1, and $0.5 during 1994, 1993 and 1992, respectively.
(f) 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, 1994 amounted to $1,020.9 and $(11.3), respectively. Cash dividends declared during 1994, 1993 and 1992, to the Corporation by its subsidiaries amounted to $55.4, $53.9 and $50.6, respectively.
(d) Legal Proceedings-There are no material legal proceedings other than those arising in the normal course of business and which generally pertain to claim matters related to insurance policies and contracts issued by the Corporation's insurance subsidiaries.
Note 7-Information About Segments of Business - 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, although disability/accident & health coverages may be written directly or indirectly through reinsurance in either the General or Life Insurance segments.
In computing the profit or loss before taxes for each segment, the following items have not been added or deducted: general corporate revenues and expenses, parent company interest expense, income taxes, and equity in operating results of, or dividends from, unconsolidated subsidiaries and affiliates. To reconcile the total assets shown for the General, Title, Mortgage Guaranty and Life Groups with total consolidated assets at December 31, 1994 and 1993, adjustments must be made for the parent company assets of $1,745.2 and $1,650.1, and consolidating eliminations of $2,143.0 and $2,022.9, respectively.
Certain subsidiaries of the Company have sold various accounts receivable to a finance company subsidiary of the Mutual. Total receivables sold as of December 31, 1994 and 1993 amounted to approximately $6.6 and $8.5, respectively.
At December 31, 1994 and 1993, the Group held approximately 8.0% of Old Republic's issued and outstanding common shares. For financial accounting purposes only, 4,439,267 of such shares have been treated as treasury shares at each respective date in consolidating the Group's accounts with those of the Corporation.
At December 31, 1994, the Corporation owned 90% of the voting common stock of Employers General Insurance Group, Inc. ("EGI") an affiliated insurance holding company engaged in the property and liability insurance and reinsurance business, primarily in Texas. At such date, 10% of EGI's voting common stock was held by public shareholders.
EGI commenced operations in May, 1992, its insurance subsidiary received its license in December, 1993. The following table is a summary of intercompany transactions:
We have audited the accompanying consolidated balance sheets of Old Republic International Corporation and subsidiaries (the "Company") as of December 31, 1994 and 1993, and the related consolidated statements of income, preferred stock and common shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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.