The consolidated accounts are presented in conformity with the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") of accounting principles generally accepted in the United States of America ("GAAP"). As a publicly held company, Old Republic utilizes GAAP largely to comply with the financial reporting requirements of the Securities and Exchange Commission ("SEC"). From time to time the FASB and the SEC issue various releases, most of which require additional financial statement disclosures and provide related application guidance. Of particular relevance to the Company's financial statements is guidance recently issued by the FASB relative to revenue recognition, recognition and measurement of financial instruments including the prospective addition of equity security unrealized gains and losses in periodic income statements, lease accounting, and accounting for credit losses on financial instruments, all of which are discussed further in the Notes to Consolidated Financial Statements.
(a) A special cash dividend of $1.00 per share was declared in late December 2017 in addition to the regular quarterly dividend payment of $0.1900 per share.
Detailed analysis of certain elements included in pretax and post-tax earnings for the periods shown below:
The preceding tables show both operating and net income to highlight the effects of realized investment gains or losses on period-to-period earnings comparisons. Management uses operating income, a non-GAAP financial measure, to evaluate and better explain operating performance, believing that the measure enhances an understanding of Old Republic's core business results. Operating income, however, does not replace GAAP net income as a measure of total profitability.
In recent years, asset management operations have to a large extent been oriented toward an enhancement of income from interest and dividends to counter a perniciously low yield environment. The strategy has led to a minimization of non-income producing or low-yielding securities. Proceeds from such securities' sales and maturities, as well as newly investable funds have largely been directed to purchases of higher yielding common shares of American companies with distinguished long-term records of earnings and dividend growth. More recently, the Company has allotted greater investable funds to tax-exempt issues which generally provide pretax yields lower than those of fully taxable corporate or U.S. Government fixed maturity securities but tend to generate better post-tax yields. The latter approach may be reconsidered, however, in light of the newly established U.S. Federal income tax rates that took effect on January 1, 2018.
The Company's reported net realized investment gains for 2017 are substantially higher than those recorded in the comparable periods of recent years. 2017 realized gains largely stemmed from managed sales of investment portfolio securities whose values had risen to higher than expected levels over the course of the year's strong securities market. 2017 net realized gains were $211.6 while net realized gains for the years 2016 and 2015 totaled $72.8 and $91.3,
respectively. The net-of-tax proceeds from gross securities sales of $464.5 in 2017’s final quarter were reinvested in common stocks expected to return moderately higher dividend income than income from securities sold. As shown in a preceding table, 2017 net realized investment gains (losses) includes $104.9 of deferred income tax credits to adjust to the new 21% tax rate pertaining to unrealized gains (losses) as of December 31, 2017. Deferred income taxes on unrealized gains (losses) would normally be a part of the statement of comprehensive income rather than the income statement.
Beginning in 2018, in pursuance of recently established rules of the Financial Accounting Standards Board, the Company will include the market-driven changes of its equity investments’ valuations in periodic income statements. The inclusion of such unrealized gains or losses is likely to produce greater period-to-period fluctuations in reported net income particularly at times of significant instability or volatility in the securities markets. The change, however, will have no impact on the conduct of the Company’s business or evaluation of its core operating performance, nor on the determination of GAAP shareholders’ equity at any point in time.
(a) General insurance pretax results for the year ended December 31, 2017 include hurricane-related claim costs currently estimated at $8.0.
Positive general insurance earned premiums trends throughout 2017 were unevenly distributed among various insurance coverages and sources of business. Gains were registered most prominently in commercial automobile (trucking), risk management and national accounts, home and auto warranty, and in a new underwriting facility established in early 2015. On the other hand, premium growth was constrained by low volume in a large account contractors book of business faced with a particularly competitive market place, and by reduced opportunities in gas and oil energy services and several smaller industry sectors. 2016 earned premiums were basically level with the preceding year’s production with trends unevenly distributed among various insurance coverages. Low to mid-single digit gains were experienced in commercial automobile (trucking) and national accounts, as well as other coverages such as home warranty. Premium volume from the new underwriting facility established in early 2015 also added measurably to earned premiums in 2016. In other regards, 2016 premium levels were hindered by lower volume in a large account contractors book of business operating in a particularly competitive environment, and by reduced production in the energy services field.
The ratio of claims and related settlement costs to earned premiums improved in 2017 compared with 2016. While current accident year claim ratios reflected moderate year-over-year declines, these were affected by moderately unfavorable developments of prior years’ reserves of 0.7 percentage points in 2017. 2017’s unfavorable developments were concentrated in the Company’s largest insurance coverages of workers’ compensation and general liability which were partially offset by favorable development trends in commercial automobile (trucking). For the respective 2016 and 2015 periods, the claim and related settlement costs ratios include unfavorable developments of 0.3 and 1.5 percentage points. The expense ratio for 2017 was slightly above the range of a long-term operating objective of 23% to 25% due to the above noted charges for estimated employee incentive awards. The slightly higher sales and general expense ratio in 2016 resulted mostly from greater costs incurred in the above-noted underwriting facility, additional litigation cost provisions in the year's second quarter, and by a slightly different premium mix and attendant production costs associated with the business’ responses to recurring changes in insurance market conditions and opportunities.
Annual claim provisions and the trends they display may not be particularly meaningful in Old Republic’s long-term liability insurance mix of business. Absent significant economic and insurance industry dislocations in the foreseeable future, it is currently anticipated that reported claim ratios could range within targeted averages in the high 60% to low 70% levels. The current mix of business should result in expense ratios within the aforementioned range.
Title Insurance Results - 2017 pretax operating income gained for the year as both revenues and claim costs extended the favorable trends of recent years.
The declining premium base led to a higher claim ratio for 2017 though current accident year reported claim costs, absent the MI charges referred to below, were relatively level in comparison to 2016. Reductions in the provision for current year losses stemming from a continuing drop in newly reported delinquencies as well as improving cure rates resulted in favorable developments of previously established claim reserves. The developments led to reductions of the claim ratio by 38.3 percentage points in 2017. In the respective periods of 2016 and 2015, the claim ratio reductions amounted to 39.8 and 65.0 percentage points. As already noted however, MI claim costs for 2017 rose most significantly due to a third quarter additional claim provision of $23.0 which added 20.9 percentage points to the claim ratio for the year. Furthermore, the 2016 claim ratio was less affected by litigation expense provisions that impacted adversely the 2015 ratio. MI operating costs and the related expense ratios were also impacted by costs stemming from the partial termination of a leased facility in early 2017.
2017 year-over-year operating performance comparisons for the CCI portion of the Run-off business were most significantly affected by the aforementioned claim provision of $107.0. Excluding this charge, CCI’s pretax operating results would have reflected a minor improvement for the year as a whole.
Corporate and Other Operations - The combination of a small life and accident insurance business and the net costs associated with operations of the parent holding company and its internal corporate services subsidiaries usually produce highly variable results. Earnings variations posted by these elements of Old Republic's business stem from volatility inherent to the small scale of the life and accident insurance line, changes in net investment income, and net interest expenses related to external and intra-system financing arrangements. Year-over-year comparisons were particularly affected by a $9.5 charge resulting from a periodic review and resulting update of previously established estimates of future interest rates, mortality, and persistency applicable to largely inactive life insurance products in the fourth quarter 2017. The dynamic period-to-period interplay of these various operating elements is summarized in the following table:
Consolidated Results - The above summarized operating results of Old Republic’s segmented business are reflected in the following consolidation of accounts.
The sum-total of Old Republic's segmented results is represented by the following major components of pretax consolidated income:
(b) The consolidated financial statements reflect an immaterial adjustment of $11.0 post-tax (or 0.28%) to previously reported shareholders’ equity as of January 1, 2015. The adjustment relates to immaterial expense accruals pertaining to the earlier period. As a result, previously reported book values per share decreased by $0.04 per share for the years ended 2015 and 2016.
Capitalization - The following table indicates that Old Republic's capitalization has risen since 2015 following issuance of a new debt security in 2016, and continued growth of the shareholders' equity account. During 2017, $79.0 of the 3.75% Convertible Senior Notes due 2018 had been converted into 5,146,127 common shares through year-end 2017.
a) The consolidated financial statements reflect an immaterial adjustment of $11.0 post-tax (or 0.28%) to previously reported shareholders’ equity as of January 1, 2015. The adjustment relates to immaterial expense accruals pertaining to the earlier period.
The Company recognized no OTTI adjustments for the years ended December 31, 2017 and 2015 and $4.9 of adjustments for the year ended December 31, 2016.
The eligibility for deferral and the recoverability of DAC is based on the successful acquisition of new or renewal contracts and estimated profitability of the insurance contracts to which they relate. For each of the three most recent year ends, consolidated DAC balances amounted to 1.5% of consolidated assets. The annual change in DAC balances for the three-year period affected underwriting, acquisition and other expenses within a range of (.9)% and (.7)%, and averaged (.8)% of such expenses.
Assets consisting of gross paid losses recoverable from assuming reinsurers, and balance sheet date reserves similarly recoverable in future periods as gross losses are settled and paid, are established at the same time as the gross losses are paid or recorded as reserves. Accordingly, these assets are subject to the same estimation processes and valuations as the related gross amounts that are discussed below. As of the three most recent year ends, paid and outstanding reinsurance recoverable balances ranged between 30.6% and 32.3% and averaged 31.2% of the related gross reserves. See Part I, Item 1(d) for further discussion regarding recoverability of the Company's reinsurance balances.
Consolidated claim costs developed favorably in the three most recent calendar years. This development had the consequent effect of reducing consolidated annual loss costs for the three most recent years within a range of 3.6% and 5.9%, or by an average of approximately 4.5% per annum. As a percentage of each of these years' consolidated earned premiums and fees, the favorable developments have ranged between 1.6% and 2.8%, and have averaged 2.1%. The variances in prior years' positive or negative claim developments are further discussed within the Incurred Loss Experience section of this document.
Possible future declines in fair values for Old Republic's available for sale bond and equity portfolios would negatively affect the common shareholders' equity account at any point in time and would result in the posting of unrealized losses, but would not necessarily lead to the recognition of realized investment losses. The Company reviews the status and fair 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 fair 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 the issuer's previously reported earnings or financial condition, are recognized as realized losses as soon as credible publicly available information emerges to confirm such developments. Absent issuer-specific circumstances that would result in a contrary conclusion, any equity security with an unrealized investment loss amounting to a 20% or greater decline consecutively during a six month period is considered other-than-temporarily-impaired. In the event the Company's estimate of other-than-temporary impairments is insufficient at any point in time, future periods' net income (loss) 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 in shareholders' equity.
Represents .9% of the cost of the total equity securities portfolio, while gross unrealized gains represent 25.1% of the portfolio.
Duration is used as a measure of bond price sensitivity to interest rate changes. A duration of 4.2 as of December 31, 2017 implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the fair value of the long-term fixed maturity investment portfolio of approximately 4.2%.
Under state insurance regulations, the Company's three mortgage guaranty insurance subsidiaries are required to operate at a maximum risk to capital ratio of 25:1 or otherwise hold minimum amounts of capital based on specified formulas. As noted in prior periods' reports, the Company's flagship mortgage guaranty insurance carrier had been operating pursuant to a waiver of minimum state regulatory capital requirements since late 2009. This waiver expired on August 31, 2011. The Company's mortgage insurance subsidiaries therefore discontinued writing new business in all states and limited themselves to servicing the run-off of their existing business, and the risk-to-capital ratio considerations are therefore no longer of consequence.
The Company's mortgage guaranty premiums primarily stem from monthly installments paid on long-duration, guaranteed renewable insurance policies. Such premiums are written and earned in the month coverage is effective. With respect to relatively few annual or single premium policies, earned premiums are largely recognized on a pro-rata basis over the terms of the policies. As described more fully in the RFIG Run-off Business' Risk Factors for premium income and long-term claim exposures, revenue recognition for insured loans is not appropriately matched to the risk exposure and the consequent recognition of both normal and catastrophic loss occurrences.
Title Group premium and fee revenues grew by 3.6%, 7.9% and 16.3% in 2017, 2016, and 2015 respectively. The continuation of a generally positive mortgage rate environment and reasonably strong housing and commercial property markets were major factors in the year-over-year gain in premiums and fees for 2017 and 2016. The increase in 2016 was achieved in spite of the adverse effects that government-imposed mortgage disclosure rules, implemented during the last quarter of 2015, had on the consummation of real estate transactions nationally. Premiums and fees levels in 2015 reflect stronger housing and commercial property transactions and the segment's expanded market share.
As previously discussed, the Company's flagship mortgage guaranty insurance carrier ceased the underwriting of new policies effective August 31, 2011 and the existing book of business was placed in run-off operating mode.
The Company's reserve for loss and loss adjustment expenses represents the accumulation of estimates of ultimate losses payable, including incurred but not reported losses and loss adjustment 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 as further discussed below. Consequently, reserves established are a reflection of the opinions of a large number of persons, of the application and interpretation of historical precedent and trends, of expectations as to future developments, and of management's judgment in interpreting all such factors. At any point in time, the Company is exposed to the incurrence of possibly higher or lower than anticipated claim costs and the resulting changes in estimates are recorded in operations of the periods during which they are made. Increases to prior reserve estimates are often referred to as unfavorable development whereas any changes that decrease previous estimates of the Company's ultimate liability are referred to as favorable development.
The Company's reserve setting process reflects the nature of its insurance business and the operationally decentralized basis upon which it is conducted. Old Republic's general insurance operations encompasses a large variety of coverages or classes of commercial insurance; it has negligible exposure to personal insurance coverages 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. Additionally, the Company's insurance subsidiaries do not provide significant amounts of insurance protection for premises; most of its property insurance exposures relate to cargo, incidental property, and insureds' inland marine assets. Consequently, the wide variety of policies issued and commercial insurance customers served require that loss reserves be analyzed and established in the context of the unique or different attributes of each block or class of business produced by the Company. For example, accident liability claims emanating from insured trucking companies or from general aviation customers become known relatively quickly, whereas claims of a general liability nature arising from the building activities of a construction company may emerge over extended periods of time. Similarly, claims filed pursuant to errors and omissions or directors and officers' liability coverages are usually not prone to immediate evaluation or quantification inasmuch as many such claims may be litigated over several years and their ultimate costs may be affected by the vagaries of judged or jury verdicts. Approximately 92% of the general insurance group's claim reserves stem from liability insurance coverages for commercial customers which typically require more extended periods of investigation and at times protracted litigation before they are finally settled. As a consequence of these and other factors, Old Republic does not utilize a single, overarching loss reserving approach.
The Company prepares periodic analyses of its loss reserve estimates for its significant insurance coverages. It establishes point estimates for most losses on an insurance coverage line-by-line basis for individual subsidiaries, sub-
Aggregate loss reserves consist of liability estimates for claims that have been reported ("case") to the Company's insurance subsidiaries and reserves for claims that have been incurred but not yet reported ("IBNR") or whose ultimate costs may not become fully apparent until a future time. Additionally, 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 case and IBNR claims over time. Long-term, disability-type workers' compensation reserves are discounted to present value based on interest rates that range from 3.5% to 4.0%. The amount of discount reflected in the year-end net reserves totaled $240.7, $231.9 and $228.6 as of December 31, 2017, 2016, and 2015, respectively. Interest accretion of $20.4, $24.2, and $36.7 for the years ended December 31, 2017, 2016, and 2015, respectively, was recognized within benefits, claims and settlement expenses in the consolidated statements of income.
Rescissions reduced the Company's paid losses by an estimated $13.1, $1.4, and $33.0 for 2017, 2016, and 2015, respectively.
The general insurance ratio of claims and related settlement costs to earned premiums improved in 2017 compared with 2016. While current accident year claim ratios reflected moderate year-over-year declines, these were affected by moderately unfavorable developments of prior years’ reserves of 0.7 percentage points in 2017. 2017’s unfavorable developments were concentrated in the Company’s largest insurance coverages of workers’ compensation and general liability which were partially offset by favorable development trends in commercial automobile (trucking). For the respective 2016 and 2015 periods, the claim and related settlement costs ratios include unfavorable developments of 0.3 and 1.5 percentage points.
The RFIG Run-off mortgage guaranty declining premium base led to a higher claim ratio for 2017 though current accident year reported claim costs, absent the MI charges referred to below, were relatively level in comparison to 2016. Reductions in the provision for current year losses stemming from a continuing drop in newly reported delinquencies as well as improving cure rates resulted in favorable developments of previously established claim reserves. The
The 2017 year-over-year claim ratio comparison for the CCI portion of the Run-off business was most significantly affected by the additional $107.0 claim and related expense provisions related to the final settlement and probable dispositions of all known litigated and other claim costs.
As determined by risk in force as of December 31, 2017, these 10 states represent approximately 52.2%, 57.9%, and 52.2%, of traditional primary, bulk, and total risk in force, respectively.
On a consolidated basis, which includes all coverages provided by the Company, the cumulative development on prior year loss reserves over the past ten years through December 31, 2017 has ranged from (7.2)% unfavorable in 2010 to 5.3% favorable in 2012 and averaged 1.4% favorable for the ten years. Although management does not have a practical business reason for making projections of likely outcomes of future loss developments, its analysis and evaluation of Old Republic's existing business mix, current aggregate loss reserve levels, and loss development patterns suggests a reasonable likelihood that 2017 year-end loss reserves could ultimately develop within a range of +/- 5%. The most significant factors impacting the potential reserve development for each of the Company's insurance segments is discussed above. Old Republic has generally experienced favorable overall loss developments for the latest ten-year period. While General Insurance has experienced unfavorable developments of previously established reserves during the most recent three years, the current analysis of loss development factors and economic conditions influencing the Company's insurance coverages point to a gradual reduction in such unfavorable development. In management's opinion, the other segments' loss reserve development patterns (most notably those associated with title and mortgage insurance) show greater variability due to changes in economic conditions which cannot be reasonably anticipated. Consequently, management believes that using a 5% potential range of reserve development provides a reasonable benchmark for a sensitivity analysis of the Company's consolidated reserves as of December 31, 2017.
Subsidiaries within the general insurance segment have generally obtained reinsurance coverage from independent insurance or reinsurance companies pursuant to excess of loss agreements. Under excess of loss reinsurance agreements the Company is generally reimbursed for claim costs exceeding contractually agreed-upon levels. During the three year period ended December 31, 2017, the Company's net retentions have risen gradually within the general insurance segment; however, such changes have not had a material impact on the Company's consolidated financial statements.
Generally, the RFIG Run-off mortgage guaranty insurance risk has historically been reinsured through excess of loss contracts with insurers owned by or affiliated with lending institutions and financial and other intermediaries whose customers are insured by Old Republic's mortgage insurance subsidiaries. Effective December 31, 2008, the Company discontinued excess of loss reinsurance cessions to lenders' captive insurance companies for all new production originated subsequent to the effective date.
The Company does not anticipate any significant changes in its reinsurance programs during 2018.
Variations in the Company's consolidated expense ratios reflect a continually changing mix of coverages sold and attendant costs of producing business in the Company's three largest operating 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. Moreover, general operating expenses 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 2017 General Insurance expense ratio was impacted by the previously mentioned charges for estimated employee incentive awards. Relatively higher General insurance expense ratios in 2016 resulted mostly from greater costs incurred for a start-up business, additional litigation cost provisions, and by a slightly different premium mix and attendant production costs associated with the business’ responses to recurring changes in insurance market conditions and opportunities. The RFIG Run-off 2017 operating expense ratio was impacted by costs stemming from the partial termination of a MI leased facility in early 2017. Finally, except for the effect of the previously mentioned additions for employee incentive awards in the final quarter of 2017, the Title Insurance expense ratio for the periods reported upon remained generally aligned with earned premiums and fees levels.
(c) 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. The consolidated financial statements reflect an immaterial adjustment of $11.0 post-tax (or 0.28%) to previously reported shareholders' equity as of January 1, 2015. The adjustment relates to immaterial expense accruals pertaining to the earlier period. Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to the most current presentation.
Fixed maturity securities and other preferred and common stocks (equity securities) classified as "available for sale" are included at fair value with changes in such values, net of deferred income taxes, reflected directly in shareholders' equity while fixed maturity securities classified as "held to maturity" are carried at amortized cost. 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 uses quoted values and other data provided by a nationally recognized independent pricing source as inputs into its quarterly process for determining fair values of its fixed maturity and equity securities. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; and (ii) comparing other sources including the fair value estimates to its knowledge of the current market and to independent fair value estimates provided by the investment custodian. The independent pricing source obtains market quotations and actual transaction prices for securities that have quoted prices in active markets and uses its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of "matrix pricing" in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.
There were no transfers between Levels 1, 2 or 3 during 2017 or 2016.
In June 2016, the FASB issued guidance on accounting for credit losses on financial instruments which will be effective in 2020. The guidance will require immediate recognition of expected credit losses for certain financial instruments including reinsurance recoverables, held to maturity securities, and accounts and notes receivable. The guidance also modifies the impairment model for available for sale fixed maturity securities. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.
Substantially all general insurance premiums pertain to annual policies and are reflected in income on a pro-rata basis in general association with the related benefits, claims, and expenses. 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.
amounted to $117.4 and $121.2 gross, respectively, and $96.4 and $97.1 net of reinsurance, respectively. Old Republic's average five year paid loss survival ratios stood at 4.6 years (gross) and 6.3 years (net of reinsurance) as of December 31, 2017 and 4.3 years (gross) and 6.3 years (net of reinsurance) as of December 31, 2016. Fluctuations in this ratio between years can be caused by the inconsistent pay out patterns associated with these types of claims.
The Company has the legal right to rescind mortgage insurance coverage unilaterally as expressly stated in its policy. Moreover, two federal courts that have considered that policy wording have each affirmed that right (See First Tennessee Bank N.A. v. Republic Mortg. Ins. Co., Case No. 2:10-cv-02513-JPM-cgc (W.D. Tenn., Feb. 25, 2011) and JPMorgan Chase Bank N.A. v. Republic Mortg. Ins. Co., Civil Action No. 10-06141 (SRC) (D. NJ, May 4, 2011), each decision citing supporting state law legal precedent). RMIC's mortgage insurance policy provides that the insured represents that all statements made and information provided to it in an application for coverage for a loan, without regard to who made the statements or provided the information, have been made and presented for and on behalf of the insured; and that such statements and information are neither false nor misleading in any material respect, nor omit any fact necessary to make such statements and information not false or misleading in any material respect. According to the policy, if any of those representations are materially false or misleading with respect to a loan, the Company has the right to cancel or rescind coverage for that loan retroactively to commencement of the coverage. Whenever the Company determines that an application contains a material misrepresentation, it either advises the insured in writing of its findings prior to rescinding coverage or exercises its unilateral right to rescind coverage for that loan, stating the reasons for that action in writing and returning the applicable premium. The rescission of coverage in instances of materially faulty representations or warranties provided in applications for insurance is a necessary and prevailing practice throughout the insurance industry. In the case of mortgage guaranty insurance, rescissions have occurred regularly over the years but have been generally immaterial. Since 2008, however, the Company has experienced a much greater incidence of rescissions due to increased levels of observed fraud and misrepresentations in insurance applications pertaining to business underwritten between 2004 and the first half of 2008. As a result, the Company has incorporated certain assumptions regarding the expected levels of coverage rescissions and claim denials in its reserving methodology since 2008. Such estimates, which are evaluated at each balance sheet date, take into account observed as well as historical trends in rescission and denial rates. The table below shows the estimated effects of coverage rescissions and claim denials on loss reserves and settled and incurred losses.
The RFIG Run-off mortgage guaranty provision for insured events of the current year was reduced by estimated coverage rescissions and claims denials of $6.2, $8.3 and $18.8, respectively, for 2017, 2016 and 2015. The provision for insured events of prior years in 2017, 2016 and 2015 was increased by estimated coverage rescissions and claims denials of $3.7, $24.8 and $17.6, respectively. Prior year development was also affected in varying degrees by differences between actual claim settlements relative to expected experience, by reinstatement of previously rescinded or denied claims, and by subsequent revisions of assumptions in regards to claim frequency, severity or levels of associated claim settlement costs which result from consideration of underlying trends and expectations.
The amount of discount reflected in the year-end net reserves totaled $240.7 and $231.9 as of December 31, 2017 and 2016, respectively.
The Tax Cuts and Jobs Act ("TCJA") was enacted into law on December 22, 2017, thereby requiring that various accounting adjustments be reflected in the consolidated financial statements at year-end 2017. The TCJA, among its many elements, lowers the federal corporate tax rate to 21.0% from the existing 35.0%. Accordingly, the Company revalued its deferred tax items to reflect the lower tax rate, resulting in a $63.1 income tax credit reflected in the consolidated statements of income.
elected to follow the IRS industry average tables. The TCJA requires the IRS to publish tables linking the interest rates used to discount loss reserves to the corporate bond yield curve as opposed to the Federal mid-term rates used under the old law. As of the date of this report, the IRS has not published the updated tables. Accordingly, the Company is unable to make a reasonable estimate of any adjustment resulting from the application of the new IRS published discount rates. The Company has used the most recently published IRS tables for the preparation of the accompanying consolidated financial statements. Any adjustment to the loss reserve discount will be recorded in the period in which additional information becomes available.
Furthermore, the Company elected to early adopt income tax accounting guidance issued by the FASB in February 2018, which allows for the reclassification of the income tax effects of TCJA on items within accumulated other comprehensive income to retained earnings. The reclassification adjustment, which consisted of the revaluation of net deferred taxes on net unrealized gains (losses) on securities and pension adjustments, resulted in an increase to accumulated other comprehensive income and a corresponding decrease to retained earnings of $85.1.
A valuation allowance was held against deferred tax assets as of December 31, 2014 related to certain tax credit carryforwards which the Company did not expect to realize. In 2015, the Company released the valuation allowance previously established. In valuing the deferred tax assets, the Company considered certain factors including primarily the scheduled reversals of certain deferred tax liabilities, estimates of future taxable income, the impact of available
Goodwill resulting from business combinations is not amortizable against operations but must be tested annually for possible impairment of its continued value. Intangible assets with definitive lives are amortized against future operating results; whereas indefinite-lived intangibles are tested annually for impairment.
pension liability; offsetting entries are reflected as a component of shareholders' equity in accumulated other comprehensive income, net of deferred taxes. The effects of these measurements and the resulting funded status of the Plan are reflected below.
The following tables present a summary of the Plan's assets segregated among the various input levels described in Note 1(d).
The benefits expected to be paid as of December 31, 2017 for the next 10 years are as follows: 2018: $27.3; 2019: $28.8; 2020: $29.8; 2021 $31.7; 2022: $31.8 and for the five years after 2022: $166.5.
(o) 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 ($1,502.6 and $1,447.0 at December 31, 2017 and 2016, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
The exercise price of stock options is equal to the closing market price of the Company's common stock on the date of grant, and the contractual life of the grant is generally ten years from the date of the grant. Options granted may be exercised to the extent of 10% of the number of shares covered thereby as of December 31st of the year of the grant and, cumulatively, to the extent of an additional 15%, 20%, 25% and 30% on and after the second through fifth calendar years, respectively. Effective in 2014, options granted to employees who meet certain retirement eligibility provisions are fully vested on the date of grant.
A summary of stock options outstanding and exercisable at December 31, 2017 follows:
At December 31, 2017, the Company had restricted common stock issued to certain employees which are expected to vest over the next 5 years. During the vesting period, restricted shares are nontransferable and subject to forfeiture. Compensation expense for the restricted stock award is recognized over the vesting period of the award and was immaterial for the years ended December 31, 2017, 2016 and 2015.
(s) Regulatory Matters - The material increases in mortgage guaranty insurance claims and loss payments that began in 2007 gradually depleted RMIC's statutory capital base and forced it to discontinue writing new business in 2011. The insurance laws of 16 jurisdictions, including RMIC's and RMGIC’s domiciliary state of North Carolina, require a mortgage insurer to maintain a minimum amount of statutory capital relative to risk in force (or a similar measure) in order to continue to write new business. The formulations currently allow for a maximum risk-to-capital ratio of 25 to 1, or alternatively stated, a “minimum policyholder position” (“MPP”) of one-twenty-fifth of the total risk in force. The failure to maintain the prescribed minimum capital level in a particular state generally requires a mortgage insurer to immediately stop writing new business until it reestablishes the required level of capital or receives a waiver of the requirement from a state's insurance regulatory authority. RMIC breached the minimum capital requirement during the third quarter of 2010. RMIC and its sister company RMGIC were placed under administrative supervision by the North Carolina Department of Insurance ("NCDOI") in 2012 and ultimately ordered to defer the payment of 40% of all settled claims as a deferred payment obligation ("DPO").
Scheduled maturities of the above debt at the respective year ends are as follows: 2018: $475.1; 2019: $6.5; 2020: $6.5; 2021: $19.5; 2022 and after: $950.0. During 2017, 2016 and 2015, $64.5, $50.9 and $42.9, respectively, of interest expense on debt was charged to consolidated operations.
(a) Preferred Stock - At December 31, 2017, there were 75,000,000 shares of preferred stock authorized. The Company has designated one series of preferred stock: 10,000,000 shares of Series A Junior Participating Preferred Stock (Series A). No shares have been issued or are outstanding. The Series A Stock, if and when issued, shall pay a dividend of the greater of $1.00 or 100 times (subject to adjustment) the aggregate per share amount (payable in kind) of all non-cash dividend or other distributions, other than a dividend payable in shares of common stock declared on the common stock of the Company. Each share of Series A stock shall have 100 votes on each matter submitted to a vote of the shareholders.
(b) Common Stock - At December 31, 2017, there were 500,000,000 shares of common stock authorized. 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. During 2008, the Company issued 5,488,475 shares to the ESSOP for consideration of $50.0. The ESSOP's common stock purchases were financed by a $30.0 bank loan and by $20.0 of pre-fundings from ESSOP participating subsidiaries. During 2015, the ESSOP purchased 2,200,000 shares of Old Republic common stock for $34.0. The purchases were financed by a loan from the Company. Common stock held by the ESSOP is classified as a charge to the common shareholders' equity account until it is allocated to participating employees' accounts contemporaneously with the repayment of the ESSOP debt incurred for its acquisition. Such unallocated shares are not considered outstanding for purposes of calculating earnings per share. Dividends on unallocated shares are used to pay debt service costs. Dividends on allocated shares are credited to participants' accounts.
In late December 2017 the Board declared a special cash dividend of $1.00 per share payable on January 31, 2018.
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 TRIREA revised the definition of "property and casualty insurance" to exclude commercial automobile, burglary and theft, surety, professional liability and farm owners multi-peril insurance. TRIPRA did not make any further changes to the definition of property and casualty insurance, however, it did include domestic acts of terrorism within the scope of the program. Although insurers are permitted to charge an additional premium for terrorism coverage, insureds may reject the coverage. Under TRIPRA, the program's protection is not triggered for losses arising from an act of terrorism until the industry first suffers losses in excess of a prescribed aggregate deductible during any one year. The program deductible trigger is $160, $180, and $200 for 2018, 2019, and 2020, respectively. Once the program trigger is met, the program will be responsible for a fixed percentage of the Company's terrorism losses that exceed its deductible which ranges from 85% in 2015 and declines by one percentage point per year until it reaches 80% in 2020. The Company's deductible amounts to 20% of direct earned premium on eligible property and casualty insurance coverages. The Company currently reinsures limits on a treaty basis of $195.0 in excess of $5.0 for claims arising from certain acts of terrorism for casualty clash and catastrophe workers' compensation liability insurance coverages. The Company also purchases facultative reinsurance on certain accounts in excess of $200.0 to manage the Company's net exposure.
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 underwriting expenses and proportionately related claims costs.
At December 31, 2017, the Company's General Insurance Group's ten largest reinsurers represented approximately 53% of the total consolidated reinsurance recoverable on paid and unpaid losses, with Munich Re America, Inc. the largest reinsurer representing 13.1% of the total recoverable balance. Of the balances due from these ten reinsurers, 63.0% was recoverable from A or better rated reinsurance companies, 6.3% from an industry-wide insurance assigned risk pool, 26.0% from foreign unrated companies, and 4.7% from domestic unrated companies.
The following information relates to reinsurance and related data for the General Insurance and RFIG Run-off Groups for the three years ended December 31, 2017. Reinsurance transactions of the Title Insurance Group and small life and accident insurance operation are not material.
(b) Leases - Some of the Company'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 $57.1, $55.7 and $54.7 in 2017, 2016 and 2015, respectively. These expenses relate primarily to building leases of the Company. A number of the Company's subsidiaries also lease other equipment for use in their businesses. At December 31, 2017, aggregate minimum rental commitments (net of expected sub-lease receipts) under noncancellable operating leases are summarized as follows: 2018: $58.1; 2019: $50.8; 2020: $38.7; 2021: $29.4; 2022: $23.7; 2023 and after: $109.4.
(c) General - In the normal course of business, the Company 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 claim 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. The Company does not have a basis for anticipating any significant losses or costs that could result from any known or existing contingencies.
The General Insurance Group provides property and liability insurance primarily to commercial clients. Old Republic does not have a meaningful participation in personal insurance coverages. Workers' compensation is the largest type
of coverage underwritten by the General Insurance Group, accounting for 32.9% of the Group's direct premiums written in 2017. The remaining premiums written by the General Insurance Group are derived largely from a wide variety of coverages, including commercial automobile (principally trucking), general liability, general aviation, directors and officers indemnity, fidelity and surety indemnities, and home and auto warranties.
Income (loss) before taxes (credits) is reported net of interest charges on intercompany financing arrangements with Old Republic's holding company parent for the following segments: General - $57.2, $51.9 and $41.6 for the years ended December 31, 2017, 2016, and 2015, respectively; Title - $7.8, $8.4 and $8.1 for the years ended December 31, 2017, 2016, and 2015, respectively.
General Insurance income before taxes (credits) for 2017 includes hurricane-related claim costs currently estimated at $8.0.
RFIG Run-off income before taxes (credits) for 2017 include additional claim and related expense provisions of $130.0. These costs apply to the final settlements and probable dispositions of all known litigated and other claim costs incurred by the Company's run-off Financial Indemnity business during the Great Recession years and their aftermath.
As of December 31, 2017 and 2016, the Mutual's statutory capital included surplus notes due to Old Republic of $10.5 out of total statutory capital of $32.7 and $30.6, respectively. AB&M's accounts are not consolidated with Old Republic's since it is owned by its policyholders and, in any event, their inclusion would not have a significant effect on Old Republic's consolidated financial statements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.