Each of our business segments uses our executive offices at MacArthur Place in Santa Ana, California. This office campus consists of five office buildings, a technology center and a two-story parking structure, totaling approximately 490,000 square feet. Three office buildings, totaling approximately 210,000 square feet, and the fixtures thereto and underlying land, are subject to a deed of trust and security agreement securing payment of a promissory note evidencing a loan made in October 2003, to our principal title insurance subsidiary in the original sum of $55.0 million. This loan is payable in monthly installments of principal and interest, is fully amortizing and matures November 1, 2023. The outstanding principal balance of this loan was $22.6 million as of December 31, 2017.
The corporate function consists primarily of certain financing facilities as well as the corporate services that support the Company’s business operations.
The provision transferred from IBNR title claims related to prior years decreased by $7.5 million, or 4.0%, in 2017 from 2016 and increased by $3.6 million, or 1.9%, in 2016 from 2015. Payments, net of recoveries, related to prior years decreased by $12.3 million, or 6.2%, in 2017 from 2016 and decreased by $45.7 million, or 18.8%, in 2016 from 2015. Generally, the provision transferred from IBNR title claims and payments are expected to decline with the runoff of older policy years that have higher expected ultimate losses, particularly policy years 2005 through 2008. 2015 was impacted by the timing of the provision transferred from IBNR title claims and payments associated with certain large claims.
“Other” primarily includes foreign currency translation gains and losses, ceded reinsurance claims and assets acquired in connection with claim settlements.
For further discussion of title provision recorded in 2017, 2016 and 2015, see Results of Operations, pages 33 and 34.
Fair value of investment portfolio. The Company categorizes the fair values of its debt and equity securities using a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the Company (observable inputs) and the Company’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. The hierarchy level assigned to each security in the Company’s available-for-sale portfolio was based on management’s assessment of the transparency and reliability of the inputs used to estimate the fair values at the measurement date. See Note 14 Fair Value Measurements to the consolidated financial statements for a more detailed description of the three-level hierarchy and a description for each level.
Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign government bonds, governmental agency bonds, governmental agency mortgage-backed securities and U.S. and foreign corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. Certain of the Company’s corporate debt securities were not actively traded and there were fewer observable inputs available requiring the use of more judgment in determining their fair values, which resulted in their classification as Level 3.
The Company did not record any other-than-temporary impairment losses related to its debt securities for 2017. The Company recorded other-than-temporary impairment losses considered to be credit related on its debt securities of $0.5 million and $2.2 million for 2016, and 2015, respectively.
When a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in fair value is other-than-temporary, the factors considered by the Company include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
When an equity security has been in an unrealized loss position and its fair value is less than 80% of cost for twelve consecutive months, the Company’s review of the security will include the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company did not record any other-than-temporary impairment losses related to its equity securities for 2017, 2016 and 2015.
Litigation and regulatory contingencies. The Company and its subsidiaries are parties to a number of ongoing routine and non-ordinary course legal proceedings. For those lawsuits where the Company has determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure based on known facts has been recorded. Actual losses may materially differ from the amounts recorded. For a substantial majority of these lawsuits it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. As a result of, among other factors, ambiguities and inconsistencies in the myriad laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements. Furthermore, because most of these lawsuits are putative class actions, it is often impossible to estimate the possible loss or a range of loss, even where the Company has determined that a loss is reasonably possible. In addition, many of the Company’s businesses are regulated by various federal, state, local and foreign governmental agencies and are subject to numerous statutory guidelines. These regulations and statutory guidelines often are complex, inconsistent or ambiguous, which results in additional uncertainty as to the outcome of a given lawsuit-including the amount of damages a plaintiff might be afforded-or makes it difficult to analogize experience in one case or jurisdiction to another case or jurisdiction.
Employee benefit plans. The Company recognizes the underfunded status of its unfunded supplemental benefit plans as a liability on its consolidated balance sheets. Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive loss. Plan obligations are measured annually as of December 31.
In March 2016, the FASB issued updated guidance intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016. While the adoption of this guidance did have an impact on the Company’s effective income tax rate for 2017, it did not have a material impact on the Company’s consolidated financial statements. See Note 11 Income Taxes to the consolidated financial statements for further discussion of the Company’s effective income tax rates. Beginning in 2017, excess tax benefits from share-based compensation are presented in the consolidated statements of cash flows in cash flows from operating activities within net change in income tax accounts.
In May 2017, the FASB issued updated guidance intended to reduce diversity in practice by clarifying which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In November 2016, the FASB issued updated guidance intended to reduce the diversity in practice on presenting restricted cash and restricted cash equivalents in the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In August 2016, the FASB issued updated guidance intended to eliminate the diversity in practice regarding the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated statements of cash flows.
In 2016, the Company terminated its funded defined benefit pension plans, and in 2017, the Company transferred all remaining benefit obligations related to the pension plans to a highly rated insurance company. In connection with the termination, the Company recognized pension settlement costs of $152.4 million and $66.3 million in personnel costs in the corporate segment for 2017 and 2016, respectively. The Company estimates an annual reduction of approximately $22 million in personnel costs related to the pension plans within the corporate segment, based on the level of these expenses for 2016. For further discussion of the pension termination see Note 13 Employee Benefit Plans to the consolidated financial statements.
In addition, the Company continues to monitor developments in its regulatory environment. Currently, federal officials are discussing various potential changes to laws and regulations that could impact the Company’s businesses, including changes to the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the reform or privatization of government-sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). In addition, the Tax Reform Act included changes that could affect the real estate and mortgage markets, including changes to the mortgage interest deduction, the increase in the standard deduction (which limits the benefit of itemizing and deducting mortgage interest separately) and the limitation on state and local tax deductions, among others. The impact of the Tax Reform Act on volumes of real estate transactions and mortgage originations is not currently known. Other changes in these areas, and more generally in the regulatory environment, in which the Company and its customers operate, could similarly impact the volume of mortgage originations in the United States and the Company’s competitive position and results of operations. At this time, the nature and impact of any future changes is unknown.
Direct premiums and escrow fees increased $17.7 million, or 0.9%, in 2017 from 2016 and $74.9 million, or 3.9%, in 2016 from 2015. The increase in direct premiums and escrow fees in 2017 from 2016 was primarily due to an increase in domestic average revenues per order closed, partially offset by a decrease in the domestic title orders closed by the Company’s direct title operations. The increase in direct premiums and escrow fees in 2016 from 2015 was primarily due to an increase in domestic title orders closed by the Company’s direct title operations, partially offset by a decrease in domestic average revenues per order closed. The domestic average revenues per order closed were $2,264, $1,931 and $2,012 for 2017, 2016 and 2015, respectively. The 17.2% increase in average revenues per order closed in 2017 from 2016 was primarily due to a shift in the mix of direct revenues generated from lower premium residential refinance products to higher premium residential purchase and commercial products, higher average revenues per order from commercial transactions, higher residential real estate values, and premium and fee increases related to residential purchase transactions. The 4.0% decrease in average revenues per order closed in 2016 from 2015 was primarily due to a shift in the mix of direct revenues generated from higher premium commercial products to lower premium residential refinance products. The Company’s direct title operations closed 823,700, 958,400 and 882,400 domestic title orders during 2017, 2016 and 2015, respectively. The 14.1% decrease in orders closed in 2017 from 2016 and the 8.6% increase in orders closed in 2016 from 2015 were generally consistent with the changes in residential mortgage origination activity in the United States as reported in the MBA Forecast.
Information and other revenues increased $52.9 million, or 7.4%, in 2017 from 2016 and $43.2 million, or 6.4%, in 2016 from 2015. The increases were driven by recent acquisitions. Excluding the $77.4 million impact of new acquisitions for the year ended December 31, 2017, information and other revenues decreased $24.5 million, or 3.4%, in 2017 compared to 2016. The decrease in 2017 from 2016, adjusted for the impact of new acquisitions, was due to lower demand for the Company’s default information products driven by a decrease in loss mitigation activities and lower demand for the Company’s valuation services, fulfillment services, and automated products driven by a decrease in mortgage origination volumes, partially offset by higher fees earned on non-insured products related to commercial transactions. Excluding the $48.5 million impact of new acquisitions for the year ended December 31, 2016, information and other revenues decreased $5.3 million, or 0.8%, in 2016 compared to 2015. The decrease in 2016 from 2015, adjusted for the impact of new acquisitions, was due to lower demand for the Company’s default information products as a result of a decrease in domestic loss mitigation activities and lower revenue in the Company’s Australian operations due to the loss of a large customer, partially offset by higher demand for the Company’s title plant and data products.
Net investment income increased $26.7 million, or 24.1%, in 2017 from 2016 and $13.2 million, or 13.6%, in 2016 from 2015. The increase in 2017 from 2016 was primarily attributable to the increase in short-term interest rates which drove higher interest income in the Company’s cash balances and investment portfolio. The increase in 2016 from 2015 was primarily attributable to higher interest income from the debt securities portfolio due to higher average balances in 2016 when compared to 2015. Net investment income for 2017 and 2015 included impairment losses of $1.5 million and $2.0 million, respectively, recognized on investments accounted for using the equity method. No impairment losses were recognized on investments accounted for using the equity method in 2016.
The Company continues to closely monitor order volumes and related staffing levels and intends to adjust staffing levels as considered necessary. The Company’s direct title operations opened 1,069,000, 1,281,400 and 1,261,700 domestic title orders in 2017, 2016 and 2015, respectively, representing a decrease of 16.6% in 2017 from 2016 and an increase of 1.6% in 2016 from 2015.
The premium split between underwriter and agents is in accordance with the respective agency contracts and can vary from region to region due to divergences in real estate closing practices and state regulations. As a result, the percentage of title premiums retained by agents can vary due to the geographic mix of revenues from agency operations. The changes in the percentage of title premiums retained by agents in 2017 from 2016 and in 2016 from 2015 were primarily due to changes in the geographic mix of agency revenues.
Other operating expenses (principally related to direct operations) increased $23.6 million, or 3.1%, in 2017 from 2016 and $19.1 million, or 2.6%, in 2016 from 2015. The increases were driven by recent acquisitions. Excluding the $32.4 million impact of new acquisitions for the year ended December 31, 2017, other operating expenses decreased $8.8 million, or 1.2%, in 2017 compared to 2016. The decrease in 2017 from 2016, adjusted for the impact of new acquisitions, was primarily attributable to lower production related costs driven by lower order volumes, higher foreign currency exchange gains, and declines in furniture and equipment costs, software related costs and litigation related costs. The decreases were partially offset by increased occupancy expense and the first quarter of 2016 benefitting from the recovery of an insurance claim. In addition, other operating expenses increased by $8.5 million due to an out-of-period adjustment recorded to write-off certain uncollectible balances related to fees that should have been previously written off. To correct for this error, the Company recorded the $8.5 million adjustment in the fourth quarter of 2017. For further discussion of the out-of-period adjustments see Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements. Excluding the $14.0 million impact of new acquisitions for the year ended December 31, 2016, other operating expenses increased $5.1 million, or 0.7%, in 2016 compared to 2015. The increase in 2016 from 2015, adjusted for the impact of new acquisitions, was primarily attributable to higher professional services expenses and higher software related expenses, partially offset by lower bad debt expense, lower foreign currency exchange losses and a recovery on an insurance claim.
The prior year rate of 5.5% reflected an ultimate loss rate of 4.5% for policy year 2016 and a $42.6 million net increase in loss reserve estimates for prior policy years. The increase in loss reserve estimates for prior policy years was primarily attributable to potential uncertainty with respect to the Company’s exposure to large title claims. A large title claim is defined as a title claim with a total ultimate loss in excess of $2.5 million. This uncertainty was due to the following factors, among others: (i) the volatility associated with the timing and severity of large title claims, (ii) the potential of incurring one or more large title claims that significantly exceed estimated ultimate losses indicated by current historical trends, and (iii) the complexity associated with handling large title claims which makes it difficult to estimate the ultimate outcome. While the Company believed its claims reserve attributable to large title claims was reasonable, this uncertainty increased the potential for adverse loss development.
Depreciation and amortization expense increased $28.5 million, or 30.6%, in 2017 from 2016 and $12.7 million, or 15.8%, in 2016 from 2015. The increase in 2017 from 2016 was primarily attributable to higher amortization expense associated with internally developed technology and purchased software licenses, $6.5 million related to recent acquisitions, and $4.7 million in out-of-period adjustments to fully amortize certain title plant imaging assets that were misclassified as title plants assets. The higher amortization expense related to internally developed technology included $5.3 million of accelerated amortization for 2017, resulting from a shortened useful life for a software interface. For further discussion of the out-of-period adjustments see Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements. The increase in 2016 from 2015 was primarily attributable to higher amortization expense associated with internally developed technology and purchased software licenses and $2.7 million related to recent acquisitions.
Net realized investment gains for the specialty insurance segment totaled $4.6 million, $4.1 million and $1.5 million for 2017, 2016 and 2015, respectively, and were primarily from the sales of debt and equity securities. Net realized investment gains for 2016 also included $2.3 million of gains from the sale of real estate.
The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 53.5% in 2017, 60.7% in 2016 and 56.5% in 2015. The decrease in rate in 2017 from 2016 was primarily attributable to a decrease in the frequency and severity of claims and, to a lesser extent, an increase in average revenue per contract. The decrease in the severity of claims was primarily due to more efficient claims management, which was mainly driven by improved rates with contractors and more efficient allocation of claims to contractors. The severity and frequency of home warranty claims also benefited from milder weather conditions when compared to the prior year. The increase in rate in 2016 from 2015 was primarily attributable to higher contract servicing costs due to an increase in the frequency of higher cost claims related to increased equipment and replacement costs and less efficient claims management. The efficiency of claims management was adversely impacted by the increased level of claims opened in 2016 as a result of the higher volume of home warranty residential service contracts outstanding in 2016.
The Company’s effective income tax rates (income tax expense as a percentage of income before income taxes) were 5.3% for 2017, 28.1% for 2016 and 33.3% for 2015. The differences in the effective tax rates are typically due to changes in state and foreign income taxes resulting from fluctuations in the Company’s noninsurance and foreign subsidiaries’ contributions to pretax income and changes in the ratio of permanent differences to income before income taxes. The Company’s effective tax rate for 2017 also reflects the estimated impact of the Tax Reform Act, state tax benefits relating to the termination of the Company’s pension plan, and the release of reserves relating to tax positions taken on prior year tax returns. For further discussion of the impact of the Tax Reform Act on the Company’s consolidated financial statements, see Note 11 Income Taxes to the consolidated financial statements. In addition, the Company’s effective tax rate for 2017 reflects the adoption of new accounting guidance related to the accounting for share-based payment transactions, which requires, among other items, that all excess tax benefits and tax deficiencies associated with share-based payment transactions be recorded in income tax expense rather than in additional paid-in capital, as previously required. The impact to the Company of adopting this guidance was a reduction in income tax expense of $3.4 million. For further discussion of the new guidance, see Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements. The Company’s effective tax rate for 2016 reflects the resolution of certain tax authority examinations and tax credits claimed in 2016 and prior years. The Company’s effective tax rate for 2015 includes a benefit for the release of valuation allowances previously provided against certain foreign net operating losses and other deferred tax assets.
Cash provided by operating activities totaled $632.1 million, $489.4 million and $551.3 million for the years ended December 31, 2017, 2016 and 2015, respectively, after claim payments, net of recoveries, of $472.0 million, $463.0 million and $476.5 million, respectively. The principal nonoperating uses of cash and cash equivalents for the years ended December 31, 2017, 2016 and 2015 were purchases of debt and equity securities, dividends to common stockholders, capital expenditures and business acquisitions. The most significant nonoperating sources of cash and cash equivalents for the years ended December 31, 2017, 2016 and 2015 were proceeds from the sales and maturities of debt and equity securities and increases in the deposit balances at the Company’s banking operations, and, for the year ended December 31, 2016, net proceeds from the issuance of debt. The net effect of all activities on total cash and cash equivalents was an increase of $381.1 million, a decrease of $21.2 million, and a decrease of $162.8 million for the years ended December 31, 2017, 2016 and 2015, respectively.
The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. In August 2017, the Company’s board of directors approved an increase in the Company’s quarterly cash dividend to 38 cents per common share, representing a 12% increase from the prior level of 34 cents per common share. The dividend increase became effective beginning with the September 2017 dividend. In January 2018, the Company’s board of directors approved a first quarter cash dividend of 38 cents per common share. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.
Holding company. First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As of December 31, 2017, under such regulations, the maximum amount available to the holding company from its insurance subsidiaries in 2018, without prior approval from applicable regulators, was dividends of $338.4 million and loans and advances of $96.0 million. However, the timing and amount of dividends paid by the Company’s insurance subsidiaries to the holding company falls within the discretion of each insurance subsidiary’s board of directors and will depend upon many factors, including the level of total statutory capital and surplus required to support minimum financial strength ratings by certain rating agencies. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.
The Tax Reform Act amends the Internal Revenue Code to reduce U.S. tax rates and modify policies, credits and deductions for individuals and businesses. While the changes resulting from the Tax Reform Act are broad and complex and will require additional analysis, the Company expects that the Tax Reform Act will have an overall favorable impact on its effective tax rate resulting in less cash required for tax payments in future periods. In addition, the Tax Reform Act moves the U.S. to a partial territorial tax system, which as a result, will reduce the tax costs associated with future distributions of earnings from foreign subsidiaries. For further discussion of the impact of the Tax Reform Act on the Company’s consolidated financial statements, see Note 11 Income Taxes to the consolidated financial statements.
As of December 31, 2017, the holding company’s sources of liquidity included $233.9 million of cash and cash equivalents and $540.0 million available on the Company’s revolving credit facility. Management believes that liquidity at the holding company is sufficient to satisfy anticipated cash requirements and obligations for at least the next twelve months.
Financing. The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $700.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments under the credit agreement will terminate on May 14, 2019. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2017, outstanding borrowings under the facility totaled $160.0 million at an interest rate of 3.32%.
In addition to amounts available under its credit facility, certain subsidiaries of the Company are parties to master repurchase agreements which are used as part of the Company’s liquidity management activities and to support its risk management activities. In particular, securities loaned or sold under repurchase agreements may be used as short-term funding sources. During 2017, the Company financed securities for funds received totaling $10.0 million under these agreements. As of December 31, 2017, no amounts remained outstanding under these agreements.
In addition to being a party to master repurchase agreements, the Company’s federal savings bank subsidiary, First American Trust, FSB maintains a secured line of credit with the Federal Home Loan Bank and federal funds lines of credit with correspondent institutions. As of December 31, 2017, no amounts remained outstanding under any of these facilities.
Contractual obligations. A summary of the Company’s contractual obligations at December 31, 2017, by due date, is as follows:
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $7.5 billion and $6.8 billion at December 31, 2017 and 2016, respectively, of which $2.9 billion and $2.6 billion, respectively, were held at First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.
Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015
II. Condensed Financial Information of Registrant as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015
IV. Reinsurance for the years ended December 31, 2017, 2016 and 2015
V. Valuation and Qualifying Accounts for the years ended December 31, 2017, 2016 and 2015
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 their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. 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 COSO.
The Company maintains investments in debt securities in accordance with certain statutory requirements for the funding of statutory premium reserves and state deposits. At December 31, 2017 and 2016, the fair value of such investments totaled $108.4 million and $110.6 million, respectively. See Note 2 Statutory Restrictions on Investments and Stockholders’ Equity for additional discussion of the Company’s statutory restrictions.
Expected future cash flows for debt securities are based on qualitative and quantitative factors specific to each security, including the probability of default and the estimated timing and amount of recovery. The detailed inputs used to project expected future cash flows may be different depending on the nature of the individual debt security.
Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value. Impairment losses on property and equipment, which primarily related to impairments of internally developed software, were $0.5 million, $5.2 million and $10.9 million for the years ended December 31, 2017, 2016 and 2015, respectively.
The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized in the Company’s financial statements over the requisite service period of the award using the straight-line method for awards that contain only a service condition and the graded vesting method for awards that contain a performance or market condition. The Company accounts for forfeitures as they occur.
The Company recognizes the underfunded status of its unfunded supplemental benefit plans as a liability on its consolidated balance sheets. Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive loss. Plan obligations are measured annually as of December 31.
Trust assets held or managed by First American Trust, FSB totaled $3.7 billion and $3.2 billion at December 31, 2017 and 2016, respectively. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.
In February 2018, the Financial Accounting Standards Board (“FASB”) issued updated guidance which permits entities to reclassify stranded tax effects in accumulated other comprehensive income to retained earnings as a result of the Tax Cuts and Jobs Act enacted by the U.S. federal government on December 22, 2017. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company elected to adopt this change in accounting principle in the fourth quarter of 2017 and applied the change as of the beginning of 2017, which resulted in an increase to retained earnings and a decrease to accumulated other comprehensive income of $4.0 million in 2017 on the Company’s consolidated statements of equity.
In March 2017, the FASB issued updated guidance intended to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost through the disaggregation of the service cost component from the other components of net benefit cost. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In January 2017, the FASB issued updated guidance intended to simplify how an entity tests goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the updated guidance, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the loss recognized limited to the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In June 2016, the FASB issued updated guidance 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 updated guidance replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires the consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the Company is limited, principally for the protection of policyholders. As of December 31, 2017, under such regulations, the maximum amount available to the Company from its insurance subsidiaries in 2018, without prior approval from applicable regulators, was dividends of $338.4 million and loans and advances of $96.0 million.
The Company’s principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), maintained total statutory capital and surplus of $1.2 billion as of December 31, 2017 and 2016. Statutory net income for the years ended December 31, 2017, 2016 and 2015 was $315.4 million, $150.0 million and $191.8 million, respectively. FATICO was in compliance with the minimum statutory capital and surplus requirements as of December 31, 2017.
FATICO is domiciled in Nebraska and its statutory-based financial statements are prepared in accordance with accounting practices prescribed or permitted by the Nebraska Department of Insurance. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures Manual (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by the state of Nebraska. The state of Nebraska has adopted certain prescribed accounting practices that differ from those found in the NAIC SAP. Specifically, the timing of amounts released from the statutory premium reserve under Nebraska’s required practice differs from NAIC SAP resulting in total statutory capital and surplus that was lower by $148.5 million and $69.6 million at December 31, 2017 and 2016, respectively, than if reported in accordance with NAIC SAP.
Sales of debt and equity securities resulted in realized gains of $35.5 million, $30.7 million and $8.7 million and realized losses of $18.4 million, $9.7 million and $10.0 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Investments in debt securities at December 31, 2017, by contractual maturities, are as follows:
The composition of the investment portfolio at December 31, 2017, by credit rating, is as follows:
As of December 31, 2017, the estimated fair value of total debt securities included $142.9 million of bank loans, of which $130.7 million were non-investment grade; $103.5 million of high yield corporate debt securities, all of which were non-investment grade; and $81.0 million of emerging market debt securities, of which $9.1 million were non-investment grade.
The composition of the investment portfolio in an unrealized loss position at December 31, 2017, by credit rating, is as follows:
As of December 31, 2017, the estimated fair value of total debt securities in an unrealized loss position included $25.9 million of bank loans, of which $25.2 million were non-investment grade; $22.6 million of high yield corporate debt securities, all of which were non-investment grade; and $23.1 million of emerging market debt securities, of which $2.5 million were non-investment grade.
“Other” primarily includes foreign currency translation gains and losses, ceded reinsurance claims and assets acquired in connection with claim settlements. Included for the year ended December 31, 2015, are recoveries of $23.8 million on reinsured losses related to a large commercial title claim. Payments and recoveries on reinsured losses for the Company’s title insurance and property and casualty businesses were immaterial during the years ended December 31, 2017 and 2016.
The provision for title insurance losses, expressed as a percentage of title insurance premiums and escrow fees, was 4.0%, 5.5% and 6.6% for the years ended December 31, 2017, 2016 and 2015, respectively.
The current year rate of 4.0% reflects the ultimate loss rate for the current policy year and no change in the loss reserve estimates for prior policy years.
The following reflects information about incurred and paid claims development for the Company’s specialty insurance segment as of December 31, 2017, net of reinsurance, as well as cumulative claims frequency, by claims event, and the total of incurred but not reported claims plus expected development on reported claims included with the net incurred claims amounts.
The information below about incurred and paid claims development for the years ended December 31, 2008 to 2015, is presented as supplementary information.
The following reflects supplementary information about average historical claims duration for the Company’s specialty insurance segment as of December 31, 2017:
The weighted-average interest rate for the Company’s notes and contracts payable was 4.24% and 4.10% at December 31, 2017 and 2016, respectively.
The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $700.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments under the credit agreement will terminate on May 14, 2019. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2017, outstanding borrowings under the facility totaled $160.0 million at an interest rate of 3.32%.
Deemed Repatriation of Foreign Earnings. In connection with the move by the U.S. to a partial territorial tax system, the Tax Reform Act provides for the exclusion of foreign-sourced dividends received by a U.S. corporation from its foreign-owned corporations beginning in 2018. In addition, the Tax Reform Act imposes a toll charge in 2017 on the deemed repatriation of a U.S. shareholder’s pro-rata share of certain foreign subsidiaries’ post-1986 accumulated earnings. The toll charge assesses an effective tax rate of 15.5% on cash and other liquid assets of U.S.-owned foreign corporations, while subjecting all other property of such corporations to an effective tax rate of 8.0%, and allows for available foreign tax credits to reduce the resulting toll charge. Taxpayers may elect to pay this tax liability over eight years on an interest-free basis. The Company has accrued an estimated toll charge liability of $1.8 million, reflected in current taxes payable as of December 31, 2017, and will elect to pay the tax over eight years.
Investment of Foreign Earnings. For years prior to 2017, the Company asserted that earnings from foreign affiliates would be indefinitely reinvested into those foreign businesses. Accordingly, deferred taxes were not provided on outside basis differences in the Company’s investments in foreign subsidiaries. With the transition by the U.S. to a partial territorial tax system, including the one-time deemed repatriation of historical foreign earnings and a participation exemption for the distribution of future foreign earnings, the Company has determined that it will no longer assert the indefinite reinvestment of foreign earnings. Accordingly, estimated deferred taxes of $15.0 million have been provided for anticipated foreign withholding and U.S. state taxes due on hypothetical future distributions of earnings from foreign subsidiaries.
Income taxes differ from the amounts computed by applying the federal income tax rate of 35.0%. A reconciliation of these differences is as follows:
At December 31, 2017, the Company had available a foreign tax credit carryover of $8.0 million. The Company expects to utilize this credit within the carryover period.
The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and adjusts the allowance, if necessary. The factors used to assess the likelihood of realization include the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The Company’s ability or failure to achieve forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of its deferred tax assets. Based on future operating results in certain jurisdictions, it is possible that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015 is as follows:
The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction, various state jurisdictions, and various non-U.S. jurisdictions. The primary non-federal jurisdictions are California, Canada, India and the United Kingdom. During 2016, the Company concluded U.S. federal income tax examinations for calendar years 2005 through 2013. The Company is generally no longer subject to U.S. federal, state or non-U.S. income tax examinations by taxing authorities for years prior to 2005.
For the years ended December 31, 2017 and 2015, 2 thousand and 6 thousand RSUs, respectively, were excluded from the weighted-average diluted common shares outstanding due to their antidilutive effect. For the year ended December 31, 2016, no stock options or RSUs had an antidilutive effect on weighted-average diluted common shares outstanding.
Certain of the Company’s subsidiaries have separate savings plans and the Company’s international subsidiaries have other employee benefit plans. Expenses related to these plans and the Company’s deferred compensation plan are included in the table below under “other plans, net”.
The following table summarizes the benefit obligations, assets and funded status associated with the Company’s funded defined benefit pension and unfunded supplemental benefit plans:
Weighted-average discount rate assumption used to determine the projected benefit obligation at December 31, 2017 and 2016, was as follows:
The Company expects to make cash contributions of $14.3 million to its unfunded supplemental benefit plans during 2018.
The valuation techniques and inputs used by the Company to estimate the fair values of assets measured on a recurring basis are summarized as follows:
The carrying amount for cash and cash equivalents is a reasonable estimate of fair value due to the short-term maturity of these investments.
The fair value of notes receivable, net is estimated based on current market rates being offered for notes with similar maturities and credit quality.
The First American Financial Corporation 2010 Incentive Compensation Plan (the “Incentive Compensation Plan”), effective May 28, 2010, permits the granting of stock options, stock appreciation rights, restricted stock, RSUs, performance units, performance shares and other stock-based awards. Eligible participants in the Incentive Compensation Plan include the Company’s directors and officers, as well as other employees. At December 31, 2017, 3.3 million shares of common stock remain available to be issued from either authorized and unissued shares or previously issued shares acquired by the Company, subject to certain annual limits based on the type of award granted. The Incentive Compensation Plan terminates 10 years from its effective date unless previously canceled by the Company’s board of directors.
The First American Financial Corporation 2010 Employee Stock Purchase Plan (the “ESPP”) allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each quarterly offering period. There were 390,000 and 371,000 shares issued in connection with this plan for the years ended December 31, 2017 and 2016, respectively. At December 31, 2017, there were 2.4 million shares reserved for future issuances.
The following table summarizes RSU activity for the year ended December 31, 2017:
The total intrinsic value of stock options exercised for the years ended December 31, 2017 and 2015 was $1.0 million and $9.7 million, respectively. No stock options were exercised during the year ended December 31, 2016. Intrinsic value represents the difference between the fair market value of the Company’s common stock on the date of exercise and the exercise price of each option.
The following table presents a summary of the changes in each component of AOCI for the years ended December 31, 2017, 2016 and 2015:
Components of AOCI allocated to the Company and noncontrolling interests at December 31, 2017, 2016 and 2015, are as follows:
The following table presents the effect of the reclassifications out of AOCI on the respective line items in the consolidated statements of income:
Future minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year, as of December 31, 2017, are as follows:
Total rental expense for all operating leases, including month-to-month rentals, was $91.0 million, $91.4 million and $93.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
For a substantial majority of these lawsuits, however, it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. These requirements include, among others, demonstration to a court that the law proscribes in some manner the Company’s activities, the making of factual allegations sufficient to suggest that the Company’s activities exceeded the limits of the law and a determination by the court-known as class certification-that the law permits a group of individuals to pursue the case together as a class. In certain instances the Company may also be able to compel the plaintiff to arbitrate its claim on an individual basis. If these procedural requirements are not met, either the lawsuit cannot proceed or, as is the case with class certification or compelled arbitration, the plaintiffs lose the financial incentive to proceed with the case (or the amount at issue effectively becomes de minimis). Frequently, a court’s determination as to these procedural requirements is subject to appeal to a higher court. As a result of, among other factors, ambiguities and inconsistencies in the myriad laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements.
Chavez v. First American Specialty Insurance Company, filed on June 29, 2017 and pending in the Superior Court of the State of California, County of Los Angeles,
Lennen v. First American Financial Corporation, et al., filed on May 19, 2016 and pending in the United States District court for the Middle District of Florida,
Tenefufu vs. First American Specialty Insurance Company, filed on June 1, 2017, pending in the Superior Court of the State of California, County of Sacramento, and
The Company also is a party to non-ordinary course lawsuits other than those described above. With respect to these lawsuits, the Company has determined either that a loss is not reasonably possible or that the estimated loss or range of loss, if any, is not material to the consolidated financial statements as a whole.
The Company’s Canadian operations provide certain services to lenders which it believes to be exempt from excise tax under applicable Canadian tax laws. However, in October 2014, the Canadian taxing authority provided internal guidance that the services in question should be subject to the excise tax. While discussions with the taxing authority are ongoing, the Company believes that the guidance may result in an assessment. The amount, if any, of such assessment is not currently known, and any such assessment would be subject to negotiation. In the event that the Company disagrees with the ultimate assessment, the Company intends to avail itself of avenues of appeal. While the Company believes it is reasonably likely that the Company would prevail on the merits, a loss associated with the matter is possible. In light of the foregoing, the Company is not currently able to reasonably estimate a loss or range of loss associated with the matter. While such a loss could be material to the Company’s operating results in any particular period if an unfavorable outcome results, the Company does not believe that this matter will have a material adverse effect on the Company’s overall financial condition or liquidity.
During the years ended December 31, 2017 and 2016, the Company completed acquisitions for an aggregate purchase price of $91.1 million and $115.3 million, respectively. These acquisitions have been included in the Company’s title insurance and services segment.
Selected financial information about the Company’s operations, by segment, for the years ended December 31, 2017, 2016 and 2015, is as follows:
Revenues from external customers allocated between domestic and foreign operations, by segment, for the years ended December 31, 2017, 2016 and 2015, are as follows:
Long-lived assets allocated between domestic and foreign operations, by segment, as of December 31, 2017, 2016 and 2015, are as follows:
Net income per share attributable to the Company’s stockholders for the four quarters of each fiscal year may not sum to the total for the fiscal year because of the different number of shares outstanding during each period.
As other investments are not publicly traded, estimates of the fair values could not be made without incurring excessive costs.
Net investment income includes net investment income and net realized investment gains (losses).