CERTAIN STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS MAY CONTAIN THE WORDS “BELIEVE,” “ANTICIPATE,” “EXPECT,” “PLAN,” “PREDICT,” “ESTIMATE,” “PROJECT,” “WILL BE,” “WILL CONTINUE,” “WILL LIKELY RESULT,” OR OTHER SIMILAR WORDS AND PHRASES.
The provision transferred from IBNR title claims related to prior years decreased by $33.3 million, or 18.5%, in 2018 from 2017 and decreased by $7.5 million, or 4.0%, in 2017 from 2016. Payments, net of recoveries, related to prior years decreased by $34.1 million, or 18.4%, in 2018 from 2017 and decreased by $12.3 million, or 6.2%, in 2017 from 2016. 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.
The provision related to current year decreased by $1.8 million, or 1.0%, in 2018 from 2017. This decrease was attributable to a decrease in title premiums and escrow fees in 2018 from 2017.
If the Company does not expect to recover the amortized cost basis of a debt security with declines in fair value (even if the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security), the loss is considered an other-than-temporary impairment loss and the credit portion of the loss (“credit loss”) is recognized in earnings and the non-credit portion is recognized in other comprehensive income. The credit loss is the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security. The cash flows expected to be collected are discounted at the rate implicit in the security immediately prior to the recognition of the other-than-temporary impairment.
Business Combinations. The Company allocates the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets.
Impairment of property and equipment. 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 $41 thousand, $0.5 million and $5.2 million for 2018, 2017 and 2016, respectively.
The assumption that has had the most significant impact to net periodic costs for the unfunded supplemental benefit plans is the discount rate. The discount rate assumption reflects the yield available on high-quality, fixed-income debt securities that match the expected timing of the benefit obligation payments.
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. The Company adopted this change in accounting principle at the beginning of 2018 and applied the change retrospectively. As a result, other components of net benefit cost totaling $175.0 million and $101.5 million were reclassified from personnel costs to other operating expenses on the consolidated statements of income for the years ended December 31, 2017 and 2016, respectively. See Note 13 Employee Benefit Plans to the consolidated financial statements for further information on the Company’s net periodic pension costs.
In October 2016, the FASB issued updated guidance intended to simplify and improve the accounting for the income tax consequences of intra-entity transfers of assets, other than inventory. The updated guidance, which eliminates the intra-entity transfers exception, requires entities to recognize the income tax consequences of intra-entity transfers of assets, other than inventory, when the transfers occur. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The adoption of this guidance had no impact on the Company’s consolidated financial statements.
In January 2016, the FASB issued updated guidance intended to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. In addition to making other targeted improvements to current guidance, the updated guidance also requires all equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, to be measured at fair value with changes in the fair value recognized through net income. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The Company adopted this guidance at the beginning of 2018 and recognized cumulative net unrealized gains, net of taxes, of $40.6 million related to its investments in equity securities, previously classified as available-for-sale, through a cumulative-effect adjustment to retained earnings. Changes in the fair values of these investments are reflected in net realized investment gains/losses on the Company’s consolidated statements of income. See Note 3 Debt and Equity Securities to the consolidated financial statements for further discussion of the Company’s investments in equity securities.
In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within and across industries, and across capital markets. The new revenue standard contains principles that an entity will apply to determine the measurement of revenue and the timing of recognition. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. Revenue from insurance contracts is not within the scope of this guidance. In 2016, the FASB issued additional updates to the new guidance primarily to clarify, among other things, the implementation guidance related to principal versus agent considerations, identifying performance obligations, accounting for licenses of intellectual property, and to provide narrow-scope improvements and additional practical expedients. In February 2017, the FASB issued an additional update to the new guidance to clarify the scope of derecognition guidance for nonfinancial assets and to provide guidance for partial sales of nonfinancial assets. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The Company elected to adopt the new guidance under the modified retrospective approach, which did not have a material impact on its consolidated financial statements. See Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements for further information about the Company’s revenues within the scope of the new guidance.
During the fourth quarter of 2018, the level of domestic residential purchase title orders opened per day by the Company’s direct title operations decreased 4.5% when compared to the same quarter in 2017. This trend continued in January 2019 as open purchase orders declined 4.0% when compared to January 2018. The Company expects the ongoing decline in the residential purchase market to continue in 2019 but also anticipates rising investment income. Based on current orders and market conditions, the Company also expects its commercial business to continue to perform well. During the fourth quarter of 2018, the Company adjusted its cost structure to position itself for 2019.
The Company is increasingly utilizing decision science, artificial intelligence and other innovative technologies, processes and techniques to speed the delivery of its products, increase efficiency and otherwise improve the customer experience. These efforts include streamlining the closing process by converting certain manual processes into digital ones, which improves the customer experience by simplifying and reducing the time it takes to close a transaction, reducing the risk of fraud and improving communication. These efforts also include the automation of many of the tasks required to build and update title plants and to search and examine title records, among others. While many of these initiatives are also designed to decrease risk, they present risks of their own. The degree to which these innovative efforts will be successful, and their ultimate impact on the Company’s results of operations, is not currently known.
Direct premiums and escrow fees increased $30.6 million, or 1.5%, in 2018 from 2017 and $17.7 million, or 0.9%, in 2017 from 2016. The increases in direct premiums and escrow fees in 2018 from 2017 and in 2017 from 2016 were 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 domestic average revenues per order closed were $2,600, $2,264 and $1,931 for 2018, 2017 and 2016, respectively. The 14.8% increase in average revenues per order closed in 2018 from 2017 and the 17.2% increase in average revenues per order closed in 2017 from 2016 were primarily due to a shift in the mix of direct revenues generated from lower premium residential refinance products to higher premium 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 Company’s direct title operations closed 730,800, 823,700 and 958,400 domestic title orders during 2018, 2017 and 2016, respectively. The 11.3% decrease in orders closed in 2018 from 2017 and the 14.1% decrease in orders closed in 2017 from 2016 were generally consistent with the changes in residential mortgage origination activity in the United States as reported in the MBA Forecast.
Agent premiums decreased $75.8 million, or 3.2%, in 2018 from 2017 and increased $74.0 million, or 3.2%, in 2017 from 2016. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums typically reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The decrease in agent premiums in 2018 from 2017 was generally consistent with the 1.0% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2018 as compared with the twelve months ended September 30, 2017. The increase in agent premiums in 2017 from 2016 was generally consistent with the 3.0% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2017 as compared with the twelve months ended September 30, 2016.
Information and other revenues increased $4.7 million, or 0.6%, in 2018 from 2017 and $52.9 million, or 7.4%, in 2017 from 2016. The increases were driven by recent acquisitions. Excluding the $42.2 million impact of new acquisitions for the year ended December 31, 2018, information and other revenues decreased $37.5 million, or 4.9%, in 2018 compared to 2017. The decrease in 2018 from 2017, adjusted for the impact of new acquisitions, was primarily due to lower demand for the Company’s valuation services, fulfillment services, and automated products driven by a decrease in mortgage origination volumes and, to a lesser extent, lower demand for the Company’s default information products driven by a decrease in loss mitigation activities. 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.
Net realized investment losses were $49.1 million for 2018 and were primarily from a decrease in the fair values of equity securities of $32.6 million and losses from the sales of debt securities. Net realized investment gains totaled $6.7 million for 2017 and were primarily from the sales of debt and equity securities, partially offset by a $6.6 million loss recognized when the Company purchased the remaining equity ownership in an investment in an affiliate during the third quarter of 2017. Net realized investment gains were $18.9 million for 2016 and were primarily from the sales of debt and equity securities. Net realized investment gains for 2018, 2017 and 2016 included $1.1 million, $0.8 million and $3.3 million, respectively, of gains from the sale of real estate. In addition, net realized investment gains for 2018, 2017 and 2016 included impairment losses of $1.1 million, $3.0 million and $5.2 million, respectively. The impairment losses in 2018, 2017 and 2016 were primarily related to the retirement of a trade name, title plants and internally developed software, respectively.
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 2018 from 2017 and in 2017 from 2016 were primarily due to changes in the geographic mix of agency revenues.
Other operating expenses (principally related to direct operations) increased $5.3 million, or 0.7%, in 2018 from 2017 and $23.6 million, or 3.1%, in 2017 from 2016. The increases were driven by recent acquisitions. Excluding the $19.6 million impact of new acquisitions for the year ended December 31, 2018, other operating expenses decreased $14.3 million, or 1.8%, in 2018 compared to 2017. The decrease in 2018 from 2017, adjusted for the impact of new acquisitions, was primarily attributable to a reduction in discretionary spending, an increase in earnings credits and small decreases across several expense categories, partially offset by higher software expense and foreign currency exchange losses. The decrease was also related to the $8.5 million out-of-period adjustment recorded in 2017, which is further discussed below. 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.
The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 4.0% for the years ended December 31, 2018 and 2017 and 5.5% for the year ended December 31, 2016.
As of December 31, 2018, the projected ultimate loss rates for policy years 2018, 2017 and 2016 were 4.0%, 3.9% and 3.8%, respectively.
Insurers generally are not subject to state income or franchise taxes. However, in lieu thereof, a premium tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of operating revenues. The Company’s noninsurance subsidiaries are subject to state income tax and do not pay premium tax. Accordingly, the Company’s total tax burden at the state level for the title insurance and services segment is composed of a combination of premium taxes and state income taxes. Premium taxes as a percentage of title insurance premiums and escrow fees were 1.4% for the years ended December 31, 2018, 2017 and 2016.
Interest expense increased $4.0 million, or 113.1%, in 2018 from 2017 and $670 thousand, or 23.5%, in 2017 from 2016. The increase in 2018 from 2017 was primarily attributable to higher interest paid related to customer deposits at the Company’s banking subsidiary, First American Trust, FSB, and secured financings payable. The increase in interest paid on customer deposits is due to an increase in average balances and higher interest rates paid. The secured financings payable relate to a specialized warehouse lender that the Company acquired in 2018.
Direct premiums increased $15.2 million, or 3.5%, in 2018 from 2017 and $28.1 million, or 6.8%, in 2017 from 2016. The increases were due to higher premiums earned in the home warranty business driven by an increase in the number of home warranty residential service contracts issued and an increase in the average price charged per contract.
The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 53.8% in 2018, 53.5% in 2017 and 60.7% in 2016. The slight increase in rate in 2018 from 2017 was primarily attributable to an increase in claims severity, mostly offset by a decrease in claims frequency. The increase in claims severity was primarily due to higher claims management costs driven in part by the mix of claims. 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 in 2017 when compared to 2016.
Premium taxes as a percentage of specialty insurance segment premiums were 1.6% in 2018 and were 1.7% in 2017 and 2016.
Net investment losses totaled $3.1 million in 2018 and net investment income totaled $15.3 million and $5.9 million in 2017 and 2016, respectively. The change in net investment income for all three years was primarily attributable to fluctuations in earnings on investments associated with the Company’s deferred compensation plan.
Corporate personnel costs and other operating expenses were $35.6 million, $216.6 million and $137.5 million in 2018, 2017 and 2016, respectively. The change in personnel costs and other operating expenses for all three years was primarily attributable to pension settlement costs that the Company recognized related to the termination of its funded defined benefit pension plans of $152.4 million and $66.3 million in 2017 and 2016, respectively.
Interest expense increased $1.0 million, or 3.2%, in 2018 from 2017 and $3.1 million, or 10.7%, in 2017 from 2016. The increase in 2018 from 2017 was due to an increase in the interest rate on borrowings under the Company’s credit facility. Borrowings under the credit facility bear interest at a variable rate, which increased in 2018 when compared to 2017. The increase in 2017 from 2016 was due to the Company borrowing $160.0 million under its credit facility during September 2016.
The Company’s inter-segment eliminations were not material for the years ended December 31, 2018, 2017 and 2016.
Cash requirements. The Company generates cash primarily from the sale of its products and services and investment income. The Company’s current cash requirements include operating expenses, taxes, payments of principal and interest on its debt, capital expenditures, dividends on its common stock, and may include business acquisitions and repurchases of its common stock. Management forecasts the cash needs of the holding company and its primary subsidiaries and regularly reviews their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying such forecasts. Based on the Company’s ability to generate cash flows from operations, its liquid-asset position and amounts available on its revolving credit facility, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months.
The substantial majority of the Company’s business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. Periods of increasing interest rates and reduced mortgage financing availability generally have an adverse effect on residential real estate activity and therefore typically decrease the Company’s revenues. In contrast, periods of declining interest rates and increased mortgage financing availability generally have a positive effect on residential real estate activity, which typically increases the Company’s revenues. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months. Residential refinance activity is typically more volatile than purchase activity and is highly impacted by changes in interest rates. Commercial real estate volumes are less sensitive to changes in interest rates, but fluctuate based on local supply and demand conditions for space and mortgage financing availability.
Cash provided by operating activities totaled $793.2 million, $632.1 million and $489.4 million for the years ended December 31, 2018, 2017 and 2016, respectively, after claim payments, net of recoveries, of $450.8 million, $472.0 million and $463.0 million, respectively. The principal nonoperating uses of cash and cash equivalents for the years ended December 31, 2018, 2017 and 2016 were purchases of debt and equity securities, dividends to common stockholders, capital expenditures and business acquisitions, and for the year ended December 31, 2018, advances and repayments under secured financing agreements. The most significant nonoperating sources of cash and cash equivalents for the years ended December 31, 2018, 2017 and 2016 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 years ended December 31, 2018 and 2016, borrowings and collections under secured financing agreements and net proceeds from the issuance of notes and contracts payable, respectively. The net effect of all activities on total cash and cash equivalents were increases of $79.9 million and $381.1 million for the years ended December 31, 2018 and 2017, respectively, and a decrease of $21.2 million for the year ended December 31, 2016.
In March 2014, the Company’s board of directors approved an increase in the size of the Company’s stock repurchase plan from $150.0 million to $250.0 million, of which $163.6 million remained as of December 31, 2018. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. During the year ended December 31, 2018, the Company repurchased and retired 425 thousand shares of its common stock for a total purchase price of $18.8 million and, as of December 31, 2018, had repurchased and retired 3.6 million shares of its common stock under the current authorization for a total purchase price of $86.4 million. In January 2019, the Company repurchased and retired 47 thousand shares of its common stock for a total purchase price of $2.1 million.
The Tax Reform Act amended the Internal Revenue Code to reduce U.S. tax rates and modify policies, credits and deductions for individuals and businesses. The changes resulting from the Tax Reform Act had an overall favorable impact on the Company’s effective tax rate, resulting in less cash required for tax payments, and the Company expects the Tax Reform Act will continue to have an overall favorable impact on its effective tax rate and 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.
As of December 31, 2018, the holding company’s sources of liquidity included $327.3 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 and outstanding borrowings will become due and payable 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, 2018, outstanding borrowings under the facility totaled $160.0 million at an interest rate of 4.15%.
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 2018, the Company financed securities for funds received totaling $10.0 million under these agreements. As of December 31, 2018, no amounts remained outstanding under these agreements.
Investment portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of December 31, 2018, 94% of the Company’s investment portfolio consisted of debt securities, of which 69% were either United States government-backed or rated AAA and 97% were either rated or classified as investment grade. Percentages are based on the estimated fair values of the securities. Credit ratings reflect published ratings obtained from globally recognized securities rating agencies. If a security was rated differently among the rating agencies, the lowest rating was selected. For further information on the credit quality of the Company’s investment portfolio at December 31, 2018, see Note 3 Debt and Equity Securities to the consolidated financial statements.
In addition to its debt and equity securities portfolio, the Company maintains certain money-market and other short-term investments.
The Company facilitates tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code and tax-deferred reverse exchanges pursuant to Revenue Procedure 2000-37. As a facilitator and intermediary, the Company holds the proceeds from sales transactions and takes temporary title to property identified by the customer to be acquired with such proceeds. Upon the completion of each such exchange, the identified property is transferred to the customer or, if the exchange does not take place, an amount equal to the sales proceeds or, in the case of a reverse exchange, title to the property held by the Company is transferred to the customer. Like-kind exchange funds held by the Company totaled $2.7 billion and $2.6 billion at December 31, 2018 and 2017, respectively. The like-kind exchange deposits are held at third-party financial institutions and, due to the structure utilized to facilitate these transactions, the proceeds and property are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by the Federal Deposit Insurance Corporation. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the returns on such proceeds.
Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016
III. Supplementary Insurance Information as of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016
IV. Reinsurance for the years ended December 31, 2018, 2017 and 2016
V. Valuation and Qualifying Accounts for the years ended December 31, 2018, 2017 and 2016
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, 2018 and 2017, the fair values of such investments totaled $111.0 million and $108.4 million, respectively. See Note 2 Statutory Restrictions on Investments and Stockholders’ Equity for additional discussion of the Company’s statutory restrictions.
Interest income, as well as the related amortization of premium and accretion of discount, on debt securities are recognized under the effective yield method and are included in the accompanying consolidated statements of income in net investment income. Realized gains and losses on sales of debt securities are determined on a first-in, first-out basis.
Secured financings payable reflect borrowings under secured warehouse lending facilities with several banking institutions. Repayment of the warehouse borrowing occurs upon sale of the mortgage loan to investors as noted above. Interest expense is recorded during the period the borrowing remains outstanding.
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 $41 thousand, $0.5 million and $5.2 million for the years ended December 31, 2018, 2017 and 2016, respectively.
For 2018 and 2017, the Company chose to perform qualitative assessments for its title insurance and home warranty reporting units and performed a quantitative impairment test for its property and casualty insurance reporting unit. Based on the results of its quantitative impairment tests for 2018 and 2017, the Company determined that the fair value of its property and casualty insurance reporting unit exceeded the carrying amount and, therefore, no additional analysis was required. The results of the Company’s qualitative assessments for its title insurance and home warranty reporting units for 2018 and 2017 supported the conclusion that their fair values were not more likely than not less than their carrying amounts and, therefore, a quantitative impairment test was not considered necessary. For 2016, the Company chose to perform a quantitative impairment test for all three reporting units and, based on the results, determined that the fair values of its reporting units exceeded their carrying amounts and, therefore, no additional analysis was required. As a result of the Company’s annual goodwill impairment assessments, the Company did not record any goodwill impairment losses for 2018, 2017 or 2016.
The reserve for property and casualty insurance losses reflects management’s best estimate of the amount necessary to settle all reported and unreported claims for the ultimate cost of insured losses, based upon the facts of each case and the Company’s experience with similar cases. The Company also utilizes the services of an independent actuary as part of its reserve analysis. Because the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process, the ultimate cost of insured losses may be more or less than the reserve amount. Reserve estimates are regularly analyzed and updated to reflect the most current information available.
The Company has also elected to apply the practical expedient allowed under the new guidance whereby it can disregard the impact to the transaction price of the effects of a significant financing component for arrangements where the Company expects the period between delivery of the product or service and customer payment to be one year or less. In addition, the Company has elected to apply the practical expedient whereby it can recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period for the asset that the Company otherwise would have recognized is one year or less.
The Company records a contract asset, and recognizes revenue, upon delivery of certain products related to the closing of a real property transaction where the Company’s right to payment is subject to the closing of the real estate transaction. The Company records a contract liability for payments received in advance of revenue recognition for certain products or services. Contract assets and liabilities were not material at December 31, 2018. Revenues recognized during the year ended December 31, 2018 that were included in contract liabilities at the beginning of the period were not material.
During 2016, the Company terminated its funded defined benefit pension plans and, in 2017, transferred all remaining benefit obligations relating to the pension plans to a highly rated insurance company. See Note 13 Employee Benefit Plans for further discussion of the termination of the Company’s funded defined benefit pension plans.
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. The adoption of this guidance had no impact on the Company’s 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. The adoption of this guidance had no impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued updated guidance that is intended to reduce potential diversity in practice in accounting for the costs of implementing cloud computing arrangements (i.e., hosting arrangements) that are service contracts. The updated guidance aligns the requirements for capitalizing implementation costs for these arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. 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 this guidance 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 this guidance on its consolidated financial statements.
In February 2016, the FASB issued updated guidance that requires the rights and obligations associated with leasing arrangements be reflected on the balance sheet in order to increase transparency and comparability among organizations. Under the updated guidance, lessees will be required to recognize a right-of-use asset and a liability to make lease payments and disclose key information about leasing arrangements. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018. The updated guidance may either be adopted using a modified retrospective transition approach or may be initially applied on the adoption date with the recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company has elected to initially apply the guidance as of the adoption date, January 1, 2019, and expects to record on its balance sheet right-of-use assets and lease liabilities of approximately $350 million and an immaterial cumulative-effect adjustment to retained earnings. The Company expects the new guidance to have an insignificant impact on its consolidated statements of income and statements of cash flows.
Investments totaling $129.2 million and $131.0 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2018 and 2017, respectively.
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, 2018, under such regulations, the maximum amount available to the Company from its insurance subsidiaries in 2019, without prior approval from applicable regulators, was dividends of $291.2 million and loans and advances of $98.6 million.
Statutory accounting principles differ in some respects from GAAP, and these differences include, but are not limited to, non-admission of certain assets (principally limitations on deferred tax assets, goodwill, capitalized furniture and other equipment, capitalized software, and premiums and other receivables 90 days past due), reporting of bonds at amortized cost, amortization of goodwill, deferral of premiums received as statutory premium reserve, supplemental reserve (if applicable) and exclusion of the incurred but not reported claims reserve. In addition, beginning in 2018, the changes in the fair values of equity securities are recorded through net income for GAAP, whereas statutory accounting principles continue to require these changes to be recorded on the balance sheet.
Based on the Company’s review of its debt securities in an unrealized loss position at December 31, 2018, it determined that the losses were primarily the result of changes in interest rates, which were considered to be temporary, rather than a deterioration in credit quality. The Company does not intend to sell and it is not more likely than not that the Company will be required to sell these securities prior to recovering their amortized cost. As such, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2018.
The Company adopted new accounting guidance on January 1, 2018, which requires investments in equity securities with readily determinable fair values to be measured at fair value with changes in fair value recognized through net income. See Note 1 Basis of Presentation and Significant Accounting Policies for further discussion of the new guidance.
Net losses (realized and unrealized) of $38.6 million were recognized for the year ended December 31, 2018 as a result of changes in the fair values of equity securities. Included in net losses during the year ended December 31, 2018 were net unrealized losses of $37.6 million related to equity securities still held at December 31, 2018. For the years ended December 31, 2017 and 2016, sales of equity securities resulted in realized gains of $30.2 million and $18.1 million and realized losses of $2.1 million and $7.0 million, respectively.
The composition of the debt securities portfolio in an unrealized loss position at December 31, 2018, by credit rating, is as follows:
Debt securities in an unrealized loss position at December 31, 2018, included bank loans totaling $141.2 million, of which $129.8 million were non-investment grade; high yield corporate debt securities totaling $36.7 million, all of which were non-investment grade; and emerging market debt securities totaling $63.4 million, of which $9.6 million were non-investment grade.
Amortization expense for finite-lived intangible assets was $30.4 million, $28.1 million and $15.4 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The 2017 rate of 4.0% reflected the ultimate loss rate for policy year 2017 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, 2018, 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, 2009 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, 2018:
Line of credit borrowings due May 14, 2019, weighted-average interest rate of 4.15% and 3.32% at December 31, 2018 and 2017, respectively
On December 22, 2017, comprehensive tax reform legislation known as the Tax Cuts and Jobs Act (the “Tax Reform Act”) was signed into law. The Tax Reform Act amended the Internal Revenue Code to reduce U.S. tax rates and modify policies, credits and deductions for individuals and businesses.
Income taxes differ from the amounts computed by applying the federal income tax rates of 21% for 2018 and 35.0% for 2017 and 2016. A reconciliation of these differences is as follows:
The exercise of stock options and vesting of RSUs represent a tax benefit that has been reflected as a reduction of income taxes payable and a reduction of income tax expense for the years ended December 31, 2018 and 2017. The benefits recorded were $5.2 million and $3.4 million for the years ended December 31, 2018 and 2017, respectively.
At December 31, 2018, the Company had available a foreign tax credit carryover net of valuation allowance of $8.3 million. The Company expects to utilize this credit within the carryover period.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2018, 2017 and 2016 is as follows:
The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in income tax expense. As of December 31, 2018, 2017 and 2016, the Company had accrued $5.8 million, $5.3 million and $4.1 million, respectively, of interest and penalties (net of tax benefits of $1.6 million, $1.4 million and $1.8 million, respectively) related to uncertain tax positions.
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. As of December 31, 2018, the Company had concluded U.S. federal income tax examinations through 2015 and is generally no longer subject to state and non-U.S. income tax examinations for years prior to 2005.
For the years ended December 31, 2018 and 2017, 11 thousand and 2 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.
The Company maintains a deferred compensation plan for certain employees that allows participants to defer up to 100% of their salary, commissions and certain bonuses. Participants can allocate their deferrals among a variety of investment crediting options (known as “deemed investments”). The term deemed investments means that the participant has no ownership interest in the funds they select; the funds are only used to measure the gains or losses that will be attributed to each participant’s deferral account over time. Participants can elect to have their deferral balance paid out while they are still employed or after their employment ends. The deferred compensation plan is exempt from most provisions of the Employee Retirement Income Security Act (“ERISA”) because it is only available to a select group of management and highly compensated employees and is not a qualified employee benefit plan. To preserve the tax-deferred savings advantages of a nonqualified deferred compensation plan, federal law requires that it be unfunded or informally funded. Participant deferrals, and any earnings on those deferrals, are general unsecured obligations of the Company. The Company informally funds the deferred compensation plan through a tax-advantaged investment known as variable universal life insurance. Deferred compensation plan assets are held as an asset of the Company within a special trust, known as a “Rabbi Trust.” At December 31, 2018 and 2017, the value of the assets held in the Rabbi Trust of $86.5 million and $92.7 million, respectively, and the unfunded liabilities of $94.3 million and $97.2 million, respectively, were included in the consolidated balance sheets in other assets and pension costs and other retirement plans, respectively.
Net actuarial loss and prior service credit for the unfunded supplemental benefit plans expected to be amortized from accumulated other comprehensive loss into net periodic cost over the next fiscal year include an expense of $3.7 million and a credit of $4.1 million, respectively.
The weighted-average discount rate assumption used to determine the projected benefit obligation for the Company’s unfunded supplemental benefits plans at December 31, 2018 and 2017, was as follows:
The Company expects to make cash contributions of $14.6 million to its unfunded supplemental benefit plans during 2019.
In estimating the fair values of its financial instruments not measured at fair value, the Company used the following methods and assumptions:
The fair value of deposits with banks is estimated based on rates currently offered for deposits of similar remaining maturities, where applicable.
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, which include the Company’s directors and officers, as well as other employees, may elect to defer the distribution of their RSUs to a future date beyond the scheduled vesting date. At December 31, 2018, 2.5 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 following table summarizes RSU activity for the year ended December 31, 2018:
The following table summarizes stock option activity for the year ended December 31, 2018:
As of December 31, 2018, there was no unrecognized compensation cost related to unvested stock options.
Cash proceeds from stock options exercised totaled $1.0 million and $1.8 million, and the total intrinsic value of stock options exercised was $1.1 million and $1.0 million for the years ended December 31, 2018 and 2017, 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 Company recognized a cumulative-effect adjustment to retained earnings for cumulative net unrealized gains related to its investments in equity securities upon adoption of new accounting guidance on January 1, 2018. See Note 1 Basis of Presentation and Significant Accounting Policies for further discussion of the new guidance.
Net realized losses for the year ended December 31, 2018 related to sales of debt securities and net realized gains for the years ended December 31, 2017 and 2016 related to sales of debt and equity securities.
These components of AOCI are components of net periodic cost. See Note 13 Employee Benefit Plans for additional details.
Future minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year, as of December 31, 2018, are as follows:
Leramo v. First American Title Insurance Company, et al., filed on December 19, 2018 and pending in the United States District Court for the Eastern District of California,
Simons v. First American Title Insurance Company, filed on December 14, 2018 and pending in the United States District Court for the Middle District of Florida,
All of these lawsuits are putative class or collective actions for which a class or collective has not been certified. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is not material to the consolidated financial statements as a whole.
During the year ended December 31, 2018, the Company completed acquisitions for an aggregate purchase price of $82.9 million. For acquisitions in which the Company has not completed its purchase price allocation, preliminary fair value estimates for the assets acquired and liabilities assumed have been recorded. The Company allocates the purchase price of each acquisition to the assets acquired and liabilities assumed using a variety of valuation techniques, including discounted cash flow analysis. These acquisitions have been included in the Company’s title insurance and services segment.
Current year acquisitions included the purchase of a specialized warehouse lender that provides financing for correspondent mortgage lenders. The business has itself secured warehouse lending facilities with several banking institutions. The mortgage loans are generally sold by the correspondent mortgage lenders to investors within 30 days and more typically in less than 10 days. The assets acquired included secured financings receivable from correspondent mortgage lenders of $69.6 million and liabilities assumed included secured financings payable of $69.8 million. The combined capacity for the warehouse lending facilities totals $123.0 million with one additional warehouse lending facility having no stated capacity. Interest rates for the warehouse lending facilities range from 3.50% to the current prime lending rate as published by The Wall Street Journal. At December 31, 2018, outstanding borrowings under the facilities totaled $76.3 million.
The Company’s specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and the District of Columbia and actively issues policies in 47 states. The majority of policy liability is in the western United States, including approximately 62% in California. In certain markets it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems, such as heating and air conditioning systems, and certain appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 36 states and the District of Columbia.
Revenues from external customers allocated between domestic and foreign operations, by segment, for the years ended December 31, 2018, 2017 and 2016, are as follows:
Long-lived assets allocated between domestic and foreign operations, by segment, as of December 31, 2018, 2017 and 2016, are as follows:
The holding company received cash dividends from subsidiaries of $394.4 million, $87.4 million and $46.4 million for the years ended December 31, 2018, 2017 and 2016, respectively.