Total capitalization consists of debt, preferred stock, and common shareholders' equity.
This management analysis of financial position and results of operations pertains to the consolidated accounts of Old Republic International Corporation (“Old Republic” or “the Company”). The Company conducts its operations through three major regulatory segments, namely, its General (property and liability), Mortgage Guaranty, and Title insurance segments. A small life and health insurance business, accounting for 2.1% of both consolidated revenues for the year ended December 31, 2007 and consolidated assets as of December 31, 2007, is included within the corporate and other caption of this report. The consolidated accounts are presented on the basis of generally accepted accounting principles (“GAAP”). This management analysis should be read in conjunction with the consolidated financial statements and the footnotes appended to them.
Consolidated Results - The major components of Old Republic’s consolidated results were as follows for the periods being reported on:
Increases in general insurance premiums for 2007 stemmed mainly from a new book of contractors’ liability insurance acquired in late 2006. Premiums from all other sources combined were slightly higher, as a moderately declining rate environment for various liability insurance coverages made it more difficult to retain and attract new business.
The 2007 benefits and claims ratio of 67.8 percent was slightly higher than 2006’s, and nearly equal to the average of 67.7 percent registered in the preceding five years. This basic stability reflects the ongoing benefits of Old Republic’s widely diversified book of general insurance coverages. The expense ratio of 24.1 percent for 2007 compared favorably with the preceding five years’ average of 25.4 percent, and remained aligned with premium revenue levels. In combination, the 2007 composite ratio of claim costs and expenses, the most widely accepted indicator of underwriting performance in the industry, continued at a favorable level for the sixth consecutive year.
Mortgage Guaranty premiums rebounded throughout 2007 due to higher persistency of business underwritten in prior years, and greater production of traditional insurance products in 2007. Persistency of traditional primary insurance improved to 77.6 percent as of year end 2007 from 73.1 percent at the end of 2006, and traditional new insurance written rose by 85.3 percent year-over-year. As noted above, however, an unprecedented cyclical downturn in housing and related mortgage finance markets contributed to much higher claim costs. Such costs reflect a continuation of unfavorable loan default trends since 2006, and greater claim severity due to larger insured loan values. Opportunities to mitigate such costs have been reduced significantly in a market affected by higher mortgage foreclosures and inflated inventories of unsold homes. While the net paid loss ratio was 21.8 percent higher for all of 2007, much greater claim reserve provisions were required to address a deteriorating claims environment. As of December 31, 2007, net claim reserves of $644.9 million were 158.4 percent higher than the like amount twelve months earlier. While production and operating expenses continued to fall in 2007, the beneficial effect of this trend was blunted by the more severe impact of greater claim costs. As a consequence, the composite ratio of claims and expenses was materially unfavorable in the latest quarter and year, reaching levels unseen in twenty and more years.
The above factors notwithstanding, Old Republic’s Mortgage Guaranty segment continued to register strong operating cash flows in 2007. These were aided by rising premium volume and paid loss growth lagging that of reserve-impacted incurred claim costs. The positive operating cash flows were additive to an already liquid invested asset base, and contributed to greater investment income for the year.
Corporate and Other Operations - Old Republic’s small life and health business, and the net costs associated with the parent holding company and its corporate services subsidiaries produced higher income contributions in 2007. Period-to-period variability in the results of these relatively minor elements of the Company’s operations usually stems from the volatility inherent to the Company’s small scaled life and health business, fluctuations in the timing of expense recognition related to such variable costs as stock option expenses, interest on intercompany financing arrangements, and costs associated with a relatively small debt level.
Cash flow from operating activities added significantly to the invested asset base, and amounted to $862.5 million for the year ended 2007 versus $1,004.7 million for 2006. Operating cash flow in 2006 included approximately $198 million stemming from the aforementioned acquisition of a book of contractors’ liability insurance acquired late in the year.
Substantially all of the changes in the shareholders’ equity account for the periods reported upon reflect earnings retained in excess of dividend payments. Pursuant to standing authority, the Company reacquired a total of 1,566,100 shares of its common stock during 2007’s third quarter for $28.3 million or $18.13 per share. A summary of all changes affecting book value per share follows:
In the event of issuer default on significant obligations or emergence of such adverse information as to bring into question the validity of previously reported earnings or financial condition; and
When the probability of non-recovery of the original investment is established, the foregoing events or occurrences notwithstanding.
For the three years ended December 31, 2007, pretax charges due to other-than-temporary impairments in the value of securities reduced pretax income within a range of 0% and 1.2% and averaged .4% of such income.
Loss development factors, expected claim rates and average claim costs all of which are based on Company and/or industry statistics used to project reported and unreported losses for each accounting period.
For each of the three most recent calendar years, prior accident years’ consolidated claim costs have developed favorably and have had the consequent effect of reducing consolidated annual loss costs between 2.9% and 6.9%, or by an average of approximately 4.3% per annum. As a percentage of each of these years’ consolidated earned premiums and fees the favorable developments have ranged between 1.3% and 3.4%, and have averaged 2.2%.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123-Revised (“FAS 123R”), “Share-Based Payment” using the modified prospective transition method. The impact of the adoption of FAS123R is discussed in Note 1(r) of the notes to consolidated financial statements.
On December 31, 2006, the Company adopted the recognition provisions of Statement of Financial Accounting Standards No. 158 (“FAS 158”) “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans”. Additionally, the measurement date provisions of FAS 158 were adopted by the Company effective December 31, 2007. The impact of the adoption of FAS 158 is discussed in Note 1(n) of the notes to the consolidated financial statements.
$862.5 million in 2007 compared to $1,004.7 million in 2006 and $833.6 in 2005. As of December 31, 2007, the invested asset base increased 8.8% to $8,761.2 million principally as a result of positive operating cash flows.
Investments - During 2007 and 2006, the Company committed substantially all investable funds to short to intermediate-term fixed maturity securities. At both December 31, 2007 and 2006, approximately 99% of the Company’s investments consisted of marketable securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities. Investable funds have not been directed to so-called “junk bonds”, illiquid private equity investments, real estate, mortgage loans, mortgage-backed securities, collateralized debt obligations (“CDO’s”), or derivatives. In a similar vein, the Company does not invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous counter-party risk attributes. At December 31, 2007, the Company had no fixed maturity investments in default as to principal and/or interest.
Represents 10.0% of the cost of the total equity securities portfolio, while gross unrealized gains represent 14.3% of the portfolio.
Capitalization - Old Republic’s total capitalization of $4,605.7 million at December 31, 2007 consisted of debt of $64.1 million and common shareholders' equity of $4,541.6 million. Changes in the common shareholders’ equity account for the three most recent years reflect primarily the retention of earnings in excess of dividend requirements. Old Republic has paid cash dividends to its shareholders without interruption since 1942, and has increased the annual rate in each of the past 26 years. The annual dividend rate is typically reviewed and approved by the Board of Directors during the first quarter of each year. In establishing each year’s cash dividend rate the Company does not follow a strict formulaic approach. Rather it favors a gradual rise in the annual dividend rate that is largely reflective of long-term consolidated operating earnings trends. Accordingly, each year’s dividend rate is set judgmentally in consideration of such key factors as the dividend paying capacity of the Company’s insurance subsidiaries, the trends in average annual statutory and GAAP earnings for the six most recent calendar years, and management’s long-term expectations for the Company’s consolidated business. At its February 22, 2007 meeting, the
The Company’s mortgage guaranty premiums primarily stem from monthly installment policies. Accordingly, substantially all such premiums are generally written and earned in the month coverage is effective. With respect to annual or single premium policies, earned premiums are largely recognized on a pro-rata basis over the terms of the policies.
The following tables provide information on production and related risk exposure trends for Old Republic’s Mortgage Guaranty Group:
Bulk pool risk in-force, which represented 43.0% of total bulk risk in-force at December 31, 2007, has been allocated pro-rata based on insurance in-force.
Net investment income is affected by trends in interest and dividend yields for the types of securities in which the Company’s funds are invested during each reporting period. The following tables reflect the segmented and consolidated invested asset bases as of the indicated dates, and the investment income earned and resulting yields on such assets. Since the Company can exercise little control over market values, yields are evaluated on the basis of investment income earned in relation to the amortized cost of the underlying invested assets, though yields based on the market values of such assets are also shown in the statistics below.
Consolidated net investment income grew by 11.2%, 10.2% and 6.6% in 2007, 2006 and 2005, respectively. This revenue source was affected by a rising invested asset base caused by positive consolidated operating cash flows, by a concentration of investable assets in interest-bearing securities, and by changes in market rates of return. Yield trends reflect the relatively short maturity of Old Republic’s fixed maturity securities portfolio as well as continuation of a relatively lower yield environment during the past several years.
The Company prepares periodic analyses of its loss reserve estimates for its significant insurance coverages. It establishes point estimates for most losses on an insurance coverage line-by-line basis for individual subsidiaries, sub-classes, individual accounts, blocks of business or other unique concentrations of insurance risks such as directors and officers’ liability, that have similar attributes. Actuarially or otherwise derived ranges of reserve levels are not utilized as such in setting these reserves. Instead the reported reserves encompass the Company’s best point estimates at each reporting date and the overall reserve level at any point in time therefore represents the compilation of a very large number of reported reserve estimates and the results of a variety of formula calculations largely driven by statistical analysis of
Aggregate loss reserves consist of liability estimates for claims that have been reported (“case”) to the Company’s insurance subsidiaries and reserves for claims that have been incurred but not yet reported (“IBNR”) or whose ultimate costs may not become fully apparent until a future time. Additionally, the Company establishes unallocated loss adjustment expense reserves for loss settlement costs that are not directly related to individual claims. Such reserves are based on prior years’ cost experience and trends, and are intended to cover the unallocated costs of claim departments’ administration of case and IBNR claims over time. Long-term, disability-type workers’ compensation reserves are discounted to present value based on interest rates that range from 3.5% to 4.0%. The amount of discount reflected in the year end net reserves totaled $148.5 million, $151.0 million and $138.3 million as of December 31, 2007, 2006, and 2005, respectively.
Management is of the opinion that the Company’s overall reserving practices have been consistently applied over many years. For at least the past ten years, previously established aggregate reserves have produced reasonable estimates of the cumulative ultimate net costs of claims incurred. However, there are no guarantees that such outcomes will continue, and accordingly, no representation is made that ultimate net claim and related costs will not develop in future years to be greater or lower than currently established reserve estimates. In management’s opinion, however, such potential development is not likely to have a material effect on the Company’s consolidated financial position, although it could affect materially its consolidated results of operations for any one annual or interim reporting period. See further discussion in this Annual Report on Form 10-K under Item 1A - Risk Factors.
Total Delinquency Ratios for Top Ten States (includes “other” business) (2):
Mortgage guaranty net claim reserve levels can be affected adversely by several factors, including a change in the mix of insured business toward loans that have a higher probability of default, an increase in the average risk per insured loan, a deterioration of regional or national economic conditions leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a drop in housing values and/or an increase in housing supply that can increase the rate at which defaults evolve into claim and the overall severity of such claims.
To maintain premium production within its capacity and limit maximum losses and risks for which it might become liable under its policies, Old Republic may cede a portion or all of its premiums and liabilities on certain classes of insurance, individual policies, or blocks of business to other insurers and reinsurers. Further discussion of the Company’s reinsurance programs can be found in Part 1 of this Annual Report on Form 10-K.
Subsidiaries within the general insurance segment have generally obtained reinsurance coverage from independent insurance or reinsurance companies pursuant to excess of loss agreements. Under excess of loss reinsurance agreements, the Company is generally reimbursed for losses exceeding contractually agreed-upon levels. During the three year period ended December 31, 2007, the Company’s net retention has been increasing gradually within the general insurance segment; however, such changes have not had a material impact on the Company’s consolidated financial statements.
Generally, mortgage guaranty insurance risk is reinsured through excess of loss contracts through insurers owned by or affiliated with lending institutions, and financial and other intermediaries whose customers are insured by Old Republic. Except for minor amounts of facultative reinsurance covering large risks, the title insurance segment does not utilize reinsurance in managing its insurance risk.
The Company does not anticipate any significant changes to its reinsurance programs during 2008.
The decline in the Mortgage Guaranty segment’s 2007 ratio is reflective of the growth in net earned premium coupled with continued emphasis on operating efficiency; the slight increase in the 2006 expense ratio in comparison to 2005 reflects higher stock option compensation costs.The increase in the Title segment’s 2007 and 2006 expense ratios result from a decline in revenues from direct operations during these periods, most of which are concentrated in the Western United States, to a level lower than necessary to support the fixed portion of the operating expense structure.
Some of the statements made in this report and other Company-published reports, as well as oral statements or commentaries made by the Company’s management in conference calls following earnings releases, can constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Of necessity, any such forward-looking statements, commentaries, or inferences, involve assumptions, uncertainties, and risks that may affect the Company’s future performance. With regard to Old Republic’s General Insurance segment, its results can be affected, in particular, by the level of market competition, which is typically a function of available capital and expected returns on such capital among competitors, the levels of interest and inflation rates, and periodic changes in claim frequency and severity patterns caused by natural disasters, weather conditions, accidents, illnesses, work-related injuries, and unanticipated external events. Mortgage Guaranty and Title Insurance results can be affected by similar factors and, most particularly, by changes in national and regional housing demand and values, the availability and cost of mortgage loans, employment trends, and default rates on mortgage loans. Mortgage Guaranty results, in particular, may also be affected by various risk-sharing arrangements with business producers as well as the risk management and pricing policies of government sponsored enterprises. Life and health insurance earnings can be affected by the levels of employment and consumer spending, variations in mortality and health trends, and changes in policy lapsation rates. At the parent holding company level, operating earnings or losses are generally reflective of the amount of debt outstanding and its cost, interest income on temporary holdings of short-term investments, and period-to-period variations in the costs of administering the Company’s widespread operations. A more detailed discussion of all the foregoing risks appears in Part I, Item 1A - Risk Factors, of this Annual Report, which is specifically incorporated herein by reference.
(a) Accounting Principles - The Company’s insurance subsidiaries are managed pursuant to the laws and regulations of the various states in which they operate. As a result, the subsidiaries maintain their accounts in conformity with accounting practices permitted by various states’ insurance regulatory authorities. Federal income taxes and dividends to shareholders are based on financial statements and reports complying with such practices. The statutory accounting requirements vary from generally accepted accounting principles (“GAAP”) in the following major respects: (1) the costs of selling insurance policies are charged to operations immediately, while the related premiums are taken into income over the terms of the policies; (2) investments in fixed maturity securities designated as available for sale are generally carried at amortized cost rather than their estimated fair value; (3) certain assets classified as “non-admitted assets” are excluded from the balance sheet through a direct charge to earned surplus; (4) changes in allowed deferred income tax assets or liabilities are recorded directly in earned surplus and not through the income statement; (5) mortgage guaranty contingency reserves intended to provide for future catastrophic losses are established as a liability through a charge to earned surplus; (6) title insurance premium reserves, which are intended to cover losses that will be reported at a future date are based on statutory formulas, and changes therein are charged in the income statement against each year’s premiums written; (7) the effect of discounting the medical and loss adjustment expense portion of workers compensation reserves is excluded from losses incurred; and (8) certain required formula-derived liabilities are established for claim reserves in excess of amounts considered adequate by the Company as well as for credits taken relative to reinsurance placed with other insurance companies not licensed in the respective states, all of which are charged directly against earned surplus. In consolidating the statutory financial statements of its insurance subsidiaries, the Company has therefore made necessary adjustments to conform their accounts with GAAP. The following table reflects a summary of all such adjustments:
(b) Consolidation Practices - The consolidated financial statements include the accounts of the Company and those of its majority owned insurance underwriting and service subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
(d) Investments - The Company may classify its invested assets in terms of those assets relative to which it either (1) has the positive intent and ability to hold until maturity, (2) has available for sale or (3) has the intention of trading. As of December 31, 2007 and 2006, substantially all the Company's invested assets were classified as “available for sale.”
The amortized cost and estimated fair value of fixed maturity securities at December 31, 2007, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Bonds and other investments with a statutory carrying value of $356.1 million as of December 31, 2007 were on deposit with governmental authorities by the Company's insurance subsidiaries to comply with insurance laws.
Investment income is reported net of allocated expenses and includes appropriate adjustments for amortization of premium and accretion of discount on fixed maturity securities acquired at other than par value. Dividends on equity securities are credited to income on the ex-dividend date. Realized investment gains and losses, which are comprised of sales of securities and provisions or write-downs of securities, are reflected as revenues in the income state­ment and are determined on the basis of amortized value at date of sale for fixed maturity securities, and cost in regard to equity securities; such bases apply to the specific securities sold. Unrealized investment gains and losses, net of any defer­red income taxes, are recorded directly as a component of accumulated other comprehensive income in shareholders’ equity.
The following table reflects the composition of net investment income, net realized gains or losses, and the net change in unrealized invest­ment gains or losses for each of the years shown:
The Company’s mortgage guaranty premiums primarily stem from monthly installment policies. Accordingly, substantially all such premiums are generally written and earned in the month coverage is effective. With respect to annual or single premium policies, earned premiums are recognized on a pro-rata basis over the terms of the policies.
Title premium and fee revenues stemming from the Company’s direct operations (which include branch offices of its title insurers and wholly owned agency subsidiaries) represent a pproximately 32% of 2007 consolidated title business revenues. Such premiums are generally
recognized as income at the escrow closing date which approximates the policy effective date. Fee income related to escrow and other closing services is recognized when the related services have been performed and completed. The remaining 68% of consolidated title premium and fee revenues is produced by independent title agents and underwritten title companies. Rather than making estimates that could be subject to significant variance from actual premium and fee production, the Company recognizes revenues from those sources upon receipt. Such receipts can reflect a three to four month lag relative to the effective date of the underlying title policy, and are offset concurrently by production expenses and claim reserve provisions.
(g) Unearned Premiums - Unearned premium reserves are generally calculated by application of pro-rata factors to premiums in force. At December 31, 2007 and 2006, unearned premiums consisted of the following:
or subrogation opportunities are considered in the establishment of such reserves as applicable. As part of overall claim and claim expense reserves, the point estimates incorporate amounts to cover net estimates of unusual claims such as those emanating from asbestosis and environmental (“A&E”) exposures as discussed below. Such reserves can affect claim costs and related loss ratios for such insurance coverages as general liability, commercial automobile (truck), workers’ compensation and property.
Old Republic's reserve estimates also include provisions for indemnity and settlement costs for various asbestosis and environmental impairment (“A&E”) claims that have been filed in the normal course of business against a number of its insurance subsidiaries. Many such claims relate to policies issued prior to 1985, including many issued during a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. Over the years, the Company's property and liability insurance subsidiaries have typically issued general liability insurance policies with face amounts ranging between $1.0 million and $2.0 million and rarely exceeding $10.0 million. Such policies have, in turn, been subject to reinsurance cessions which have typically reduced the subsidiaries’ net retentions to $.5 million or less as to each claim. Old Republic's exposure to A&E claims cannot, however, be calculated by conventional insurance reserving methods for a variety of reasons, including: a) the absence of statistically valid data inasmuch as such claims typically involve long reporting delays and very often uncertainty as to the number and identity of insureds against whom such claims have arisen or will arise; and b) the litigation history of such or similar claims for insurance industry members which has produced inconsistent court decisions with regard to such questions as when an alleged loss occurred, which policies provide coverage, how a loss is to be allocated among potentially responsible insureds and/or their insurance carriers, how policy coverage exclusions are to be interpreted, what types of environmental impairment or toxic tort claims are covered, when the insurer's duty to defend is triggered, how policy limits are to be calculated, and whether clean-up costs constitute property damage. In recent times, the Executive Branch and/or the Congress of the United States have proposed or considered changes in the legislation and rules affecting the determination of liability for environmental and asbestosis claims. As of December 31, 2007, however, there is no solid evidence to suggest that possible future changes might mitigate or reduce some or all of these claim exposures. Because of the above issues and uncertainties, estimation of reserves for losses and allocated loss adjustment expenses for A&E claims in particular is much more difficult or impossible to quantify with a high degree of precision. Accordingly, no representation can be made that the Company's reserves for such claims and related costs will not prove to be overstated or understated in the future. At December 31, 2007 and 2006, Old Republic’s aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to $190.5 million and $194.9 million gross, respectively, and $158.1 million and $157.8 million net of reinsurance, respectively. Old Republic’s average five year survival ratios stood at 7.7 years (gross) and 10.7 years (net of reinsurance) as of December 31, 2007 and 7.6 years (gross) and 10.9 years (net of reinsurance) as of December 31, 2006. Fluctuations in this ratio between years can be caused by the inconsistent pay out patterns associated with these types of claims.
Title insurance and related escrow services loss and loss adjustment expense reserves are established as point estimates to cover the projected settlement costs of known as well as claims incurred but not reported, concurrently with the recognition of premium and escrow service revenues of each reporting period. Reserves for known claims are based on an assessment of the facts available to the Company during the settlement process. The point estimates covering all claim reserves take into account incurred but not reported (“IBNR”) claims based on past experience and evaluations of such variables as changing trends in the types of policies issued, changes in real estate markets and interest rate environments, and changing levels of loan refinancing, all of which can have a bearing on the emergence, number, and ultimate cost of claims.
The provision for combined current and deferred income taxes reflected in the consolidated statements of income does not bear the usual relationship to income before income taxes as the result of permanent and other differences between pretax income and taxable income determined under existing tax regulations. The more significant differences, their effect on the statutory income tax rate, and the resulting effective income tax rates are summarized below:
Tax and related interest recoveries of $57.9 million ($45.9 million net of tax) were recorded in the second quarter of 2005 due to the favorable resolution of tax issues applicable to the three years ended December 31, 1990. This adjustment reduced the 2005 effective tax rate by approximately 6.2 percentage points.
Pursuant to special provisions of the Internal Revenue Code pertaining to mortgage guaranty insurers, a contingency reserve (established in accordance with insurance regulations designed to protect policyholders against extraordinary volumes of claims) is deductible from gross income. The tax benefits obtained from such deductions must, however, be invested in a special type of non-interest bearing U.S. Treasury Tax and Loss Bonds which aggregated $536.5 million at December 31, 2007. For Federal income tax purposes, amounts deducted from the contingency reserve are taken into gross statutory taxable income in the period in which they are released. Contingency reserves may be released when incurred losses exceed thresholds established under state law or regulation, upon special request and approval by state insurance regulators, or in any event, upon the expiration of ten years. During 2007, the Company released net contingency reserves of $115.2 million and consequently, $35.3 million of U.S. Treasury Tax and Loss Bonds were to be redeemed during the first quarter of 2008.
(m) Goodwill and Intangible Assets - Goodwill resulting from business combinations is no longer amortizable against operations but must be tested annually for possible impairment of its continued value ($159.1 million and $155.6 million at December 31, 2007 and 2006, respectively). No impairment charges were required for any period presented. Goodwill and intangible assets of $58.5 million were recorded during 2006 as a result of the November 30, 2006 acquisition of a casualty insurance book of business (see Note 7). Intangible assets related to the acquisition will be amortized against future operating results.
The amounts included in accumulated other comprehensive income expected to be recognized as components of net periodic pension cost during 2008 consist of the following:
assets assumption, the Plans considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocation of the pension portfolios.
The following information is being provided for plans with accumulated benefit obligations in excess of plan assets as of the above measurement dates:
The benefits expected to be paid as of December 31, 2007 for the next 10 years are as follows: 2008: $11.2 million; 2009: $11.7 million; 2010: $12.5 million; 2011: $13.0 million; 2012: $13.9 million and for the five years after 2012: $86.3 million.
Plan assets are managed pursuant to the investment policies set forth at Note 1(d).
(o) Escrow Funds - Segregated cash deposit accounts and the offsetting liabilities for escrow deposits in connection with Ti­tle Insurance Group real estate transactions in the same amounts ($660.8 million and $928.6 million at December 31, 2007 and 2006, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
Outstanding stock option awards totaling 4,864,000, 1,517,025 and 0 shares as of December 31, 2007, 2006 and 2005, respectively, were excluded from the computation of earnings per share because their effect would have been antidilutive to the periods presented.
A summary of stock option activity under the plan as of December 31, 2007, 2006 and 2005, and changes in outstanding options during the years then ended is presented below:
A summary of stock options outstanding and exercisable at December 31, 2007 follows:
As of December 31, 2007, there was $15.8 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted average period of approximately 3 years.
The Company has access to the commercial paper market for up to $300.0 million of which $240.0 million remains unused as of December 31, 2007. The carrying amount of the Company's commercial paper borrowings approximates its fair value. The fair value of publicly traded debt is based on its quoted market price.
(c) Stock Option Plan - The Company has had stock option plans in effect for certain eligible key employees since 1978. An amended plan adopted in 1992 was replaced at its expiration by a plan approved by the shareholders in 2002, and the 2002 plan was replaced by the 2006 Incentive Compensation Plan approved by the shareholders in May 2006. Under the current plan, options awarded at the date of grant together with options previously issued and then-outstanding may not exceed 9% of the Company’s outstanding common stock at the end of the month immediately preceding an option grant. Under the current plan, like its predecessors, the exercise price of stock options is equal to the closing market price of the Company’s common stock on the date of the grant, and the contractual life of the grant is generally ten years from the date of the grant. Options granted in 2001 and prior years under the 1992 plan may be exercised to the extent of 10% of the number of shares covered thereby on and after the date of grant, and cumulatively, to the extent of an additional 10% on and after each of the first through ninth subsequent calendar years. Options granted in 2002 and thereafter may be exercised to the extent of 10% of the number of shares covered thereby as of December 31st of the year of the grant and, cumulatively, to the extent of an additional 15%, 20%, 25% and 30% on and after the second through fifth calendar years, respectively. Options granted to employees who meet certain retirement eligibility provisions become fully vested upon retirement.
(e) Undistributed Earnings - At December 31, 2007, the equity of the Company in the GAAP undistributed earnings, and net unrealized investment gains (losses) of its subsidiaries amounted to $3,273.3 million and $79.2 million, respectively. Dividends declared dur­ing 2007, 2006 and 2005, to the Company by its subsidiaries amounted to $175.8 million, $362.3 million and $287.2 million, respectively.
Except as noted in the following paragraph, reinsurance protection on property and liability coverages generally limits the net loss on most individual claims to a maximum of : $1.8 million for workers' compensation; $1.8 million for commercial auto liability; $1.8 million for general liability; $5.6 million for executive protection (directors & officers and errors & omissions); $1.0 million for aviation; and $1.0 million for property coverages. Roughly 53% of the mortgage guaranty traditional primary insurance in force is subject to lender sponsored captive reinsurance arrangements structured primarily on an excess of loss basis. All bulk and other insurance risk in force is retained. Exclusive of reinsurance, the average net primary mortgage guaranty exposure is approximately (in whole dollars) $35,300. Title insurance risk assumptions are currently limited to a maximum of $100.0 million as to any one policy. The vast majority of title policies issued, however, carry exposures of $1.0 million or less.
Due to worldwide reinsurance capacity and related cost constraints, effective January 1, 2002, the Company began retaining exposures for all, but most predominantly workers’ compensation liability insurance coverages in excess of $40.0 million that were previously assumed by unaffiliated reinsurers for up to $100.0 million. Effective January 1, 2003 reinsurance ceded limits were raised to the $100.0 million level, and as of January 1, 2005, they were further increased to $200.0 million. Pursuant to regulatory requirements, however, all workers’ compensation primary insurers such as the Company remain liable for unlimited amounts in excess of reinsured limits. Other than the substantial concentration of workers’ compensation losses caused by the September 11, 2001 terrorist attack on America, to the best of the Company’s knowledge there had not been a similar accumulation of claims in a single location from a single occurrence prior to that event. Nevertheless, the possibility continues to exist that non-reinsured losses could, depending on a wide range of severity and frequency assumptions, aggregate several hundred million dollars for an insurer such as the Company. Such aggregations could result from a catastrophe such as caused by an earthquake that could lead to the death or injury of a large number of employees concentrated in a single facility such as a high rise building.
At December 31, 2007, the Company’s ten largest reinsurers represented approximately 66% of reinsurance recoverable on paid and unpaid losses, with Munich Re America, Inc. the largest reinsurer representing 32.1% of the total recoverable balance. Of the balance due from these ten reinsurers, 79.4% was recoverable from A or better rated reinsurance companies, 12.6% from industry-wide insurance assigned risk pools, and 8.0% from captive reinsurance companies.
The following information relates to reinsurance and related data for the General Insurance and Mortgage Guaranty Groups for the three years ended December 31, 2007. Reinsurance transactions of the Title Insurance Group and small life and health insurance operation are not material.
Property and liability insurance companies are required to annualize certain policy premiums in their regulatory financial statements though such premiums may not be contractually due nor ultimately collectable. The annualization process relies on a large number of estimates, and has the effect of increasing direct, ceded, and net premiums written, and of grossing up corresponding balance sheet premium balances and liabilities such as unearned premium reserves. The accrual of these estimates has no effect on net premiums earned or GAAP net income. During 2005, the Company further refined certain premium annualization estimates. In the following table, the sum total of these adjustments had the effect of increasing general insurance direct premiums written by $66.3 million, premiums written ceded by $43.2 million, and net premiums written by $23.1 million for 2005.
(b) Leases - Some of the Company's subsidiaries maintain their offices in leased premises. Some of these leases provide for the payment of real estate taxes, insurance, and other operating expenses. Rental expenses for operating leases amounted to $42.5 million, $41.0 million and $39.9 million in 2007, 2006 and 2005, respectively. These expenses relate primarily to building leases of the Company. A number of the Company’s subsidiaries also lease other equipment for use in their businesses. At December 31, 2007, ag­gregate minimum rental commitments (net of expected sub-lease receipts) under noncancellable operating leases are summarized as follows: 2008: $39.0 million; 2009: $30.6 million; 2010: $21.7 million; 2011: $15.6 million; 2012: $11.2 million; 2013 and after: $48.5 million.
(d) Legal Proceedings - Legal proceedings against the Company arise in the normal course of business and usually pertain to claim matters related to insurance policies and contracts issued by its in­surance subsidiaries. Other legal proceedings are discussed below.
Note 5 - Consolidated Quarterly Results - Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 2007 is presented below.
In the opinion of management, all adjustments consisting of normal recurring adjustments necessary for a fair statement of quarterly results have been reflected in the data which follows. It is also management's opinion, however, that quarterly operating data for insurance enterprises such as the Company is not indicative of results to be achieved in succeeding quarters or years. The long-term nature of the insurance business, seasonal and cyclical factors affecting premium production, the fortuitous nature and, at times, delayed emergence of claims, and changes in yields on invested assets are some of the factors necessitating a review of operating results, changes in shareholders' equity, and cash flows for periods of several years to obtain a proper indicator of perfor­mance trends. The data below should be read in conjunction with the “Management Analysis of Financial Position and Results of Operations”:
Private mortgage insurance produced by the Mortgage Guaranty Group protects mortgage lenders and investors from default related losses on residential mortgage loans made primarily to homebuyers who make down payments of less than 20% of the home’s purchase price. The Mortgage Guaranty Group insures only first mortgage loans, primarily on residential properties having one-to-four family dwelling units. The Mortgage Guaranty segment’s ten largest customers were responsible for 49.5%, 39.7% and 44.2% of traditional primary new insurance written in 2007, 2006 and 2005, respectively. The largest single customer accounted for 9.8% of traditional primary new insurance written in 2007 compared to 8.8% and 11.5% in 2006 and 2005, respectively.
General Insurance tax expense was reduced by $45.9 million in 2005 as discussed in Note 1(j).
Management is responsible for the preparation of the Company’s consolidated financial statements and related information appearing in this report. Management believes that the consolidated financial statements fairly reflect the form and substance of transactions and that the financial statements reasonably present the Company’s financial position and results of operations in conformity with generally accepted accounting principles. Management also has included in the Company’s financial statement amounts that are based on estimates and judgments which it believes are reasonable under the circumstances.
The independent registered public accounting firm has advised that it audits the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board and provides an objective, independent review of the fairness of reported operating results and financial position.