We lease approximately 253,000 square feet, under a non-cancelable lease expiring in 2016, in an office building in Houston, Texas, which is used for our corporate offices and for offices of several of our subsidiaries. In addition, we lease offices at approximately 750 additional locations that are used for branch offices, regional headquarters and technology centers. These additional locations include significant leased facilities in Los Angeles, Dallas, San Diego, Seattle and Las Vegas.
Our leases expire from 2006 to 2016 and have an average term of four years, although our typical lease term ranges from three to five years. We believe we will not have any difficulty obtaining renewals of leases as they expire or, alternatively, leasing comparable properties. The aggregate annual rent expense under all leases was approximately $64,698,000 in 2005.
We also own six office buildings located in Texas, Arizona and Colorado. These owned properties are not material to our financial position. We consider all buildings and equipment that we own or lease to be well maintained, adequately insured and generally sufficient for our purposes.
Our most critical accounting estimate is providing for title loss reserves. Our liability for estimated title losses at December 31, 2005 comprises both known claims ($79.2 million) and claims expected to be reported in the future ($267.5 million). The amount of the reserve represents the aggregate future payments, net of recoveries, that we expect to incur on policy and escrow losses and in costs to settle claims.
We base our estimates on reported claims, historical loss experience, title industry averages and the current legal and economic environment. In making estimates, we use moving-average ratios of recent actual policy loss payment experience (net of recoveries) to premium revenues.
Provisions for title losses, as a percentage of title operating revenues, were 5.5%, 4.8% and 4.4% for the years ended December 31, 2005, 2004 and 2003, respectively. Actual loss payment experience, including the impact of large losses, is the primary reason for increases or decreases in our loss provision. A change of 0.5% in this percentage, a reasonably likely scenario based on historical loss experience, would have changed the provision for title losses and pretax earnings by approximately $11.6 million for the year ended December 31, 2005.
Estimating future loss payments is difficult and our assumptions are subject to the risk of change. Claims, by their very nature, are complex and involve uncertainties as to the dollar amount and timing of individual payments. Our experience has been that most claims against policies and claim payments are made in the first six years after the policy has been issued, although claims are incurred and paid many years later.
We have consistently followed the same basic method of estimating loss payments for more than ten years. Independent consulting actuaries have reviewed our title loss reserves and found them to be adequate at each year end for more than ten years.
Based on our annual June 30th evaluation of goodwill and events that may indicate impairment of title plants and other long-lived assets, we estimate and expense any loss in value to our current operations. The process of determining impairment relies on projections of future cash flows, operating results and market conditions. Uncertainties exist in these projections and bear the risk of change related to factors such as interest rates and overall real estate markets. Actual market conditions and operating results may vary materially from our projections. There were no impairment write-offs of goodwill during the years ended December 31, 2005 and 2004. During 2003, $2.0 million of goodwill attributed to a subsidiary held for sale was written off and is included in other operating expenses in the consolidated financial statements. We use independent appraisers to assist us in determining the fair value of our reporting units and assessing whether an impairment of goodwill exists.
We recognize revenues on title insurance policies written by independent title agencies (agencies) when the policies are reported to us. In addition, where reasonable estimates can be made, we also accrue for policies issued but not reported until after period end. We believe that reasonable estimates can be made when recent and consistent policy issuance information is available. Our estimates are based on historical reporting patterns and other information about our agencies. We also consider current trends in our direct operations and in the title industry. In this accrual, we are not estimating future transactions. We are estimating policies that have already been issued but not yet received by us. We have consistently followed the same basic method of estimating unreported policy revenues for more than ten years.
Operations. Our business has two main segments: title insurance-related services and real estate information (REI). These segments are closely related due to the nature of their operations and common customers.
Most industry experts project mortgage interest rates to rise modestly in 2006. Due to the large number of refinancings completed in 2003, 2004 and 2005 and rising interest rates, significantly fewer refinancing transactions are being forecast for 2006.
Trends and order counts. In the third quarter of 2003 mortgage interest rates increased significantly by 50 basis points to 6.01%. Since that time, mortgage interest rates have fluctuated from 5.45% to a high of 6.33% in the fourth quarter of 2005. Mortgage originations fell to lower levels beginning in the fourth quarter of 2003 primarily because refinancing transactions fell dramatically. Mortgage originations continued to fall substantially during 2004, although there was a slight increase in 2005. Sales of new and existing homes continued an upward trend throughout 2004 and 2005.
As a result of the above trends, the Company’s order levels began to decline in the third quarter of 2003. They remained below prior year levels through August 2004. For the rest of 2004, orders exceeded the number of orders received in 2003. Order levels for 2005 remained relatively comparable to 2004, although orders for the fourth quarter of 2005 were lower than the comparable period in 2004. Some of the increases in 2005 and 2004 were due to acquisitions.
A comparison of the results of operations of the Company for 2005 with 2004 and 2004 with 2003 follows. Factors contributing to fluctuations in results of operations are presented in their order of monetary significance. We have quantified, when necessary, significant changes.
The average revenue per closing increased 12.3% in 2005 and 25.2% in 2004 primarily due to a lower ratio of refinancings closed by our direct operations compared to the prior year. Title insurance premiums on refinancings are typically less than on property sales. The increase in 2005 in average revenue per closing was also due to an increased proportion of commercial transactions and rising home prices.
Revenues from agencies increased 5.9% in 2005 and decreased 3.9% in 2004. The increase in 2005 was primarily due to a decrease in the ratio of refinancing transactions compared to property sales, partially offset by our acquisitions of some agencies that were formerly independent. The decrease in 2004 was primarily due to an overall decrease in the volume of transactions completed and a decrease in refinancing transactions offset somewhat by an increase in property sales. We are unable to quantify the relative contributions from refinancings and property sales because, in most jurisdictions, our independent agencies are not required to report this information. Our statements on sales and refinancings are based on published industry data from sources such as Fannie Mae, the Mortgage Bankers Association, the National Association of Realtors® and Freddie Mac. We also use information from our direct operations.
The largest increases in revenues from agencies in 2005 were primarily in Florida, New Jersey, Georgia and Maryland, offset partially by decreases in California and Texas. The largest decreases in 2004 in revenues from agencies were primarily in California, Utah, New York and Michigan, offset partially by increases in Virginia, Florida and Pennsylvania.
The Texas Department of Insurance reduced title insurance premium rates by 6.5% effective July 1, 2004. As a consequence, our revenues and net earnings were reduced by approximately $17.6 million and $5.2 million, respectively, in 2005 and $8.8 million and $2.6 million, respectively, in 2004.
Investments. Investment income increased 29.4% in 2005 because of an increase in average balances invested and higher yields. Investment income increased 13.7% in 2004 because of increases in average balances invested, partially offset by lower yields. Certain investment gains in 2005, 2004 and 2003 were realized as part of the ongoing management of the investment portfolio for the purpose of improving performance.
Selected cost ratios (by segment). The following table shows employee costs and other operating expenses as a percentage of related title and REI operating revenues.
Other operating expenses. Other operating expenses for the combined business segments increased 14.9% in 2005 and 5.7% in 2004. The increase in other operating expenses in 2005 was partially due to acquisitions, which contributed approximately $9.4 million of the increase. Other 2005 increases included rent of $10.0 million, certain REI expenses, business promotion and technology costs. Increases in 2004 were in acquisitions, which contributed $12.4 million of the increase, litigation costs of $4.7 million, rent and technology costs. The increases were partially offset by decreases in certain REI expenses in response to volume decreases, supplies expense and attorney fees.
Income taxes. The provisions for federal, state and foreign income taxes represented effective tax rates of 37.9%, 37.4% and 37.6% in 2005, 2004 and 2003, respectively.
Material contractual obligations consist primarily of notes payable, operating leases and estimated title losses. Operating leases are primarily for office space and expire over the next 11 years. The timing for the payment of estimated title losses is not set by contract. Rather, it is projected based on historical payment patterns. The actual timing of estimated title loss payments may vary materially from the above projection because claims, by their nature, are complex and paid over long periods of time. Loss reserves represent a total estimate only, whereas the other contractual obligations are determinable as to timing and amounts. Title losses paid were $82.2 million, $68.4 million and $58.0 million in 2005, 2004 and 2003, respectively.
Cash provided by operations was $173.5 million, $170.4 million and $190.1 million in 2005, 2004 and 2003, respectively. Cash flow from operations has been the primary source of financing for additions to property and equipment, expanding operations, dividends to stockholders and other requirements. This source is supplemented by bank borrowings.
Acquisitions during 2005, 2004 and 2003 resulted in additions to goodwill of $30.1 million, $45.6 million and $13.7 million, respectively.
Restrictions on liquidity. A substantial majority of our consolidated cash and investments at December 31, 2005 was held by Stewart Title Guaranty Company (Guaranty) and its subsidiaries. The use and investment of these funds, dividends to the Company and cash transfers between Guaranty and its subsidiaries and the Company are subject to certain legal restrictions (Notes 2 and 3).
Our liquidity at December 31, 2005, excluding Guaranty and its subsidiaries, was comprised of cash and investments aggregating $35.6 million and short-term liabilities of $3.3 million. We know of no commitments or uncertainties that are likely to materially affect our ability to fund cash needs (Note 17).
Loss reserves. Our loss reserves are fully funded, segregated and invested in high-quality securities and short-term investments. This is required by the insurance regulators of the states in which our underwriters are domiciled. At December 31, 2005, these investments aggregated $427.0 million and our estimated title loss reserves were $346.7 million.