Investors Title Company (the “Company”) is a holding company that engages primarily in issuing title insurance through two subsidiaries, Investors Title Insurance Company (“ITIC”) and National Investors Title Insurance Company (“NITIC”). Total revenues from the title segment accounted for 95.6% of the Company’s revenues in 2017. Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Title insurance protects against loss or damage resulting from title defects that affect real property.
The Company’s volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes sales, mortgage financing and mortgage refinancing. Real estate activity, home sales and mortgage lending are cyclical in nature. In turn, real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels and general United States economic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.
Services other than title insurance provided by operating divisions of the Company are not reported separately and are reported collectively in a category called “All Other.” These other services include those offered by the Company and by its wholly owned subsidiaries, Investors Title Exchange Corporation (“ITEC”), Investors Title Accommodation Corporation (“ITAC”), Investors Trust Company (“Investors Trust”) and Investors Title Management Services, Inc. (“ITMS”).
In efforts to provide transparency, the Federal Open Market Committee (“FOMC”) of the Federal Reserve issues disclosures on a periodic basis that include projections of the federal funds rate and expected actions. At the December 2015 meeting, the FOMC voted to raise the federal funds rate for the first time since December 2008 to a target range between 0.25% and 0.50%. Since December 2015, the FOMC has voted four times to increase the federal funds rate. Specifically, the FOMC voted to increase the federal funds rate at the December 2016 meeting to a target range between 0.50% and 0.75%, at the March 2017 meeting to a target range between 0.75% and 1.00%, at the June 2017 meeting to a target range between 1.00% and 1.25%, and most recently at the December 2017 meeting to a target range between 1.25% and 1.50%. Any future adjustments to the rate are expected to be based on realized and expected economic developments to achieve maximum employment and 2.0% inflation. The FOMC anticipates future economic conditions to evolve in ways that will warrant gradual increases and that for some time, the federal funds rate is expected to be below long range levels. At the September 2017 meeting, the FOMC announced the reduction of securities held on the Federal Reserve's balance sheet, also known as normalization, which began in October 2017.
In 2008, the federal government took control of Fannie Mae and Freddie Mac in an effort to keep these government-sponsored entities from failing. The primary functions of Fannie Mae and Freddie Mac are to provide liquidity to the nation's mortgage finance system by purchasing mortgages on the secondary market, pooling them and selling them as mortgage-backed securities. In order to securitize, Fannie Mae and Freddie Mac typically require the purchase of title insurance for loans they acquire. Since the federal takeover, there have been various discussions and proposals regarding their reform. Changes to these entities could impact the entire mortgage loan process and, as a result, could affect the demand for title insurance. The timing and results of reform are currently unknown; however, any changes to these entities could affect the Company and its results of operations.
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, reducing the federal corporate income tax rate from 35% to 21%, effective January 1, 2018. As required under generally accepted accounting principles, the Company’s deferred tax assets and liabilities were revalued at the new tax rate, and the impact was recognized in the provision for income taxes in the fourth quarter. The revaluation resulted in a benefit to the year and the quarter of approximately $5.3 million, or $2.82 per diluted share.
Overall, the economy is expanding and there has been a steady reduction in unemployment in recent years. The Mortgage Bankers Association's (“MBA”) January 2018 Economic and Mortgage Finance Commentary predicts continued improvement in the employment rate in 2018, as the economy is projected to add approximately 150,000 jobs per month in early 2018 with a deceleration to around 100,000 jobs per month by the end of year. The unemployment rate is expected to be 3.7% in the fourth quarter of 2018. Given the boost in economic growth, it is projected that the FOMC will raise the federal funds rate four times during 2018. Overall, the MBA believes that the TCJA is a net positive for the economy. In regards to housing, the MBA projects the TCJA to have a minimal impact for most of the country, with a potentially negative impact for higher income borrowers in the highest cost markets.
In October 2016, National Investors Holdings, LLC ("NIH"), a subsidiary of the Company, acquired all of the outstanding shares of a title insurance agency doing business in the state of Texas. NIH paid $10 million plus a $918,000 adjustment for the agency’s net cash position at closing.
The key actuarial assumptions are principally loss development factors and expected loss ratios. The selected loss development factors are based on a combination of the Company’s historical loss experience and title industry loss experience. Expected loss ratios are estimated for each policy year based on the Company’s own experience and title industry loss ratios. When updated data is incorporated into the actuarial models, the resulting loss development factors and expected loss ratios will likely change from the prior values. Changes in these values for historical policy years have generally been the result of actual Company and industry experience during the calendar years.
If one or more of the variables or assumptions used changed such that the Company’s recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased three loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2017 would be as follows:
The Company recorded net deferred tax liabilities at December 31, 2017 and 2016. The deferred tax liabilities recorded during both periods primarily relate to net unrealized gains on investments, the recorded reserve for claims, net of statutory premium reserves, the excess of tax over book depreciation and intangible assets. See Note 8 to the Consolidated Financial Statements in this Annual Report on Form 10-K for further information on the Company’s deferred taxes.
The following table presents certain income statement data for the years ended December 31, 2017, 2016 and 2015:
Net Premiums: Net premiums written increased 14.9% in 2017 to $138,588,877 compared with $120,569,151 in 2016, and increased 7.7% in 2016 compared with $111,909,473 in 2015. The increase in 2017 compared with 2016 was primarily due to higher levels of home sales in our core markets, a continuation of the multi-year trend of increases in the underlying values of real estate, and business from newly-signed agents, partially offset by a decrease in the level of refinance activity. The increase in 2016 net premiums versus the prior year is primarily attributable to growth in average real estate values, coupled with growth in transaction volumes stemming from higher levels of home sales and refinance activity.
During the quarter ended March 31, 2016, the North Carolina Title Insurance Rating Bureau, which establishes premium rates for title insurance in North Carolina, and of which Investors Title Insurance Company is a member, filed updated premium rates that took effect on April 1, 2016. The revised rates positively impacted the Company's branch and agency premiums by approximately $3,042,000 and $3,950,000 for 2017 and 2016, respectively.
Investment income and realized gains and losses from investments are included in investment related revenues.
Investment income was $4,444,447 in 2017 compared with $4,684,489 in 2016 and $4,531,319 in 2015. The decrease in investment income in 2017 compared with 2016 was primarily due to a lower average level of investments in fixed income securities, partially offset by an increase in equity securities. The increase in investment income in 2016 compared with 2015 was primarily due to higher average portfolio balances for both fixed maturities and equity securities compared with the previous year. See Note 3 in the accompanying Consolidated Financial Statements for the major categories of investments, scheduled maturities, amortized cost, fair values of investment securities and earnings by security category.
The net realized gain (loss) on investments was $1,040,901 for 2017 compared with $768,436 for 2016 and $(116,163) for 2015. The net realized gain (loss) on investments included impairment charges of $208,077, $233,941 and $984,128, on certain investments and other assets that were deemed to be other-than-temporarily impaired in 2017, 2016 and 2015, respectively, offset by a net realized gain on the sales of investments and other assets of $1,248,978, $1,002,377 and $867,965 in 2017, 2016, and 2015, respectively. Management believes unrealized losses on remaining fixed income and equity securities at December 31, 2017 are temporary in nature.
The Company’s operating expenses consist primarily of agent commissions, salaries, employee benefits and payroll taxes, office occupancy and operations and the provision for claims. Operating expenses increased 19.0% in 2017 compared with 2016 primarily due to increases in payroll expense, agent commissions, claims expense and office occupancy and operations. Operating expenses increased 0.9% in 2016 compared with 2015 primarily due to increases in payroll expense and agent commissions, mostly offset by a decrease in claims.
Office Occupancy and Operations: Office occupancy and operations expenses primarily include office rent and utilities, depreciation, maintenance, telecommunications and insurance expenses. Office occupancy and operations expenses were $8,966,623, $6,265,908 and $5,885,336 for 2017, 2016 and 2015, respectively. The increase in office and occupancy and operations expense in 2017 compared with 2016 was primarily related to increases in contract services, office equipment and facilities expenses. The increase in office occupancy and operations expense in 2016 compared with 2015 was primarily related to increases in maintenance and depreciation, partially offset by decreases in printing and telecommunications. Office occupancy and operations expenses as a percentage of total revenues were 5.5%, 4.5% and 4.6% for 2017, 2016 and 2015, respectively.
Business Development: Business development expenses primarily include marketing and travel-related expenses. Business development expenses increased to $3,164,730 in 2017 compared with $2,511,699 in 2016 and $2,373,270 in 2015, primarily due to increases in travel and marketing expenses.
Professional and Contract Labor Fees: Professional and contract labor fees were $1,825,598 in 2017 compared with $2,115,754 in 2016 and $2,691,411 in 2015. The decreases in professional and contract labor fees for 2017 and 2016, compared with the previous years, were primarily attributable to decreases in legal fees and consulting fees associated with the Company's ongoing software initiatives.
Commissions: Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. In 2017, commissions to agents increased 7.9% to $68,643,220 compared with $63,643,321 in 2016, and increased 2.4% in 2016 compared with $62,174,301 in 2015. Commission expense as a percentage of net premiums written by agents was 69.8%, 73.1% and 74.0% in 2017, 2016 and 2015, respectively. Commissions expense as a percentage of net premiums written decreased in 2017 compared with 2016 primarily due to the elimination of intercompany commissions for affiliated agents upon consolidation. Commissions expense as a percentage of net premiums written decreased in 2016 compared with 2015 primarily due to changes in geographic mix. The increases in commission expense for 2017 and 2016 were primarily attributable to higher agent premium volume. Commission rates vary by market due to local practice, competition and state regulations.
Provision for Claims: The provision for claims as a percentage of net premiums written was 2.4%, 0.2% and 4.0% in 2017, 2016 and 2015, respectively. The increase in the provision for claims as a percentage of net premiums written in 2017 compared with 2016 primarily related to higher levels of favorable loss development in 2016. The decrease in the provision for claims in 2016 compared with 2015 primarily related to favorable loss development, as the Company’s incurred losses for policy years 2009 through 2015 continued to develop favorably.
Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $3,815,080, $2,725,953 and $3,367,494 in 2017, 2016 and 2015, respectively.
Reserve for Claims: At December 31, 2017, the total reserve for claims was $34,801,000. Of that total, approximately $4,646,000 was reserved for specific claims, and approximately $30,155,000 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.
Premium and Retaliatory Taxes: Title insurance companies are generally not subject to state income or franchise taxes. However, in most states they are subject to premium and retaliatory taxes, as defined by statute. Premium and retaliatory tax rates vary from state to state; accordingly, the total premium and retaliatory tax incurred is dependent upon the geographical mix of insurance revenues. Premium and retaliatory taxes as a percentage of net premiums written were 1.9%, 1.8% and 1.9% in 2017, 2016 and 2015, respectively.
The Company believes it is more likely than not that the tax benefits associated with recognized impairments and unrecognized losses recorded through December 31, 2017 will be realized. However, this judgment could be impacted by further market fluctuations. Information regarding the components of income tax expense and the items included in the reconciliation of the effective rate with the federal statutory rate can be found in Note 8 to the accompanying Consolidated Financial Statements.
The Company’s current cash requirements include general operating expenses, income taxes, capital expenditures, dividends on its common stock and repurchases of its common stock. Cash flows from operations have historically been the primary source of financing for expanding operations, whether through organic growth or outside investments.
The Company’s operating results and cash flows are heavily dependent on the real estate market. The Company’s business has certain fixed costs such as personnel; therefore, changes in the real estate market are monitored closely, and operating expenses such as staffing levels are managed and adjusted accordingly. The Company believes that its significant working capital position and management of operating expenses will aid its ability to manage cash resources through fluctuations in the real estate market.
Cash flows from non-operating activities have historically consisted of purchases and proceeds from investing activities, repurchases of common stock and the issuance of dividends. In 2017, the Company had higher levels of investment purchase activity, proceeds received from investments, and dividends paid and lower levels of subsidiary purchases and repurchases of common stock compared with 2016. In 2016, the Company had a lower level of investment purchase activity, the purchase of a subsidiary, and a higher level of common stock repurchases compared with 2015.
The ability of the Company's title insurance subsidiaries to pay dividends to the Company is subject to state regulation from their respective states of domicile. Each state regulates the extent to which title underwriters can pay dividends or make distributions and requires prior regulatory approval of the payment of dividends and other intercompany transfers. The maximum dividend permitted by law is not necessarily indicative of an insurer’s actual ability to pay dividends. Depending on regulatory conditions, the Company may in the future need to retain cash in its title insurance subsidiaries in order to maintain their statutory capital position. As of December 31, 2017, both ITIC and NTIIC met the minimum capital, surplus and reserve requirements for each state in which they are licensed.
As of December 31, 2017, approximately $102,082,000 of the consolidated stockholders’ equity represented net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior approval from the respective state insurance department. These regulations require prior regulatory approval of the payment of dividends and other intercompany transfers. The Company believes, however, that amounts available for transfer from the insurance and other subsidiaries are adequate to meet the Company’s current operating needs.
During 2018, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $18,960,000.
Capital Expenditures: Capital expenditures were approximately $2,883,000, $2,457,000 and $2,743,000 during 2017, 2016 and 2015, respectively. The Company has plans for various capital improvement projects, including increased investment in a number of technology and system development initiatives and hardware purchases which are anticipated to be funded via cash flows from operations. All material anticipated capital expenditures are subject to periodic review and revision and may vary depending on a number of factors.
As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $20,880,000 and $18,032,000 as of December 31, 2017 and 2016, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
External assets under management by the Investors Trust Company totaled approximately $490,000,000 and $440,000,000 for the years ended December 31, 2017 and 2016, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets.
It is not the general practice of the Company to enter into off-balance sheet arrangements or issue guarantees to third parties. The Company does not have any material source of liquidity or financing that involves off-balance sheet arrangements. Other than items noted above, off-balance sheet arrangements are generally limited to the future payments under noncancelable operating leases and payments due under various agreements with third party service providers.
As of December 31, 2017, the Company had a claims reserve totaling $34,801,000. The amounts and timing of these obligations are estimated and not set contractually. Nonetheless, based on historical insurance claims experience, the Company anticipates the payments shown in the Contractual Obligations table. Events such as fraud, defalcation, and multiple property title defects can substantially and unexpectedly cause increases in both the amount and timing of estimated title insurance loss payments and loss cost trends whereby increases or decreases in inflationary factors (including the value of real estate) will influence the ultimate amount of title insurance loss payments and could increase total obligations and influence claim payout patterns. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, claim estimates are subject to variability and future payments could increase or decrease from these estimated amounts in the future.
exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the ASU clarifies that an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The update is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. None of these amendments is expected to have a material impact on the Company's financial position or results of operations.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718). ASU 2016-09 updated guidance to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The update is effective for annual periods beginning after December 15, 2016, and interim periods within that reporting period. The Company adopted this update on January 1, 2017 with no material impact to the Company's financial position or results of operations. All excess tax benefits and tax deficiencies are now recognized as income tax expense or benefit in the Consolidated Statements of Income. In addition, a reclassification was made on the Consolidated Statements of Cash Flows, as companies are now required to present excess tax benefits as an operating activity on the Consolidated Statements of Cash Flows rather than as a financing activity. The Company began recording all excess tax benefits and tax deficiencies as an income tax expense or benefit on a prospective basis. The amendments relating to the presentation of excess tax benefits within the Consolidated Statements of Cash Flows were adopted by the Company retrospectively.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 updated guidance to improve the comparability of revenue recognition practices for entities that either enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards such as insurance contracts or lease standards. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, this update originally became effective for interim and annual reporting periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. ASU 2015-14 updated guidance to defer the effective date of the standard by one year. Based on the Company’s evaluation of ASU 2014-09, there will be no significant changes to revenue recognition practices upon adoption.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements of the Company as of December 31, 2017 and 2016, and for each of the three years in the period ended December 31, 2017, and our report dated March 12, 2018, expressed an unqualified opinion on those consolidated financial statements.
Short-term investments are comprised of money market accounts which are invested in short-term funds, commercial paper, certificates of deposit, and other investments expected to have maturities or redemptions greater than three months and less than twelve months. The Company monitors any events or changes in circumstances that may have a significant adverse effect on the fair value of these investments.
Other investments consist primarily of investments in title insurance agencies structured as limited liability companies (“LLCs”), which are accounted for under the equity or cost methods of accounting. The aggregate cost of the Company’s cost method investments totaled $5,438,745 and $4,744,402 at December 31, 2017 and 2016, respectively. The Company monitors any events or changes in circumstances that may have had a significant adverse effect on the fair value of these investments and makes any necessary adjustments.
Fees are recognized at the signing of a binding agreement and investment earnings are recognized as they are earned. Exchange services revenue is included in other revenues in the Consolidated Statements of Income.
The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, short-term investments, premium and fees receivable, accrued interest and dividends, accounts payable, commissions payable, reinsurance payable and current income taxes recoverable/payable approximate fair value due to the short-term nature of these assets and liabilities. Estimated fair values for the majority of investment securities are based on quoted market prices. Refer to Note 3 for further information regarding investments in securities and fair value.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains/losses on available-for-sale securities, net of tax, and unrecognized prior service cost and unrealized gains/losses associated with postretirement benefit liabilities, net of tax. Accumulated other comprehensive income as of December 31, 2017 consists of $16,002,382 of unrealized holding gains on available-for-sale securities and $57,556 of unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2016 consists of $11,870,647 of unrealized holding gains on available-for-sale securities and $109,200 of unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2015 consists of $11,597,741 of unrealized holding gains on available-for-sale securities and $114,726 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities.
The Company’s other intangible assets consist of non-compete agreements, referral relationships and a tradename resulting from agency acquisitions; all of which are recorded at the acquisition date fair value. The fair value of the Company’s other intangible assets is principally based on values obtained from a third party valuation service. These assets are amortized on a straight-line basis over their useful lives, which range from 1 to 30 years; noting that the amortization of certain non-compete contracts will start at a future date when the related employment agreements are terminated. Other intangible assets are reviewed for impairment at least annually or when events or changes in circumstances indicate the carrying value may not be recoverable.
In February 2018, the FASB issued Accounting Standards Update ("ASU") 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 is intended to help organizations reclassify certain stranded income tax effects in accumulated other comprehensive income resulting from the Tax Cuts and Jobs Act (“TCJA”). Under the ASU, entities will have the option to reclassify tax effects within other comprehensive income to retained earnings in each period in which the effect of the change in the federal corporate tax rate under the TCJA is recorded. The update is effective for annual periods beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted upon issuance of the standard, and the Company expects to adopt the standard during 2018. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). This update removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, under the ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, the ASU clarifies that an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The update is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. None of these amendments is expected to have a material impact on the Company's financial position or results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). ASU 2016-13 is 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 update broadens the information that an entity must consider in developing its expected credit loss estimates, and is meant to better reflect an entity’s current estimate of all expected credit losses. In addition, this update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The update is effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact. Currently, the Company's potential credit losses under this accounting standard relate to available-for-sale securities. The Company does not believe that the risk of credit losses, based on current available-for-sale security holdings, is material to the Company's financial statements as a whole. Please refer to Note 3 for further information about the Company's investments.
Combined capital and surplus on a statutory basis was $171,896,522 and $152,700,227 as of December 31, 2017 and 2016, respectively. Net income on a statutory basis was $18,766,527, $17,863,815 and $13,621,174 for the twelve months ended December 31, 2017, 2016 and 2015, respectively.
Bonds totaling approximately $7,119,000 and $6,843,000 at December 31, 2017 and 2016, respectively, are deposited with the insurance departments of the states in which business is conducted.
The aggregate estimated fair value, gross unrealized holding gains, gross unrealized holding losses, and cost or amortized cost for securities by major security type at December 31 were as follows:
The following table presents the gross unrealized losses on investment securities and the estimated fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position at December 31, 2017 and 2016:
The Company holds investments in variable interest entities (“VIEs”) that are not consolidated in the Company's financial statements as the Company is not the primary beneficiary. These entities are considered VIEs as the equity investors at risk, including the Company, do not have the power over the activities that most significantly impact the economic performance of the entities; this power resides with a third-party general partner or managing member that cannot be removed except for cause. The following table sets forth details about the Company's variable interest investments in VIEs, which are structured either as limited partnerships ("LPs") or limited liability companies ("LLCs"), as of December 31, 2017:
The FASB has established a valuation hierarchy for disclosure of the inputs used to estimated measure fair value of financial assets and liabilities, such as securities. This hierarchy categorizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.
A number of the Company’s investment grade corporate bonds are frequently traded in active markets, and trading prices are consequently available for these securities. However, these securities are classified as Level 2 because the pricing service from which the Company has obtained estimated fair values for these instruments uses valuation models that use observable market inputs in addition to trading prices. Substantially all of the input assumptions used in the service’s model are observable in the marketplace or can be derived or supported by observable market data.
The Company uses various financial instruments in the normal course of its business. In the measurement of the estimated fair value of certain financial instruments, other valuation techniques were utilized if quoted market prices were not available. These derived fair value estimates are significantly affected by the assumptions used. Additionally, ASC 820 excludes from its scope certain financial instruments including those related to insurance contracts, pension and other postretirement benefits, and equity method investments.
The carrying amounts and estimated fair values of other financial instruments (see previous table for investments carried at estimated fair value) as of December 31, 2017 and 2016 are presented in the following table:
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $3,000 and $264,000, respectively, for 2017, $17,000 and $141,000, respectively, for 2016 and $34,000 and $215,000, respectively, for 2015. Ceded reinsurance is comprised of excess of loss treaties, which outline the conditions in which the reinsurance company will pay claims and protect against losses over certain agreed amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event that the assuming insurance companies are unable to meet their obligations under these contracts. The Company has not paid or recovered any reinsured losses during the three years ended December 31, 2017.
The Company continually refines its reserve estimates as current loss experience develops and credible data emerges. Movements in the reserve related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data. The 2017 increase in the provision for claims compared with 2016 primarily related to higher levels of favorable loss development in 2016. The 2016 calendar year change in the provision relating to prior years resulted mostly from changes to certain actuarial inputs and favorable development in 2016 versus the prior year related primarily to policy years 2009 through 2015. Due to variances between actual and expected loss payments, loss development is subject to significant variability.
The Company does not recognize claim recoveries until an actual payment has been received by the Company. The Company realized claim recoveries of approximately $570,000, $1,040,000 and $467,000 during 2017, 2016 and 2015, respectively.
There were 4,500 potential shares excluded from the computation of diluted earnings per share in 2017. There were no potential shares excluded from the computation of diluted earnings per share in 2016 and 2015.
In 2017, 4,500 SARs vested with a fair value of $219,315.
At December 31, 2017 and 2016, no valuation allowance was recorded. Based upon the Company’s historical results of operations, the existing financial condition of the Company and management’s assessment of all other available information, management believes that it is more likely than not that the benefit of these deferred income tax assets will be realized.
A reconciliation of income tax as computed for the years ended December 31 at the U.S. federal statutory income tax rate of 35% for 2017, 34.6% for 2016 and 34.4% for 2015, respectively, to income tax expense follows:
In accounting for uncertainty in income taxes, the Company is required to recognize in its financial statements the impact of a tax position if that position is more likely than not of being sustained on an audit, based on the technical merits of the position. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. There were no unrecognized tax benefits or liabilities as of December 31, 2017.
The Company has a 401(k) savings plan. In order to participate in the plan, individuals must have worked at the Company for at least 3 months. In order to be eligible for employer contributions, individuals must be employed for one full year and work at least 1,000 hours annually. The Company makes a 3% Safe Harbor contribution and also has the option annually to make a discretionary profit share contribution. Individuals may elect to make contributions up to the maximum deductible amount as determined by the Internal Revenue Code. Expenses related to the 401(k) plan were approximately $1,577,000, $810,000 and $741,000 for 2017, 2016 and 2015, respectively.
In addition, during the second quarter of 2004, ITIC entered into nonqualified deferred compensation plan agreements with these executives. The amount accrued for all agreements at December 31, 2017 and 2016 was approximately $9,492,000 and $8,487,000, respectively, which includes postretirement compensation and health benefits, and was calculated based on the terms of the contract. Both the 2017 and 2016 accruals are included in the accounts payable and accrued liabilities line item of the Consolidated Balance Sheets. These executive contracts are accounted for on an individual contract basis. On December 24, 2008, the executive contracts were amended effective January 1, 2009 to bring them into compliance with Section 409A of the Internal Revenue Code, and were amended and restated to provide for an annual cash payment to the officers equal to the amounts the Company would have contributed to their accounts under its 401(k) plan if such contributions were not limited by the federal tax laws, less the amount of any contributions that the Company actually makes to their accounts under the Company’s 401(k) plan.
On November 17, 2003, ITIC entered into employment agreements with key executives that provide for the continuation of certain employee benefits upon retirement. The executive employee benefits include health insurance, dental insurance, vision insurance and life insurance. The benefits are unfunded. Estimated future benefit payouts expected to be paid for each of the next five years are $11,789 in 2018, $13,343 in 2019, $14,913 in 2020, $16,501 in 2021, $24,250 in 2022 and $174,283 in the next five years thereafter.
The amounts currently in accumulated other comprehensive income, pre-tax, that will be reclassified to the Consolidated Statements of Income and recognized as components of net periodic benefit costs in 2018 are:
Assumed health care cost trend rates do have an effect on the amounts reported for the postretirement benefit obligations. The following illustrates the effects on the net periodic postretirement benefit cost (“NPPBC”) and the accumulated postretirement benefit obligation (“APBO”) of a one percentage point increase and one percentage point decrease in the assumed health care cost trend rate as of December 31, 2017:
Legal Proceedings. The Company and its subsidiaries are involved in legal proceedings that are incidental to their business. In the Company’s opinion, based on the present status of these proceedings, any potential liability of the Company or its subsidiaries with respect to these legal proceedings, will not, in the aggregate, be material to the Company’s consolidated financial condition or operations.
Escrow and Trust Deposits. As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $20,880,000 and $18,032,000 as of December 31, 2017 and 2016, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
If any person or group of affiliated or associated persons acquires beneficial ownership of 15% or more of the outstanding common stock, each holder of a Right (other than the acquiring person or group) will have the right to buy, at the exercise price, common stock of the Company having a market value of twice the exercise price. If the Company is acquired in a merger or consolidation in which the Company is not the surviving corporation, or the Company engages in a merger or consolidation in which the Company is the surviving corporation and the Company’s common stock is changed or exchanged, or more than 50% of the Company’s assets or earning power is sold or transferred, the Rights entitle a holder (other than the acquiring person or group) to buy, at the exercise price, stock of the acquiring company having a market value equal to twice the exercise price. At any time after a person or group of affiliated or associated persons has acquired beneficial ownership of 15% or more of the outstanding common stock and prior to the acquisition by such person or group of 50% or more of the outstanding common stock, the Company’s Board of Directors may exchange the Rights (other than the Rights owned by such person or group), in whole or in part, at an exchange ratio of one share of the Company’s common stock, or one one-hundredth of a share of Preferred Stock, per Right.
The Company generates a significant amount of title insurance premiums in North Carolina, Texas and South Carolina. In 2017, 2016 and 2015, North Carolina accounted for 38.3%, 35.5% and 32.5% of total title premiums, respectively. In 2017, 2016 and 2015, Texas accounted for 19.1%, 20.0% and 22.5% of total title premiums, respectively. In 2017, 2016 and 2015, South Carolina accounted for 10.3%, 10.1% and 10.1% of total title premiums, respectively.
The fair values of intangible assets recognized as the result of title insurance agency acquisitions, all Level 3 inputs, are principally based on values obtained from a third party valuation service. In accordance with ASC 350, Intangibles - Goodwill and Other, management determined that certain events and changes in circumstances occurred during 2017 that indicated a portion of the carrying amount of the Company’s intangible assets may not be recoverable. Therefore, net identifiable intangible assets of $153,667 were impaired during 2017.
Identifiable intangible assets consist of the following as of December 31:
As of December 31, 2017 and 2016, the Company recognized $4,349,851 in goodwill and $690,000 in a title plant, net of impairments, as the result of title agency acquisitions. The fair values of goodwill and the title plant, both Level 3 inputs, are principally based on values obtained from a third party valuation service. In accordance with ASC 350, Intangibles - Goodwill and Other, management determined that certain events and changes in circumstances occurred during 2017 that indicated a portion of the carrying amount of the Company’s goodwill may not be recoverable. Therefore, goodwill of $29,000 was impaired during 2017.
The following tables provide significant amounts reclassified out of each component of accumulated other comprehensive income for the periods ended December 31, 2017, 2016 and 2015: