The Company conducts its business operations primarily in leased office space. Lawyers Title leases approximately 83,300 square feet of office space for its corporate headquarters in Richmond, Virginia. This lease expires on September 30, 2000. At December 31, 1997, the Company has numerous other leases for its branch offices and subsidiaries throughout the states in which it operates. In addition, it owns several properties which in aggregate are not material to its business taken as a whole.
the public records. They contain material dating back a number of years and are kept current on a daily or other frequent basis by the addition of copies of documents filed of record which affect real property. The Company maintains title plants covering many of the areas in which it operates, although certain offices utilize jointly owned and maintained plants. The Company capitalizes only the initial cost of title plants. The cost of maintaining such plants is charged to expense as incurred.
The title plants and title examination procedures have been automated and computerized to a large extent in many areas. To protect against casualty loss, the Company's offices maintain duplicate files and backups of all title plants.
On February 23, 1998, the Company entered into an Agreement Containing Consent Order (the "Consent Order") with the Federal Trade Commission (the "FTC"). The Consent Order requires that the Company divest, within six months from the date of the Consent Order, either the rights, title and interest held by the Company prior to consummation of the Acquisition or the rights, title and interest held by Reliance prior to consummation of the Acquisition of all title plants serving each of 12 localities named in the Consent Order. Seven of such localities are in Florida, three are in Michigan, and one each is in Washington, D.C., and St. Louis, Missouri. The Consent Order further requires that the Company divest all user or access agreements pertaining to each divested title plant. In addition, the Company cannot acquire, without prior notice to the FTC, any interest in a title plant in any of the named localities for a period of 10 years following the date of the Consent Order. The Company believes that the divestitures will not result in a material loss nor will such divestitures have a material effect on future operations due to the Company's access to other title plants in these markets.
On February 25, 1993, the Company's Board of Directors declared a three-for-two split of its Common Stock to all shareholders of record on April 15, 1993. Accordingly, all common share, per common share and stock option data have been restated to reflect the stock split.
The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. For further discussion of earnings per share and the impact of Statement No. 128, see the Notes to the Consolidated Financial Statements beginning on page.
Premiums and related fees are determined both by competition and by state regulation. Operating revenues from direct title operations are recognized at the time real estate transactions close, which is generally 60 to 90 days after the opening of a title order. Operating revenues from agents are recognized when the issuance of a policy is reported to the Company by an agent. Although agents generally report the issuance of policies on a monthly basis, heightened levels of real estate activity may slow this reporting process. This typically results in delays of 30 to 60 days from the closing of real estate transactions until the recognition of revenues from agents. As a result, there can be a significant lag between changes in general real estate activity and their impact on the Company's revenues.
In addition to the premiums and related fees, the Company earns investment income from its portfolio of fixed-maturity and equity securities. Investment income includes dividends and interest as well as realized capital gains or losses on the portfolio. The Company regularly reexamines its portfolio strategies in light of changing earnings or tax situations. In the fourth quarter of 1996 the Company shifted its investment strategy, eliminating its investment in equity securities and beginning to move the majority of its investment portfolio into fixed-maturity securities. The repositioning of the portfolio eliminated the exposure of the regulated surplus of the Company's insurance subsidiaries to market fluctuations inherent in equity portfolios. Additionally, the commensurate increase in fixed-maturity securities increased the level of more stable, predictable interest income earned.
The Company's principal variable expense is commissions paid to independent agents. The Company regularly reviews the profitability of its agency revenues, adjusting commission levels or cancelling certain agents where profitability objectives are not being met and expanding operations where acceptable levels of profitability are available. The Company continually monitors its expense ratio (net of interest and goodwill), which is the sum of salaries and employee benefits, agency commissions and other expenses expressed as a percentage of operating revenues.
Generally, title insurance claim rates are lower than for other types of insurance because title insurance policies insure against prior events affecting the quality of real estate titles, rather than against unforeseen, and therefore less predictable, future events. A provision is made for estimated future claim payments at the time revenue is recognized. Both the Company's experience and industry data indicate that claims activity continues through 20 years after the policy is issued. Management uses actuarial techniques to estimate future claims by analyzing past claim payment patterns. Management has continued to emphasize and strengthen claims prevention and product quality programs.
In the fourth quarter of 1996 the Company made a change from reporting policy and contract claims on a discounted to an undiscounted basis. This change was made to conform with industry practice and because it is considered preferable by rating agencies and investment analysts. The effect of the change for 1996 was to increase the provision for policy and contract claims by $76.0 million and decrease net income by $49.0 million and net income per share by $5.51 and net income per share assuming dilution by $5.38.
In addition, during the fourth quarter of 1996 the Company changed its estimate of the ultimate net cost of all reported and unreported losses incurred through September 30, 1996 to reflect favorable experience. Under the Company's reserving methodology, the provision for losses on policies issued in each year is based on historical experience determined over a period of years. As a result, the very high incidence of losses on policies issued in the 1980's had the effect of pushing up the rate at which losses were provided in the 1990's. The early 1990's were also affected by a high volume of residential refinance business which time has proven is experiencing a lower incidence of losses. The Company began to see favorable development indications on the 1991-1994 policy years as those years began to develop some meaningful experience, i.e., 3-4 years. However, because title losses are paid over a long period of time and experience has shown that significant losses can be reported and paid more than 20 years out, the Company chose to proceed cautiously with respect to projecting its favorable experience over these early years to the projected ultimate losses for the subject policy years. The Company monitored development of these years very closely through 1995 and the first three quarters of 1996 and, while indications continued to be favorable for the 1991-1994 policy years, the Company as of September 30, 1996 did not believe that the limited development of those years was sufficient to justify a significant reduction in the projected ultimate losses for those years.
The volume of orders for title insurance opened in the Company's direct operations increased 4.6% in 1997 and 14.2% in 1996 compared to the previous years.
General, Administrative and Other Expenses. The most significant components of other expenses are rent for office space, outside costs of title production, travel, communications and taxes levied by states on premiums. Portions of these expenses vary with the volume of business transacted by the Company.
Cash provided by operating activities was $18.8 million, $33.2 million and $18.3 million for the fiscal years ended December 31, 1997, 1996 and 1995, respectively. In addition to $70.0 million of cash and invested cash on hand and $261.1 million of fixed-maturity securities at December 31, 1997, the Company had no long-term debt and maintained a $237.5 million working credit facility, of which $4.0 million was used at December 31, 1997.
Historically, the Company has not maintained significant levels of debt. Upon closing the Acquisition (as described in Note 16 of the Notes to Consolidated Financial Statements), the Company incurred debt of $200.7 million under the credit facility and issued 2.2 million shares of Series B Preferred Stock. The Company estimates that servicing the debt and preferred stock will require approximately $20.0 million per year, which management expects to be funded largely from increased cash flow from operations resulting from the Acquisition. Additionally, management believes that these cash requirements will be partially offset by approximately $15.0 million of federal income tax benefits related to the tax deductibility of both interest expense, amortization of intangibles and amortization of tax reserve discount. In view of the historical ability of the Company and Commonwealth/Transnation to generate strong, positive cash flows, and the projected strong cash position and relatively conservative capitalization structure of the Company following consummation of the Acquisition, the Company believes that the Company will have sufficient liquidity and adequate capital resources to meet both its short- and long-term capital needs. Further, the Company expects to maintain approximately $30.0 million in unused credit facilities.
Many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or in the year 2000. The potential costs and uncertainties to companies in addressing this issue (the "Year 2000 issue") will depend on a number of factors, including their software and hardware and the nature of their industries. Companies must also coordinate with other entities with which they electronically interact, both domestically and globally, including suppliers, customers, creditors, borrowers and financial service organizations.
In connection with the title insurance industry in general, factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include the following: (i) the costs of producing title evidence are relatively high, whereas premium revenues are subject to regulatory and competitive restraints; (ii) the amount of title insurance business available is influenced by housing starts, housing resales and commercial real estate transactions; (iii) real estate activity levels have historically been cyclical and are influenced by such factors as interest rates and the condition of the overall economy; (iv) the value of the Company's investment portfolio is subject to fluctuation based on similar factors; (v) the title insurance industry may be exposed to substantial claims by large classes of claimants; and (vi) the industry is regulated by state laws that require the maintenance of minimum levels of capital and surplus and that restrict the amount of dividends that may be paid by the Company's insurance subsidiaries without prior regulatory approval.