The principal executive offices of the Company are located in the Old Republic Building in Chicago, Illinois. This Company owned building contains 151,000 square feet of floor space of which approximately 50% is occupied by Old Republic, and the remainder is leased to others. In addition to the Company-owned principal executive offices, a subsidiary of the Title Insurance Group partially occupies its headquarters building. This building contains 110,000 square feet of floor space of which approximately 65% is occupied by the Old Republic National Title Insurance Company. The remainder of the building is leased to others. Eleven smaller buildings are owned by Old Republic and its subsidiaries in various parts of the country and are primarily used for its business. The carrying value of all buildings and related land at December 31, 1998 was approximately $18.3 million. Certain other operations of the Company and its subsidiaries are directed from leased premises. See Note 4(b) of the Notes to Consolidated Financial Statements for a summary of all material lease obligations.
(a) Consists of cash, investments and investment income due and accrued. (b) Total capitalization consists of debt and debt equivalents, preferred stock, and common shareholders' equity. (c) In February 1996, the Company called for the redemption of its 10% debentures maturing in 2018 ($75.0 principal amount), and its 5.75% convertible subordinated debentures maturing in 2002 ($110.0 principal amount). In April 1996, the Company called for redemption its 11.5% debentures maturing in 2015 ($30.0 principal amount). Redemption of the debentures was effected with internally available funds, while the subordinated debentures were converted by their terms into approximately 9.6 million Old Republic common shares. The early retirement of the Company's debentures produced a net of tax charge of $4.4 or $.03 per share that has been reflected as an extraordinary item in 1996. (d) Effective in 1997, the Company adopted Financial Accounting Statement (FAS) No. 128 "Earnings Per Share" which establishes a new methodology for computing earnings per share. It replaces Primary Earnings Per Share with Basic Earnings Per Share. Basic Earnings Per Share excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the period. Diluted Earnings Per Share per FAS-128 is computed in a fashion similar to the former Fully Diluted Earnings Per Share as required by prior authoritative FASB pronouncements. Prior year data has been retroactively restated. (e) Calculated after deduction of preferred stock dividend requirements of $.2 in 1998, $1.7 in 1997, $7.5 in 1996, $6.7 in 1995 and $7.0 in 1994. (f) Calculated after deduction of preferred stock dividend requirements and, as applicable, after adjustment for post-tax convertible debentures interest of $4.0 in 1996, $.6 in 1995 and $.9 in 1994.
Old Republic's financial position at December 31, 1998 reflected increases in assets and common shareholders' equity of 1.4% and 7.1%, respectively, and a decrease in liabilities of 1.2% when compared to the immediately preceding year-end. Cash and invested assets represented 70.5% and 69.6% of consolidated assets as of December 31, 1998 and 1997, respectively.
maturities continued to provide sufficient funds to meet obligations to policyholders and claimants, as well as debt service and cash dividend requirements at the holding company level.
Consolidated operations produced positive cash flows for the latest three years. Higher cash flow in 1997 vis-a-vis 1996 and 1998 was due mainly to higher operating cash flow in Old Republic's general insurance segment. The Company's mortgage, title and life segments' cash flow from operations have been greater in each of the last three years.
The parent holding company has met its liquidity and capital needs principally through dividends paid by its subsidiaries. The insurance subsidiaries' ability to pay cash dividends to the parent company is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. Additionally, the terms of guarantees by the Company of bank loans to the trustee of the Company's Employees Savings and Stock Ownership Plan restrict the amount of debt the Company may incur; this covenant is being met.
Consolidated net premiums and fees earned increased by 11.2%, 8.0% and 9.7% in 1998, 1997 and 1996, respectively. Property and liability earned premiums decreased 0.4% in 1998 and increased 4.5% in 1997 and 1.9% in 1996; premium production trends in this segment in the past three years were generally affected by the continuation of a soft pricing environment for most insurance coverages. Growth in mortgage guaranty premiums for the past three years was enhanced principally by a rise in the amount of renewal business, by territorial expansion, and by relatively strong mortgage lending activity, though 1998 premium revenue growth was hindered by higher loan refinancings. Title Group premiums and fee revenues increased 38.9% in 1998, 9.4% in 1997 and 20.3% in 1996. Greater housing and mortgage finance activity were the main reasons for the rise in revenues in these years. Life and disability premium volume increased during the last three years as a result of greater term life and accident insurance production.
Net investment income grew by 0.9%, 3.9% and 3.4% in 1998, 1997 and 1996, respectively. For each of the past three years, this revenue source was affected by positive consolidated operating cash flows and by a concentration of investable assets in interest-bearing, fixed maturity securities. The Company, as previously mentioned, used internal funds in 1998 and 1997 for open market purchases of its common stock and in 1996 to redeem certain debt and preferred stock, thus reducing the size and earning power of its invested asset base. The average annual yield on investments was 5.7%, 5.9% and 6.0% for the years ended December 31, 1998, 1997 and 1996, respectively. This yield pattern reflects at once the relatively short
The effective consolidated income tax rates were 31.2% in 1998, 30.3% in 1997 and 31.6% in 1996. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from tax-exempt investment income, on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand. The lower rate in 1997 was also affected positively by the above noted income tax recoveries for prior years.
The Company and its subsidiaries have been aware for several years of the issues associated with programming codes in existing computer systems as the Year 2000 approaches. Most Old Republic subsidiaries are operated with reasonable autonomy, and, accordingly, Year 2000 issues are independently managed at each of the operating entities. Simply stated, Year 2000 issues stem from computer programs that were written in earlier years with only two digits to specify a year, as opposed to four digits; such programs may therefore be unable to interpret dates beyond 1999, which could cause a system failure or other computer errors that could lead to a disruption of operations.
Old Republic's subsidiaries are scheduled to complete by March 31, 1999, the identification and implementation of changes, and the testing of systems affected by Year 2000 issues. Confirmations of Year 2000 compliance from principal customers, vendors and other important third party relationships are in process of being circulated. While this process is not completed, the Company is not currently aware of any principal customer, vendor, or other important third party whose Year 2000 projects will not be completed in a timely manner.
The costs of identifying, implementing and testing the required changes has not been material to operating results. A significant portion of these costs were not incremental as the Company and its subsidiaries have mostly utilized existing resources.
The Company's subsidiaries have commenced consideration of contingency plans in the event remediation efforts of Year 2000 issues are unsuccessful. Such plans should be more fully developed in 1999, to the extent deemed applicable and practicable.
Any forward-looking commentary or inferences contained in this report involve, of necessity, 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, as well as periodic changes in claim frequency and severity patterns caused by natural disasters, weather conditions, accidents, illnesses and work-related injuries. Mortgage Guaranty and Title insurance results can be affected by such factors as 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 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 disability insurance results can be impacted by the levels of employment and consumer spending, as well as mortality
and health trends. At the holding company level, results are affected mostly by the amount of debt outstanding and its cost.
(b) Accounting Principles-The Corporation's insurance underwriting subsidiaries maintain their records in confor mity with accounting practices prescribed or permitted by state insurance regulatory authorities. In consolidating such subsidiaries, adjustments have been made to conform their accounts with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Bonds and other investments carried at $165.1 as of December 31, 1998 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
upon the substantial completion of the policy issuance process. Title abstract, escrow, service, and other fees are taken into income at the time of closing of the related escrow. Ordinary life and annuity premiums are recognized as revenue when due. Decreasing term credit life and credit disability/accident & health insurance premiums are generally earned on a sum-of-the-years-digits or similar method.
(f) Future Policy Benefits/Unearned Premiums-General insurance and level term credit life insurance policy liabilities represent unearned premium reserves developed by application of monthly pro-rata factors to premiums in force. Disability/accident & health and decreasing term credit life insurance policy liabilities are calculated primarily on a sum-of-the-years-digits method. Mortgage guaranty unearned premium reserves are calculated primarily on a pro-rata basis. Ordinary life policy liabilities are determined on a level premium method and take into account mortality and withdrawal rates based principally on anticipated company experience; assumed interest rates range from 3.0% to 6.0%. With respect to annuity policies, the liabilities represent the surrender value of such policies during deferral periods, without adjustment for surrender charges; such values are deemed appropriate to provide for ultimate benefit reserves in the event policyholders exercise an annuity benefit option at a later date.
- ------------ (1) The Company has entered into an agreement to sell its small annuity book of business; this will have no material effect on Old Republic's consolidated results or financial position.
With respect to mortgage guaranty insurance (net insurance in force of $57,401.1 and $50,362.3, at December 31, 1998 and 1997, respectively) the Company's reserving policies are set forth below in Note 1(g).
All reserves are necessarily based on estimates which are periodically reviewed and evaluated in the light of emerging claim experience and changing circumstances. The resulting changes in estimates are recorded in operations of the periods during which they are made. Return and additional premiums and policyholders dividends, all of which tend to be affected by development of claims in future years, may offset in whole or in part developed claim redundancies or deficiencies for certain coverages such as workers' compensation.
The data in the table above, incorporates Old Republic's estimates for various asbestosis and environmental impairment ("A&E") claims or related costs 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, and during a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. During all years and through the current date, the Corporation's insurance subsidiaries have typically issued general liability insurance policies with face amounts ranging between $1.0 and $2.0 and rarely exceeding $10.0. Such policies have, in turn, been subject to reinsurance cessions which have typically reduced the Corporation's retentions to $.5 or less as to each claim.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to provide for normal claim occurrences as well as unusual exposures such as those pertaining to A&E claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves to cover claims such as those emanating from A&E exposures. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 1998, the Corporation's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to approximately $66.6 gross, and $33.7 net of reinsurance. Based on average annual claims payments during the five most recent calendar years, such reserves represented 8.0 years (gross) and 12.3 years (net) of average annual claims payments.
Life insurance companies domiciled in the United States and qualifying as life insurers for tax purposes are taxed under special provisions of the Internal Revenue Code. As a result of legislation, 1983 and prior years' tax deferred earnings (cumulatively $18.1 at December 31, 1998) credited to the former memorandum "policyholders' surplus account" will generally not be taxed unless they are subsequently distributed to shareholders. The Company does not presently anticipate any distribution or payment of taxes on such earnings in the future.
As a result of regular examinations of the tax returns for the Corporation and its subsidiaries, the Internal Revenue Service ("IRS") has proposed certain adjustments for additional taxes applicable to the years 1983 to 1995. The proposed adjustments pertain to the timing of certain deductions, the IRS's contention that contractually obligated premium refunds should be treated as dividends, deductions for certain loss and related reserves, a reinsurance transaction, and several other issues not involving material amounts. The Company and its tax counsel believe that substantially all of the proposed material adjustments are without merit, that the Company will be successful in vigorously defending its positions, and that the ultimate adjustments, if any, will not significantly affect its financial condition or results of operations.
In 1997, several life insurance subsidiaries recovered income taxes and related accumulated interest due to favorable resolution with the Internal Revenue Services of various outstanding issues pertaining to income tax returns for the years 1979 through 1982. These cash recoveries, net of miscellaneous charges, increased other income by $12.6, reduced income tax expense by $5.9 and increased net income by $14.2.
The Financial Accounting Standards Board (FASB) issued, in January, 1998, Statement of Financial Accounting Standards No. 132 (FAS-132) "Employers' Disclosures About Pensions and Other Postretirement Benefits". FAS-132 revises disclosures about pension and other postretirement benefit plans. The Statement did not change the measurements or recognition of pension or other postretirement costs of the plans.
The Company sponsors a leveraged Employees Savings and Stock Ownership Plan (ESSOP) in which a majority of its employees participate. The ESSOP acquired all of its stock of the Company in 1987 and prior years. Accordingly, it is not required to adopt the American Institute of Certified Public Accountants' SOP No. 93-6, "Employers' Accounting for Employee Stock Ownership Plans." Shares of Company stock owned by the ESSOP are released to participants based on a formula prescribed by the Employee Retirement Income Security Act of 1974, and dividends on released shares are allocated to participants as earnings. The Company's contributions are based on a formula considering growth in net income per share over consecutive five year periods. As of December 31, 1998, there were 7,102,553 Common Shares owned by the ESSOP of which 764,515 were unreleased and unallocated. There are no repurchase obligations in existence. (See Note 2).
(m) 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 ($681.7 and $541.7 at December 31, 1998 and 1997, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(n) Earnings Per Share-In 1997, the Company adopted Statement of Financial Accounting Standard No. 128 "Earnings Per Share" which established a new methodology for computing earnings per share. Consolidated basic earnings per share excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the year. Diluted earnings per share are similarly calculated with the inclusion of common stock equivalents. The following tables provide a reconciliation of the income before extraordinary items and number of shares used in basic and diluted earnings per share calculations.
- ------------ (a) The Company has guaranteed bank loans (balance at December 31, 1998 was $5.1) to a Trust established by the Old Republic Employees Savings and Stock Ownership Plan ("ESSOP"). The loans have been used to fund the purchase of Series D Redeemable Convertible Preferred Stock from the Company by the Trust for the original amount of the loans. All remaining Series D Preferred Stock shares were fully converted into common shares as of August 22, 1997. The Trust's loan principal repayments (currently scheduled at $2.6 in 1999 and $2.5 in 2000) are expected to be met by annual profit sharing contributions by the Corporation and its participating subsidiaries, while interest payments are to be covered by Trust income, including dividends on the Corporation's stock held by the ESSOP. The interest on the Trust's loans is payable quarterly and at rates ranging from 75% to 80% of the prime rate. See Notes 3a and 3c.
- ------------ (1) The Corporation has authorized up to 1,000,000 shares of Series G Convertible Preferred Stock ("Series G") for issuance pursuant to the Corporation's Stock Option Plan. Series G has been issued under two different designations; the most recent designation being Series G-2 (except as otherwise stated, Series G and Series G-2 are collectively referred to as Series G). Each share of Series G pays a floating rate dividend based on the prime rate of interest. At December 31, 1998, the annual dividend rate for Series G was $.82 per share. Each share of Series G is convertible at any time, after being held six months, into 0.95 shares of Common Stock (See 3(d)). Unless previously converted, Series G shares may be redeemed at the Corporation's sole option five years after their issuance.
A summary of the status of the Corporation's stock options as of December 31, 1998, 1997 and 1996, and changes in outstanding options during the years then ended follows:
(e) Common Stock-There were 500,000,000 shares of common stock authorized at December 31, 1998. At the same date, there were 100,000,000 shares of Class "B" common stock authorized but none were issued or outstanding. Class "B" common shares have the same rights as common shares except for being entitled to 1/10th of a vote per share.
(g) Statutory Data-The policyholders' surplus and net income, determined in accordance with statutory accounting practices, of the Corporation's insurance subsidiaries was as follows at the dates and for the periods shown:
The following information relates to reinsurance and related data for the General Insurance, Mortgage Guaranty and Life Insurance Groups for the three years ended December 31, 1998. For the years 1996 to 1998, reinsurance transactions of the Title Insurance Group have not been material.
However, various governmental entities have filed suit against or performed examinations of the records of an underwritten title agency subsidiary operating in the State of California, which is consolidated in these financial statements. These actions allege that 1) the subsidiary failed to escheat unclaimed escrow funds; 2) charged for services not necessarily provided; and 3) collected illegal interest payments or fees from banks on the basis of funds held for escrow customers. Additional suits seeking class action status have been filed on the basis of the same allegations.
Between July 1998, when the Company learned of these actions and February 1999 when a draft examination report was received from a regulatory authority, the subsidiary conducted an internal review of its records and concluded that it had certain liabilities for the issues denoted as (1) and (2) in the preceding paragraph. Through December 31, 1998 it had paid or otherwise provided reserves aggregating $19.5 to cover its best estimate of litigation and related costs associated with these issues. Management believes that the alleged practices denoted in (3) in the preceding paragraph, are common within the industry, are not in conflict with various laws and regulations, and that it has meritorious defenses, which will ultimately lead to a successful resolution of these matters.
In the opinion of management, all adjustments consisting of normal recurring adjustments necessary to a fair presentation 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 is not indicative of results to be achieved in succeeding quarters or years. The long-term nature of the insurance business, seasonal patterns in premium production and incidence 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. The data below should be read in conjunction with the "Management Analysis of Financial Position and Results of Operations":
The General Insurance Group provides property and liability insurance to commercial clients and is the major contributor to consolidated operating income. Old Republic does not have a meaningful participation in personal lines of insurance. Commercial automobile (principally trucking) insurance is the largest type of coverage underwritten by the General Insurance Group accounting for 48.3% of the Group's direct premiums written in 1998. The remaining premiums written by the General Insurance Group are derived largely from a wide variety of coverages, including workers' compensation and general liability insurance, loan credit guaranty insurance, and surety bonds. The General Insurance Group's operations have been expanded, over the years, to insure certain specialty lines such as directors' and officers' liability and errors and omissions liability insurance, to cover owners and operators of private aircraft for hull and liability exposures, and to insure grain elevators and liquid petroleum gas operations.
Real estate mortgage loan insurance produced by the Mortgage Guaranty Group protects lending institutions against certain losses, generally to the extent of 10% to 35% of the sum of the outstanding amount of each insured mortgage loan, and allowable costs incurred in the event of default by the borrower. The Corporation insures only first mortgage loans, primarily on residential properties having one-to-four family dwelling units. Mortgage guaranty insurance premiums originate from savings and loan associations, mortgage bankers and other lending institutions. The Corporation's residential real estate loan insurance business is originated, approximately 16% by savings and loan associations, 69% by mortgage bankers and 15% by other lenders. The Corporation's mortgage guaranty insurance in force at December 31, 1998, was originally produced by approximately 4,100 different lending institutions and about 2,200 such institutions originated business in 1998.
The Life Insurance Group markets and writes consumer credit life and disability insurance primarily through automobile dealers. Old Republic has also written various conventional life and disability/accident and health insurance coverages for many years, principally on a direct marketing basis through banks and other financial services institutions. Old Republic also sells ordinary term life insurance through independent agents and brokers for relatively large face amounts, in both the United States and Canada.