We lease a three building complex in Glen Allen, Virginia that is currently used for our corporate offices. This property consists of approximately 298,000 square feet of office space and parking facilities. Our subsidiaries conduct their business operations primarily in leased office space in forty states, Puerto Rico, Canada, Mexico Germany and Switzerland. In addition, we own certain properties that, in the aggregate, are not material to our business taken as a whole.
Our title plants constitute a principal asset. Title plants consist of copies of public records, maps, documents, previous reports, and policies indexed to specific properties in an area. The title plants are generally located at the office which serves a particular locality or in “service centers” serving multiple localities in major metropolitan areas. They enable title personnel to examine title matters relating to a specific parcel of real property as reflected in the title plant, and eliminate or reduce the need for a separate search of the public records. They contain material dating back a number of years and are updated (with the exception of certain title plants) through the addition of copies of documents filed of record which affect real property. We maintain title plants covering many of the areas in which we operate, although certain offices utilize title plants jointly owned and maintained with other title insurers. We capitalize 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.
We believe that our properties are maintained in good operating condition and are suitable and adequate for our purposes.
(3) In 2004, we (1) incurred litigation settlement costs of $9.2 million, or $5.9 million after taxes, (2) amended our pension plan effective December 31, 2004 to cease future accruals resulting in a curtailment gain of $4.8 million, or $3.1 million after taxes, (3) recorded exit and termination costs of $6.5 million, or $4.2 million after taxes, and (4) recorded title plant impairments of $5.0 million, or $3.2 million after taxes.
Our long-term goal is to improve our position as one of the largest providers of real estate transaction services. To accomplish this objective, we have expanded our operations through internal growth and selective strategic acquisitions. Our business operations are organized under three primary business segments: Title Operations, Lender Services and Financial Services. Other operating business segments not required to be reported separately are reported in a category called Corporate and Other. Based on changes in the organizational structure and combination of service offerings in the Lender Services segment, we have reclassed our LandAmerica OneStop operation, which provides title and closing services to national lenders, from the Title Operations segment to the Lender Services segment. Amounts from 2004 and 2005 have been reclassified to conform to the 2006 presentation. The Lender Services segment has been reorganized into three primary lines of business: mortgage origination, loan servicing and loan subservicing. Each line of business within the Lender Services segment continues to focus on mortgage lenders and servicers as a distinct customer base. These groupings of our business operations are consistent with the way we view our business results and are consistent with Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information.
Our predominant business operation continues to be our Title Operations segment which accounted for 90.3 percent of our operating revenue in 2006, 90.3 percent of our operating revenue in 2005 and 92.4 percent of our operating revenue in 2004.
Our Title Operations segment is affected by the level of real estate activity and the cost and availability of mortgage funds. The demand for our title insurance products and services is dependent upon, among other things, the volume of residential and commercial real estate transactions, including mortgage refinancing transactions. The volume of these transactions has historically been influenced by factors such as interest rates and the state of the overall economy. For example, when interest rates are increasing or the economy is experiencing a downturn or recession, real estate activity typically declines and we experience lower revenue and profitability. The cyclical nature of our business has caused fluctuations in revenue and profitability in the past and is expected to do so in the future. In addition to cyclicality in our title business, we also experience seasonality. Residential real estate activity is generally slower in the winter, when fewer families buy or sell homes, with increased volumes in the spring and summer. Residential refinancing activity is generally more uniform throughout the seasons, but is subject to interest rate variability. We typically report our lowest revenue in the first quarter, with revenue increasing into the second quarter and through the third quarter. The fourth quarter may be as strong as the third quarter, depending on the level of activity in the commercial real estate market and residential refinancing activity. Due to a downturn in the residential real estate environment in 2006, our results did not follow the typical seasonal patterns with third quarter 2006 results below second quarter 2006 results. See Part I, Item 1, “Cyclicality and Seasonality.”
On September 8, 2006, we completed the merger with Capital Title, which consists of a title insurance underwriter, several title and escrow agency operations, a property appraisal company, a settlement services provider and other related companies. Capital Title services customers primarily in Arizona, California and Nevada in addition to providing lender services on a national basis. Under the terms of the merger, we acquired 100 percent of Capital Title’s common stock for approximately $252.6 million which included direct transaction costs of $3.6 million. We believe that our merger with Capital Title will strengthen our presence in key western states and add scale to the services we provide to our mortgage lending customers.
Our profit margins are affected by several factors, including the volume of real estate transactions, the type of title policies issued, the distribution channel used to issue our policies, the amount of liability insured and the level of cancellations.
Volume is an important determinant of profitability because we, like any other real estate services company, have a significant level of fixed costs arising from personnel, occupancy costs and maintenance of title plants. While we utilize title orders opened as a forward-looking indicator of business volume, our results are impacted during times of rapidly increasing or decreasing volumes since we cannot immediately match our staffing requirements to changes in business volumes.
The type of title policies issued affects our profitability margin. Profit margins from refinancing activity are generally lower than those from buy/sell activity because, in many states, there are premium discounts on refinance transactions.
Cancellations affect profitability because costs incurred both in opening and in processing orders typically are not offset by fees.
Based on the information known to management at this time, it is not possible to predict the outcome of any of the currently pending governmental inquiries and investigations into the title insurance industry’s market, business practices, pricing levels, and other matters, or the market’s response thereto. However, any material change in our business practices, pricing levels, or regulatory environment may have an adverse effect on our business, operating results and financial condition. See Part I, Item 3, “Legal Proceedings.”
The loan servicing business currently realizes approximately 20 percent of its reported revenue through service revenue associated with tracking and reporting of real estate tax payments related to mortgage loans for lending institutions. Our servicing agreements typically call for us to service the mortgage loan until cancellation or sale. The lenders pay for these services at the time they add a loan to their servicing portfolio. We defer a significant portion of the revenue received for these services to account for the life of loan servicing aspects of the contracts. As a result, revenue reported in the financial statements represents the amortization of both current and prior service fees and is not representative of new contract sales levels. Expenses on the other hand are charged to the income statement as incurred and are not deferred. Thus, an understanding of the levels of deferred revenue or new contract cash received in this area is critical to understanding the relative strength of the underlying business related to tax and flood services. The estimated life of loans is reviewed regularly to determine if there have been changes in contract lives and/or changes in the number or timing of prepayments, and adjusted to reflect current trends. In certain instances, we are required to reimburse part of the fees if the lender sells a loan to another party. See further discussion in “Critical Accounting Estimates” below.
During the past three years, we have expanded the scope and scale of businesses included in Corporate and Other through strategic acquisitions. In 2004, we acquired a commercial assessment business and we purchased Buyers Home Warranty Company which has the ability to provide and service home warranty contracts in every state except for Virginia, where its license application is pending, and Buyers Real Estate Services, which offers natural hazard certifications in California and Arizona. In addition, we acquired residential home inspection businesses during 2004, 2005 and 2006.
Commercial revenue was 54.1 percent of operating revenue in Corporate and Other and, as discussed above, tends to be less sensitive to interest rate fluctuations. The full year 2006 continued to benefit from strong levels of commercial activity. Consequently, operating revenue in 2006 increased 19.2 percent over 2005. We believe that the commercial real estate cycle reached its peak in 2006 and will level off in 2007.
During 2006, we announced our plan to relocate and consolidate our corporate offices and shared resource operations. As a result, we wrote down the building and related assets to fair value less cost to sell by approximately $10.3 million.
This discussion and analysis of our financial condition and results of operations is based upon our accompanying Consolidated Financial Statements which have been prepared in accordance with accounting principles generally accepted in the United States. We consider the following accounting estimates to be critical in preparing and understanding such statements. Actual results could differ from these estimates. Significant accounting policies are disclosed in Note 1 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
Provisions for title losses as a percentage of operating revenues from the Title Operations segment were 6.1 percent for 2006, 5.2 percent for 2005, and 4.3 percent for 2004. A change of 1 percent in this percentage would have changed the provision for title losses and pretax earnings by approximately $35.1 million for the year ended December 31, 2006. We review our loss provision rates quarterly and adjust as experience develops or new information becomes known.
We also review the status of our title plants at least annually. As a result of these reviews, we periodically determine that a title plant will no longer be used or has been abandoned at which time we take a charge to earnings. During 2006, we identified several title plants in the Title Operations segment with an aggregate book value of $4.4 million that will not continue to be used or maintained. Accordingly, we recorded an impairment loss of $4.4 million, which is reflected in “Write-off of intangible and other long-lived assets” in Part II, Item 8, “Financial Statements and Supplementary Data.” We anticipate that additional charges in future periods may be taken as state and local courts and municipalities continue to automate their property records and make them available through electronic media.
One significant assumption is the expected long-term rate of return on plan assets. A lower expected return on plan assets increases the amount of pension expense. The use of expected long-term rates of return may result in recognized returns that are greater or less than actual returns in any given year. Over time the expected returns are used to approximate actual long-term returns, which result in a pattern of expense recognition that more closely matches the service lives of typical employees. We use long-term and actual historical returns, current and targeted asset mix and future estimates of long-term investment returns to develop our long-term return for plan assets. Our anticipated rate of return was 8.25 percent as of the 2006 valuation date. Another significant assumption in valuing the pension liability is the discount rate. In general, the liability increases as the discount rate decreases and conversely, the liability decreases as the discount rate increases. The discount rate utilized is based on rates on high quality fixed income debt instruments available at the end of each valuation period. We utilized a discount rate of 5.75 in determining our 2006 benefit obligations.
See further information in Note 12 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. We are evaluating the impact of adopting SFAS No. 159 on our financial statements.
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 with earlier application encouraged. We are evaluating the impact of adopting SFAS No. 157 on our financial statements.
In June 2006, FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertain tax positions. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006 with earlier adoption permitted. We do not expect the adoption of adopting FIN 48 will have a material impact on our financial statements.
A summary of our operating revenue for the years ended December 31, 2006, 2005 and 2004 is as follows:
Title Operations - Operating revenue from direct title operations increased $4.4 million, or 0.3 percent, in 2006 over 2005. Capital Title contributed approximately $66.9 million to operating revenue from direct operations for 2006. Direct operating revenue during 2006 was impacted by the decline in volume from residential operations offset, in part, by strong commercial revenues. Title insurance revenue from commercial operations, was $425.0 million for 2006, an increase of 11.2 percent over 2005.
Closed orders from direct title operations were 861,000 in 2005 with an average fee per closed order (which includes title insurance premiums and other revenue related to completed transactions by direct operations) of approximately $1,800, compared to 835,000 in 2004 with an average fee per closed order of approximately $1,600. Closed orders from acquired companies were approximately 28,000 in 2005. Before the impact of acquisitions, the decrease in the number of title policies issued by our direct operations in 2005 was due to lower refinance transactions as compared to 2004. The reduction in refinancing transactions shifted the mix of business toward fewer refinancing title polices, that tend to have lower premiums per policy, and more purchase title policies that tend to have higher premiums per policy. In addition, the increase in commercial activity and increases in home prices also served to increase the average fee per closed order in 2005.
Investment and other income was $123.6 million in 2006, $101.8 million in 2005 and $83.2 million in 2004. Investment and other income increased $21.8 million, or 21.4 percent, in 2006 compared to 2005. The Financial Services segment generated $11.4 million of additional investment income during 2006 compared to 2005, which was due to higher balances in the portfolio of loans receivable and investments and a modest increase in interest rates. The remaining increase in investment and other income was due to increased yields and higher invested balances in our remaining investment portfolio. Investment and other income increased $18.6 million, or 22.4 percent, in 2005 compared to 2004. The Financial Services segment generated $8.6 million of additional investment income during 2005 compared to 2004, which was due to higher balances in the portfolio of loans receivable and investments and higher returns. The remaining increase in investment and other income was due to increased yields and higher invested balances in our remaining investment portfolio.
Net realized investment gains totaled $7.1 million in 2006, $4.2 million in 2005 and $5.8 million in 2004. The increase in net realized investment gains from 2005 to 2006 was primarily due to the repositioning of our REIT portfolio. Net realized investment gains in 2006 included a realized loss of $2.9 million related to the impairment of certain securities. See Note 3 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.” The decrease in net realized investment gains from 2004 to 2005 was primarily due to higher interest rates and repositioning of our investment portfolio toward equity securities and responding to market changes.
Title Operations - Our Title Operations segment accounted for approximately 83.8 percent of our total salaries and other personnel expenses in 2006. In particular, the direct operations portion of the Title Operations segment is labor intensive and, as a result, salaries and employee benefits are a significant component of variable expense for this segment. We manage personnel expenses to reflect changes in the level of activity in the real estate market. As a result, our employee base expands and contracts over time. In order to manage personnel costs more effectively throughout the real estate cycle, we use temporary or part time employees where appropriate to staff operations so that we can respond promptly to changes in real estate activity. We continuously monitor personnel levels in connection with changes in real estate transaction volumes. Depending on the speed and severity of change in real estate activity, we may not be able, in the short run, to match decreasing levels of title orders with reduced staffing levels. As a result, in periods of declining activity, personnel costs as a percentage of revenue, may increase.
Salaries and employee benefit expenses in the Title Operations segment increased $44.5 million, or 4.7 percent, in 2006 over 2005. Before the impact of the Capital Title merger, salary and employee benefit costs declined by $2.3 million, or 0.2 percent, in 2006 primarily due to reduced staffing levels in response to lower business volume. Average full time equivalent (“FTE”) counts increased to 10,853 in 2006 from 10,778 in 2005, an increase of 0.7 percent (a decrease of 4.2 percent before Capital Title).
Salaries and employee benefit expenses in the Title Operations segment increased $120.2 million, or 14.6 percent, in 2005 over 2004. Before the impact of acquisitions, salary and employee benefit expenses increased by $95.4 million, or 11.6 percent, in 2005 primarily due to compensation increases associated with the increase in operating revenue and increased staffing as a result of higher commercial and buy/sell activity, which is more labor intensive than refinance activity. FTE counts increased to 10,778 in 2005 from 9,956 in 2004, an increase of 8.3 percent (4.3 percent before acquisitions). The increase in FTEs was as a result of increased buy/sell and commercial transactions year over year which tend to be more labor intensive than refinance transactions.
Financial Services - Salary and employee benefit expenses for the Financial Services segment were essentially flat from 2005 to 2006 and from 2004 to 2005.
The provision for title policy and contract claims includes an estimate of known and anticipated claims. The estimate for anticipated claims that are incurred but not yet reported is established at the time premium revenue is recognized based on reported claims, historical loss experience and other factors, including industry trends. Provisions for title losses as a percentage of operating revenues from the Title Operations segment were 6.1 percent for 2006, 5.2 percent for 2005, and 4.3 percent for 2004. The increase in the loss percentage in 2006 compared to 2005 reflects increases in claims primarily in the 2003 and 2004 policy years. The loss percentage increase in 2005 compared to the loss percentage in 2004 reflects a higher estimated loss rate for the 2005 policy year and the negative impact of two large claims totaling approximately $15.6 million, partially offset by a favorable adjustment to prior year loss reserves. In 2004, the loss percentage reflected lower than expected payment levels on policies issued in prior years that included a high proportion of refinance business. We review our loss provision rates quarterly and adjust the rates as experience develops or new information becomes known.
In 2005, we wrote off a portion of the customer relationship intangible related to the acquisition of our tax and flood business in 2003 and a non-solicitation intangible related to one of our title acquisitions. For further details, see Note 13, “Impairment and Exit and Termination Charges” in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
Insurers are generally not subject to state income or franchise taxes. They are, however, subject to a “premium tax” on certain operating revenue, depending on the state. Tax rates and the amounts that are subject to tax vary from state to state. Premium taxes as a percentage of operating revenue from the Title Operations segment remained relatively constant during the last three years. This percentage was 1.2 percent for 2006 and 2005 and 1.3 percent for 2004.
Title Operations - General and administrative expenses for the Title Operations segment increased by $28.6 million or 6.0 percent in 2006 compared to 2005. Incremental costs from Capital Title contributed $26.2 million of the increase in 2006. The reductions to Capital Title’s overhead costs in response to softening market conditions did not have a significant effect on 2006 costs.
General and administrative expenses for the Title Operations segment increased by $73.6 million or 18.4 percent in 2005 as compared to 2004. Incremental costs from acquisitions completed during 2005 and 2004 contributed $8.5 million of the increase in 2005. Before the impact of these acquisitions, the increase in general and administrative expenses for 2005 was due to increased order volume and increased legal costs of $26.1 million. The increased legal costs included previously announced charges for legal reserves for regulatory matters of $12.3 million.
Lender Services - General and administrative expenses for the Lender Services segment increased $8.0 million, or 7.1 percent, in 2006 from 2005 and $15.0 million, or 15.2 percent in 2005 from 2004. Before the impact of acquisitions, general and administrative expenses decreased 4.0 percent in 2006 over 2005 as a result of lower volumes in the mortgage origination business and decreased 6.8 percent in 2005 over 2004 as a result of lower business volumes.
Financial Services - General and administrative expenses for the Financial Services segment increased by $0.2 million in 2006 from 2005 and decreased by $0.4 million in 2005 from 2004.
Lender Services - The Lender Services segment had pretax income of $26.4 million in 2006, $8.3 million in 2005 and $16.4 million in 2004. Before acquisitions, the increase in pretax income from 2005 to 2006 was due to a gain realized from the sale of a joint venture of $4.5 million, combined with cost reductions in response to lower volumes in the mortgage originations business. Pretax earnings in 2005 reflect the write-off of a portion of the customer relationship intangible of $39.1 million related to the acquisition of our tax and flood business partially offset by the acceleration of $33.8 million in deferred revenue. Pretax income in 2004 was impacted by acquisitions made in the third and fourth quarters of 2003.
Corporate and Other - The Corporate and Other segment reported pretax losses of $(116.6) million in 2006, $(87.4) million in 2005 and $(92.1) million in 2004. The Corporate and Other segment includes unallocated corporate expenses and our home warranty, residential inspection, and commercial appraisal and assessment businesses. The increase in pretax losses from 2005 to 2006 was due in part to the write-down of the corporate offices building of $10.3 million, relocation and related exit cost of our corporate offices of $5.2 million, higher interest expense related to the merger with Capital Title and increases in personnel costs from investments in technology resources. The decrease in pretax losses from 2004 to 2005 was primarily due to the impact of acquisitions completed during 2005 and 2004.
Our primary uses of funds at our holding company level include payment of general operating expenses, payment of principal, interest and other expenses related to holding company debt, payment of dividends on our common stock and share repurchases. At December 31, 2006, there was approximately $165.5 million of cash, short-term investments and marketable securities at the holding company level available for general corporate purposes and to pay dividends to our shareholders.
Our operating results and cash flows are heavily dependent on the real estate market, particularly in the Title Operations segment. While we have continued to diversify our products and services portfolio over the last several years, a significant downturn in the real estate market would adversely impact our cash flows. Our business is labor intensive. Changes to the real estate market are monitored closely, and staffing levels are adjusted accordingly. There is typically a lag between changes in the real estate market and changes in personnel levels resulting in higher personnel costs in periods where the real estate market declines in advance of headcount reductions. The Lender Services segment provides real estate tax payment and flood certification services for the life of loans for which we receive cash at loan closing. This revenue related to the long-term servicing is deferred and amortized over the life of the loan. As a result, our cash flows in the Lender Services segment are greater than reported earnings. Revenue, cash receipts and loans in our Financial Services segment are dependent on the ability of the bank to attract deposits and qualified commercial customers. We believe that our product diversification efforts along with our management of operating expenses and significant working capital position will aid our ability to manage cash resources through declines in the real estate market.
We do not match maturities of our investments with anticipated claims payments, which may result in our having periods in which cash flows from operations are positively or negatively impacted by the difference between the liability for claims being established and the actual payment stream. As opposed to insurance companies where claims account for a substantial portion of premiums, our title insurance claims typically average approximately 4 percent to 6 percent of title insurance operating revenue. Additionally, the time period in which we are liable for a claim is long, with potential claims being paid over 20 years after a title policy is issued and the timing of claims payments may vary from period to period. Over the past several years, exclusive of our operating cash flows, our investment income returns plus maturities of fixed obligation securities have resulted in a maturity and investment income to claims payment ratio in excess of two times.
We used the proceeds from the sale of the Series D Notes to pay our 7.16 percent Senior Notes, Series A that matured on August 31, 2006. The proceeds from the sale of the Series E Notes were used to pay a portion of the Capital Title merger consideration. (See Note 2, “Acquisitions” in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”)
On July 28, 2006, we entered into a new five year credit agreement with SunTrust Bank, as administrative agent for a syndicate of other banks, issuing bank and swingline lender. The new credit agreement replaced our previous five-year revolving credit arrangement entered into as of November 6, 2003. The credit agreement established a credit facility in the aggregate principal amount of up to $200.0 million. As of December 31, 2006, there were $100.0 million of borrowings outstanding under the credit agreement which was used to fund a portion of the Capital Title merger consideration. We anticipate repaying the outstanding borrowings by the end of March 2007.
In 2004 and 2003, we issued Convertible Senior Debentures totaling $125.0 million and $115.0 million, respectively. These Debentures are convertible only upon the occurrence of certain events. In February 2005, we made an irrevocable election under the terms of our 2003 Debentures to satisfy in cash 100 percent of the principal amount of the 2003 Debentures converted after February 15, 2005. Prior to the election, we had the ability to make payment upon conversion for the principal amount of the 2003 Debentures in cash or shares of our common stock.
During the first three quarters of 2004, we repurchased 1.25 million shares under a stock repurchase program authorized by the Board of Directors. As a result, in December 2004, the Board of Directors approved a program expiring February 2006 that authorized us to repurchase up to 1 million additional shares at a cost not to exceed $60.0 million. During the fourth quarter 2005, we fully executed the share repurchase program approved in December 2004. In October 2005, the Board of Directors approved a program expiring July 2007 that authorized us to repurchase an additional 1.25 million shares. As of December 31, 2006, we had repurchased 681,000 shares for $44.1 million under the current repurchase program and there are approximately 569,000 shares remaining at December 31, 2006.
Centennial maintains an allowance for loan losses related to our loans receivable. During 2006, we did not experience a significant change in the underlying components of the allowance for loan losses or the balance in total. There have been no significant changes in the underlying rationale for our provision for loan losses or significant changes in asset quality.
We administer escrow and trust deposits as a service to our customers. These deposits totaled $3,747.3 million and $3,102.4 million at December 31, 2006 and 2005, respectively. Our escrow and trust deposits are not considered assets and are not included in the accompanying balance sheets. However, we remain contingently liable for the disposition of these deposits. We have begun depositing a portion of these escrow and trust deposits in Centennial. Of the $3,747.3 million in escrow, we have deposited $288.5 million in Centennial and those assets and liabilities have been reflected in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
In the ordinary course of business, we enter into business arrangements that fall within the scope of FIN No. 45, Guarantors Accounting and Disclosure Requirements Including Guarantees of Indebtedness of Others, and FIN No. 46, Variable Interest Entities, both of which we adopted in 2003. There were no arrangements in these categories that are reasonably likely to have a material impact on our current or future operations, financial condition or results of operations. Required disclosures are in Notes 14 and 15 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
Our policy and contract claims loss reserve projected annual payments as of December 31, 2006 were as follows:
We maintain an Executive Voluntary Deferral Plan and an Outside Directors Deferral Plan. The Executive Voluntary Deferral Plan allows executives to defer eligible compensation into deferred stock units or a cash account bearing interest at a fixed rate of return. The Outside Directors Deferral Plan allows directors to defer eligible compensation into deferred stock units bearing interest at a fixed rate of return. We funded the purchase of 66,371 shares of common stock related to these plans in 2006. The shares are held in a trust to be used for payments to participants under the plans. The trustee held 288,220 shares at December 31, 2006. Further information on these plans can be found in Note 11 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data.”
As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Capital Title Group, Inc. acquired by LandAmerica Financial Group, Inc. in September 2006, which is included in the 2006 consolidated financial statements of LandAmerica Financial Group, Inc. and constituted approximately 7 percent of total assets as of December 31, 2006 and 2 percent and 5 percent of total revenues and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of LandAmerica Financial Group, Inc. also did not include an evaluation of the internal control over financial reporting of Capital Title Group, Inc.
In our opinion, management’s assessment that LandAmerica Financial Group, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, LandAmerica Financial Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on COSO criteria.
We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LandAmerica Financial Group, Inc. and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with United States generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Additionally, we provide real estate transaction products and services to national and regional mortgage lenders including mortgage origination, which consists of centralized transaction management services, residential appraisal services, flood zone determinations and consumer mortgage credit reporting; loan servicing, which consists of real estate tax processing services, default management services; and loan subservicing. These businesses are included in the Lender Services segment.
We operate a California industrial bank which makes up the Financial Services segment. The bank’s primary business is the origination and bulk purchase of commercial real estate loans in the Southern California market, and to a lesser degree in the Arizona and Nevada markets.
The preparation of financial statements in conformity with generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
The accompanying consolidated financial statements include the accounts and operations, after intercompany eliminations, of LandAmerica and its subsidiaries. We also consolidate any variable interest entity of which we are the primary beneficiary in accordance with Financial Accounting Standards Board Interpretation Number (“FIN”) 46, Variable Interest Entities. Our investments in non-majority owned partnerships and affiliates that are not variable interest entities are accounted for under the equity method. Certain 2005 and 2004 amounts have been reclassified to conform to the 2006 presentation.
Fixed-maturity and equity security investments are carried at fair value and are classified as available-for-sale. The change in the unrealized appreciation and depreciation is reported as a separate component of shareholders’ equity. The amortized cost of fixed-maturity investments is adjusted for amortization of premiums and accretion of discounts and is included in net investment income.
Investment grade mortgage-backed securities are accounted for on the retrospective method. Non-investment grade mortgage-backed securities are accounted for on the prospective short-term investments method.
Goodwill is tested for recoverability annually on October 1, or sooner if events or changes in circumstances indicate that the carrying amount of our reporting units, including goodwill, may exceed their fair values. Our reporting units are determined in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The fair value of the reporting units is determined using cash flow analysis which projects the future cash flows produced by the reporting units and discounts those cash flows to the present value. The projection of future cash flows is necessarily dependent upon assumptions on the future levels of income as well as business trends, prospects and market and economic conditions. When the fair value is less than the carrying value for the net assets of the reporting unit, including goodwill, an impairment loss may be charged to operations. Based on our annual analysis, no impairment was identified for the years ending December 31, 2006, 2005, and 2004. See Notes 2 and 6 for additional information.
Intangible assets primarily include capitalized customer relationships and non-competition arrangements. These assets were initially recognized and measured at fair value in accordance with SFAS No. 141, Business Combinations. These assets are amortized on a straight-line basis over expected useful lives of 18 months to 10 years. See Notes 2 and 6 for additional information.
Long-lived assets, other than goodwill, are tested for impairment whenever recognized events or changes in circumstances indicate the carrying value of these assets may exceed fair value. If indicators of impairment are present, fair value is calculated using estimated future cash flows expected to be generated from the use of those assets and their eventual disposal. In 2006, 2005 and 2004, we identified certain intangible and long-lived assets that were impaired. See Note 13 for additional information.
Title insurance reserve estimates are subject to a significant degree of inherent variability due to the length of time over which claim payments are made and the effects of external factors, such as general economic conditions. Although we believe that the reserve for policy and contract claims is reasonable, it is possible that our actual incurred policy and contract claims will not conform to the assumptions inherent in the determination of these reserves. Accordingly, the ultimate settlement of policy and contract claims may vary significantly from the estimates included in our financial statements. We believe that the reserves for losses and loss adjustment expenses are our best estimate of the future costs to settle claims at December 31, 2006. The estimates are continually reviewed and adjusted as experience develops or new information becomes known; such adjustments are included in current operations.
As a service to our customers, we administer escrow and trust deposits which represent undisbursed amounts received for settlements of real estate transactions. These escrow and trust deposits totaled approximately $3,747.3 million at December 31, 2006 and $3,102.4 million at December 31, 2005. Escrow funds held on deposit at Centennial and included in the accompanying consolidated balance sheet were $288.5 million at December 31, 2006 and $200.0 million at December 31, 2005. The remaining balance in escrow funds of $3,458.8 million at December 31, 2006 and $2,902.4 million at December 31, 2005 are not considered assets of LandAmerica and, therefore, are excluded from the accompanying consolidated balance sheets.
Fees for property tax information services are received in advance for the entire period that a loan will be serviced. Revenue is recognized for property tax information services on a straight-line basis over the anticipated life of the loan. The amount not recognized as revenue in the financial statements in the period received is reported
Revenue is recognized on other Lender Services products at the time of delivery, as we have no significant ongoing obligation after delivery.
Fees for home warranty revenue are received in advance for the entire period the contract is in force and revenue is recognized over the term of the contract. The amount not recognized as revenue in the financial statements in the period received is reported in the accompanying balance sheet as deferred service arrangements. Revenue is recognized on other products in this group of businesses at the time of delivery, as we have no significant ongoing obligations after delivery.
The following pro forma information shows net income and earnings per basic and diluted share if compensation expense for our employee stock options had been determined based on the fair value method of accounting:
The following table sets forth the computation of basic and diluted earnings per share for the years ended December 31:
On September 8, 2006, we completed the merger with Capital Title Group, Inc. (“Capital Title”) whereby Capital Title became a wholly-owned subsidiary of LandAmerica. Capital Title consists of a title insurance underwriter, several title and escrow agency operations, a property appraisal company, a settlement services provider and other related companies. Capital Title services customers primarily in Arizona, California and Nevada in addition to providing lender services on a national basis. We believe that our merger with Capital Title will strengthen our presence in key western states and add scale to the services we provide to our mortgage lending customers.
The merger was accounted for using the purchase method in accordance with FASB SFAS No. 141, Business Combinations (“SFAS No. 141”). Under the terms of the merger, we acquired 100 percent of Capital Title’s common stock for approximately $252.6 million which consisted of $202.9 million of cash, including direct transaction costs of $3.6 million, and $49.7 million of our common stock, which represented 775,576 shares. In recording the merger, the value of the 775,576 shares issued was determined based on the measurement criteria in EITF 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination.
Excluding the Capital Title merger described above, the following table summarizes the number of acquisitions by segment:
The amortized cost and estimated fair value of fixed-maturity securities at December 31, 2006, by contractual maturity are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.
Realized and unrealized gains (losses) representing the change in fair value and cost on fixed maturities and equity securities for the three years ended December 31, are summarized below:
Gross unrealized gains and (losses) relating to investments in equity securities were $20.3 million and $(1.8) million at December 31, 2006 and $10.7 million and $(2.9) million at December 31, 2005.
In 2006, net realized gains on fixed maturities included an other-than-temporary impairment of $2.9 million. See below for further discussion. Gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows:
At December 31, 2005, we held 835 securities which were in an unrealized loss position with a total estimated fair value of $540.6 million and gross unrealized losses of $11.6 million. Of the 835 securities, 124 had been in a continuous unrealized loss position for greater than one year and had a total estimated fair value of $120.7 million and gross unrealized losses of $3.6 million. The 124 securities with unrealized losses in excess of twelve months were investment grade long-term bonds and we had the intent and the ability to hold those securities to recovery.
At December 31, 2006, we did not hold any fixed maturity securities in any single issuer which exceeded 10 percent of shareholders’ equity other than securities issued or guaranteed by the U.S. government.
The average yield on our loan portfolio was 6.9 percent for the year ended December 31, 2006 and 6.5 percent for the year ended December 31, 2005. Average yields are affected by amortization of discounts on loans, prepayment penalties recorded as income, amortization of loan fees and market interest rates.
The allowance for loan losses is maintained at a level that we consider appropriate to provide for risks in the portfolio.
The following table presents details of our intangible assets that are subject to amortization as of December 31, 2006 and December 31, 2005:
The estimated future amortization expense of intangible assets for the next five years is $24.3 million in 2007, $23.4 million in 2008, $22.1 million in 2009, $18.8 million in 2010 and $16.0 million in 2011.
Interest bearing passbook accounts were $107.5 million at December 31, 2006 and $88.4 million at December 31, 2005. Non interest bearing passbook accounts related to escrow balances were $288.5 million at December 31, 2006 and $200.0 million at December 31, 2005.
Our recorded liability for claim losses at December 31, 2006 includes reserves for known claims of $146.0 million and reserves for losses that have been incurred but have not yet been reported of $643.1 million. Reserves for known claims include the estimated amount of the claim and the costs required to settle the claim. A provision for estimated claims that are incurred but not yet reported is established at the time premium revenue is recognized based on reported claims, historical loss experience and other factors, including industry trends.
As a result of an audit of the 2003 to 2004 tax years, the Internal Revenue Service (“IRS”) has proposed certain adjustments relating to our tax treatment of agency revenue. Currently, revenue from title policies issued through independent agents is recognized when the policies are reported by the agent for book and tax purposes. The IRS believes we are required to estimate the income and commissions associated with the sale of policies by agents during the tax year. We have estimated our maximum tax exposure with respect to the matter to be approximately $35 million; however, we are disputing the proposed adjustment as we continue to believe that our tax treatment of these transactions are correct and we believe we will prevail in any dispute with the IRS related to this matter. Accordingly, no amount has been accrued for this proposed IRS adjustment. We expect to defend the matter vigorously through the IRS appeal process and, if necessary, through litigation. We do not expect that the ultimate resolution of this matter will have a material adverse effect on our financial condition or results of operations.
On July 28, 2006, we entered into a Note Purchase and Master Shelf Agreement (the “Note Purchase Agreement”) with Prudential Investment Management, Inc. (“Prudential”) and the other purchasers thereunder. Under the Note Purchase Agreement, we issued $50.0 million of Senior Notes, Series D (the “Series D Notes”) to the Series D Note purchasers on August 31, 2006 and we issued $100.0 million of Senior Notes, Series E (the “Series E Notes”) to the Series E Note purchasers on September 7, 2006. In addition, the Note Purchase Agreement contained provisions for an uncommitted shelf facility for which we may issue, on or prior to July 28, 2009, up to $75.0 million of Senior Notes (the “Shelf Notes”) to Prudential, upon mutually acceptable terms and conditions as may be agreed upon at the time of issuance. The Shelf Notes, if issued, will bear interest at a to-be-determined per annum rate and will have maturities of no more than ten years. At December 31, 2006, there were no borrowings outstanding under the Shelf Notes. The Note Purchase Agreement, which governs the Series D Notes, Series E Notes and Shelf Notes, contains certain restrictive covenants, including a minimum debt to capitalization ratio and debt service ratio. We were in compliance with all debt covenants at December 31, 2006.
We used the proceeds from the sale of the Series D Notes to pay our 7.16 percent Senior Notes, Series A that matured on August 31, 2006. The proceeds from the sale of the Series E Notes were used to pay a portion of the Capital Title merger consideration. (See Note 2, “Acquisitions.”)
Interest paid was $48.5 million in 2006, $30.7 million in 2005 and $23.1 million in 2004.
The Rights will expire on August 20, 2007, and may be redeemed by us at a price of one cent per Right at any time before they become exercisable. Until the Rights become exercisable, they are evidenced by the common stock certificates and are transferred with and only with such certificates.
The total compensation expense for these plans was $16.7 million ($10.7 million, net of tax) in 2006, $8.2 million ($5.1 million, net of tax) in 2005, and $5.7 million ($3.7 million, net of tax) in 2004. As of December 31, 2006, there was $8.3 million of unrecognized compensation cost related to non-vested share-based compensation arrangements under the plan. That cost is expected to be recognized over a weighted-average period of approximately 2 years.
The intrinsic value of awards exercised or converted was $9.4 million in 2006, $11.5 million in 2005, and $12.4 million in 2004. The fair value of shares vested was $7.7 million in 2006, $4.0 million in 2005, and $7.3 million in 2004.
All stock options have been granted with an exercise price equal to the fair market value of a share of common stock at the date of grant. All options granted to directors vest ratably over four years and expire ten years from the date of grant; all other options generally vest ratably over four years and expire seven years from the date of grant. There have been no stock options granted since 2002. All outstanding stock options are fully vested as of December 31, 2006 and there is no unrecognized compensation cost remaining. The following schedule summarizes stock option activity for the year ended December 31, 2006:
Prior to July 1, 2002, we provided the Plan Trustee with funds to purchase shares on the open market to use in matching employee contributions. After that date, we have matched employee contributions in cash. The total number of shares purchased and allocated to employees including both company match and employee contributions and cost follows:
Amounts charged to income for our matching contributions were $21.0 million in 2006, $18.8 million in 2005 and $12.8 million in 2004.
In November and December 2003, we issued $115.0 million of 3.125 percent Convertible Senior Debentures due 2033 (the “2003 debentures”) through a private placement. The 2003 debentures are convertible into shares of our common stock at the current conversion rate of 15.1098 shares per $1,000 principal amount of the debentures, which is equivalent to a conversion price of $66.18 per share of common stock. The conversion rate is subject to adjustment upon the occurrence of certain specified events. On February 15, 2005, we made an irrevocable election to satisfy in cash 100 percent of the principal amount of the 2003 debentures converted after that date. The remainder, if any, of our conversion obligation may be satisfied in cash or common stock. We may redeem some or all of the 2003 debentures at any time on or after November 2010. The holders may also require us to repurchase the 2003 debentures for cash or common stock at five designated repurchase dates as defined in the indenture. Holders may convert the 2003 debentures into cash and shares, if any, of our common stock prior to stated maturity, under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after December 31, 2003, and before December 31, 2028, if the last reported sale price of our common stock is greater than or equal to 125 percent of the conversion price for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter; (2) at any time on or after January 1, 2029, if the last reported sale price of our common stock on any date on or after December 31, 2028, is greater than or equal to 125 percent of the conversion price; (3) subject to certain limitations, during the five business day period after any five consecutive trading day period in which the trading price per 2003 debenture for each day of that period was less than 98 percent of the product of the conversion rate and the last reported sale price of our common stock; (4) if we call the 2003 debentures for redemption; (5) upon the occurrence of certain corporate transactions; or (6) if we obtain credit ratings for the 2003 debentures, at any time when the credit ratings assigned to the 2003 debentures are below the specified levels in the indenture. At December 31, 2006 none of the 2003 debentures had been converted or redeemed.
In May 2004, we issued approximately $125.0 million principal amount of 3.25 percent Convertible Senior Debentures due 2034 (the “2004 debentures”) through a private placement. The 2004 debentures are convertible into shares of our common stock at current conversion rate of 18.6148 shares per $1,000 principal amount of the 2004 debentures, which is equivalent to a conversion price of approximately $53.72 per share of common stock. The conversion rate is subject to adjustment upon the occurrence of certain specified events. Upon conversion, we will deliver cash equal to the lesser of the aggregate principal amount of 2004 debentures to be converted and our total conversion obligation and common stock in respect of the remainder, if any, of our conversion obligation. Holders may convert the 2004 debentures into cash and shares, if any, of our common stock prior to stated maturity, under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after June 30, 2004, and before June 30, 2029, if the last reported sale price of our common stock is greater than or equal to 125 percent of the conversion price for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter; (2) at any time on or after July 1, 2029 if the last reported sale price of our common stock on any date on or after June 30, 2029 is greater than or equal to 125 percent of the conversion price; (3) subject to certain limitations, during the five business day period after any five consecutive trading day period in which the trading price per 2004 debenture for each day of that period was less than 98 percent of the product of the conversion rate and the last reported sale price of our common stock; (4) if we call the 2004 debentures for redemption; (5) upon the occurrence of certain corporate transactions; or (6) if we obtain credit ratings for the 2004 debentures, at any time when the credit ratings assigned to the 2004 debentures are below the specified levels in the indenture. At December 31, 2006, none of the debentures had been converted or redeemed.
Concurrently with the sale of the 2004 debentures, we entered into a bond hedge transaction designed to mitigate the potential dilution from the conversion of the 2004 debentures. Under the ten year term of the bond hedge transaction, we may exercise an option to require a counterparty to deliver our shares of common stock at a price approximately equal to the conversion price of the 2004 debentures.
We have elected to display comprehensive income in the statements of shareholders’ equity, net of reclassification adjustments. Reclassification adjustments are made to avoid double counting in comprehensive income items that are displayed as part of net income for a period that also had been displayed as part of other comprehensive income in that period or earlier periods.
A summary of unrealized investment gains (losses) and reclassification adjustments, net of tax, of available-for-sale securities for the years ended December 31, 2006, 2005 and 2004 were as follows:
Accumulated other comprehensive income (loss) at December 31, 2006, 2005 and 2004 was as follows:
Additionally we sponsor a postretirement benefit plan that provides for postretirement health care and life insurance benefits to our employees hired prior to January 1, 2000. We also sponsor non-qualified, unfunded supplemental benefit plans covering key management personnel.
The incremental effects of adopting the provisions of SFAS No. 158 on the December 31, 2006 balance sheet are presented in the following table. The additional minimum pension liability that would have been required prior to the adoption of SFAS No. 158 is included in the balances in the “Prior to Adopting” column of the table. The adoption of SFAS No. 158 had no effect on our Statements of Operations.
AOCI at December 31, 2006 includes $77.8 million ($49.0 million, net of tax) of unrecognized actuarial loss and $0.9 million ($0.5 million, net of tax) of unrecognized prior service cost. AOCI includes an increase (decrease) related to pension and other postretirement benefits, net of taxes, of $4.0 million in 2006, $(4.6) million in 2005, and $2.5 million in 2004.
The measurement date for both the pension and postretirement benefits was September 30, 2006.
Obligations, funded status and net amount recognized for 2006 and 2005 were as follows:
During 2006, a postretirement plan was amended to cap benefits to certain retirees. The accumulated benefit obligation for the cash balance plan is equal to the projected benefit obligation since the plan is frozen. The underfunded status of the plans that is recognized in the 2006 balance sheet is $16.1 million accrued pension liability and $52.2 million accrued postretirement liability in accordance with SFAS No. 158.
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans with an accumulated benefit obligation in excess of plan assets at September 30 were:
Employer contributions to our cash balance plan were $15.0 million in 2006 and $15.0 million in 2005. We do not anticipate making contributions in 2007. We did not make any pre-funding contributions to other benefit plans in 2006 and 2005 nor do we anticipate making any pre-funding contribution amounts in 2007.
During 2006 and 2004, we identified certain title plants in the Title Operations segment operations that will not continue to be used or maintained. Accordingly, we recorded impairment losses of $4.4 million in 2006 and $5.0 million in 2004, which is reflected in “Write-off of intangible and other long-lived assets” in the Consolidated Statements of Operations. There were no material impairment charges related to title plants in 2005.
We conduct a major portion of our operations from leased office facilities under operating leases that generally expire over the next 10 years but are renewable. Additionally, we lease data processing and other equipment under operating leases that generally expire over the next five years but for the most part are renewable.
Rent expense was $109.7 million in 2006, $93.2 million in 2005 and $87.3 million in 2004.
In November 2002, FASB issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements Including Guarantees of Indebtedness of Others (“FIN 45”). We had guarantees of indebtedness of others of approximately $3.4 million at December 31, 2006, and $3.9 million at December 31, 2005.
Although we conduct our business primarily on a national basis through a network of branch and agency offices, approximately 50.0 percent, 52.7 percent and 47.2 percent of consolidated title revenues for the years ended December 31, 2006, 2005 and 2004, respectively, were generated in the states of California, Texas, Florida, New York and Arizona.
We are involved in certain litigation arising in the ordinary course of our businesses. Although the ultimate outcome of these matters cannot be ascertained at this time and the results of legal proceedings cannot be predicted with certainty, we believe, based on current knowledge, that the resolution of these matters will not have a material adverse effect on our financial position or results of operations.
On June 22, 2004, Gateway Title Company, Inc. (“Gateway”), Commonwealth Land Title Company, Inc. and LandAmerica Financial Group, Inc. (collectively, “Plaintiffs”) filed a Complaint, subsequently amended by a First Amended Complaint filed June 25, 2004, in the Superior Court of California, County of Los Angeles, Central District (the “Court”), against the Mercury Company and its affiliates Financial Title, Alliance Title, Investors Title and various individuals including Joseph DiChiacchio, a former manager of LandAmerica (Case No. BC 317441) (collectively, “Defendants”). The lawsuit claims substantial monetary and punitive damages for unfair competitive business practices in conjunction with Plaintiffs’ loss of over 300 employees in California, most of which appears to have occurred within an approximately twenty-four month period. On August 12, 2004, the Court granted a Temporary Restraining Order, followed by a Preliminary Injunction granted September 27, 2004, against Defendants based upon a showing of significant likelihood of Plaintiffs prevailing on the merits combined with irreparable harm to Plaintiffs if injunctive relief did not issue. The injunctive relief generally prohibited the solicitation of Plaintiffs’ employees. The preliminary injunctive relief has now expired. On December 13, 2004, Alliance Title Company, Inc., Financial Title Company, Inc., Roberto Olivera and Ray Arias filed a Cross-Complaint for unfair competitive business practices. On December 13, 2004, Mr. DiChiacchio also filed a Cross-Complaint alleging similar claims, including back wages and additional bonus payments. Plaintiffs are disputing and intend to vigorously defend the Cross-Complaints. A mandatory settlement conference was held on August 1, 2005 and voluntary mediation on September 7, 2005. After completion of discovery, a jury trial began in early May 2006 and resulted in a verdict for Gateway of approximately $8.3 million. Judgment has not been entered pending resolution of the Cross-Complaints currently set for trial on April 16, 2007. We are evaluating whether or not to appeal the verdict and have agreed to engage in voluntary mediation on April 4, 2007 in an effort to resolve all claims. Management believes that the award of damages to Plaintiffs exceeds any claim of offset raised in the Cross-Complaints.
On January 25, 2002, Miles R. Henderson and Patricia A. Henderson (the “Plaintiffs in the Henderson Suit”) filed a putative class action suit (the “Henderson Suit”) against Lawyers Title Insurance Corporation (“Lawyers Title”) in the Court of Common Pleas for Cuyahoga County, Ohio. Lawyers Title removed the case to the District Court for the Northern District of Ohio on March 6, 2002, and the Plaintiffs amended the complaint on March 8, 2002. On June 28, 2002, the District Court remanded the case to the Court of Common Pleas for Cuyahoga County, Ohio. A similar putative class action suit was filed against Commonwealth, by Rodney P. Simon and Tracy L. Simon (the “Plaintiffs in the Simon Suit”) in the Court of Common Pleas for Cuyahoga County, Ohio on March 5, 2003. The Plaintiffs in both suits alleged that the defendants had a practice of charging original rates for owners title insurance policies when lower, reissue rates should have been charged. Both defendants initially responded by demanding that the actions be arbitrated, but on final appeal to the Ohio Supreme Court, the Court ruled that arbitration was not required for either suit. On remand to the trial court, the Plaintiffs in the Henderson Suit are now seeking to have the case certified as a class action on behalf of all sellers and buyers of residential property in Ohio who paid the higher original rate from 1992 to the present. The court has set a hearing date of August 29, 2007. The Plaintiffs in the Simon Suit are seeking to have the case certified as a class action on behalf of all sellers of residential property in Ohio, who paid the original rate from 1993 to the present, as requested in the original complaint, although no hearing date on the class certification has been scheduled. The Plaintiffs in both cases have demanded an unspecified amount of compensatory damages, declaratory and injunctive relief, punitive damages, and attorneys’ fees and costs. These cases are in the early stages, there have been no class certifications, and the defendants believe that they have meritorious defenses. At this stage of the litigation, the amount or range of loss that could result from an unfavorable outcome cannot be reasonably estimated.
In addition, a number of state inquiries have focused on captive reinsurance. Captive reinsurance involves the provision of reinsurance by a reinsurance company that is owned by another entity, typically a lender, developer or other party that is a provider of real estate-related services. From the inception of our captive reinsurance programs in 1997 through 2004, reinsurance premiums paid by us to captive reinsurers totaled approximately $12.0
million. The revenues from these programs were not material to our results of operations. We voluntarily terminated our captive reinsurance arrangements as of February 2005, notwithstanding our belief that we had operated the programs in accordance with applicable law. We settled these investigations with six states, representing approximately 81.4 percent of our captive reinsurance business, without admitting any liability.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States which differ in some respects from statutory accounting practices prescribed or permitted in the preparation of financial statements for submission to insurance regulatory authorities. Combined statutory equity of our insurance subsidiaries was $619.4 million at December 31, 2006 and $505.9 million at December 31, 2005. The difference between statutory equity and equity determined on the basis of accounting principles generally accepted in the United States is primarily due to differences between (1) the provision for policy and contract claims included in the accompanying financial statements and the statutory unearned premium reserve, which is calculated in accordance with statutory requirements, and (2) statutory regulations that preclude the recognition of certain assets and limit the recognition of goodwill and deferred income tax assets. Statutory net income for our insurance subsidiaries was $226.7 million in 2006, $124.4 million in 2005 and $109.9 million in 2004.
Statutory-basis financial statements are prepared in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. These regulatory authorities recognize only statutory accounting practices prescribed or permitted by their individual state for determining and reporting the financial condition and results of operations of an insurance company and for determining their solvency. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures manual (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by each of the states that regulate us. Each of the states have adopted a material prescribed accounting practice that differs from that found in NAIC SAP. Specifically, amounts added to the statutory unearned premium reserve are released more rapidly in the first three years of the
Based on changes in the organizational structure and combination of service offerings in the Lender Services segment, we have reclassified our LandAmerica OneStop operation, which provides title and closing services to national and regional mortgage lenders, from the Title Operations segment to the Lender Services segment. Amounts from 2004 and 2005 have been reclassified to conform to the 2006 presentation.
Lender Services provides services to national and regional mortgage lenders consisting primarily of mortgage origination (e.g. real estate transaction management services, consumer mortgage credit reporting, flood zone determinations, etc.), loan servicing (e.g. real estate tax processing, residential appraisal and valuation services and default management) and loan subservicing.
In 2005, we (1) recorded the recognition of deferred income of $33.8 million, or $20.0 million after taxes, (2) recorded the write-off of intangible and other long-lived assets of $39.1 million, or $23.2 million after taxes, and (3) incurred legal and settlement costs of $22.6 million, or $15.4 million after taxes.
Primarily relates to new acquisitions, whereby the increase in balance was entirely related to the take-on balance sheet of the consolidated subsidiary.