The selected historical consolidated financial data for First American Financial Corporation (the “Company”) as of and for each of the five years in the period ended December 31, 2019, have been derived from the Company’s consolidated financial statements. The selected historical consolidated financial data should be read in conjunction with “Item 8. Financial Statements and Supplementary Data,” “Item 1 - Business,” and “
The consolidated financial statements have been prepared in accordance with GAAP and reflect the consolidated operations of the Company. The consolidated financial statements include the accounts of First American Financial Corporation and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Investments in affiliates in which the Company exercises significant influence, but does not control and is not the primary beneficiary, are accounted for using the equity method. Investments in affiliates in which the Company does not exercise significant influence over the investee and without readily determinable fair values, are accounted for at cost, less impairment and are adjusted up or down for any observable price changes.
The Company’s specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and the District of Columbia and actively issues policies in 47 states. The majority of policy liability is in the western United States, including approximately 59% in California. In certain markets it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems, such as heating and air conditioning systems, and certain appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 36 states and the District of Columbia.
The preparation of financial statements in accordance with GAAP requires the application of accounting policies that often involve a significant degree of judgment. The Company’s management considers the accounting policies described below to be the most dependent on the application of estimates and assumptions in preparing the Company’s consolidated financial statements. See Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements for a more detailed description of the Company’s significant accounting policies.
Provision for policy losses. The Company provides for title insurance losses through a charge to expense when the related premium revenue is recognized. The amount charged to expense is generally determined by applying a rate (the loss provision rate) to total title insurance premiums and escrow fees. The Company’s management estimates the loss provision rate at the beginning of each year and reassesses the rate quarterly to ensure that the resulting incurred but not reported (“IBNR”) loss reserve and known claims reserve included in the Company’s consolidated balance sheets together reflect management’s best estimate of the total costs required to settle all IBNR and known claims. If the ending IBNR reserve is not considered adequate, an adjustment is recorded.
The provision transferred from IBNR title claims related to prior years decreased by $3.9 million, or 2.6%, in 2019 from 2018 and decreased by $33.3 million, or 18.5%, in 2018 from 2017. Payments, net of recoveries, related to prior years decreased by $5.5 million, or 3.6%, in 2019 from 2018 and decreased by $34.1 million, or 18.4%, in 2018 from 2017. Generally, the provision transferred from IBNR title claims and payments are expected to decline with the runoff of older policy years that have higher expected ultimate losses, particularly policy years 2005 through 2008.
For further discussion of title provision recorded in 2019, 2018 and 2017, see Results of Operations, page 38.
Litigation and regulatory contingencies. The Company and its subsidiaries are parties to a number of ongoing routine and non-ordinary course legal proceedings. For those lawsuits where the Company has determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure based on known facts has been recorded. Actual losses may materially differ from the amounts recorded. For a substantial majority of these lawsuits it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. As a result of, among other factors, ambiguities and inconsistencies in the laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements. Furthermore, because most of these lawsuits are putative class actions, it is often impossible to estimate the possible loss or a range of loss, even where the Company has determined that a loss is reasonably possible. In addition, many of the Company’s businesses are regulated by various federal, state, local and foreign governmental agencies and are subject to numerous statutory guidelines. These regulations and statutory guidelines often are complex, inconsistent or ambiguous, which results in additional uncertainty as to the outcome of a given lawsuit-including the amount of damages a plaintiff might be afforded-or makes it difficult to analogize experience in one case or jurisdiction to another case or jurisdiction.
Business combinations. The Company allocates the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets.
Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, may differ from actual results. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.
The Company chose to perform qualitative assessments for its title insurance and home warranty reporting units and performed quantitative impairment tests for its property and casualty insurance reporting unit for 2019, 2018 and 2017. The results of the Company’s qualitative assessments for its title insurance and home warranty reporting units supported the conclusion that their fair values were not more likely than not less than their carrying amounts and, therefore, a quantitative impairment test was not considered necessary. Based on the results of its quantitative impairment tests, the Company determined that the fair value of its property and casualty insurance reporting unit exceeded the carrying amount and, therefore, no additional analysis was required. As a result of the Company’s annual goodwill impairment assessments, the Company did not record any goodwill impairment losses for 2019, 2018 or 2017.
Management’s impairment assessment for indefinite-lived other intangible assets may involve calculating the fair value by using a discounted cash flow analysis or through a market approach valuation. If the fair value exceeds its carrying amount, the asset is not considered impaired and no additional analysis is required. However, if the carrying amount is greater than the fair value, an impairment loss is recorded equal to the excess.
Equity investments in which the Company does not exercise significant influence over the investee and without readily determinable fair values are measured at cost, less impairment and are adjusted up or down for any observable price changes.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance that requires the rights and obligations associated with leasing arrangements to be reflected on the balance sheet in order to increase transparency and comparability among organizations. Under the updated guidance, lessees are required to recognize a right-of-use asset and a liability to make lease payments and disclose key information about leasing arrangements. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018. The Company adopted the updated guidance using the modified retrospective transition approach and initially applied the guidance on January 1, 2019. Upon adoption, the Company recognized deferred gains of $1.3 million on previous sale and operating leaseback transactions as a cumulative-effect adjustment to retained earnings. The Company elected to adopt the package of practical expedients allowed under the guidance, which was applied to all leases as of the adoption date. The package of practical expedients included (1) entities could choose not to reassess whether any expired or existing contracts are or contain leases, (2) entities could choose not to reassess the lease classification for any expired or existing leases, and (3) entities could choose not to reassess initial direct costs for any existing leases. See Note 1 Basis of Presentation and Significant Accounting Policies and Note 5 Leases to the consolidated financial statements for further information on the Company’s leasing arrangements.
In January 2017, the FASB issued updated guidance intended to simplify how an entity tests goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the updated guidance, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the loss recognized limited to the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019. The adoption of this guidance, effective January 1, 2020, did not have a material impact on the Company’s consolidated financial statements.
The Company’s total revenues for 2019 were $6.2 billion, which reflected an increase of $0.5 billion, or 7.9%, when compared with $5.7 billion for 2018. This increase was primarily attributable to increases in direct premiums and escrow fees of $151.6 million, or 6.0%, agent premiums of $88.2 million, or 3.9%, and investment income of $85.1 million, or 37.0%. The Company’s total revenues for 2019 also included $66.4 million of net realized investment gains compared to $56.5 million of net realized investment losses for the prior year. The increase in direct premiums and escrow fees attributable to the title insurance and services segment was $135.1 million, or 6.6%. Direct premiums and escrow fees in the title insurance and services segment from domestic residential refinance, commercial and residential purchase transactions increased $119.7 million, or 66.1%, $13.7 million, or 1.8%, and $6.5 million, or 0.7%, respectively, in 2019 when compared to 2018.
The Company’s title insurance and services segment has benefited from rising net investment income over the past several years. This positive trend in net investment income was due to increases in short-term interest rates and higher average balances. The increase in short-term interest rates was driven by actions taken by the Federal Reserve to increase the federal funds rate. The higher average balances were largely driven by strength in the Company’s commercial business. However, the Federal Reserve decreased the federal funds rate 50 basis points and 25 basis points during the third and fourth quarters of 2019, respectively, which will negatively impact the Company’s net investment income in 2020. Additionally, any future decreases in short-term interest rates or average balances will have a negative impact on future net investment income.
Direct premiums and escrow fees increased $135.1 million, or 6.6%, in 2019 from 2018 and $30.6 million, or 1.5%, in 2018 from 2017. The increase in direct premiums and escrow fees in 2019 from 2018 was primarily due to an increase in the domestic title orders closed by the Company’s direct title operations, partially offset by a decrease in domestic average revenues per order closed. The increase in direct premiums and escrow fees in 2018 from 2017 was primarily due to an increase in domestic average revenues per order closed, partially offset by a decrease in the domestic title orders closed by the Company’s direct title operations. The domestic average revenues per order closed were $2,558, $2,600 and $2,264 for 2019, 2018 and 2017, respectively. The 1.6% decrease in average revenues per order closed in 2019 from 2018 was primarily due to a shift in the mix of direct revenues generated from higher premium commercial products to lower premium residential refinance products, partially offset by higher revenues per order from commercial transactions and higher residential real estate values. The 14.8% increase in average revenues per order closed in 2018 from 2017 was primarily due to a shift in the mix of direct revenues generated from lower premium residential refinance products to higher premium commercial products, higher average revenues per order from commercial transactions, higher residential real estate values, and premium and fee increases related to residential purchase transactions. The Company’s direct title operations closed 795,800, 730,800 and 823,700 domestic title orders during 2019, 2018 and 2017, respectively. The 8.9% increase in orders closed in 2019 from 2018 and the 11.3% decrease in orders closed in 2018 from 2017 were generally consistent with the changes in residential mortgage origination activity in the United States as reported in the MBA Forecast.
Agent premiums increased $88.2 million, or 3.9%, in 2019 from 2018 and decreased $75.8 million, or 3.2%, in 2018 from 2017. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums typically reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The increase in agent premiums in 2019 from 2018 was generally consistent with the 2.6% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2019 as compared with the twelve months ended September 30, 2018. The decrease in agent premiums in 2018 from 2017 was generally consistent with the 1.0% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2018 as compared with the twelve months ended September 30, 2017.
Information and other revenues increased $5.4 million, or 0.7%, in 2019 from 2018 and $4.7 million, or 0.6%, in 2018 from 2017. The increase in information and other revenues in 2019 from 2018 was primarily attributable to the growth in real estate transactions and mortgage origination activity that led to higher demand for the Company’s title information products, partially offset by changes in certain contractual arrangements that require the netting of production related costs against related revenues and lower demand for the Company’s default information products due to a decrease in loss mitigation activities. The increase in information and other revenues in 2018 from 2017 was driven by acquisitions. Excluding the $42.2 million impact of new acquisitions for the year ended December 31, 2018, information and other revenues decreased $37.5 million, or 4.9%, in 2018 compared to 2017. The decrease in 2018 from 2017, adjusted for the impact of new acquisitions, was primarily due to lower demand for the Company’s valuation services, fulfillment services, and automated products driven by a decrease in mortgage origination volumes and, to a lesser extent, lower demand for the Company’s default information products driven by a decrease in loss mitigation activities.
Net realized investment gains were $55.7 million for 2019 and were primarily from an increase in the fair values of equity securities of $56.3 million. Net realized investment losses were $49.1 million for 2018 and were primarily from a decrease in the fair values of equity securities of $32.6 million and losses from the sales of debt securities. Net realized investment gains totaled $6.7 million for 2017 and were primarily from the sales of debt and equity securities, partially offset by a $6.6 million loss recognized when the Company purchased the remaining equity ownership in an investment in an affiliate during the third quarter of 2017. Net realized investment gains for 2019, 2018 and 2017 included impairment losses of $7.8 million, $1.1 million and $3.0 million, respectively. The impairment losses in 2019, 2018 and 2017 primarily related to internally developed software, the retirement of a trade name and title plants, respectively.
The Company continues to closely monitor order volumes and related staffing levels and intends to adjust staffing levels as considered necessary. The Company’s direct title operations opened 1,093,000, 981,800 and 1,069,000 domestic title orders in 2019, 2018 and 2017, respectively, representing an increase of 11.3% in 2019 from 2018 and a decrease of 8.2% in 2018 from 2017.
The premium split between underwriter and agents is in accordance with the respective agency contracts and can vary from region to region due to divergences in real estate closing practices and state regulations. As a result, the percentage of title premiums retained by agents can vary due to the geographic mix of revenues from agency operations. The changes in the percentage of title premiums retained by agents in 2019 from 2018 and in 2018 from 2017 were primarily due to changes in the geographic mix of agency revenues.
Other operating expenses (principally related to direct operations) increased $12.1 million, or 1.5%, in 2019 from 2018 and $5.3 million, or 0.7%, in 2018 from 2017. The increase in 2019 from 2018 in other operating expenses was primarily attributable to higher software expense, higher production related costs driven by the growth in transaction activity, and impairments related to certain leases that were impacted by the consolidation of office locations related to a previous acquisition. These increases were partially offset by lower foreign currency exchange losses, lower computer hardware related costs and lower regulatory costs due to the recording of a reserve related to a legacy regulatory matter during the third quarter of 2018. The increase in other operating expenses in 2019 from 2018 was also partially offset by changes in certain contractual arrangements that require the netting of production related costs against related revenues. The increase in other operating expenses in 2018 from 2017 was driven by acquisitions. Excluding the $19.6 million impact of acquisitions for the year ended December 31, 2018, other operating expenses decreased $14.3 million, or 1.8%, in 2018 compared to 2017. The decrease in other operating expenses in 2018 from 2017, adjusted for the impact of new acquisitions, was primarily attributable to a reduction in discretionary spending, an increase in earnings credits and small decreases across several expense categories, partially offset by higher software expense and foreign currency exchange losses. The decrease was also related to an $8.5 million out-of-period adjustment recorded in the fourth quarter of 2017 to write-off certain uncollectible balances related to fees that should have been previously written off. For further discussion of this out-of-period adjustment see Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements.
As of December 31, 2019, the IBNR claims reserve for the title insurance and services segment was $904.0 million, which reflected management’s best estimate. The Company’s internal actuary determined a range of reasonable estimates of $708.8 million to $945.7 million. The range limits are $195.2 million below and $41.7 million above management’s best estimate, respectively, and represent an estimate of the range of variation among reasonable estimates of the IBNR reserve. Actuarial estimates are sensitive to assumptions used in models, as well as the structures of the models themselves, and to changes in claims payment and incurral patterns, which can vary materially due to economic conditions, among other factors.
Depreciation and amortization expense increased $2.6 million, or 2.2%, in 2019 from 2018 and decreased $2.5 million, or 2.0%, in 2018 from 2017. The increase in depreciation and amortization expense in 2019 from 2018 was primarily attributable to higher amortization expense associated with internally developed software. The decrease in depreciation and amortization expense in 2018 from 2017 was primarily attributable to 2017 being impacted by $5.3 million of accelerated amortization charges, resulting from a shortened useful life for a software interface, and $4.7 million in out-of-period adjustments to fully amortize certain title plant imaging assets that were misclassified as title plant assets. The decrease in 2018 was partially offset by $7.7 million of amortization expense related to recent acquisitions. For further discussion of this out-of-period adjustment see Note 1 Basis of Presentation and Significant Accounting Policies to the consolidated financial statements.
The profit margins for the title insurance business reflect the high cost of performing the essential services required before insuring title, whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to the relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are also impacted by the segment’s net investment income and net realized investment gains or losses, which may not move in the same direction as closed order volumes. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. Title insurance profit margins are also affected by the percentage of title insurance premiums generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. The pre-tax margins were 16.1%, 12.4% and 12.1% for the years ended December 31, 2019, 2018 and 2017, respectively.
Direct premiums increased $16.5 million, or 3.6%, in 2019 from 2018 and $15.2 million, or 3.5%, in 2018 from 2017. The increases were primarily attributable to higher premiums earned in the home warranty business driven by an increase in the number of home warranty residential service contracts issued and an increase in the average price charged per contract.
Net realized investment gains for the specialty insurance segment were $10.7 million for 2019 and were primarily from the increase in the fair values of equity securities of $10.4 million. Net realized investment losses were $7.4 million for 2018 and were primarily from a decrease in the fair values of equity securities of $6.1 million and losses from the sales of debt securities. Net realized investment gains totaled $4.6 million for 2017 and were primarily from the sales of debt and equity securities.
Personnel costs and other operating expenses increased $11.4 million, or 7.7%, in 2019 from 2018 and $10.0 million, or 7.1%, in 2018 from 2017. The increase in 2019 from 2018 was primarily attributable to increases in professional services, salary, advertising and employee benefit expenses. The increase in salary expense was due to higher average salaries. The increase in 2018 from 2017 was primarily attributable to higher salary expense due to higher average salaries, higher allocations related to corporate shared services, and higher advertising, sales tax, and employee benefit expenses.
Premium taxes as a percentage of specialty insurance segment premiums were 1.6% in 2019 and 2018, and 1.7% in 2017.
Interest expense decreased $0.3 million, or 1.0%, in 2019 from 2018 and increased $1.0 million, or 3.2%, in 2018 from 2017. The increase in 2018 from 2017 was due to an increase in the interest rate on borrowings under the Company’s credit facility. Borrowings under the credit facility bear interest at a variable rate, which increased in 2018 when compared to 2017.
The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. In January 2020, the Company’s board of directors approved an increase in the Company’s quarterly cash dividend to 44 cents per common share, representing a 5% increase from the prior level of 42 cents per common share. The dividend increase is effective beginning with the March 2020 dividend. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.
The Company maintains a stock repurchase plan with authorization up to $250.0 million, of which $161.6 million remained as of December 31, 2019. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. During the year ended December 31, 2019, the Company repurchased and retired 47 thousand shares of its common stock for a total purchase price of $2.1 million and, as of December 31, 2019, had repurchased and retired 3.6 million shares of its common stock under the current authorization for a total purchase price of $88.4 million.
The Tax Reform Act amended the Internal Revenue Code to reduce U.S. tax rates and modify policies, credits and deductions for individuals and businesses. The changes resulting from the Tax Reform Act had an overall favorable impact on the Company’s effective tax rate, resulting in less cash required for tax payments, and the Company expects the Tax Reform Act will continue to have an overall favorable impact on its effective tax rate and tax payments in future periods. In addition, the Tax Reform Act moves the U.S. to a partial territorial tax system, which as a result, reduces the tax costs associated with distributions of earnings from foreign subsidiaries.
Financing. In April 2019, the Company entered into a senior unsecured credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement, which is comprised of a $700.0 million revolving credit facility, includes an expansion option that permits the Company, subject to satisfaction of certain conditions, to increase the revolving commitments and/or add term loan tranches in an aggregate amount not to exceed $350.0 million. Unless terminated earlier, the credit agreement will terminate on April 30, 2024. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Upon entry into the credit agreement, the Company borrowed $160.0 million and repaid the $160.0 million obligation outstanding under the previous $700.0 million senior unsecured credit agreement, which was terminated at that time. Other proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2019, outstanding borrowings under the facility totaled $160.0 million at an interest rate of 3.30%.
In addition to amounts available under its credit facility, certain subsidiaries of the Company maintain separate financing arrangements. The primary financing arrangements maintained by subsidiaries of the Company are as follows:
The Company’s debt to capitalization ratios were 18.5% and 17.8% at December 31, 2019 and 2018, respectively.
Investment portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of December 31, 2019, 94% of the Company’s investment portfolio consisted of debt securities, of which 68% were either United States government-backed or rated AAA and 98% were either rated or classified as investment grade. Percentages are based on the estimated fair values of the securities. Credit ratings reflect published ratings obtained from globally recognized securities rating agencies. If a security was rated differently among the rating agencies, the lowest rating was selected. For further information on the credit quality of the Company’s investment portfolio at December 31, 2019, see Note 3 Debt and Equity Securities to the consolidated financial statements.
Capital expenditures. Capital expenditures are primarily related to software development costs and purchases of property and equipment and software licenses. Capital expenditures totaled $110.5 million, $125.5 million and $136.7 million for 2019, 2018 and 2017, respectively.
The timing of payments related to claims losses is estimated and is not set contractually. Nonetheless, based on historical claims experience, the Company anticipates the above payment patterns. Changes in future claims settlement patterns, judicial decisions, legislation, economic conditions and other factors could affect the timing and amount of actual claims payments. The timing and amount of payments in connection with employee benefit plans are based on the Company’s current estimates and require the use of significant assumptions. Changes in significant assumptions could affect the amount and timing of employee benefit plan payments.
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 2017
II. Condensed Financial Information of Registrant as of December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for Leases in 2019 and the manner in which it accounts for unrealized gains and losses associated with equity securities in 2018.
As described in Notes 1 and 9 to the consolidated financial statements, as of December 31, 2019, approximately $904 million of the Company’s reserve for known and incurred but not reported claims represented the incurred but not reported (“IBNR”) loss reserve balance for the title insurance and services segment. Management provides for title insurance losses through a charge to expense when the related premium revenue is recognized. The amount charged to expense is generally determined by applying a loss provision rate to total title insurance premiums and escrow fees. Management estimates the loss provision rate at the beginning of each year and reassesses the rate quarterly, which involves an evaluation of the results of an in-house actuarial review. The Company’s in-house actuary performs a reserve analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and loss development factors. For recent policy years at early stages of development (generally the last three years), IBNR is generally estimated using a combination of expected loss rate and multiplicative loss development factor calculations. For more mature policy years, IBNR generally is estimated using multiplicative loss development factor calculations. Current economic and business trends are also reviewed and used in the reserve analysis. These include conditions in the real estate and mortgage markets, changes in residential and commercial real estate values, and changes in the levels of defaults and foreclosures that may affect claims levels and patterns of emergence, as well as any company-specific factors that may be relevant to past and future claims experience.
The principal considerations for our determination that performing procedures relating to the valuation of the IBNR loss reserve - title claims is a critical audit matter are there was significant judgment by management when developing their estimate of the IBNR loss reserve. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence relating to the actuarial methods, which included significant assumptions related to loss development factors and expected loss rate. Also, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) and reflect the consolidated operations of the Company. The consolidated financial statements include the accounts of First American Financial Corporation and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Equity investments in which the Company exercises significant influence, but does not control and is not the primary beneficiary, are accounted for using the equity method. Equity investments in which the Company does not exercise significant influence over the investee and without readily determinable fair values, are accounted for at cost, less impairment and are adjusted up or down for any observable price changes.
Accounts and accrued income receivable are generally due within thirty days and are recorded net of an allowance for doubtful accounts. The Company considers accounts outstanding longer than the contractual payment terms as past due. The Company determines the allowance by considering a number of factors, including the length of time trade accounts receivable are past due, previous loss history, a specific customer’s ability to pay its obligations to the Company and the condition of the general economy and industry as a whole. Amounts are charged off in the period in which they are deemed to be uncollectible.
Debt securities are carried at fair value and consist primarily of investments in obligations of the United States Treasury, foreign governments, various U.S. and foreign corporations, certain state and political subdivisions and mortgage-backed securities. The Company classifies its debt securities as available-for-sale with unrealized gains or losses recorded as a component of accumulated other comprehensive loss.
The Company evaluates its debt securities with unrealized losses on a quarterly basis for potential other-than-temporary impairments in value.
If the Company intends to sell a debt security in an unrealized loss position or determines that it is more likely than not that the Company will be required to sell a debt security before it recovers its amortized cost basis, the debt security is other-than-temporarily impaired and it is written down to fair value with all losses recognized in earnings. As of December 31, 2019, the Company did not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell any debt securities before recovery of their amortized cost basis.
Investments in real estate are classified as held for sale and carried at the lower of cost or fair value, less estimated selling costs.
Secured financings receivable, which reflect financing transactions with correspondent mortgage lenders involved in residential real estate lending, are collateralized by mortgages on residential real estate. Collections of the receivable balance occur upon sale of the underlying mortgage loan to investors, generally within 30 days and more typically in less than 10 days. Secured financings receivable is stated at the principal balance outstanding and no allowance for doubtful accounts is maintained as the receivable balance is generally considered fully collectible. Interest income is recorded on an accrual basis during the period the principal balance remains outstanding.
Management recognizes an impairment loss when the carrying amount of a lease asset is not recoverable and exceeds its fair value. The carrying amount is considered not recoverable if it exceeds the sum of the undiscounted future cash flows that are directly associated with, and that are expected to arise as a result of, the use and eventual disposition of the lease asset. An impairment loss is measured as the amount by which the carrying amount of a lease asset exceeds its fair value. Impairment losses related to the Company’s commercial real estate may occur if the Company ceased using all, or a portion of, a leased property while a contractual obligation remains. Impairment losses related to commercial real estate leases were $7.5 million for 2019. Prior to 2019, operating lease commitments were not recognized as assets on the balance sheet.
The Company provides for claims losses relating to its home warranty business based on the average cost per claim and historical loss experience as applied to the total of new claims incurred. The average cost per home warranty claim is calculated using the average of the most recent 12 months of claims experience adjusted for estimated future increases in costs.
The Company records a contract asset, and recognizes revenue, upon delivery of certain products related to the closing of a real estate transaction where the Company’s right to payment is subject to the closing of the transaction. The Company records a contract liability for payments received in advance of revenue recognition for certain products or services. Contract assets and liabilities were not material at December 31, 2019 and 2018. Revenues recognized during the years ended December 31, 2019 and 2018 that were included in contract liabilities at the beginning of the period were not material.
For information about the Company’s revenues disaggregated by reportable segment see Note 20 Segment Financial Information.
The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized in the Company’s financial statements over the requisite service period of the award using the straight-line method for awards that contain only a service condition and the graded vesting method for awards that contain a performance or market condition. For awards with retirement eligibility provisions, the cost is recognized through the date the employee becomes eligible to retire and is no longer required to provide service to earn the award. The Company accounts for forfeitures as they occur.
The Company recognizes the underfunded status of its unfunded supplemental benefit plans as a liability on its consolidated balance sheets. Actuarial gains and losses and prior service costs and credits that have not been previously recognized as a component of net periodic benefit cost are recorded as a component of accumulated other comprehensive loss. Plan obligations are measured annually as of December 31.
The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $7.3 billion and $7.6 billion at December 31, 2019 and 2018, respectively, of which $3.2 billion and $3.6 billion, respectively, were held at First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.
Trust assets held or managed by First American Trust, FSB totaled $4.2 billion and $3.6 billion at December 31, 2019 and 2018, respectively. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.
Investments totaling $111.5 million and $129.2 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2019 and 2018, respectively.
The Company’s principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), maintained total statutory capital and surplus of $1.5 billion and $1.2 billion as of December 31, 2019 and 2018, respectively. Statutory net income for the years ended December 31, 2019, 2018 and 2017 was $473.6 million, $258.4 million and $306.5 million, respectively. FATICO was in compliance with the minimum statutory capital and surplus requirements as of December 31, 2019.
Investments in debt securities at December 31, 2019, by contractual maturities, are as follows:
Mortgage-backed securities, which include contractual terms to maturity, are not categorized by contractual maturity as borrowers may have the right to call or prepay obligations with, or without, call or prepayment penalties.
The composition of the debt securities portfolio in an unrealized loss position at December 31, 2019, by credit rating, is as follows:
Line of credit borrowings due April 30, 2024, current interest rate of 3.30% at December 31, 2019
Line of credit borrowings due May 14, 2019, current interest rate of 4.15% at December 31, 2018
The credit agreement includes representations and warranties, reporting covenants, affirmative covenants, negative covenants, financial covenants and events of default customary for financings of this type. Upon the occurrence of an event of default the lenders may accelerate the loans. Upon the occurrence of certain insolvency and bankruptcy events of default the loans will automatically accelerate. As of December 31, 2019, the Company was in compliance with the financial covenants under the credit agreement.
The Company’s actual income taxes differ from the amounts computed by applying the federal income tax rate of 21% for the years ended December 31, 2019 and 2018, and 35% for the year ended December 31, 2017. A reconciliation of these differences is as follows:
The Company’s effective income tax rates (income tax expense as a percentage of income before income taxes) were 21.6%, 21.9%, and 5.3% for the years ended December 31, 2019, 2018, and 2017, respectively. The effective tax rates differ from the federal statutory rate as a result of state and foreign income taxes for which the Company is liable, as well as permanent differences between amounts reported for financial statement purposes and taxable income. The effective tax rate for the year ended December 31, 2019 reflects the resolution of state tax matters from prior years and the effective tax rates for the years ended December 31, 2018 and 2017 reflected the impact of the 2017 comprehensive tax reform legislation known as the Tax Cuts and Jobs Act. The Company’s effective tax rate for the year ended December 31, 2017 also reflected state tax benefits relating to the termination of the Company’s defined benefit pension plan and the release of reserves relating to tax positions taken on prior year tax returns.
In connection with the Company’s June 2010 spin-off from its prior parent, the Company entered into a tax sharing agreement which governs the Company’s and its prior parent’s respective rights, responsibilities and obligations for certain tax-related matters. At December 31, 2019 and 2018, the Company had a net payable to its prior parent of $0.5 million and $15.6 million, respectively, related to tax matters prior to the spin-off. These amounts are included in the Company’s consolidated balance sheets in accounts payable and accrued liabilities. The decrease during the current year was primarily the result of the resolution of state tax matters for years prior to the spin-off.
At December 31, 2019, the Company had available a $6.5 million foreign tax credit carryover, net of a valuation allowance. The Company expects to utilize this credit within the carryover period.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2019, 2018 and 2017 is as follows:
The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in income tax expense. As of December 31, 2019, 2018 and 2017, the Company had accrued interest and penalties, net of tax benefits, of $26 thousand, $5.8 million and $5.3 million, respectively, related to uncertain tax positions.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions may increase or decrease within the next 12 months. Any such change may be the result of ongoing audits or the expiration of federal and state statutes of limitations for the assessment of taxes.
For the years ended December 31, 2019, 2018 and 2017, RSUs excluded from diluted weighted-average common shares outstanding due to their antidilutive effect were not material.
During 2017, the Company recognized settlement costs related to the termination of its funded defined benefit pension plans.
The weighted-average discount rate assumption used to determine the projected benefit obligation for the Company’s unfunded supplemental benefits plans at December 31, 2019 and 2018, was as follows:
The following tables present the fair values of the Company’s assets, measured on a recurring basis, as of December 31, 2019 and 2018:
The First American Financial Corporation 2010 Incentive Compensation Plan (the “Incentive Compensation Plan”), effective May 28, 2010, permits the granting of stock options, stock appreciation rights, restricted stock, RSUs, performance units, performance shares and other stock-based awards. Eligible participants, which include the Company’s directors and officers, as well as other employees, may elect to defer the distribution of their RSUs to a future date beyond the scheduled vesting date. At December 31, 2019, 1.8 million shares of common stock remain available to be issued from either authorized and unissued shares or previously issued shares acquired by the Company, subject to certain annual limits based on the type of award granted. The Incentive Compensation Plan terminates 10 years from its effective date unless previously canceled by the Company’s board of directors.
The following table summarizes RSU activity for the year ended December 31, 2019:
The Company maintains a stock repurchase plan with authorization up to $250.0 million, of which $161.6 million remained as of December 31, 2019. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. During the year ended December 31, 2019, the Company repurchased and retired 47 thousand shares of its common stock for a total purchase price of $2.1 million and as of December 31, 2019, had repurchased and retired 3.6 million shares of its common stock under the current authorization for a total purchase price of $88.4 million.
Net realized gains (losses) for the years ended December 31, 2019 and 2018 related to sales of debt securities and net realized gains for the year ended December 31, 2017 related to sales of debt and equity securities.
These lawsuits are putative class actions for which a class has not been certified. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.
Revenues from external customers allocated between domestic and foreign operations, by segment, for the years ended December 31, 2019, 2018 and 2017, are as follows:
The holding company received cash dividends from subsidiaries of $384.8 million, $394.4 million and $87.4 million for the years ended December 31, 2019, 2018 and 2017, respectively.