Volume is a factor in the Company’s profitability due to fixed operating costs which are incurred by the Company regardless of premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on the Company’s profitability. The Company’s profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and minimize risks such as interest rate changes, defaults and impairments of assets.
In conjunction with Investors Trust, ICMC provided investment management and trust services to individuals, companies, banks and trusts. In July 2013, Investors Trust assumed responsibility for the management of accounts previously managed by ICMC. ITMS offers various consulting services to provide clients with the technical expertise to start and successfully operate a title insurance agency.
Beginning in 2008, the United States economy experienced one of the worst economic downturns in history. Events leading to the recession were primarily the collapse of the housing market and frozen credit markets, prompting the federal government to take unprecedented monetary and fiscal action in an attempt to slow the economic rate of decline and instill consumer confidence. The economy has been slowly recovering from this downturn with the Dow Jones Industrial Average setting and remaining near the all-time high, housing values rebounding and the unemployment rate lowering.
According to data published by Freddie Mac, the average 30-year fixed mortgage interest rate in the United States was 3.98%, 3.66% and 4.45% for the years ended December 31, 2013, 2012 and 2011, respectively. According to the MBA Forecast, refinancing is expected to be significantly lower in 2014 as mortgage interest rates continue to climb to a projected 5.1% in the fourth quarter of 2014.
In Washington, D.C., there are continued discussions regarding the possible reform of government-sponsored enterprises, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Fannie Mae and Freddie Mac often require the purchase of title insurance for home loans that they securitize. Changes to these entities could impact the entire mortgage loan process and as a result, could impact the demand for title insurance. The timing and results of reform are currently unknown; however, any changes to these entities could impact the Company and its results of operations.
Effective January 10, 2014, the TILA Regulation Z rule requires a lender to assess each borrower's ability to meet the obligations of the prospective mortgage. Within this rule, there is also a provision that requires the lender to determine if the mortgage is a “Qualified Mortgage.” The key features of a Qualified Mortgage are that it (1) not have excessive upfront points and fees; (2) not have toxic loan features such as interest only, negative amortization or balloon payment provisions; and (3) limits the borrower's debt-to-income ratio. The lender must include all fees paid to an affiliate of the lender in the points and fees calculation. The Company and its subsidiaries are not involved in mortgage lending; however, this rule could have an adverse impact on mortgage lending activity and potentially reduce premium volume.
The CFPB, Office of the Comptroller of Currency and the Federal Reserve have issued memorandums to banks which have heightened their focus on vetting third party providers and may impact the Company's agents and approved providers. Further proposals to change regulations governing insurance holding companies and the title insurance industry are often introduced in Congress, in state legislatures and before various insurance regulatory agencies. The Company regularly monitors such proposals, but their likelihood and timing, and the impact they may have on the Company and its subsidiaries cannot be determined at this time.
Historically, activity in real estate markets has varied over the course of market cycles by geographic region and in response to evolving economic factors. Operating results can vary from year to year based on cyclical market conditions and do not necessarily indicate the Company's future operating results and cash flows.
The Company’s reserves for claims are established using estimates of amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future (incurred but not reported, or “IBNR”). The total reserve for all losses incurred but unpaid as of December 31, 2013 is represented by the reserve for claims totaling $35,360,000 in the accompanying Consolidated Balance Sheets. Of that total, approximately $4,671,000 was reserved for specific claims which have been reported to the Company, and approximately $30,689,000 was reserved for IBNR claims.
Despite the variability of such estimates, management believes that, based on historical claims experience and actuarial analysis, the Company’s reserves are adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2013. The ultimate settlement of policy and contract claims will likely vary from the reserve estimates included in the Company’s Consolidated Financial Statements. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. There are no known claims that are expected to have a material adverse effect on the Company’s financial position or operating results.
Securities held principally for resale in the near term are classified as trading securities and recorded at fair value. Realized and unrealized gains and losses on trading securities are included in other income. Securities that are not classified as either trading securities or held-to-maturity securities, and, securities for which the Company has the intent and ability to hold to maturity, are classified as available-for-sale and reported at fair value with unrealized gains and losses, adjusted for other-than-temporary declines in fair value, reported as accumulated other comprehensive income. As of December 31, 2013 and 2012, all of the Company’s invested securities were classified as available-for-sale. Realized gains and losses on the sale of investments are determined using the specific identification method.
Securities are regularly evaluated and reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in fair value is other-than-temporary. When, in the opinion of management, a decline in the fair value of an investment is considered to be other-than-temporary, such investment is written down to its fair value. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include, but are not limited to:
The Company recorded net deferred tax liabilities at December 31, 2013 and December 31, 2012. The deferred tax liabilities recorded during both periods primarily relates to net unrealized gains on investments and recorded reserves for claims, net of statutory premium reserves. See Note 8 to the Consolidated Financial Statements in this Annual Report on Form 10-K for further information on the Company’s deferred taxes.
Historically, real estate transactions have produced seasonal premium levels for title insurers. Residential real estate activity generally has been slower in the fall and winter months because fewer real estate transactions occur, while the spring and summer months are more active. Refinance activity is generally less seasonal than purchase activity, but it is more subject to interest rate volatility and is therefore more cyclical. However, fluctuations in mortgage interest rates, as well as other economic factors, can cause shifts in real estate activity outside of the normal traditional seasonal pattern.
The following table presents certain income statement data for the years ended December 31, 2013, 2012 and 2011:
Insurance and other services revenues include net premiums written plus other fee income, trust income, management services income, and exchange services income. Investment income and realized investment gains and losses are not included in insurance and other service revenues and are discussed separately under “Investment-Related Revenues” below. The following is a summary of the Company’s insurance and other services revenues with intersegment eliminations netted with each segment; therefore, the individual segment amounts will not agree to Note 13 in the accompanying Consolidated Financial Statements.
Home and Branch Office Net Premiums: In the Company’s home and branch operations, the Company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. Net premiums written from home and branch operations increased 4.4% in 2013 to $24,811,602 compared with $23,762,885 in 2012 and increased 44.1% in 2012 compared with $16,485,973 in 2011. The increase in 2013 home and branch operations primarily reflects increased purchase transactions and average home values. The increase in 2012 home and branch operations primarily reflects increased purchase and refinance activity and new industry-wide premium charges in the State of North Carolina that became effective March 1, 2012. All of the Company’s home office operations and the majority of branch offices are located in North Carolina; as a result, the home and branch office net premiums written are primarily for North Carolina policies.
Following is a schedule of net premiums written in select states where the Company’s two insurance subsidiaries, ITIC and NITIC, currently underwrite title insurance:
Dispositions of equity securities at a realized gain or loss reflect such factors as industry sector allocation decisions, ongoing assessments of issuers’ business prospects and tax planning considerations. Additionally, the amounts of net realized investment gains and losses are affected by assessments of securities’ valuation for other-than-temporary impairment. As a result of the interaction of these factors and considerations, net realized investment gains or losses can vary significantly from period to period.
The securities in the Company’s portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a security is other-than-temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost.
The Company’s operating expenses consist primarily of commissions to agents, salaries, employee benefits and payroll taxes, provisions for claims and office occupancy and operations. Operating expenses increased 5.8% in 2013 compared with 2012 primarily due to increases in commissions and salaries, employee benefits and payroll taxes, partially offset by a decline in the provision for claims. Operating expenses increased 21.9% in 2012 compared with 2011 primarily due to increases in commissions, salaries, employee benefits and payroll taxes, the provision for claims and professional and contract labor fees.
Profit Margin: The Company’s title insurance after-tax profit margin varies according to a number of factors, including the volume and type of real estate activity. Profit margins for the title insurance segment were 13.0%, 10.4% and 8.7% in 2013, 2012 and 2011, respectively. The increase in after-tax profit margin in 2013 compared with 2012 is primarily related to an increase in premiums written due to higher levels of purchase transactions and increases in home values and decreases in claims expenses. The increase in after-tax profit margin in 2012 compared with 2011 is primarily related to increased real estate activity, new industry wide premium charges that went into effect during 2012, and gains in net realized gains and investment income.
(Benefit) Provision for Claims: The (benefit) provision for claims as a percentage of net premiums written was (0.5)%, 5.9% and 4.1% in 2013, 2012 and 2011, respectively. The 2013 benefit related to a reduction in the reserves for claims of approximately $2,200,000 reflecting a change in certain actuarial assumptions that stems from improved claims experience in recent post-recession policy years. In addition to the change in estimate, claims experience for several recent policy years continued to emerge favorably in comparison with prior period expectations, resulting in further reductions to the claims provision. A more detailed discussion related to the adjustment can be found in Note 6 in the accompanying Notes to Consolidated Financial Statements and in the Critical Accounting Estimates and Policies section of this Management’s Discussion and Analysis. The increase in the provision for claims as a percentage of net premiums written for 2012 compared with 2011 was primarily due to favorable development experienced in 2011. An additional factor was the 2012 increase in the relative share of North Carolina premiums as a percentage of the total premiums. The loss provision rate in North Carolina trends higher due to relatively low premium rates compared with the Company’s other markets.
The decrease in the loss provision rate in 2013 from the 2012 level resulted in approximately $7,330,000 less in reserves than would have been recorded at the higher 2012 level. Loss provision ratios are subject to variability and are reviewed and adjusted as experience develops.
Reserves for Claims: At December 31, 2013, the total reserve for claims was $35,360,000. Of that total, approximately $4,671,000 was reserved for specific claims, and approximately $30,689,000 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.
Changes from prior periods in the expected liability for claims reflect the uncertainty of the claims environment, as well as the limited predictive power of historical data. The Company continually updates and refines its reserve estimates as current experience develops and credible data emerges. Such data includes payments on claims closed during the quarter, new details that emerge on still-open cases that cause claims adjusters to increase or decrease the case reserves, and the impact that these types of changes have on the Company’s total loss provision. Adjustments may be required as new information develops which often varies from past experience.
Office Occupancy and Operations: Overall office occupancy and operations as a percentage of total revenues was 3.5%, 3.5% and 4.1% in 2013, 2012 and 2011, respectively. The dollar increase in office occupancy and operations expense in 2013 was primarily related to increases in depreciation, insurance and maintenance expense. The dollar increase in 2012 was due primarily to increases in rent, office supplies, telecommunications, equipment and postage, all related to increased business activity.
Business Development: Business development expenses increased to $2,145,639 in 2013, compared with $1,856,848 in 2012 and $1,671,834 in 2011, primarily due to increases in travel and marketing expenses.
Filing Fees, Franchise and Local Taxes: Filing fees, franchise and local tax expenses include insurance filing and licensing fees, franchise taxes, excise taxes, and local taxes. The 2013 decrease primarily related to a decrease in licensing fees. The increase in 2012 from 2011 primarily related to an increase in filing fees and local taxes.
The provision for income taxes was $6,746,000, $4,889,000 and $2,565,000 for the years ended December 31, 2013, 2012 and 2011, respectively. Income tax expense as a percentage of earnings before income taxes was 31.3%, 30.4% and 27.0%, for the years ended December 31, 2013, 2012 and 2011, respectively. The increases in the effective rate in 2013 and 2012 compared with 2011 were primarily due to a lower proportion of tax-exempt to taxable income. The effective income tax rate for 2013, 2012 and 2011 was below the U.S. federal statutory income tax rate (34%), primarily due to the effect of tax-exempt income. Tax-exempt income lowers the effective tax rate.
The Company believes it is more likely than not that the tax benefits associated with recognized impairment and unrecognized losses recorded through December 31, 2013 will be realized. However, this judgment could be impacted by further market fluctuations. Information regarding the components of the income tax expense and items included in the reconciliation of the effective rate with the federal statutory rate can be found in Note 8 to the accompanying Consolidated Financial Statements.
Due to the Company’s historical ability to consistently generate positive cash flows from its consolidated operations and investment income, management believes that funds generated from operations will enable the Company to adequately meet its current operating needs for the foreseeable future. However, there can be no assurance that future experience will be similar to historical experience, since it is influenced by such factors as the interest rate environment, the Company’s claims-paying ability and its financial strength ratings. The Company is unaware of any trend that is likely to result in material adverse liquidity changes, but continually assesses its capital allocation strategy, including decisions relating to repurchasing the Company’s stock and/or conserving cash. The Company’s current cash requirements include general operating expenses, income taxes, capital expenditures, dividends on its common stock declared by the Board of Directors and share repurchases of its common stock.
The Company’s ability to pay dividends and operating expenses is dependent on funds received from the insurance subsidiaries, which are subject to regulation in the states in which they do business. Each state regulates the extent to which title underwriters can pay dividends or make distributions. As of December 31, 2013, approximately $83,311,000 of the consolidated stockholders’ equity represented net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior approval from the respective state insurance department. These regulations require prior regulatory approval of the payment of dividends and other intercompany transfers. The Company believes, however, that amounts available for transfer from the insurance and other subsidiaries are adequate to meet the Company’s current operating needs.
The maximum dividend permitted by law is not necessarily indicative of an insurer’s actual ability to pay dividends, which may be constrained by regulatory and business considerations, such as the impact of dividends on surplus, which could affect an insurer’s ratings. Further, depending on regulatory and business conditions, the Company may in the future need to retain cash in its underwriters in order to maintain their ratings or their statutory capital position. Such requirements could be the result of adverse financial results, changes in statutory accounting requirements by regulators, reserve charges or investment losses.
Purchase of Company Stock: On November 12, 2012, the Board of Directors of the Company approved the purchase of an additional 260,246 shares pursuant to the Company’s repurchase plan, such that there was authority remaining under the plan to purchase up to an aggregate of 500,000 shares of the Company’s common stock pursuant to the plan immediately after this approval. Unless terminated earlier by resolution of the Board of Directors, the plan will expire when all shares authorized for purchase under the plan have been purchased. Pursuant to this approval, the Company has purchased 56,223 shares in the twelve months ended December 31, 2013, 70,702 shares in the twelve months ended December 31, 2012 and 182,615 shares in the twelve months ended December 31, 2011 at an average per share price of $75.81, $56.23 and $32.53, respectively. The Company anticipates making further purchases under this plan from time to time in the future, depending on such factors as the prevailing market price of the Company’s common stock, the Company’s available cash and then existing alternative uses for such cash.
Capital Expenditures: Capital expenditures were approximately $1,420,000, $570,000 and $360,000 during 2013, 2012 and 2011, respectively. The increase in capital expenditures for 2013, primarily relates to capital improvement projects, including increased investment in a number of technology and system development initiatives and hardware purchases that are anticipated to be funded via cash flows from operations. All material anticipated capital expenditures are subject to periodic review and revision and may vary depending on a number of factors.
As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnifies against specific title risks. Cash held by the Company for these purposes was approximately $11,824,000 and $11,689,000 as of December 31, 2013 and 2012, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
In addition, in administering tax-deferred property exchanges, ITEC serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. ITAC serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property held by the Company for the purpose of completing such transactions totaled approximately $76,037,000 and $55,580,000 as of December 31, 2013 and 2012, respectively. These exchange deposits are held at third-party financial institutions. These amounts are not considered assets of the Company for accounting purposes and, therefore, are excluded from the accompanying Consolidated Balance Sheets. Exchange services revenues include earnings on these deposits; therefore, investment income is shown as exchange services revenue, rather than investment income. The Company remains contingently liable to customers for the transfers of property, disbursements of proceeds, and the return on the proceeds at the agreed upon rate.
External assets administered by the Investors Trust Company totaled approximately $450,000,000 and $650,000,000 for each of the years ended December 31, 2013 and 2012. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets.
It is not the general practice of the Company to enter into off-balance sheet arrangements; nor is it the policy of the Company to issue guarantees to third parties. Off-balance sheet arrangements are generally limited to the future payments under noncancelable operating leases, payments due under various agreements with third-party service providers, and unaccrued obligations pursuant to certain executive employment agreements.
The following table summarizes the Company’s future estimated cash payments under existing contractual obligations at December 31, 2013, including, payments due by period:
In February 2013, the FASB updated guidance to improve the reporting of reclassifications from accumulated other comprehensive income. The main provisions of this guidance require an entity to provide information about the amount reclassified from accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the footnotes, the amount reclassified out of accumulated other comprehensive income by the respective line items of net income if the amount is reclassified to net income in its entirety in the same reporting period. For other amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures providing additional detail about those amounts. The amendments do not change the requirements for reporting net income or other comprehensive income in financial statements. The Company complied with this update, and it did not have an impact on the Company’s financial condition or results of operations.
We have audited the accompanying consolidated balance sheets of Investors Title Company and Subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial schedules listed in the Index at Item 15(a)(2). These consolidated financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 14, 2014, expressed an unqualified opinion thereon.
Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2013.
We have audited Investors Title Company and Subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2013, and our report dated March 14, 2014, expressed an unqualified opinion on those consolidated financial statements.
Securities for which the Company has the intent and ability to hold to maturity are classified as held-to-maturity and reported at cost, adjusted for amortization of premiums or accretion of discounts, and other-than-temporary declines in fair value. Securities held principally for resale in the near term are classified as trading securities and recorded at fair values. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading or held-to-maturity are classified as available-for-sale and reported at fair value with unrealized gains and losses, net of tax, adjusted for other-than-temporary declines in fair value, reported as accumulated other comprehensive income. As of December 31, 2013 and 2012, all investments in securities are classified as available-for-sale. Securities are regularly reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in fair value is other-than-temporary. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include the duration and extent to which the fair value has been less than cost and the Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. Fair values of the majority of investments are based on quoted market prices. Realized gains and losses are determined on the specific identification method. Refer to Note 3 for further information regarding investments in securities and fair value.
Other investments consist primarily of investments in title insurance agencies structured as limited liability companies (“LLCs”), which are accounted for under the equity or cost methods of accounting. The aggregate cost of the Company’s cost method investments totaled $1,834,229 and $1,778,115 at December 31, 2013 and December 31, 2012, respectively. The Company monitors any events or changes in circumstances that may have had a significant adverse effect on the fair value of these investments and makes any necessary adjustments.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2013 is represented by the reserves for claims. The Company’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserves are adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2013. The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
The Company makes certain estimates and judgments in determining income tax expense (benefit) for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. The Company provides for deferred income taxes (benefits) for the tax consequences in future years of temporary differences between the financial statements’ carrying values and the tax bases of assets and liabilities using currently enacted tax rates. The Company establishes valuation allowances if it believes that it is more likely than not that some or all of its deferred tax assets will not be realized. Refer to Note 8 for further information regarding income taxes.
The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, short-term investments, premium and fees receivable, accrued interest and dividends, accounts payable, commissions payable, reinsurance payable and current income taxes recoverable/payable approximate fair value due to the short-term nature of these assets and liabilities. Fair values for the majority of investment securities are based on quoted market prices. Auction rate securities (“ARS”) are valued using discounted cash flow models to determine the estimated fair value of these investments. Some of the inputs for determining the fair value of ARS are unobservable in the securities markets and are significant. Refer to Note 3 for further information regarding investments in securities and fair value.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains/losses on available-for-sale securities, net of tax, and unrecognized prior service cost and unrealized gains/losses associated with postretirement benefit liabilities, net of tax. Accumulated other comprehensive income as of December 31, 2013 consists of $11,395,757 of unrealized holding gains on available-for-sale securities and $48,353 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2012 consists of $8,920,884 of unrealized holding gains on available-for-sale securities and $102,454 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities.
The Company’s reserves for claims are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which have been incurred but not reported (“IBNR”). During the third quarter of 2013 certain actuarial inputs were changed to provide a more refined IBNR reserve estimate. See Note 6 in the accompanying Consolidated Financial Statements for further information regarding this change in accounting estimate.
A financial instrument’s classification within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement-consequently, if there are multiple significant valuation inputs that are categorized in different levels of the hierarchy, the instrument’s hierarchy level is the lowest level (with Level 3 being the lowest level) within which any significant input falls.
The Level 2 category includes fixed maturity investments such as corporate bonds, U.S. government and agency bonds and municipal bonds. Fair value is principally based on market values obtained from a third party pricing service. Factors that are used in determining fair market value include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. The Company receives one quote per security from a third party pricing service, although as discussed below, the Company does consult other pricing resources when confirming that the prices it obtains reflect the fair values of the instruments in accordance with Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures. Generally, quotes obtained from the pricing service for instruments classified as Level 2 are not adjusted and are not binding. As of December 31, 2013 and December 31, 2012, the Company did not adjust any Level 2 fair values.
A number of the Company’s investment grade corporate bonds are frequently traded in active markets, and trading prices are consequently available for these securities. However, these securities were classified as Level 2 because the pricing service from which the Company has obtained fair values for these instruments uses valuation models which use observable market inputs in addition to traded prices. Substantially all of the input assumptions used in the service’s model are observable in the marketplace or can be derived or supported by observable market data.
Based upon these inputs and assumptions, the pricing service provides a range of values to the Company for its ARS. The Company records the fair value based on the midpoint of the range and believes that this valuation is the most reasonable estimate of fair value. In 2013 and 2012, the difference in the low and high values of the ranges was approximately zero and four percent of the carrying value of the Company’s ARS.
The following table presents a reconciliation of the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), which are all ARS securities, for the twelve months ended December 31, 2013 and 2012:
The following table presents a reconciliation of the Company’s liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3), consisting solely of contingent consideration, for the twelve months ended December 31, 2013 and 2012:
Certain cost-basis investments are measured at estimated fair value on a non-recurring basis, such as investments that are determined to be other-than temporarily impaired during the period and recorded at estimated fair value in the Consolidated Financial Statements as of December 31, 2013 and 2012. The following table summarizes the corresponding estimated fair value hierarchy of such investments at December 31, 2013 and 2012 and the related impairments recognized:
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $6,000 and $211,000, respectively, for 2013, $16,000 and $233,000, respectively, for 2012 and $17,000 and $177,000, respectively, for 2011. Ceded reinsurance is comprised of excess of loss treaties, which protects against losses over certain amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event that the assuming insurance companies are unable to meet their obligations under these contracts. The Company has not paid or recovered any reinsured losses during the three years ended December 31, 2013.
The Company continually refines its reserve estimates as current loss experience develops and credible data emerges. Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data. The 2013 calendar year change in the provision relating to prior years resulted mostly from changes to certain actuarial inputs and favorable development in 2013 versus prior year related primarily to policy years 2008 through 2012. Due to variances between actual and expected loss payments, loss development is subject to significant variability.
During 2013 certain actuarial inputs were changed to provide a more refined IBNR reserve estimate. The Company considers these modifications in actuarial inputs to be a change in estimate. The Company believes that these changes in actuarial inputs were necessary in response to favorable reserve development and claims experience incurred in several recent reporting periods. The approximate impact of this change in estimate for the year ended December 31, 2013 was a reduction of $2,200,000 to the reserves for claims in the Consolidated Balance Sheets, and in the Consolidated Statements of Income a decrease of $2,200,000 to the provision for claims, an increase of $750,000 in the provision for income taxes and an increase of $1,450,000 in net income, or $0.71 per basic share and $0.70 per diluted share, compared with the amounts that would have been recorded under the Company’s prior estimate. This change in estimate, coupled with several recent policy years which continued to emerge favorably in comparison with prior expectations, contributed to a benefit in the claims provision this quarter. The change in estimate was primarily driven by the following:
Basic earnings per common share is computed by dividing net income attributable to the Company by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive potential common stock, comprised of shares issuable under the Company’s share-based compensation plans and the weighted average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money share-based awards, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, when share-based awards are exercised, (a) the exercise price of a share-based award; (b) the amount of compensation cost, if any, for future service that the Company has not yet recognized; and (c) the amount of estimated tax benefits that would be recorded in additional paid-in capital, if any, are assumed to be used to repurchase shares in the current period. The incremental dilutive potential common shares, calculated using the treasury stock method, were 20,459, 35,090 and 18,286 for 2013, 2012 and 2011, respectively.
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock at December 31, 2013. The intrinsic values of options exercised during 2013, 2012 and 2011 were approximately $3,486,000, $153,000 and $118,000, respectively.
During the second quarters of 2013, 2012 and 2011, the Company issued 3,000 share-settled SARs to the directors of the Company. SARs give the holder the right to receive stock equal to the appreciation in the value of shares of stock from the grant date for a specified period of time, and as a result, are accounted for as equity instruments. The fair value of each award is estimated on the date of grant using the Black-Scholes option valuation model with the weighted average assumptions noted in the table shown below. Expected volatilities are based on both the implied and historical volatility of the Company’s stock. The Company uses historical data
There was approximately $84,000, $75,000 and $214,000 of compensation expense relating to SARs or options vesting on or before December 31, 2013, 2012 and 2011, respectively, included in salaries, employee benefits and payroll taxes in the Consolidated Statements of Income. As of December 31, 2013, there was approximately $23,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s stock award plans. That cost is expected to be recognized over a weighted average period of approximately 3 months.
A reconciliation of income tax as computed for the years ended December 31 at the U.S. federal statutory income tax rate of 34.1% for 2013 and 34% for 2012 and 2011, respectively, to income tax expense follows:
The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal or state and local examinations by taxing authorities for years before 2010.
future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2013, are summarized as follows:
The Company has a 401(k) savings plan. In order to participate, individuals must be employed for one full year and work at least 1,000 hours annually. The Company makes a 3% Safe Harbor contribution and also has the option annually to make a discretionary profit share contribution. Individuals may elect to make contributions up to the maximum deductible amount as determined by the Internal Revenue Code. Expenses related to the 401(k) plan were approximately $579,000, $518,000 and $479,000 for 2013, 2012 and 2011, respectively.
In November 2003, ITIC, a wholly owned subsidiary of the Company, entered into employment agreements with the Chief Executive Officer, Chief Financial Officer and Chief Operating Officer of ITIC. These individuals also serve as the Chairman, President and Executive Vice President, respectively, of the Company. The agreements provide compensation and life, health, dental and vision benefits upon the occurrence of specific events, including death, disability, retirement, termination without cause or upon a change in control. The employment agreements also prohibit each of these executives from competing with ITIC and its parent, subsidiaries and affiliates in the State of North Carolina while employed by ITIC and for a period of two years following termination of their employment.
In addition, during the second quarter of 2004, ITIC entered into nonqualified deferred compensation plan agreements with these executives. The amount accrued for all agreements at December 31, 2013 and 2012 was approximately $6,580,000 and $6,303,000, respectively, which includes postretirement compensation and health benefits, and was calculated based on the terms of the contract. Both the 2013 and 2012 accruals are included in the Accounts payable and accrued liabilities line item of the Consolidated Balance Sheets. These executive contracts are accounted for on an individual contract basis. On December 24, 2008, the executive contracts were amended effective January 1, 2009 to bring them into compliance with Section 409A of the Internal Revenue Code, and were amended and restated to provide for an annual cash payment to the officers equal to the amounts the Company would have contributed to their accounts under its 401(k) plan if such contributions were not limited by the federal tax laws, less the amount of any contributions that the Company actually makes to their accounts under the Company’s 401(k) plan.
On November 17, 2003, ITIC entered into employment agreements with key executives that provide for the continuation of certain employee benefits upon retirement. The executive employee benefits include health insurance, dental insurance, vision insurance and life insurance. The benefits are unfunded. Estimated future benefit payouts expected to be paid for each of the next five years are $4,231 in 2014, $4,596 in 2015, $4,937 in 2016, $8,093 in 2017, $11,751 in 2018 and $100,122 in the next five years thereafter.
the net unrecognized actuarial losses and unrecognized prior service costs. The effects of the funded status on the Company’s Consolidated Balance Sheets at December 31, 2013 and 2012 are presented in the following table:
The amounts currently in accumulated other comprehensive income, pre-tax, that will be reclassified to the Consolidated Statements of Income and recognized as components of net periodic benefit costs in 2014 are:
Assumed health care cost trend rates do have an effect on the amounts reported for the postretirement benefit obligations. The following illustrates the effects on the net periodic postretirement benefit cost (“NPPBC”) and the accumulated postretirement benefit obligation (“APBO”) of a one percentage point increase and one percentage point decrease in the assumed health care cost trend rate as of December 31, 2013:
Legal Proceedings. A class action lawsuit is pending in the United States District Court for the Eastern District of Michigan, Southern Division, against several title insurance underwriters, including Investors Title Insurance Company, and several title insurance agents, entitled Bushman et al. v. R. Kevin Clinton, Treasurer of the State of Michigan, et al. (2:14-cv-10011-GCS-MAR). Michigan law requires the seller of property to pay a transfer tax based on the total value of the property at the time of transfer. Exemptions from the payment of this tax exist if (1) the property is the seller’s principal residence, and (2) the state equalized value (“SEV”) of the property at the time of purchase is greater than the SEV at the time of sale. Plaintiffs contend that, notwithstanding this exemption, they were assessed, charged and paid the full transfer tax when they sold their property. The plaintiffs seek an award of actual damages, statutory damages, attorneys’ fees and other relief as determined at trial. The Company believes that this case is without merit, and intends to vigorously defend against the allegations. At this stage in the litigation, the Company does not have the ability to make a reasonable range of estimates in regards to potential loss amounts, if any.
As previously reported, Investors Title Insurance Company and several other title insurance companies were named in a class action lawsuit in the United States District Court for the Southern District of West Virginia entitled Backel v. Fidelity National Title Insurance et al. (6:2008-CV-00181). The plaintiff in this case contended a lack of meaningful oversight by agencies with which title insurance rates are filed and approved. There were further allegations that the title insurance companies conspired to fix title insurance rates. This case, which had been inactive, was administratively closed in the third quarter of 2013. The Company will not report further on this matter unless there are any material developments.
The Company and its subsidiaries are involved in legal proceedings that are incidental to their business. In the Company’s opinion, based on the present status of these proceedings, any potential liability of the Company or its subsidiaries with respect to these legal proceedings, will not, in the aggregate, be material to the Company’s consolidated financial condition or operations.
Escrow and Trust Deposits. As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $11,824,000 and $11,689,000 as of December 31, 2013 and 2012, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
Combined capital and surplus on a statutory basis was $119,897,974 and $102,047,179 as of December 31, 2013 and 2012, respectively. Net income on a statutory basis was $11,858,699, $11,035,792 and $6,416,684 for the twelve months ended December 31, 2013, 2012 and 2011, respectively.
Provided below is selected financial information about the Company’s operations by segment for the periods ended December 31, 2013, 2012 and 2011:
On October 31, 2012, the Plan was amended to, among other things, extend the expiration date of the plan from November 11, 2012 to October 31, 2022 and increase the exercise price of the stock purchase rights from $80 per unit to $220 per unit. In connection with the amendments to the shareholders’ rights plan, the Board of Directors of the Company also amended the Company’s Articles of Incorporation to increase the number of shares designated under the rights plan as Series A Participating Preferred Stock from 100,000 shares to 200,000 shares. There were 1,000,000 shares of Preferred Stock authorized as of December 31, 2013 and 2012, with 200,000, being designated Class A Junior Participating Preferred Stock.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company invests its cash and cash equivalents into high credit quality security instruments.
On November 9, 2010, the Federal Deposit Insurance Corporation (“FDIC”) issued a Final Rule implementing section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that provides for unlimited insurance coverage of noninterest-bearing transaction accounts. Beginning December 31, 2010, through December 31, 2012, all noninterest bearing transaction accounts were fully insured, regardless of the balance of the account, at all FDIC insured institutions. All other deposits which exceed $250,000, including noninterest bearing transaction accounts prior to December 31, 2010, at each institution are not insured by the FDIC. Of the $20.8 million in cash and cash equivalents at December 31, 2012, $3.2 million was not insured by the FDIC.
The Company generates a significant amount of title insurance premiums in Texas, North Carolina and South Carolina. In 2013, 2012 and 2011, Texas accounted for 26.8%, 24.8% and 32.2% of total title premiums, respectively. In 2013, 2012 and 2011, North Carolina accounted for 27.4%, 30.5% and 26.6% of total title premiums, respectively. In 2013, 2012 and 2011, South Carolina accounted for 11.4%, 8.6% and 8.2% of total title premiums, respectively.
In 2013, 2012 and 2011, the Company had one agent that accounted for 16.4%, 14.0% and 22.6% of net premiums written, respectively.
The acquisition date fair value of the total consideration to be transferred was $1,041,250. This fair value total was equal to $350,000 ITIC had already paid toward the purchase price, as well as $691,250 in estimated contingent payments. As of December 31, 2013, management’s calculation of the fair value of consideration to be transferred is materially unchanged from its acquisition date amount. During the second quarter of 2013, ITIC paid an additional $350,000 toward the purchase price. The resulting contingent payments of $341,250 and $691,250 are categorized in the Consolidated Balance Sheets as Accounts payable and accrued liabilities as of December 31, 2013 and December 31, 2012, respectively.
As certain provisions of the membership interest purchase and sale agreement place the acquisition of the remaining 30% by ITIC out of ITIC’s control, the noncontrolling interest in United is deemed redeemable. The redeemable noncontrolling interest is presented outside of permanent equity, as redeemable equity in the Consolidated Balance Sheets. On the acquisition date, the fair value of the redeemable noncontrolling interest was $446,250. The fair value of the redeemable noncontrolling interest was based on the noncontrolling interest’s share of the value of net assets.
The following table provides a reconciliation of total redeemable equity for the periods ended December 31, 2013, 2012 and 2011:
The transaction was accounted for using the acquisition method required by ASC 805, Business Combinations. Accordingly, the Company recognized the required identifiable intangible assets of United. There was no goodwill recorded as a result of the acquisition. The fair values of intangible assets, all Level 3 inputs, are principally based on values obtained from a third party valuation service. At acquisition, intangible assets included $645,685 relating to a non-compete contract resulting from the acquisition and $836,215 from referral relationships. The non-compete contract is being amortized over a 10-year period using the straight-line method, starting at a future date when the related employment agreement is terminated. The referral relationships are being amortized over a 12-year period using the straight-line method. At December 31, 2013 and December 31, 2012, accumulated amortization of intangible assets was $121,947 and $52,263, respectively. Net intangible assets of $1,359,953 and $1,429,637 are categorized as prepaid expenses and other assets in the Consolidated Balance Sheets as of December 31, 2013 and December 31, 2012. In accordance with ASC 350, Intangibles - Goodwill and Other, the Company completed interim impairment testing and determined that the intangible assets assigned to United were not impaired at December 31, 2013.
The following tables illustrate changes in the balances of each component of accumulated other comprehensive income, net of tax, for the periods ended December 31, 2013, 2012 and 2011:
The following tables provide significant amounts reclassified out of each component of accumulated other comprehensive income for the periods ended December 31, 2013, 2012 and 2011: