Certain other operations of the Company and its subsidiaries are directed from leased premises. See Note 5(b) of the Notes to Consolidated Financial Statements for a summary of all material lease obligations.
In 1993, the Company adopted several changes in accounting policies to comply with Financial Accounting Standards Board (FASB) pronouncements. The resulting adoption of the asset and liability method for calculating deferred income taxes and the recognition of present value liabilities pertaining to post - -retirement health benefits under retirement plans maintained by a few Old Republic subsidiaries increased net income by $8.6 or 15 cents per share (14 cents fully diluted) in the first quarter of 1993. The Company also reexamined the classification of its invested assets which led to reporting such assets as either "held to maturity" or "available for sale"; the effect of these classification changes was to increase assets and the liability for deferred taxes by $25.2 and $8.7, respectively, and common shareholders' equity for the net unrealized appreciation of securities newly reclassified at fair value by $16.4 or 32 cents per common share as of December 31, 1993.
In November 1995, the Company reevaluated the classification of invested assets, as permitted by a Special Report issued by the FASB in November 1995. As a result, the Company reclassified from "held to maturity" to "available for sale" certain fixed maturity securities with an amortized cost of $1,365.7, fair value of $1,394.2 and an unrealized gain of $28.4. The unrealized gain, net of deferred income taxes of $9.9, has been credited directly to a separate account in the common shareholders' equity section of the balance sheet in the final quarter of 1995.
In the fourth quarter of 1995, the Company's Mortgage Guaranty Group adopted the accrual method for recording past-due premium revenues and the related premium receivable arising from new monthly premium policies. This new payment mode has emerged as a significant factor for the mortgage guaranty industry since mid-1994. Before adoption of this accrual method, past-due premiums were recognized on receipt of cash. With the adoption of this accrual method, a cumulative increase in net premiums written of $9.8 million, net premiums earned of $6.3 million, and post-tax income of $3.9 million or 6 cents per fully diluted share was reflected in the Company's final quarter and the year of 1995.
Old Republic's financial position at December 31, 1995 reflected increases in assets of 5.3%, liabilities of 1.0%, and common shareholders' equity of 21.3% when compared to the immediately preceding year-end. At December 31, 1995 and 1994, cash and invested assets represented 67.0% and 62.4% of consolidated assets, respectively. Relatively high short-term investment positions were maintained as of the most recent year-ends to provide necessary liquidity for specific operating needs, and flexibility in investment strategy. Changes in short-term investments reflect a variety of seasonal and intermediate-term factors including seasonal operating cash needs, investment strategy, and expectations as to trends in interest yields. Accordingly, the future level of short-term investments will vary and respond to the dynamics of these factors and may, as a result, increase or decrease from current levels. During 1995 and 1994, the Corporation committed substantially all investable funds in short to intermediate-term fixed maturity securities. In the latter regard, Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; the Corporation has not directed its investable funds to so-called "junk bonds" or derivative types of securities. During 1995, Old Republic's commitment to equity securities decreased by 52.2% vis-a-vis the related invested balance at year-end 1994. As of December 31, 1995, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in relation to consolidated assets or shareholders' equity.
Consolidated operations produced positive cash flows for the latest three years. The decline in cash flow from operations in 1994 was due mainly to a substantial drop in title segment revenues and profitability, and a small decline in property and liability insurance premiums. The parent holding company has met its liquidity and capital needs for the past three years through dividends paid by its subsidiaries and through the issuance of debt. The insurance subsidiaries' ability to pay cash dividends to the parent company is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. Additionally, the terms of guarantees by the Company of bank loans to the trustee of the Company's Employees Savings and Stock Ownership Plan require the Company to maintain a minimum consolidated tangible net worth and restrict the amount of debt the Company may incur, both of which covenants are being met.
Old Republic's capitalization of $2,005.6 at December 31, 1995 consisted of debt and debt equivalents of $320.5, redeemable convertible preferred stock of $17.0 (excluding $11.7 of such stock classified as a debt equivalent), convertible preferred stock of $.6 , cumulative preferred stock of $54.8, and common shareholders' equity of $1,612.5. The rise in the common shareholders' equity account during the past three years reflects primarily the retention of earnings in excess of dividends declared on outstanding preferred and common shares, the conversion of preferred stock to common stock and an increase during 1995 in the carrying value of fixed maturity and equity securities stated at fair value.
Net premiums and fees earned decreased by 3.5% and 1.6% in 1995 and 1994 and increased by 11.9% in 1993. In 1993 property and liability insurance premium increases were due to varying levels of growth in certain parts of the Company's business, but principally among liability coverages. In 1994 and 1995, lower property and liability premium growth was due to a continuation of a soft premium rate environment for most insurance coverages and lower participation in involuntary market pools. For the past three years, mortgage guaranty premiums have increased due to a rise in the amount of renewal and new business, and market expansion. Depressed conditions in the large California housing market and much lower refinancing activity nationwide resulted in reduced title insurance revenues in 1995 and 1994. Greater housing and mortgage refinancing activity during 1993 had led to higher revenues in the title segment. Life and disability premium volume increased moderately during the last three years as a result of greater term life and accident insurance production.
While the Company's investment policies have not been designed to maximize realized investment gains, such gains were higher in 1995 and 1993 than those realized in 1994. Dispositions of securities have been
caused principally by calls prior to maturity by issuers and by sales of equity securities. In 1995, approximately 59% of total fixed maturity securities dispositions represented contractual maturities and early calls of existing holdings; for the year 1994 these amounted to approximately 64%.
Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 54% in 1995, 53% in 1994 and 56% in 1993. This consolidated ratio was affected principally by an improving claim ratio for liability insurance coverages. Through 1993 the Corporation's property and liability insurance subsidiaries, along with other companies in the industry, sustained higher loss assessments for residual market (assigned risk) business. In 1995 and 1994, provisions for such assessments declined as a result of the aforementioned reduction in residual market participations by the Company's subsidiaries and by moderately improving premium rates for workers compensation insurance. Additionally, Old Republic's general insurance results for 1994 benefitted from improved underwriting performance in its property and other non-liability lines due to lower loss ratios. Policyholders' dividends incurred mainly for the Corporation's workers compensation insurance coverages for each year reflect changes in the loss ratio for individual experience-rated policies. The loss ratio rose in 1995 and 1994 in the mortgage guaranty insurance line due to a rise in frequency of claim occurrences, mostly in the California market which has been affected by an economic slowdown for the past several years. The title insurance loss ratio in 1995 and 1994 was affected by favorable trends in claims frequency and severity for business underwritten since 1992, while higher than normal claim provisions in 1993 added approximately 3 percentage points to this group's loss ratio.
Income before taxes decreased by 7% and 3% in 1994 and 1993, respectively, and increased by 40% in 1995. General insurance results have trended up during the past five years and have continued as the largest contributor to consolidated earnings, principally as a result of greater investment income; in 1995 and 1994, however, improved earnings in this segment were also affected favorably by better underwriting results. The mortgage guaranty segment reflected significantly improved earnings in each of the last three years due to increased revenues, and, as noted above, a declining expense ratio. Title insurance operating results were much reduced in 1995 and 1994 due to the previously noted decline in revenues, while they increased in 1993 as a result of much greater mortgage refinancing activity. Life and disability operations have posted relatively flat earnings in the past three years. Consolidated pre-tax income for 1995 and 1993 was also affected positively by greater than normal realization of investment gains.
Old Republic International Corporation is a Chicago-based insurance holding company with subsidiaries engaged in the general (property & liability), mortgage guaranty, title, and life (life & disability) insurance businesses. In this report, "Old Republic", "the Corporation", or "the Company" refers to Old Republic International Corporation and its subsidiaries as the context requires. The aforementioned insurance segments are organized as the Old Republic General, Mortgage Guaranty, Title, and Life Groups, and references herein to such groups apply to the Company's subsidiaries engaged in the respective segments of business. See Note 7 for a discussion of the Company's business segments.
Note 1-Summary of Significant Accounting Policies-The significant accounting policies employed by Old Republic International Corporation and its subsidiaries are set forth in the following summary.
Fixed maturity securities and redeemable preferred stocks classified as "held to maturity" are generally carried at amortized costs while fixed maturity securities classified as "available for sale" in addition to other preferred and common stocks (equity securities) are included at fair value. Fair values for fixed maturity securities are based on quoted market prices or estimated using values obtained from independent pricing services as applicable. Mortgage and policy loans (other long-term investments) are carried on the basis of the lower of unpaid principal balances or estimated realizable value. The aggregate fair value of fixed maturity securities - "held to maturity" at December 31, 1995 was above their carrying values.
At December 31, 1995, the Corporation and its subsidiaries had non-income producing investments aggregating $0.1.
(e) Deferred Policy Acquisition Costs-The Corporation's insurance subsidiaries, other than title companies, defer certain costs which vary with and are primarily related to the production of business. Deferred costs consist principally of commissions, premium taxes, marketing, and policy issuance expenses. With respect to most coverages, deferred acquisition costs are amortized on the same basis as the related premiums are earned or,alternatively, over the periods during which premiums will be paid or underwriting and claim services performed. The following table summarizes deferred policy acquisition costs and related data for the years shown:
The Company issues, directly or as a reinsurer, certain insurance policies generally categorized as financial guarantees. The major types of guarantees pertain to (a) state, municipal and other general or special revenue bonds, (b) variable interest rate guarantees, and (c) insurance of the future residual value of fixed assets. The types of risks involved include failure by the bond issuer to make timely payment of principal and interest, changes in interest rates, and changes in the future value of fixed assets. The degree of risk pertaining to these insurance products is largely dependent on the effects of general economic cycles and changes in the credit worthiness of issuers whose obligations have been guaranteed. During the past three years, new commitments have been limited to those identified at (a) immediately above.
With respect to mortgage guaranty insurance (net insurance in force of $38,862.7 and $30,405.3, at December 31, 1995 and 1994, respectively) the Company's reserving policies are set forth below in Note 1(g).
sation reserves, however, are discounted to present value based on interest rates ranging from 3.5% to 4%.
Individual insurance companies and others who have evaluated the potential costs of litigating and settling A&E claims have noted with increasing concern the possibility that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, could likely bankrupt or undermine seriously the financial condition of the property and liability insurance industry. In the light of this substantial public policy issue, the Corporation is of the view that the courts will not resolve in the near future the litigation gridlock stemming from the non-resolution to date of many environmental claims in particular. In recent times, the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting environmental claims. As of December 31, 1995, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
Life Insurance companies domiciled in the United States and qualifying as life insurers for tax purposes are taxed under special provisions of the Internal Revenue Code. As a result of legislation, 1983 and prior years' tax deferred earnings (cumulatively $20.4 at December 31, 1995) credited to the former memorandum "policyholders' surplus account" will not be taxed unless they are subsequently distributed to shareholders. The Company does not presently anticipate any distribution or payment of taxes on such earnings in the future.
As a result of regular examinations of the tax returns for the Corporation and its subsidiaries, the Internal Revenue Service ("IRS") has proposed certain adjustments for additional taxes applicable to the years 1982 to 1993. The proposed adjustments pertain to the timing of certain deductions, the IRS's contention that contractually obligated premium refunds should be treated as dividends, deductions for certain loss and related reserves, a reinsurance transaction, and several other issues not involving material amounts.The Company and its tax counsel believe that substantially all of the proposed material adjustments are without merit, that the Company will be successful in vigorously defending its positions, and that the ultimate adjustments, if any, will not significantly affect its financial condition or results of operations. During 1995 and 1994, certain of the proposed adjustments were finally settled for immaterial amounts.
(i) Property and Equipment-Property and equipment is generally depreciated or amortized over the estimated useful lives of the assets, (2 to 45 years), substantially by the straight-line method. Expenditures for maintenance and repairs are charged to income as incurred, and expenditures for major renewals and additions are capitalized.
(k) Goodwill-The costs of certain purchased subsidiaries in excess of related book values (goodwill) at date of acquisition are being amortized against operations principally over 40 years using the straight-line method. Amortization of goodwill amounted to $3.2 in 1995, $3.1 in 1994 and $3.2 in 1993.
The Company sponsors a leveraged Employee Savings and Stock Ownership Plan (ESSOP) in which a majority of its employees participate. The ESSOP acquired all of its stock of the Company in 1987 and prior years. Accordingly, it is not required to adopt the American Institute of Certified Public Accountants' SOP No. 93-6, "Employers' Accounting for Employee Stock Ownership Plans." Shares of Company stock owned by the ESSOP are released to participants based on a formula prescribed by the Employee Retirement Income Security Act of 1974, and dividends on released shares are allocated to participants as earnings. The Company's contributions are based on a formula considering growth in net income per share over consecutive five year periods. As of December 31, 1995, there were 22,256,680 Series "D" Redeemable Convertible Preferred Shares and 447,248 Common Shares owned by the ESSOP of which 4,929,467 Series "D" Redeemable Convertible Preferred Shares and 23,050 Common Shares were unreleased and unallocated. There are no repurchase obligations in existence. (See Note 3).
(m) Escrow Funds-Segregated cash deposit accounts and the offsetting liabilities for escrow deposits in connection with Title Insurance Group real estate transactions in the same amounts ($299.5 and $198.7 at December 31, 1995 and 1994, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(n) Earnings Per Share-Consolidated primary earnings per share are based upon the weighted average number of shares outstanding during each year, retroactively adjusted for all stock dividends and splits declared through December 31, 1995. Dividend requirements of $4.9 in 1995, $5.1 in 1994 and $5.2 in 1993 on preferred stock have been considered in per share calculations. The average number of common shares used in 1995, 1994 and 1993 earnings per share calculations reflect the pro forma inclusion of 5,165,377, 5,323,170 and 5,476,047 incremental common shares, respectively, which would be issued upon conversion and/or exercise of dilutive convertible preferred and stock option shares. Fully diluted earnings per share are similarly calculated with the inclusion of substantially all convertible securities and stock options includable for each year; no such data is shown when the calculations are anti- dilutive.
(o) Cash Flows-For purposes of the Consolidated Statements of Cash Flows, the Company considers short-term investments, consisting of money market funds, certificates of deposit, and commercial paper with maturities of less than 90 days to be cash equivalents. These securities are carried at cost which approximates fair value.
(p) Concentration of Credit Risk-Excluding U.S. government fixed maturity securities, the Company is not exposed to any significant credit concentration risk.
Note 2-Investments -Bonds and other investments carried at $163.1 as of December 31, 1995 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
__________ (a) The Company has guaranteed bank loans (balance at December 31, 1995 was $11.7) to a Trust established by the Old Republic Employees Savings and Stock Ownership Plan ("ESSOP").The loans have been used to fund the purchase of Series "B" and Series "D" Redeemable Convertible Preferred Stock from the Company by the trust for the original amount of the loans. The Trust's loan principal repayments (currently scheduled at $2.8 in 1996, $2.7 in 1997, $1.0 in 1998, $2.6 in 1999 and $2.5 in 2000) are expected to be met by annual profit sharing contributions by the Corporation and its participating subsidiaries, while interest payments are to be covered by Trust income, including dividends on the Corporation's stock held by the ESSOP. The interest rate on the Trust's loans of $11.7 is payable quarterly and at rates ranging from 75% to 84% of the prime rate. See Notes 4a and 4b. (b) Each one thousand dollar convertible debenture maturing in 2002, may be converted at any time into 39.024 common shares. See note (c) below. (c) In February 1996, the Company called for the redemption of its 10% debentures maturing in 2018 and its 5.75% convertible subordinated debentures of 2002; redemption of the former will be effected with available funds, while the latter are expected to be converted into approximately 4.3 million Old Republic common shares.
(b) Cash Dividend Restrictions-The payment of cash dividends by the Corporation is principally dependent upon the amount of its insurance subsidiaries' statutory policyholders' surplus available for dividend distribution. The insurance subsidiaries' ability to pay cash dividends to the Corporation is in turn generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. These authorities recognize only statutory accounting practices for determining financial position, results of operations, and the ability of an insurer to pay dividends to its shareholders. Based on 1995 data, the maximum amount of dividends payable to the Corporation by its insurance and a small number of non- insurance company subsidiaries during 1996 without the prior approval of appropriate regulatory authorities is approximately $209.5. However, management does not expect to distribute all such dividends since reinvested earnings are the Corporation's major source of capital to promote its growth, and support its obligations to policyholders.
(d) Stock Option Plans-The Corporation has had non-qualified, stock option plans (the 1979, 1985 and 1992 plans) for its key employees and those of its eligible subsidiaries since 1979. The plans provide for the issuance of options for up to 5% of the Old Republic common stock issued and outstanding at any one time. The term of each option is generally 10 years from the date of grant. Under ordinary circumstances, options may be exercised to the extent of 10% of the number of shares covered thereby on and after the date of grant and cumulatively to the extent of an additional 10% on and after each of the first through ninth anniversaries of the date of grant. The Corporation may extend 15 year loans at a prevailing market rate of interest for a portion of the exercise price. Amendments to the plans also enable optionees to, alternatively, exercise their options into Series "G" or Series "G-2" Convertible Preferred Stock. The exercise of options into such Series "G" or Series "G-2" Convertible Preferred stock reduces by 5% the number of equivalent common shares which would otherwise be obtained from the exercise of options into common shares.
During 1995, the Corporation issued a total of 661,042 common shares valued at $13.7 to effect two small acquisitions which were not material to Old Republic's financial position or operating results.
(g) Treasury Stock-A total of 5,540,360 common shares issued and outstanding are held by consolidated affiliates. See "Related Party Transactions" herein.
The following information relates to reinsurance and related data for the General Insurance, Mortgage Guaranty and Life Insurance Groups for the three years ended December 31, 1995. For the years 1993 to 1995, reinsurance transactions of the Title Insurance Group have not been material.
Note 6-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 1995 is presented below. In the fourth quarter of 1995, the Company's Mortgage Guaranty Group adopted the accrual method for recording past-due premium revenues and the related premium receivable arising from new monthly premium policies. This new payment mode has emerged as a significant factor for the mortgage guaranty industry since mid-1994. Before adoption of this accrual method, past-due premiums were recognized on receipt of cash. With the adoption this accrual method, a cumulative increase in net premiums written of $9.8 million, net premiums earned of $6.3 million, and post-tax income of $3.9 million or six cents per fully diluted share was reflected in the Company's final quarter and year of 1995.
Note 8-Related Party Transactions - At December 31, 1995 and 1994, the Corporation owned 98.85% of the non-voting common shares, and 40% of the voting common and preferred shares of the American Business & Mercantile Insurance Group, Inc., ("AB&M Group" or "Group"), an affiliated insurance holding company engaged in the property and liability reinsurance business.As of the same dates, the American Business & Personal Insurance Mutual, Inc. ("Mutual"), a property & liability mutual insurer owned by its policyholders, held directly or through a subsidiary .04% of the non-voting common shares and 60% of the Group's voting common and preferred shares. At both dates, 1.11% of the Group's non-voting common shares were held by public shareholders.
Certain subsidiaries of the Company have sold various accounts receivable to a finance company subsidiary of the Mutual. Total receivables sold as of December 31, 1995 and 1994 amounted to approximately $6.0 and $6.6,respectively.
In the normal course of business, the Company cedes, on the same terms as apply to unrelated reinsurers, certain parts of its outgoing reinsurance to a foreign reinsurer in which it has an equity interest. Total premiums ceded to this reinsurer amounted to approximately $6.0 in 1995, $6.1 in 1994 and $5.6 in 1993. As of December 31, 1995 and 1994, total premium and loss reserve credits taken on account of cumulative cessions aggregated $65.6 and $67.1, respectively, all of which credits were collateralized by cash, investments and funds held amounting to $73.2 and $69.0, respectively.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Old Republic International Corporation and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.