Consolidated operations produced positive cash flows for the latest three years. 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 and equity securities. 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.
In August 1992, the Company issued $110 of 5 3/4% convertible debentures maturing in 2002. Net proceeds from this offering were used to redeem approximately $50 of commercial paper debt, with the remainder allocated to the capital of several insurance subsidiaries. Convertible debt of approximately $41.3 outstanding at December 31, 1991 was converted into 2,676,284 shares of Old Republic common stock during 1992. Old Republic's capitalization of $1,617.7 at December 31, 1993 consisted of debt and debt equivalents of $282.7, redeemable convertible preferred stock of $16.6 (excluding $15.1 of such stock classified as a debt equivalent), conver- tible preferred stock of $3.9, cumulative preferred stock of $57.5, and common shareholders' equity of $1,256.9. 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 debt and preferred stock to common stock, and the previously noted net unrealized appreciation of securities.
Net investment income was relatively flat in 1993 and grew by 1% and 6% in 1992 and 1991, respectively. For each of the past three years, the growth in this revenue source was bolstered by positive consolidated operating cash flows and a concentration of investable assets in interest-bearing, fixed maturity securities. The average annual yield on investments was 6.4%, 7.3%, and 8.1% for the years ended December 31, 1993, 1992 and 1991, respectively; the downward trend reflects principally the declining current yields in the securities markets.
During 1992 the Company's Title Insurance Group established greater than normal loss provisions of $15.0 as additional funding for various title escrow claims in process of disposition. In 1992, the Company's life insurance subsidiaries recorded previously unrecognized tax recoveries of $1.1 and related interest credits of approximately $12.4 stemming from resolution of various long-standing Internal Revenue Service disputes applicable to taxable years 1969 to 1981. These charges and credits served to increase consolidated revenues by $12.4 and claim costs by $15.0, and to record net current and deferred income tax credits of $1.1. Above normal additions to Title Insurance Group claim reserves during 1993 affected adversely pre-tax income by approximately $13.3.
The Revenue Reconciliation Act of 1990 (the "RRA") provided for a number of changes affecting the taxation of the Corporation and a number of its subsidiaries. Among such changes are acceleration in the recognition of salvage and subrogation recoveries and deferral of costs associated with the production of life and disability business and the subsequent amortization of those costs. The TRA also provided for a number of changes affecting the taxation of the Corporation and a number of its subsidiaries. Among such changes are reductions in corporate tax rates, the discounting of loss reserves, the acceleration of premium income recognition, and the inclusion in taxable income of a portion of certain tax-exempt investment income previously not subject to tax. In addition, the TRA calls for the calculation of an alternative minimum tax. The RRA and TRA are likely to result in accelerated payment of federal income taxes. However, most of the additional tax payments are treated as timing differences for financial accounting purposes. Consequently, such payments are expected to have minimal effects on consolidated results of operations and financial position determined in accordance with generally accepted accounting principles.
Historical data pertaining to the operating results, liquidity, and other financial matters applicable to an insurance enterprise such as the Corporation, are not necessarily indicative of results to be achieved in succeeding years. The long-term nature of the insurance business, seasonal and annual patterns in premium production and incidence of claims, changes in yields obtained on invested assets, and changes in government policies and free markets affecting inflation rates and general economic conditions are some of the factors which have a bearing on year-to-year comparisons and future operating results.
Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Preferred Stock and Common Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Accountants
Proceeds from sales of fixed maturity securities-available for sale were $188.3 and fixed maturity securities-held to maturity were $486.8 during 1993 while proceeds from sales of fixed maturity securities were $1,473.0 in 1992. Gross gains of $19.5 and gross losses of $4.1 were realized on sales of fixed maturity securities-available for sale during 1993, and gross gains of $68.8 and gross losses of $7.8 were realized on the sales of fixed maturity securities during 1992.
Investment income is reported net of allocated expenses and includes appropriate adjustments for amortization of premium and accretion of discount on bonds and notes acquired at other than par value. Dividends on stock are credited to income on the ex-dividend date. Realized investment gains and losses are reflected in the income statement and are determined on the basis of amortized value at date of sale for bonds and notes, and cost in regard to stocks; such bases apply to the specific securities sold. Unrealized investment gains and losses, net of any deferred income taxes, are recorded directly in a separate account of shareholders' equity. Net unrealized appreciation of securities at December 31, 1993 included gross unrealized gains and losses of $41.6 and $3.6, respectively.
At December 31, 1993, the Corporation and its subsidiaries had non-income producing investments aggregating $1.5.
At December 31, 1993 and 1992, the Life Insurance Group had $4,286.7 and $3,515.5, respectively, of net life insurance in force. Future policy liabilities and unearned premiums, consisted of the following:
(h) Income Taxes-The Corporation and most of its subsidiaries file a consolidated tax return and provide for income taxes payable currently. The tax benefits of net operating losses are recognized in the periods during which they become recoverable. Deferred income taxes included in the accompanying consolidated financial statements pursuant to generally accepted accounting principles will not necessarily become payable/recoverable in the future. Effective January 1, 1993 the Company adopted Financial Accounting Standard (FAS) No. 109 "Accounting for Income Taxes." FAS No. 109 requires a change to the asset and liability method of calculating deferred income taxes. The cumulative effect of this change resulted in an increase in net income of $13.3, or $.23 per share ($.22 fully diluted) in 1993. This method requires the establishment of a deferred tax, calculated at currently effective tax rates, for the cumulative temporary differences between financial statement and tax bases of assets and liabilities. Prior to January 1, 1993 deferred income taxes applicable to income and expense items reported in the consolidated financial statements in different periods than for tax purposes were established.
Deferred policy acquisition costs $ 5.7 $ 1.2 Future policy benefits 3.5 (1.0) Loss and unearned premium reserve discounting and amortization (4.9) (16.4) Fresh start amortization of discounted loss reserves (1.9) (3.6) Contingency reserves 17.2 5.0 Other items - net .9 (.3) Total $ 20.5 $ (15.1)
The tax effects of temporary differences that give rise to significant portions of the Company's net deferred tax recoverable are as follows at the dates shown:
December 31, 1993 January 1, 1993 Deferred Tax Assets: Future policy benefits $ 1.7 $ 1.5 Losses, claims, and settlement expenses 182.2 165.4 Unearned premium reserves 6.2 3.4 Other 8.7 8.6 Total gross deferred tax assets 199.0 178.9 Less-valuation allowance 3.9 4.1 Net deferred tax assets 195.0 174.8 Deferred Tax Liabilities: Deferred policy acquisition costs 34.2 27.8 Mortgage Guaranty insurers contingency reserves 43.2 25.1 Fixed maturity securities adjusted to costs 4.8 3.4 Unrealized investment gains 10.2 2.6 Title plants and records 3.4 3.3 Other 15.7 18.8 Total deferred tax liability $111.9 81.3 Net deferred tax asset $ 83.2 $ 93.4
(j) Title Plants and Records-Title plants and records are carried at original cost or appraised value at date of purchase. Such values represent the cost of producing or acquiring interests in title records and indexes and the appraised value of purchased subsidiaries' title records and indexes at dates of acquisition. The cost of maintaining, updating, and operating title records is charged to income as incurred. Title records and indexes are not being amortized since they have an indefinite life and do not diminish in value.
(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 1993, $3.0 in 1992, and $2.9 in 1991.
(p) Concentration of Credit Risk-Excluding U.S. government bonds and notes, the Company is not exposed to any significant credit concentration risk.
Note 2-Investments - Bonds and other investments carried at $160.7 as of December 31, 1993 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
(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 10 years from the date of grant, although some options have a 15 year term. 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 have otherwise been obtained from the exercise of options. Under the 1979 plan, the employee's right to exercise his options is accelerated if the Corporation is dissolved or liquidated, merges or consolidates with another company and the Corporation is not the surviving corporation, or more than 50% of the members of the Board of Directors of the Corporation change in any one year unless one or more of the new directors was nominated by the Board of Directors of the Corporation.
Option prices represent the per share market price on the date of grant. No charge is made to earnings in connection with the granting or exercise of nonqualified stock options. In conjunction with the purchase or merger of various companies, the Corporation has assumed the stock option obligations under various qualified and nonqualified stock option plans previously adopted by such companies. These plans were terminated as of the merger dates, and existing options at that date became exercisable into Old Republic common shares at their original price adjusted for the appropriate exchange ratios pertaining to each merger. At December 31, 1993, options for 23,822 shares were outstanding and 21,960 shares were exercisable under all of these plans at prices ranging between $7.72 and $10.00 per share. Options for 24,568; 74,440; and 42,452 were exercised for a total consideration of approximately $0.1, $0.5 and $0.5 during 1993, 1992 and 1991, respectively.
Reinsurance protection for General Insurance operations generally limits the net loss on any one risk as follows (in thousands): fire and other physical perils-$20; accident and health-$15; workers' compensation-$1,000 and other liability-$600; loan credit guaranty-$200. Title insurance risk assumptions, based on the title insurance subsidiary's financial resources, are currently limited to $15,000 as to any one policy. A substantial portion of the mortgage guaranty insurance business is retained, with the exposure on any one risk currently averaging less than $20. The maximum amount of ordinary life insurance retained on any one life by the Life Insurance Group (without reinsurance) is $250.
Most of the reinsurance ceded by the Corporation's insurance subsidiaries in the ordinary course of business is placed on a quota share or excess of loss basis. Under quota share reinsurance, the companies remit an agreed upon percentage of their premiums written to assuming companies and are reimbursed for a pro-rata share of claims and commissions incurred and for a ceding commission to cover expenses and costs for underwriting and claim services performed. Under excess of loss reinsurance agreements, the companies are generally reimbursed for losses exceeding contractually agreed-upon levels. 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, 1993. For the years 1991 to 1993, reinsurance transactions of the Title Insurance Group have not been material.
Pursuant to underwriting and investment management agreements, Old Republic receives management fees for administering the affairs of the Group's reinsurance subsidiary and those of the Mutual. Pursuant to reinsurance treaties, the Group is a quota share participant in various types of primary and assumed reinsurance contracts produced through Old Republic underwriting facilities. Fees received in the past three years by Old Republic were im- material. The following table shows reinsurance cessions and retrocessions to the Group's reinsurance subsidiary and assumptions by Old Republic of business ceded by the Mutual for the last three years.
At December 31, 1993 and 1992, the Group held approximately 8.0% and 8.2%, respectively, of Old Republic's issued and outstanding common shares. For financial accounting purposes only, 4,439,267 of such shares have been treated as treasury shares at each respective date in consolidating the Group's accounts with those of the Corporation.
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 $5.6 in 1993, $5.8 in 1992, and $3.3 in 1991. As of December 31, 1993 and 1992, total premium and loss reserve credits taken on account of cumulative cessions aggregated $63.7 and $50.6, respectively, all of which credits were collateralized by cash, investments and funds held amounting to $70.7 and $56.7, respectively.
Pursuant to a branch management agreement, EGI supervises the solicitation and underwriting of all lines of insurance that two insurance subsidiaries of Old Republic are authorized to write. EGI's Texas domiciled insurance subsidiary has entered into a quota share reinsurance treaty with an insurance subsidiary of Old Republic. Under the reinsurance treaty, EGI's insurance subsidiary will reinsure the net retained amount of business produced by EGI and its subsidiaries.
EGI has also entered into an investment counsel agreement with Old Republic. Old Republic provides investment advise, accounting services and assists EGI in executing purchases and sales of investments. Fees received by Old Republic were immaterial.