The principal executive offices of the Company are located in the Old Republic Building in Chicago, Illinois. This Company owned building contains 151,000 square feet of floor space of which approximately 54% is occupied by Old Republic, and the remainder is leased to others. In addition to the Company-owned principal executive offices, a subsidiary of the Title Insurance Group partially occupies its headquarters building. This building contains 110,000 square feet of floor space of which approximately 65% is occupied by the Old Republic National Title Insurance Company. The remainder of the building is leased to others. Ten smaller buildings are owned by Old Republic and its subsidiaries in various parts of the country and are primarily used for its business. The carrying value of all buildings and related land at December 31, 2000 was approximately $19.1 million.
The Company does not own or utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its debt obligations. Traditional investment management tools and techniques are employed to address the yield and valuation exposures of its invested assets base. The long term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through asset diversification and the purchase of investment grade securities. Reinvestment rate risk is controlled by concentrating on non-callable issues, and by taking asset-liability matching practices into account; purchases of mortgage and asset backed securities, which have variable principal prepayment options, are generally avoided. Market value risk is limited through the purchase of bonds of intermediate maturity. The combination of these investment management tenets is expected to produce a more stable long term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration. The market value of the Company's long term fixed maturity investment portfolio is sensitive, however, to fluctuations in the level of interest rates, but not materially affected by changes in anticipated cash flows caused by any prepayments. The impact of interest rate movements on the long term fixed maturity investment portfolio generally affects net realized gains or losses when securities are sold. With a market value of approximately $4,338.5, the long term fixed maturity investment portfolio has an average maturity of 4.4 years and an indicated duration of 3.8. This implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the market value of the long term fixed maturity investment portfolio of approximately 3.8%, or $162. With regard to its $292.9 common stock portfolio, the Company does not own nor engage in any type of option writing. A 10% decrease in the U.S. equity market prices could result in a decrease of $29.2 in the market value of the Company's common stock portfolio. These possible declines in values for Old Republic's bond and stock portfolios would affect negatively the level of the common shareholders' equity account at any point in time, but would not necessarily result in the recognition of realized investment losses as a likely combination of positive operating cash flow and the scheduled emergence of bond maturities should provide sufficient funds to meet obligations to policyholders and claimants, as well as debt service and cash dividend requirements at the holding company level.
Old Republic's capitalization of $2,677.4 at December 31, 2000 consisted of long and short-term debt of $238.0, a minor amount of convertible preferred stock, and common shareholders' equity of $2,438.7. The changes in the common shareholders' equity account for the most recent three calendar years reflect primarily the retention of earnings in excess of dividends declared on outstanding preferred and common shares, an increase during 2000 and 1998 compared to a decrease during 1999 in the value of bonds and stocks carried at market value, and the acquisition of $66.4, $188.1 and $151.1 in 2000, 1999 and 1998, respectively, of the Company's common shares in open market transactions. In March 2000, the Company canceled 36.4 million common shares previously reported as treasury stock, restoring them to unissued status; this had no effect on total shareholders' equity or the financial condition of the Company. At its March 23, 2000 meeting, the Company's Board of Directors authorized the reacquisition of up to $200.0 of common shares as market conditions would warrant during the two year period from that date; as of December 31, 2000 a total of $177.3 of this authorization remained unutilized.
Consolidated net premiums and fees earned decreased by 2.5% and 1.6% in 2000 and 1999, respectively, and increased by 11.2% in 1998. Property and liability earned premiums increased 0.5% in 2000, and decreased 5.4% and 0.4% in 1999 and 1998, respectively. Premium production trends in this segment in the past three years were generally affected by a soft pricing environment that, until late 1999, made it difficult for the Company to obtain rate increases in a market place that's remained quite competitive. During the year 2000, Old Republic continued to shed some of the business for which it was unable to obtain necessary rate relief. Growth in mortgage guaranty premiums for the past three years was enhanced principally by relatively strong mortgage lending activity nationwide and by greater persistency of business in force in 1999 and 2000. Title Group premiums and fee revenues decreased 13.9% in 2000, and increased 2.8% in 1999 and 38.9% in 1998. Greater housing and mortgage finance activity were the main reasons for the rise in revenues in 1999 and 1998; the decrease in 2000 resulted mostly from a substantial decline in refinancings. Life and disability premiums in 2000 were approximately the same as in 1999; they decreased in 1999 due to reduced volume of Canadian travel accident insurance, and increased during 1998 as a result of greater term life and accident insurance production.
Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 43.8% in 2000, 46.8% in 1999 and 43.2% in 1998. The general insurance portion of the claims ratio improved in 2000 compared to 1999's; the ratio for the latter was significantly higher when compared to that for 1998. Greater severity for the most recent loss occurrences was mainly responsible for the higher general insurance claim ratio in the last two calendar years. The higher ratios were largely attributable to commercial automobile (truck) liability insurance coverages, though smaller parts of Old Republic's risk transfer business also experienced increases in 1999 in particular, when compared to 2000 and 1998. The loss ratio for mortgage guaranty insurance declined in each of the last three years; the improvement was mostly attributable to the strong employment and good general economic conditions which have led to lower loan default rates, and much higher cure rates for loans exhibiting payment difficulties. The title insurance loss ratio has been in the low single digits in each of the past three years due to a continuation of favorable trends in claims frequency and severity for business underwritten since 1992.
expense ratio remained approximately the same, averaging 28.3% during the latest three year period. The mortgage guaranty segment's expense ratio decreased in 2000 compared to 1999 and 1998 due to lower costs associated with an enhancement of information systems substantially completed in 1999, and a reduction in costs associated with contract underwriting services. The title insurance expense ratio was higher in 2000 and 1999 due in part to a decline or reduced growth in premium and fees relative to production and operating costs. Consumer and regulatory litigation and disputes in Old Republic's California title insurance subsidiary were responsible for expenses of $4.1, $16.2 and $19.5 charged to 2000, 1999 and 1998 operations, respectively. Consolidated interest and other corporate charges rose in 2000 due primarily to greater interest costs from a higher debt level.
Consolidated income before taxes increased by 34.5% in 2000, declined by 32.1% in 1999 and rose by 9.4% in 1998. General insurance results improved significantly in 2000 compared to 1999 due to better underwriting experience, which, nonetheless, was still lower than that achieved in 1998. The mortgage guaranty segment reflected rising earnings in each of the last three years due to increased premium revenues that generated higher income from underwriting operations, and higher investment income from a greater invested assets base. Title insurance earnings during the past three years were higher in 1998 compared to 2000 and 1999; this reflected the previously noted revenue and expense trends. Life and disability operations registered slightly increased earnings in 2000, whereas 1999 earnings benefited from the revision of certain actuarial factors used in calculating various life and health reserves and deferred acquisition costs. The net benefit of these revisions, the majority of which applied to 1999 premium revenues, amounted to approximately $4.8; this was partially offset by underwriting losses in Old Republic's Canadian travel accident coverages.
The effective consolidated income tax rates were 30.7% in 2000, 29.3% in 1999 and 31.2% in 1998. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from tax-sheltered investment income (principally tax-exempt interest) on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand. The lower rate in 1999 resulted from reduced income from underwriting and related services.
Any forward-looking commentary or inferences contained in this report involve, of necessity, assumptions, uncertainties, and risks that may affect the Company's future performance. With regard to Old Republic's General Insurance segment, its results can be affected in particular by the level of market competition which is typically a function of available capital and expected returns on such capital among competitors, the levels of interest and inflation rates, as well as periodic changes in claim frequency and severity patterns caused by natural disasters, weather conditions, accidents, illnesses, work-related injuries, and unanticipated external events. Mortgage Guaranty and Title insurance results can be affected by such factors as changes in national and regional housing demand and values, the availability and cost of mortgage loans, employment trends, and default rates on mortgage loans; mortgage guaranty results may also be affected by various risk-sharing arrangements with business producers as well as the risk management and pricing policies of government sponsored enterprises. Life and disability insurance results can be impacted by the levels of employment and consumer spending, as well as mortality and health trends. At the holding company level, operating earnings or losses are generally affected by the amount of debt outstanding and its cost, as well as interest income on temporary holdings of short-term investments.
Listed below are the financial statements included herein: OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES Page No. --------
- ------------ (*) At December 31, 2000 and 1999, there were 75,000,000 shares of $0.01 par value preferred stock authorized, of which 138,878 in 2000 and 153,183 in 1999 were convertible preferred shares issued and outstanding. As of the same dates, there were 500,000,000 shares of common stock, $1.00 par value, authorized, of which 121,444,862 in 2000 and 156,678,789 in 1999 were issued and outstanding. At December 31, 2000 and 1999 there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. Common shares classified as treasury stock were 3,191,362 and 34,479,299 as of December 31, 2000 and 1999, respectively.
(a) Consolidation Practices-The consolidated financial statements include the accounts of the Corporation and those of its major insurance underwriting and service subsidiaries. Non-consolidated insurance marketing and service sub sidiaries are insignificant and are reflected on the equity basis of accounting. All significant intercompany accounts and transactions have been eliminated in consolidation.
(c) Investments-The Company may classify its invested assets in terms of those assets relative to which it either (1) has the positive intent and ability to hold until maturity (generally carried at amortized costs for fixed maturity securities), (2) has available for sale (carried at fair value with adjustments to equity, net of deferred income taxes) or (3) has the intention of trading (carried at fair value with adjustments to income); as of December 31, 2000, the Company's invested assets were classified solely as "held to maturity" or "available for sale."
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 and equity securities are based on quoted market prices or estimates using values obtained from independent pricing services as applicable. Other long-term investments are carried at cost which approximates estimated realizable value.
The amortized cost and estimated fair value at December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Bonds and other investments carried at $161.3 as of December 31, 2000 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
At December 31, 2000, the Corporation and its subsidiaries had no non-income producing fixed maturity securities.
- ------------ (1) Investment expenses consist of personnel costs and investment management and custody service fees, and includes interest incurred on funds held of $1.5, $1.5 and $1.5 for the years ended December 31, 2000, 1999 and 1998, respectively. (2) Deferred income taxes do not apply since these securities are carried at amortized cost.
The Company has previously issued directly or assumed 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. Premium written is limited to renewal business written prior to 1998.
With respect to mortgage guaranty insurance (net insurance in force of $85,461.1 and $76,953.8, at December 31, 2000 and 1999, respectively) the Company's reserving policies are set forth below in Note 1(g).
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 the determination of liability for environmental claims. As of December 31, 2000, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
(h) Income Taxes-The Corporation and most of its subsidiaries file a consolidated tax return and provide for income taxes payable currently. 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. The Company uses the asset and liability method of calculating deferred income taxes. This method calls for 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.
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 $13.3 at December 31, 2000) credited to the former memorandum "policyholders' surplus account" will generally 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 1988 through 1995. The proposed adjustments pertain to the timing of certain deductions, the IRS' contention that certain salvage does not qualify for transition rule benefits, deductions for certain loss and unearned premium reserves, and several other issues not involving material amounts. The Company believes that substantially all of the proposed 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.
The Company sponsors a leveraged Employees 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, 2000, there were 7,220,514 Common Shares owned by the ESSOP of which 27,088 were unreleased and unallocated. There are no repurchase obligations in existence. (See Note 2).
(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 ($529.7 and $487.3 at December 31, 2000 and 1999, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
Scheduled maturities of the above debt at December 31, 2000 are as follows: 2001: $113.9; 2002: $.4; 2003: $.6; 2004: $.4; 2005: $.6; 2006 and after: $121.8. During 2000, 1999 and 1998, $15.9, $10.3 and $10.0, respectively, of interest expense on debt was charged to consolidated operations.
Note 3-Shareholders' Equity - All common and preferred share data herein has been retroactively adjusted as applicable for stock dividends or splits declared through December 31, 2000.
(a) Preferred Stock-The following table shows certain information pertaining to the Corporation's preferred shares issued and outstanding:
(c) Stock Option Plan-The Corporation has a stock option plan for certain eligible key employees. Outstanding options at any one time may not exceed 5% of the Old Republic common stock then issued and outstanding. The exercise price of options is equal to the market price of the Corporation's stock on the date of grant; the term of each option is generally ten years from such date. 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 subsequent calendar years. In the event the market closing price of the Old Republic common stock reaches a pre-established value ("the vesting acceleration price"), however, optionees may exercise their options to the extent of 10% of the number of shares covered by the option for each year of employment by the optionee. The option plan enables optionees to, alternatively, exercise their options into Series "G" Convertible Preferred Stock. The exercise of options into such Preferred Stock reduces by 5% the number of equivalent common shares which would otherwise be obtained from the exercise of options into common shares.
(d) Common Stock-There were 500,000,000 shares of common stock authorized at December 31, 2000. At the same date, there were 100,000,000 shares of Class "B" common stock authorized but none were issued or outstanding. Class "B" common shares have the same rights as common shares except for being entitled to 1/10th of a vote per share. In March 2000, the Company canceled 36,420,135 common shares previously reported as treasury stock, restoring them to unissued status; this had no effect on total shareholders' equity or the financial position of the Company.
(e) Undistributed Earnings-The equity of the Corporation in the undistributed earnings, determined in accordance with generally accepted accounting principles, and in the net unrealized investment gains (losses) of its respective subsidiaries at December 31, 2000 amounted to $1,722.7 and $46.0, respectively. Dividends declared during 2000, 1999 and 1998, to the Corporation by its subsidiaries amounted to $119.6, $178.9 and $158.2, respectively.
Note 4-Commitments and Contingent Liabilities: (a) Reinsurance-In order to maintain premium production within their capacity and to limit maximum losses for which they might become liable under policies underwritten, Old Republic's insurance subsidiaries, as is the common practice in the insurance industry, cede all or a portion of their premiums and liabilities on certain classes of business to other insurers and reinsurers. Although the ceding of insurance does not ordinarily discharge an insurer from liability to a policyholder, it is industry practice to establish the reinsured part of risks as the liability of the reinsurer. Old Republic also employs retrospective premium, contingent commission, and profit sharing arrangements for parts of its business in order to minimize losses for which it might become liable under insurance policies underwritten by it. To the extent that any reinsurance companies or retrospectively rated risks or producers might be unable to meet their obligations under existing reinsurance or retrospective insurance and agency agreements, Old Republic would be liable for the defaulted amounts. As deemed necessary, reinsurance ceded to other companies is secured by letters of credit, cash, and/or securities.
The Federal Department of Labor has revised the Federal Black Lung Program regulations effective January 19, 2001. These new regulations, which might require a re-evaluation of previously settled or denied workers' compensation claims, are being challenged in court by the insurance and coal mining industries. At this time, the outcome of this challenge is uncertain and the potential impact on gross and net of reinsurance reserves or retrospective rating policies due to the revised regulations is not measurable.
In mid October, 2000, the California Department of Insurance (CDI) filed a complaint against the above referenced subsidiary. The complaint alleges violations of certain sections of the Insurance Code that prohibit any form of considerations to induce the referral of business to a title company. The CDI is seeking a maximum monetary penalty of $3.8. The Company believes it has meritorious defenses to the allegations and that its overall claim and other expense accruals are sufficient to cover these and other known exposures.
Note 5-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 2000 is presented below.
The General Insurance Group provides property and liability insurance primarily to commercial clients. Old Republic does not have a meaningful participation in personal lines of insurance. Commercial automobile (principally trucking) insurance is the largest type of coverage underwritten by the General Insurance Group accounting for approximately 41.9% of the Group's direct premiums written in 2000. The remaining premiums written by the General Insurance Group are derived largely from a wide variety of coverages, including workers' compensation, general liability, loan credit guaranty, and surety bonds. The General Insurance Group's operations have been expanded over the years to insure certain specialty lines such as directors' and officers' liability and errors and omissions liability insurance, to cover owners and operators of private aircraft for hull and liability exposures, and to provide automobile and home warranties.
Home mortgage loan insurance produced by the Mortgage Guaranty Group protects lending institutions against certain losses, generally to the extent of 10% to 35% of the sum of the outstanding amount of each insured mortgage loan, and allowable costs incurred in the event of default by the borrower. The Corporation insures only first mortgage loans, primarily on residential properties having one-to-four family dwelling units. Mortgage guaranty insurance premiums originate from savings and loan associations, mortgage bankers and other lending institutions. The Corporation's residential home loan insurance business is originated, approximately 15% by savings and loan associations, 65% by mortgage bankers and 20% by other lenders. The Mortgage Guaranty segment's ten largest customers were responsible for approximately 60.3%, 48.9% and 44.5% of direct insurance in force for the years ended December 31, 2000, 1999 and 1998, respectively. The largest single customer accounted for 11.7% of the direct insurance in force for the year ended December 31, 2000 compared to 9.5% in 1999 and 9.0% in 1998.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, preferred stock and common shareholders' equity and cash flows present fairly, in all material respects, the financial position of Old Republic International Corporation and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.