The Company issues title insurance policies through its home and branch offices and through a network of agents. Issuing agents are typically real estate attorneys, independent agents or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company’s marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company’s growth in title insurance premiums written.
The Company’s volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes property sales, mortgage financing and mortgage refinancing. Real estate activity, home sales and mortgage lending are cyclical in nature. Real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels, and general United States economic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.
The Company’s exchange services division, consisting of the operations of ITEC and ITAC, provides customer services in connection with tax-deferred real property exchanges. ITEC acts as a qualified intermediary in tax-deferred exchanges of real property held for productive use in a trade or business or for investment, and its income is derived from fees for handling exchange transactions and interest earned on client deposits held by the Company. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction, and its duties include drafting standard exchange documents, holding the exchange funds between the time the old property is sold and the new property is purchased, and accepting the formal identification of the replacement property within the required identification period. ITAC provides services as an exchange accommodation titleholder for accomplishing “parking transactions” as set forth in the safe harbor contained in Internal Revenue Procedure 2000-37. These transactions include reverse exchanges when taxpayers decide to acquire replacement property before selling the relinquished property, or “build to suit” exchanges, when improvements must be made to the replacement property before the taxpayer acquires the improved replacement property. The services provided by the Company’s exchange services division, ITEC and ITAC, are pursuant to provisions in the Internal Revenue Code. From time to time, these laws are subject to review and changes, which may negatively affect the demand for tax-deferred exchanges in general, and consequently, the revenues and profitability of the Company’s exchange services division.
The Company’s trust services division, Investors Trust, provides investment management and trust services to individuals, companies, banks and trusts.
The U.S. and other countries continue to experience the outbreak of the COVID-19 pandemic. This contagious disease outbreak has continued to spread across the globe, including in U.S. states where the Company conducts business, and is impacting worldwide economic activity and financial markets. In response, the U.S. government and its agencies have taken a number of significant measures to provide fiscal and monetary stimulus. Such actions include an unscheduled cut to the federal funds rate, the introduction of new programs to preserve market liquidity, extended unemployment and sick leave benefits, mortgage loan forbearance actions, low-interest loans for working capital access and payroll assistance, and other relief measures for both workers and businesses. The Company is fully operational and did not have any reductions in workforce during 2020. A large portion of the Company's workforce is performing their job functions remotely. The Company has not taken stimulus relief funding or incurred any other forms of debt.
The Supreme Court of the United States has ruled that the structure of the CFPB is unconstitutional, but has allowed the work of the agency to continue. The timing and nature of any reforms are currently unknown, especially with the changes in the presidential administration and Congress in January 2021; however, any changes to the CFPB could affect the Company and its results of operations.
The Company’s reserve for claims is 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, 2020 is represented by the reserve for claims totaling $33.6 million in the Consolidated Balance Sheets included in Item 8 of this Annual Report on Form 10-K (the “Consolidated Balance Sheets”). Of that total, approximately $3.6 million was reserved for specific claims which have been reported to the Company, and approximately $30.0 million was reserved for IBNR claims.
Management considers factors such as the Company’s historical claims experience, case reserve estimates on reported claims, large claims, actuarial projections and other relevant factors in determining its loss provision rates and the aggregate recorded expected liability for claims. In establishing the reserve, actuarial projections are compared with recorded reserves to evaluate the adequacy of such recorded claims reserves and any necessary adjustments are then recorded in the current period’s Consolidated Statement of Operations. As the most recent claims experience develops and new information becomes available, the loss reserve estimate related to prior periods will change to more accurately reflect updated and improved emerging data. The Company reflects any adjustments to the reserve in the results of operations in the period in which new information (principally claims experience) becomes available.
The Company assumes the reported liability for known claims and IBNR, in the aggregate, will be comparable to its historical claims experience unless factors, such as loss experience and charged premium rates, change significantly. Also affecting the Company’s assumptions are large losses related to fraud and defalcation, as these can cause significant variances in loss emergence patterns. Management defines a large loss as one where incurred losses exceed $500,000. Due to the small volume of large claims, the long-tail nature of title insurance claims and the inherent uncertainty in loss emergence patterns, large claim activity can vary significantly between policy years. The estimated development of large claims by policy year is therefore, subject to significant changes as experience develops. The loss provision rate is set to provide for losses on current year policies and changes in prior year estimates.
If one or more of the variables or assumptions used changed such that the Company’s recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased three loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2020 would be as follows:
Quarterly, the Company evaluates the collectability of receivables. Write-offs of receivables have not been material to the Company.
Investments in Fixed Maturity Securities - Fixed maturity securities are classified as available-for-sale and reported at estimated fair value with unrealized gains and losses, net of tax and adjusted for other-than-temporary declines in fair value, reported as accumulated other comprehensive income. 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. In evaluating available-for-sale fixed maturity securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, the Company considers the extent to which estimated fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. If the Company intends to sell an available-for-sale security in an unrealized loss position, or determines that it is more likely than not that the Company will be required to sell the security before it recovers its amortized cost basis, the security is impaired and it is written down to estimated fair value with all losses recognized in earnings. For available-for-sale fixed maturity securities in an unrealized loss position for which the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security, the Company evaluates the securities to determine whether the decline in the estimated fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. Any impairment that is not credit related is recognized in other comprehensive income, net of applicable taxes. Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the Consolidated Balance Sheets, limited to the amount by which the amortized cost basis exceeds the estimated fair value, with a corresponding adjustment to earnings.
Both the ACL and the adjustment to the Consolidated Statements of Operations may be reversed if conditions change. Changes in the ACL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the ACL when management believes the uncollectability of an available-for-sale fixed maturity security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable is excluded from the estimate of credit losses. Impairment 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. Realized gains and losses are determined on the specific identification method. Refer to Note 3 to the Consolidated Financial Statements for further information about the Company’s investments in fixed maturity securities.
Net premiums written increased 40.8% in 2020 to $205.4 million, compared with $145.8 million in 2019. The increase in 2020, compared with 2019, was primarily driven by increased refinance activity and strong purchase volume, as lower average mortgage interest rates continued to spur real estate activity.
The Company derives a substantial portion of its income from investments in fixed maturity securities, which are primarily municipal and corporate fixed maturity securities, and equity securities. The Company’s investment policy is designed to comply with regulatory requirements and to balance the competing objectives of asset quality and investment returns. The Company’s title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. Fixed maturity securities totaling approximately $7.2 million and $7.1 million at December 31, 2020 and 2019, respectively, were deposited with the insurance departments of the states in which business is conducted.
The Company’s investment strategy emphasizes after-tax income and principal preservation. The Company’s investments are primarily in fixed maturity securities and, to a lesser extent, equity securities. The average effective maturity of the majority of the fixed maturity securities is less than 10 years. The Company’s invested assets are managed to fund its obligations and evaluated to ensure long term stability of capital accounts.
As the Company generates cash from operations, it is invested in accordance with the Company’s investment policy and corporate goals. The Company’s investment policy has been designed to balance multiple goals, including the assurance of a stable source of income from interest and dividends, the preservation of principal, and the provision of liquidity sufficient to meet insurance underwriting and other obligations as they become payable in the future. Securities purchased may include a combination of taxable or tax-exempt fixed maturity securities and equity securities. The Company also invests in short-term investments that include money market funds, U.S. Treasury bills, commercial paper and certificates of deposit. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment.
Interest and dividends were $4.4 million in 2020, compared with $4.8 million in 2019. The decrease in 2020, compared with 2019, was primarily due to lower interest rates on fixed maturity securities. Refer to Note 3 in the accompanying Consolidated Financial Statements for the major categories of investments, scheduled maturities, amortized costs, estimated fair values of investment securities and earnings by security category.
Other investment income consists primarily of income related to investments in unconsolidated affiliates, typically structured as LLCs, accounted for under either the equity method of accounting or the measurement alternative for investments that do not have readily determinable fair values. The measurement alternative method requires investments without readily determinable fair values to be recorded at cost, less impairments, and plus or minus any changes resulting from observable price changes. The Company monitors any events or changes in circumstances that may have had a significant adverse effect on the fair values of these investments and makes any necessary adjustments.
Other investment income was $3.7 million in 2020, compared with $3.2 million in 2019. Changes in other investment income are impacted by fluctuations in the carrying value of the underlying investment and or distributions received.
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 included in net realized investment gains are affected by assessments of securities’ valuation for other-than-temporary impairment. As a result of the interaction of these factors and considerations, the net realized investment gain or loss can vary significantly from period to period.
Other revenues primarily include miscellaneous revenues, gains and losses on the disposal of fixed assets and state tax credit income. Other revenues were $623 thousand in 2020, compared with $678 thousand for 2019. The decrease in 2020, compared with 2019, primarily related to a decline in state tax credit income, partially offset by an increase in miscellaneous revenues.
The Company’s after-tax profit margin varies according to a number of factors, including the volume and type of real estate activity. On a combined basis, the after-tax profit margins were 16.7% and 17.1% in 2020 and 2019, respectively. The decrease in after-tax margin in 2020, compared with 2019, was primarily related to increases in expenses from commissions to agents, personnel expenses and the provision for claims, partially offset by an increase in revenue from net premiums written. The Company continually strives to enhance its competitive strengths and market position, including ongoing initiatives to manage its operating expenses.
Personnel Expenses: Personnel expenses include base salaries, benefits and payroll taxes, bonuses paid to employees and contract labor expenses. Personnel expenses were $51.9 million and $46.1 million for 2020 and 2019, respectively. Personnel expenses increased by approximately 12.7% in 2020, compared with 2019, primarily due to additions to staffing in support of strategic growth initiatives, additional staffing required to support volume increases, and increased levels of incentive compensation. On a consolidated basis, personnel expenses as a percentage of total revenues were 22.0% and 25.1% in 2020 and 2019, respectively.
Office and Technology Expenses: Office and technology expenses primarily include facilities expenses, software and hardware expenses, depreciation expense, telecommunications expenses, and business insurance. Office and technology expenses were $10.0 million and $9.3 million for 2020 and 2019, respectively. The increase in office and technology expenses in 2020, compared with 2019, was primarily related to ongoing investments in software and technology related initiatives.
Other Expenses: Other expenses primarily include business development expenses, premium-related taxes and licensing, professional services, title and service fees, amortization of intangible assets and other general expenses. Other expenses were $12.9 million and $12.1 million for 2020 and 2019, respectively. The increase in 2020, compared with 2019, was primarily related to increases in premium-related taxes and licensing, title and service fees and professional services, partially offset by a decline in business development expenses.
Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $3.0 million and $3.9 million in 2020 and 2019, respectively.
Reserve for Claims: At December 31, 2020, the total reserve for claims was $33.6 million. Of that total, approximately $3.6 million was reserved for specific claims, and approximately $30.0 million 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 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.
The provision for income taxes was $10.2 million and $8.4 million for 2020 and 2019, respectively. Income tax expense, including federal and state taxes, as a percentage of income before income taxes was 20.6% and 21.0% for 2020 and 2019, respectively. The effective income tax rate for 2020 differs from the U.S. federal statutory income tax rate of 21% primarily due to changes in tax-exempt income, as tax-exempt income lowers the effective tax rate.
The Company believes it is more likely than not that the tax benefits associated with recognized impairments and unrecognized losses recorded through December 31, 2020 will be realized. However, this judgment could be impacted by further market fluctuations. Information regarding the components of income tax expense and the items included in the reconciliation of the effective rate with the federal statutory rate can be found in Note 8 to the Consolidated Financial Statements.
The extent to which COVID-19 impacts the Company's future operations will depend on future developments which cannot be predicted with certainty at this time, including the duration and severity of the pandemic, actions taken to contain the spread of the virus, and regulatory actions taken as a result of the outbreak. Currently, the Company is fully operational and has not had any reductions in workforce during 2020. A large portion of the Company's workforce is performing their job functions remotely. The Company has not taken stimulus relief funding or incurred any other forms of debt.
Cash flows from non-operating activities have historically consisted of purchases and proceeds from investing activities, the issuance of dividends and repurchases of common stock. In 2020, the Company had more dividends paid and a net shift to investment purchases outpacing investment proceeds, compared with net investment proceeds outpacing investment purchases in 2019. In the fourth quarters of 2020 and 2019, the Company paid special cash dividends in the amounts of $15.00 and $8.00 per share, respectively, in addition to regular cash dividends. Total dividends paid per share were $16.76 and $9.60 in 2020 and 2019, respectively.
The ability of the Company's title insurance subsidiaries to pay dividends to the Company is subject to state regulation from their respective states of domicile. Each state regulates the extent to which title underwriters can pay dividends or make distributions and requires prior regulatory approval of the payment of dividends and other intercompany transfers. The maximum dividend permitted by law is not necessarily indicative of an insurer’s actual ability to pay dividends. Depending on regulatory conditions, the Company may in the future need to retain cash in its title insurance subsidiaries in order to maintain their statutory capital position. As of December 31, 2020, both ITIC and NITIC met the minimum capital, surplus and reserve requirements for each state in which they are licensed.
During 2021, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $37.2 million.
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, especially with the onset and continued spread of COVID-19, 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, real estate activity, the Company’s claims-paying ability and its financial strength ratings. In addition to operational and investment considerations, taking advantage of opportunistic external growth opportunities may necessitate obtaining additional capital resources. The Company is carefully monitoring the COVID-19 situation and any other trends that are likely to result in material adverse liquidity changes, and will continually assess its capital allocation strategy, including decisions relating to payment of dividends, repurchasing the Company’s stock and/or conserving cash.
Contractual Obligations: As of December 31, 2020, the Company had a claims reserve totaling $33.6 million. The amounts and timing of these obligations are estimated and not set contractually. Events such as fraud, defalcation, and multiple property title defects can substantially and unexpectedly cause increases in both the amount and timing of estimated title insurance loss payments and loss cost trends whereby increases or decreases in inflationary factors (including the value of real estate) will influence the ultimate amount of title insurance loss payments and could increase total obligations and influence claim payout patterns. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, claim estimates are subject to variability and future payments could increase or decrease from these estimated amounts in the future.
ITIC, a wholly owned subsidiary of the Company, has entered into employment agreements with certain executive officers. The amounts accrued for these agreements at December 31, 2020 and 2019 were approximately $12.5 million and $12.2 million, respectively, which includes postretirement compensation and health benefits, and was calculated based on the terms of the contracts. These executive contracts are accounted for on an individual contract basis. As payments are based upon the occurrence of specific events, including death, disability, retirement, termination without cause or upon a change in control, payment periods are currently uncertain. Information regarding retirement agreements and other postretirement benefit plans can be found in Note 10 to the Consolidated Financial Statements.
The Company enters into lease agreements that are primarily used for office space. These leases are accounted for as operating leases. A portion of the Company's current leases include an option to extend or cancel the lease term, and the exercise of such an option is solely at the Company's discretion. The total of undiscounted future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2020 is $2.8 million, which includes lease payments related to options to extend or cancel the lease term if the Company determined at the date of adoption that the lease was expected to be renewed or extended. Information leases can be found in Note 9 to the Consolidated Financial Statements.
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 $16.5 million and $21.5 million as of December 31, 2020 and 2019, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the 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 LLCs 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 $237.9 million and $214.6 million as of December 31, 2020 and 2019, respectively. These exchange deposits are held at third-party financial institutions. Exchange deposits are not considered assets of the Company and, therefore, are excluded from the Consolidated Balance Sheets; however, the Company remains contingently liable for the disposition of the transfers of property, disbursements of proceeds and the return on the proceeds at the agreed upon rate. Exchange services revenue includes earnings on these deposits; therefore, investment income is shown as other revenue rather than investment income. These like-kind exchange funds are primarily invested in money market and other short-term investments.
External assets under management of Investors Trust Company totaled approximately $640.1 million and $568.6 million as of December 31, 2020 and 2019, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the Consolidated Balance Sheets.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326). ASU 2016-13 updated guidance to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The update broadened the information that an entity must consider in developing its expected credit loss estimates, and was meant to better reflect an entity’s current estimate of all expected credit losses. In addition, this update amended the accounting for credit losses on available-for-sale fixed maturity securities and purchased financial assets with credit deterioration. The update was effective for the Company for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. The Company adopted this update on January 1, 2020 with no material impact on the Company's financial position and results of operations. Refer to Note 3 for further information about the Company's investments.
We have audited the accompanying consolidated balance sheets of Investors Title Company and Subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows, for each of the years then ended, and the related notes and schedules (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of their operations and their cash flows for each of the years then ended, in conformity with U.S. generally accepted accounting principles.
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
As described in notes 1 and 6 to the Company’s consolidated financial statements, the Company’s reserve for unpaid losses and loss adjustment expenses is 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 (incurred but not reported, or “IBNR”). As of December 31, 2020, the Company had approximately $33.6 million in reserve for claims. Management records a provision for future claim payments at the time the related premium revenue is recognized by applying a loss provision rate against net premiums written. Management determines its loss provision rate through the consideration of factors such as the Company’s historical claim experience, case reserve estimates on reported claims, large claims, actuarial projections and other relevant factors. The Company utilizes accepted actuarial methodologies when performing the actuarial projections.
Our audit procedures related to the reserve for claims included the following, among others:
•We obtained an understanding, evaluated the design and implementation, and tested the operating effectiveness of the Company’s controls over the reserve for claims development process. This included the controls over the determination of the actuarial methods and assumptions utilized to support the reserve for claims calculations, and controls over the completeness and accuracy of historical loss data utilized in the reserve for claims calculations.
•We engaged a third-party actuary with specialized skill and knowledge to assist in evaluating the reasonableness of the reserving methodologies utilized by the Company’s specialist and evaluating the reasonableness of the assumptions related to loss development factors and expected loss ratios.
•We tested the inputs utilized by the Company’s specialist in developing the reserve for claims. This included testing the accuracy and completeness of the data provided to the Company’s specialist.
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 (2013) 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, 2020.
Principles of Consolidation and Basis of Presentation: The accompanying Consolidated Financial Statements include the accounts and operations of Investors Title Company and its subsidiaries, and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). All intercompany balances and transactions have been eliminated in consolidation.
For the purpose of presentation in the Consolidated Balance Sheets and Consolidated Statements of Cash Flows, cash equivalents are highly liquid instruments with remaining original maturities of three months or less. The carrying amount of cash and cash equivalents is a reasonable estimate of fair value due to the short-term maturity at purchase of these instruments.
Both the ACL and the adjustment to the Consolidated Statements of Operations may be reversed if conditions change. Changes in the ACL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the ACL when management believes the uncollectability of an available-for-sale fixed maturity security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable is excluded from the estimate of credit losses. Impairment 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. Realized gains and losses are determined on the specific identification method. Refer to Note 3 for further information about the Company’s investments in fixed maturity securities.
Investments in Equity Securities: Equity securities represent ownership interests held by the Company in entities for investment purposes. Changes in the estimated fair value of equity security investments are reported in the Consolidated Statements of Operations. Realized investment gains and losses from sales are recorded on the trade date and are determined using the specific identification method. Refer to Note 3 for further information about the Company’s investments in equity securities.
Other investments consist of investments in unconsolidated affiliated entities, typically structured as limited liability companies ("LLCs"), without readily determinable fair values. Other investments are accounted for under either the equity method or the measurement alternative method. The measurement alternative method is used when an investment does not qualify for the equity method or the practical expedient in Accounting Standards Codification (“ASC”) Topic 820, which estimates fair value using the net asset value per share. Under the measurement alternative method, investments are recorded at cost, less any impairment and plus or minus any changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. The aggregate cost of the Company’s cost method investments totaled $8.7 million and $7.9 million at December 31, 2020 and 2019, 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.
Short-term investments are comprised of money market accounts which are invested in short-term funds, U.S. Treasury bills, commercial paper, certificates of deposit, and other investments expected to have maturities or redemptions greater than three months and less than twelve months. The Company monitors any events or changes in circumstances that may have a significant adverse effect on the fair value of these investments.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2020 is represented by the reserve for claims. The Company’s reserve for unpaid losses and loss adjustment expenses is 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 (incurred but not reported, or “IBNR”). Despite the variability of such estimates, management believes that the reserve is adequate to cover claims losses resulting from pending and future claims for policies issued through December 31, 2020. 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.
Claims losses paid are charged to the reserve for claims. Although claims losses are typically paid in cash, occasionally claims are settled by purchasing the interest of the insured or the claimant in the real property. When this event occurs, the acquiring company carries assets at the lower of cost or estimated realizable value, net of any indebtedness on the property.
Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and a provision for future claims are recognized concurrent with recognition of related premium revenue.
Fees are recognized at the signing of a binding agreement and investment earnings are recognized as they are earned. Exchange services revenue is included in non-title services in the Consolidated Statements of Operations.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains or losses on available-for-sale securities, net of tax, and unrealized gains or losses associated with postretirement benefit liabilities, net of tax. Accumulated other comprehensive income as of December 31, 2020 consists of $4.5 million of unrealized holding gains on available-for-sale securities and $144 thousand of unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2019 consists of $3.1 million of unrealized holding gains on available-for-sale securities and $32 thousand of unrecognized actuarial losses associated with postretirement benefit liabilities.
In June 2016, the FASB issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326). ASU 2016-13 updated guidance to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The update broadened the information that an entity must consider in developing its expected credit loss estimates, and was meant to better reflect an entity’s current estimate of all expected credit losses. In addition, this update amended the accounting for credit losses on available-for-sale fixed maturity securities and purchased financial assets with credit deterioration. The update was effective for the Company for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. The Company adopted this update on January 1, 2020 with no material impact on the Company's financial position and results of operations. Refer to Note 3 for further information about the Company's investments.
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. ASU 2019-12 is intended to reduce the complexity in accounting for income taxes during interim and annual periods and is expected to provide clarity on income tax situations where a diversity in practice has developed. The update is effective for annual and interim periods in fiscal years beginning after December 15, 2020. Early adoption is permitted for interim or annual periods for which financial statements have not yet been issued. None of these amendments are expected to have a material impact on the Company's financial position or results of operations.
In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). This update clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative immediately before applying or upon discontinuing the equity method. In addition, this update clarifies that, when determining the accounting for certain forward contracts and purchased options, a company should not consider, whether upon settlement or exercise, if the underlying securities would be accounted for under the equity method or fair value option. The update is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted, including early adoption in an interim period, for periods for which financial statements have not yet been issued. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, and does not expect it to have a material impact.
2. Statutory Accounting and Restrictions on Consolidated Shareholders’ Equity and Investments
The special revenue category for both periods presented includes approximately 50 individual fixed maturity securities with revenue sources from a variety of industry sectors.
The scheduled maturities of fixed maturity securities at December 31, 2020 were as follows:
Factors considered in determining whether a loss is temporary include the length of time and extent to which the estimated fair value has been below cost, the financial condition and prospects of the issuer (including credit ratings and analyst reports) and macro-economic changes. A total of 12 and six fixed maturity securities had unrealized losses at December 31, 2020 and 2019, respectively. The Company does not have the intent to sell any of these securities and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such investments decline. The Company believes that the unrealized losses detailed in the previous table are due to noncredit-related factors, including changes in interest rates and other market conditions, and therefore the unrealized loss is recorded in accumulated other comprehensive income.
Reviews of the values of fixed maturity securities are inherently uncertain and the value of the investment may not fully recover, or may decline in future periods resulting in a realized loss. The Company recorded $482 thousand and $0 of other-than-temporary impairment charges related to fixed maturity securities for the twelve-month periods ended December 31, 2020 and 2019, respectively. Expenses related to other-than-temporary impairments are recorded in net realized investment gains in the Consolidated Statements of Operations when recognized.
Unrealized holding gains and losses are reported in the Consolidated Statements of Operations as changes in the estimated fair value of equity security investments.
* Maximum potential loss is calculated as the total investment in the LLC or LP including any capital commitments that may have not yet been called. The Company is not exposed to any loss beyond the total commitment of its investment.
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 securities such as corporate debt securities, U.S. government obligations, and obligations of U.S. states, territories, and political subdivisions. Estimated fair value is principally based on market values obtained from a third-party pricing service. Factors that are used in determining estimated 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 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, 2020 and 2019, the Company did not adjust any Level 2 fair values.
The following table presents, by level, estimated fair values of equity investments and other financial instruments as of December 31, 2020 and 2019:
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $3 thousand and $296 thousand, respectively, for 2020, and $2 thousand and $411 thousand, respectively, for 2019. Ceded reinsurance is comprised of excess of loss treaties, which outline the conditions in which the reinsurance company will pay claims and protect against losses over certain agreed upon amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event the assuming insurance companies are unable to meet their obligations under these contracts. The Company did not pay or recover any reinsured losses during 2020 and 2019.
Changes in the reserve for claims for the years ended December 31 are summarized as follows based on the year in which the policies were written:
There were 18 thousand and 14 thousand potential shares excluded from the computation of diluted earnings per share in 2020 and 2019, respectively, due to the out-of-the-money status of the related share-based awards rendering them anti-dilutive.
As of December 31, 2020, the only outstanding awards under the plans were SARs, which expire within seven years or less from the date of grant. All outstanding SARs vest and are exercisable within five years or less from the date of grant, and all SARs issued to date have been share-settled only. There have been no stock options or SARs granted where the exercise price was less than the market price on the date of grant.
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. The intrinsic values of SARs exercised during 2020 and 2019 were approximately $583 thousand and $364 thousand, respectively.
There were no options outstanding at December 31, 2020. The following table summarizes information about SARs outstanding at December 31, 2020:
During both 2020 and 2019, the Company issued share-settled SARs to directors of the Company. During 2020, the Company also issued share-settled SARs to certain non-executive employees 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 to project SAR exercises and pre-exercise forfeitures within the valuation model. The expected term of awards represents the period of time that SARs granted are expected to be outstanding. The interest rate assumed for the expected life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted average fair values for the SARs issued during 2020 and 2019 were $36.30 and $51.88, respectively, and were estimated using the weighted average assumptions shown in the table below.
In accounting for uncertainty in income taxes, the Company is required to recognize in its consolidated financial statements the impact of a tax position if that position is more likely than not of being sustained on an audit, based on the technical merits of the position. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. There were no unrecognized tax benefits or liabilities as of December 31, 2020.
The Company’s policy is to report interest and penalties related to income taxes in the Other Expenses line item in the Consolidated Statements of Operations.
(a) Leases with an initial term of twelve months or less are not recorded on the Consolidated Balance Sheets.
Components of the operating lease liability presented on the Consolidated Balance Sheets for the years ended December 31 are as follows:
Supplemental lease information for the years ended December 31 is as follows:
The Company does not have any material pending operating or financing lease agreements that become effective in future periods.
The Company has a 401(k) savings plan. In order to participate in the plan, individuals must have worked at the Company for at least three months. In order to be eligible for employer contributions, individuals must be employed for a period of one 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 $1.8 million and $1.2 million for 2020 and 2019, respectively.
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 $15 thousand in 2021, $23 thousand in 2022, $31 thousand in 2023, $28 thousand in 2024, $34 thousand in 2025 and $217 thousand in the next five years thereafter.
The Company is required to recognize the funded status (i.e., the difference between the fair value of the assets and the accumulated postretirement benefit obligations of its postretirement benefits) in its Consolidated Balance Sheets, with a corresponding adjustment to accumulated other comprehensive income, net of tax. The net amount in accumulated other comprehensive income is $(184) thousand, $(144) thousand net of tax, for December 31, 2020, and $(82) thousand, $(32) thousand net of tax, for December 31, 2019, and represents 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, 2020 and 2019 are presented in the following table:
Development of the accumulated postretirement benefit obligation for the years ended December 31, 2020 and 2019 includes the following:
Legal Proceedings: 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.
Provided below is selected financial information about the Company’s operations by segment for the periods ended December 31, 2020 and 2019.
The Rights are redeemable upon action by the Board of Directors at a price of $0.01 per right at any time before they become exercisable. Until the Rights become exercisable, they are evidenced only by the common stock certificates and are transferred with and only with such certificates.
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 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 Preferred Stock from 100 thousand shares to 200 thousand shares. There were 1.0 million shares of Preferred Stock authorized as of December 31, 2020 and 2019, with 200 thousand being designated Series A 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. Deposits which exceed $250 thousand at each institution are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Of the $13.7 million in cash and cash equivalents at December 31, 2020, $12.3 million was not insured by the FDIC. Of the $25.9 million in cash and cash equivalents at December 31, 2019, $24.6 million was not insured by the FDIC. The Company mitigates the risk of having cash and cash equivalents not insured by the FDIC by monitoring the credit quality of the financial institutions in which the funds are held.
The Company does business with, and has investments in, unconsolidated LLCs that are primarily title insurance agencies. The Company utilizes the equity method to account for its investments in these LLCs. The following table sets forth the approximate values by year found within each financial statement classification:
(b)These accumulated other comprehensive income components are not reclassified to net income in their entirety in the same reporting period. The amounts are presented within personnel expenses on the Consolidated Statements of Operations as amortized. Amortization related to postretirement benefit plans is included in the computation of net periodic pension costs, as discussed in Note 10.
Escrow and other title-related fees - The Company’s title segment recognizes commission revenue and fees related to items such as searches, settlements, commitments and other ancillary services. Escrow and other title-related fees are recognized as revenue at the time of the related transactions as the earnings process, or performance obligation, is then considered to be complete.
Other - The Company occasionally recognizes revenue from other miscellaneous contracts which can include, but is not limited to seminar and education registration fees and software licensing contracts. These revenue streams are deemed immaterial to the operations of the Company, and revenue is recognized when, or as, performance obligations are completed.
The following table provides a breakdown of the Company’s revenue by major business activity: