The Company owns an office building and adjacent real estate in Richmond, Virginia that it uses for its corporate headquarters. This property consists of approximately 128,000 square feet of office space and parking facilities. The Company’s title insurance subsidiaries conduct their business operations primarily in leased office space. As of December 31, 2002, the Company had numerous leases for its branch offices and subsidiaries throughout the states in which it operates. In addition, it owns several other properties that in the aggregate are not material to its business taken as a whole.
The Company’s title plants constitute a principal asset. Title plants consist of copies of public records, maps, documents, previous reports and policies indexed to specific properties in an area. The title plants are generally located at the office which serves a particular locality or in “service centers” serving multiple localities in major metropolitan areas. They enable title personnel to examine title matters relating to a specific parcel of real property as reflected in the title plant, and eliminate or reduce the need for a separate search of the public records. They contain material dating back a number of years and are kept current on a daily or other frequent basis by the addition of copies of documents filed of record which affect real property. The Company maintains title plants covering many of the areas in which it operates, although certain offices utilize title plants jointly owned and maintained with other title insurers. The Company capitalizes only the initial cost of title plants. The cost of maintaining such plants is charged to expense as incurred.
The title plants and title examination procedures have been automated and computerized to a large extent in many areas. To protect against casualty loss, the Company’s offices maintain duplicate files and backups of all title plants.
Revenue Recognition. Premiums on title insurance written by the Company’s employees are recognized as revenue when the Company is legally or contractually entitled to collect the premium. Premiums on insurance written by independent agents are generally recognized when reported by the agent and recorded on a “gross” versus “net” basis. Agency premiums are typically remitted to the Company 90 days after the close of the real estate transaction. Title search and escrow fees are recorded as revenue when an order is closed.
Goodwill. On January 1, 2002 the Company adopted the Financial Accounting Standards Board (“FASB”) Statements of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Under these rules, goodwill (and intangible assets deemed to have indefinite lives) is no longer amortized but is subject to annual impairment tests in accordance with the Statements. Prior to July 1, 2001, goodwill was subject to periodic amortization on a straight-line basis over its estimated life. Other intangible assets will continue to be amortized over their useful lives.
Pension. The Company sponsors a defined benefit pension plan which is valued by an actuary annually. The valuation is dependent on significant assumptions. One significant assumption is that of the expected long-term rate of return on plan assets. The use of expected long-term rates of return may result in recognized returns that are greater or less than actual returns in any given year. Over time the expected returns are used to approximate actual long-term returns which result in a pattern of expense recognition that more closely matches the service lives of typical employees. The Company uses long-term and actual historical returns, its asset mix and future estimates of long-term investment returns to develop its long-term return for plan assets.
During 2000, the Company decided to place increased emphasis on other products and services related to real estate transactions. As a result, in October 2000, the Company acquired Primis, Inc., a web-based provider of real estate services. In 2001, the acceptance of Primis’ technology by the Company’s customer base proved to be much slower than anticipated, necessitating a fourth quarter non cash write-off of intangibles, including goodwill, acquired in the acquisition.
The Company’s profit margins are affected by several factors, including the volume of real estate and mortgage refinance activity, policy amount and the nature of real estate transactions. Volume is an important determinant of profitability because the Company, like any other real estate services company, has a significant level of fixed costs arising from personnel, occupancy costs and maintenance of title plants. Because premiums are based on the face amount of the policy, larger policies generate higher premiums although expenses of issuance do not necessarily increase in proportion to policy size. Cancellations affect profitability because costs incurred both in opening and in processing orders typically are not offset by fees. Commercial transactions tend to be more profitable than residential transactions.
The Company’s largest expense is commissions paid to independent agents. The Company regularly reviews the profitability of its agents, adjusting commission levels or canceling certain agents where profitability objectives are not being met and expanding operations where acceptable levels of profitability are available. The Company continually monitors its expense ratio, which is the sum of salaries and employee benefits, agency commissions and other expenses (exclusive of interest, goodwill, exit and termination costs and write-off of intangibles) expressed as a percentage of operating revenues.
In the 2000 through 2002 period, the typical seasonality of the title insurance business was influenced by changes in the levels of refinancing activity. For additional information, see “Item 1 - Business - Cyclicality and Seasonality.”
Operating revenues for 2002 were $2.5 billion compared to $2.1 billion in 2001 and $1.8 billion in 2000. The revenue increase from 2000 to 2001 and from 2001 to 2002 was directly related to a drop in mortgage interest rates through the period. Average annual mortgage rates that were 8.1% in 2000 dropped to 7.0% in 2001 and dropped further in 2002 to 6.5%. Monthly mortgage rates were highest in May 2000 at 8.5% and the lowest in December 2002 at 6.0%. The lower mortgage interest rates allowed more individuals to purchase homes and encouraged the refinancing of mortgages. Direct revenue, exclusive of the discontinued Primis appraisal operation, increased $148.0 million or 15.4% in 2002 over 2001 while agency revenue increased $295.2 million or 26.6% between the same periods. In 2001 compared to 2000, direct revenue, exclusive of the discontinued Primis operations, increased $201.5 million or 26.6% a nd agency revenue increased $121.6 million or 12.3%. Orders opened in company offices were 1,178,000 in 2002, 1,069,000 in 2001 and 680,000 in 2000.
The Company reported pre-tax investment income of $53.0 million, $51.0 million and $51.1 million in 2002, 2001 and 2000, respectively. Excluding capital gains and losses, investment income was $51.7 million, $50.8 million and $51.4 million in 2002, 2001 and 2000, respectively. Although investment income was similar each year, it reflects an increase in average amounts invested offset by lower yields each year. The Company’s investment portfolio consists of primarily fixed maturity securities whose income includes dividends and interest as well as realized gains and losses.
Exit and Termination Costs. Exit and termination costs on a pre-tax basis of approximately $13.4 million, $1.7 million and $3.1 million were incurred in 2002, 2001 and 2000, respectively, in connection with the closing of Primis operations in 2002 and 2001 and the formation of a title plant management joint venture in 2000.
On June 1, 2002, the Company entered into a joint venture agreement with The First American Corporation to combine its residential real estate valuation operations. Under the terms of the agreement, the Company contributed its former Primis residential appraisal production division, which it acquired in 2000, to First American’s eAppraiseIT subsidiary. In connection with the transaction, the Company exited the residential appraisal production business which had been unprofitable and recorded a charge of $14.1 million for exit, termination and other costs during the second quarter of 2002.
percentages, exclusive of the Primis operations, were 26.8%, 28.5% and 29.2% in 2002, 2001 and 2000, respectively. Staffing levels, excluding those attributable to the discontinued Primis operations, were 10,042, 9,069 and 7,755 at December 31, 2002, 2001 and 2000, respectively.
General, Administrative and Other Expenses. The most significant components of other expenses are outside costs of title production, rent for office space, communications, travel and taxes levied by states on premiums.
Provision for Policy and Contract Claims. The loss ratio (the provision for policy and contract claims as a percentage of operating revenues) was 4.2%, 4.0% and 4.4% in 2002, 2001, and 2000, respectively. Claims paid as a percentage of operating revenues were 3.7%, 3.7% and 4.3% in 2002, 2001 and 2000, respectively. The Company’s loss experience benefitted in 2002 and 2001 from lower than expected payment levels on recent issue years which included a high proportion of refinance business.
A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefit, or that future deductibility is uncertain. The Company did not record a valuation allowance at either December 31, 2002 or 2001. The Company reassesses the realization of deferred assets quarterly and, if necessary, adjusts its valuation allowance accordingly.
During 2002 the Company performed the required initial test for impairment as required by SFAS No. 142. The test performed indicated that no goodwill impairment existed at January 1, 2002. Application of the nonamortization provisions resulted in net income of $6.6 million ($0.36 per diluted share) in 2002.
Cash provided by operating activities for the years ended December 31, 2002, 2001, and 2000 was $228.1 million, $137.5 million and $88.1 million, respectively. As of December 31, 2002, the Company held cash and invested cash of $225.9 million and fixed-maturity securities of $991.5 million.
The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company