- Management Analysis of Financial Position and Results of Operations ($ in Millions, Except Share Data) - --------------------------------------------------------------------------------
Old Republic's financial position at December 31, 2000 reflected increases in assets, liabilities and common shareholders' equity of 4.9%, 2.2% and 10.9%, respectively, when compared to the immediately preceding year-end. Cash and invested assets represented 70.6% and 69.6% of consolidated assets as of December 31, 2000 and 1999, respectively. Consolidated operations produced positive cash flows for the latest three years. 2000 cash flow returned to a level slightly above the amount reported for 1998. 1999 cash flow was down compared to 2000 and 1998 due mainly to lower contributions from Old Republic's general insurance segment. In 2000, the invested asset base increased 6.3% principally as a result of greater operating cash flow and an increase in the value of bonds and stocks carried at market value; this was offset slightly by cash outflow to finance the Company's stock buy back program.
Relatively high short-term maturity investment positions are generally maintained to provide necessary liquidity for specific operating needs and to enhance flexibility in investment strategy. Changes in short-term investments reflect a large variety of seasonal and intermediate-term factors including expected operating cash flows and investment strategy. Accordingly, the future level of short-term investments will vary and respond to the interplay of these factors and may, as a result, increase or decrease from current levels. During 2000 and 1999, the Corporation committed most investable funds in short to intermediate-term fixed maturity securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; investable funds have not been directed to so-called "junk bonds" or types of securities categorized as derivatives. Old Republic's commitment to equity securities during 2000 increased vis-a-vis the related invested balance at year-end 1999 due to securities acquired and unrealized gains during the period. At December 31, 2000, the carrying value of bond and note investments in default as to principal and/or interest was immaterial in relation to consolidated assets or shareholders' equity.
The parent holding company generally meets its liquidity and capital needs through dividends paid by its subsidiaries and the issuance of short-term debt. The insurance subsidiaries' ability to pay cash dividends to the parent company, however, is generally restricted by law or subject to approval of the insurance regulatory authorities
Net investment income grew by 4.1% and 0.9% in 2000 and 1998, respectively, and was down 3.6% in 1999. For each of the past three years, this revenue source was affected by positive consolidated operating cash flows, by a concentration of investable assets in interest-bearing fixed maturity securities, and by changes in market yields. As previously noted, the Company used mostly internal funds in the three latest calendar years for open market purchases of its common stock, thus reducing the size and earning power of its invested assets base. The average annual yield on investments was 5.6%, 5.5% and 5.7% for the years ended December 31, 2000, 1999 and 1998, respectively. This yield pattern reflects at once the relatively short maturity of Old Republic's fixed maturity securities portfolio, an uptrend in yields in 2000, and generally flat to declining yields during most of 1999 and 1998.
The Company's investment policies are not designed to maximize realized investment gains. Such gains were higher in 1998 than those registered in 2000 and 1999, mostly due to the discretionary sale of equity securities as market and other considerations warranted. Dispositions of securities were principally the result of scheduled maturities of bonds and notes and sales of equity securities. In 2000, 79.9% of total dispositions represented contractual maturities and early calls of existing holdings; for the years 1999 and 1998 these amounted to 71.0% and 58.3%, respectively.
Consolidated Balance Sheets......................................... 23-24 Consolidated Statements of Income................................... 25 Consolidated Statements of Comprehensive Income..................... 26 Consolidated Statements of Preferred Stock and Common Shareholders' Equity...................................... 27 Consolidated Statements of Cash Flows............................... 28 Notes to Consolidated Financial Statements.......................... 29-50 Report of Independent Accountants................................... 51
At December 31, 2000 and 1999, the Life Insurance Group had $6,849.1 and $7,896.5, respectively, of net life insurance in force. Future policy benefits and unearned premiums, consisted of the following:
All reserves are necessarily based on estimates which are periodically reviewed and evaluated in the light of emerging claim experience and changing circumstances. The resulting changes in estimates are recorded in operations of the periods during which they are made. Return and additional premiums and policyholders' dividends, all of which tend to be affected by development of claims in future years, may offset, in whole or in part, developed claim redundancies or deficiencies for certain coverages such as workers' compensation.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to provide for normal claim occurrences as well as unusual exposures such as those pertaining to A&E claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves to cover claims such as those emanating from A&E exposures. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 2000, the Corporation's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to approximately $75.3 gross, and $39.4 net of reinsurance. Based on average annual claims payments during the five most recent calendar years, such reserves represented 10.0 years (gross) and 15.5 years (net) of average annual claims payments.
(k) Goodwill-The costs of certain purchased subsidiaries in excess of related book values (goodwill) at date of acquisition are being amortized against operations principally over 40 years using the straight-line method. Amortization of goodwill amounted to $4.1 in 2000, $3.5 in 1999 and $3.6 in 1998.
Included in the plans' assets are Common Shares of the Company valued at $7.0 and $6.7 as of December 31, 2000 and 1999, respectively.
Annual cumulative dividend rate per share........................ $ (1) Conversion ratio of preferred into common shares ................ 1 for .95 Conversion right begins.......................................... Anytime Redemption and liquidation value per share....................... (1) Redemption beginning in year...................................... (1) Total redemption value (millions).................................. (1) Vote per share..................................................... one Shares outstanding: December 31, 1999.................................................. 153,183 December 31, 2000.................................................. 138,878 =========== - ------------ (1) The Corporation has authorized up to 1,000,000 shares of Series G-2 Convertible Preferred Stock ("Series G") for issuance pursuant to the Corporation's Stock Option Plan. Each share of Series G pays a floating rate dividend based on the prime rate of interest. At December 31, 2000, the annual dividend rate for Series G was $.92 per share. Each share of Series G is convertible at any time, after being held six months, into 0.95 shares of Common Stock (See 3(c)). Unless previously converted, Series G shares may be redeemed at the Corporation's sole option five years after their issuance.
(b) Cash Dividend Restrictions-The payment of cash dividends by the Corporation is principally dependent upon the amount of its insurance subsidiaries' statutory policyholders' surplus available for dividend distribution. The insurance subsidiaries' ability to pay cash dividends to the Corporation is in turn generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. These authorities recognize only statutory accounting practices for determining financial position, results of operations, and the ability of an insurer to pay dividends to its shareholders. Based on 2000 data, the maximum amount of dividends payable to the Corporation by its insurance and a small number of non-insurance company subsidiaries during 2001 without the prior approval of appropriate regulatory authorities is approximately $180.6.
A summary of the status of the Corporation's stock options as of December 31, 2000, 1999 and 1998, and changes in outstanding options during the years then ended follows:
In December, 1998, the National Association of Insurance Commissioners adopted a revised Accounting Practices and Procedures Manual ("Manual"). The Manual is a comprehensive compilation of statutory accounting practices and principles. The Manual is effective for accounting periods beginning January 1, 2001. Current estimates of the adoption of this Manual is not expected to have a material impact on the Company's statutory financial position or results of its statutory operations.
Reinsurance protection on property and liability operations generally limits the net loss on any one risk to a maximum of (in thousands): workers' compensation-$1,000; auto liability-$600; general liability-$600; and property coverages-$300. Substantially all the mortgage guaranty insurance business is retained, with the exposure on any one risk currently averaging approximately $29. Title insurance risk assumptions, based on the title insurance subsidiaries' financial resources, are limited to a maximum of $25,000 as to any one policy. The maximum amount of ordinary life insurance retained on any one life by the Life Insurance Group is $300.
The following information relates to reinsurance and related data for the General Insurance, Mortgage Guaranty and Life Insurance Groups for the three years ended December 31, 2000. For the years 1998 to 2000, reinsurance transactions of the Title Insurance Group have not been material.
(b) Leases-Some of the Corporation's subsidiaries maintain their offices in leased premises. Certain of these leases provide for the payment of real estate taxes, insurance, and other operating expenses. At December 31, 2000, aggregate minimum rental commitments (net of expected sub-lease receipts) under noncancellable operating leases of $133.8 are summarized as follows: 2001: $32.5; 2002: $27.1; 2003: $21.1; 2004: $13.6; 2005: $8.4; 2006 and after: $30.8.
(c) General-In the normal course of business, the Corporation and its subsidiaries are subject to various contingent liabilities, including possible income tax assessments resulting from tax law interpretations or issues raised by taxing or regulatory authorities in their regular examinations. Management does not anticipate any significant losses or costs to result from any known or existing contingencies.
In December 1999, a class action lawsuit was filed against one of the Company's mortgage guaranty insurance subsidiaries in the Federal District Court for the Southern District of Georgia. The suit alleges that the subsidiary provided pool insurance and other services to mortgage lenders at preferential, below market prices in return for mortgage insurance business, and that such practices violated the Real Estate Settlement Procedures Act. The Court ruled in favor of a summary judgement motion filed by the Company's subsidiary and dismissed the law suit. The class plaintiffs have appealed and the appeal is currently before the U.S. Court of Appeals for the Eleventh Circuit. The ultimate outcome of this litigation is unknown at the present time. Accordingly, no provision for any liability, including the additional cost of defense, has been included in the Company's financial statements.
The City and County of San Francisco and certain escrow customers of an underwritten title agency subsidiary headquartered in the State of California have filed law suits alleging that the subsidiary: 1) failed to escheat unclaimed escrow funds; 2) charged for services not necessarily provided; and 3) collected illegal interest payments or fees from banks on the basis of funds held for escrow customers. The subsidiary has in turn conducted an internal review of its records and concluded that it had certain liabilities for part of the issues denoted at (1) and (2). Management believes that the alleged practices denoted at (3) are common within the industry, are not in conflict with various laws and regulations, and that it has meritorious defenses which will ultimately lead to a successful resolution of these practices. As the litigation has progressed on several fronts and additional information has come to its attention, the subsidiary has continually re-evaluated its exposures and it has paid or otherwise provided for its best estimate of litigation and related costs associated with all these issues in the amounts of $4.1, $16.2 and $19.5 in 2000, 1999 and 1998, respectively.
The Life Insurance Group markets and writes consumer credit life and disability insurance primarily through automobile dealers. Old Republic has also written various conventional life and disability/accident and health insurance coverages for many years, principally on a direct marketing basis through banks and other financial services institutions. Ordinary term life insurance is sold through independent agents and brokers for relatively large face amounts, in both the United States and Canada.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies pertinent thereto.
- --------- In the above tables, net premiums earned on a GAAP basis differ slightly from statutory amounts due to certain differences in calculations of unearned premium reserves under each accounting method. (a) Including unallocated investment income derived from invested capital and surplus funds./(b) Represents results of holding company parent, consolidation eliminating adjustments, and general corporate expenses, as applicable./(c) In the first quarter of 1999, the Company sold its New York subsidiary and with it, its annuity book of business; this had no material effect on Old Republic's consolidated results or financial position.