The Company owns two adjacent office buildings and property located on the corner of North Columbia and West Rosemary streets in Chapel Hill, North Carolina, which serve as the Company’s corporate headquarters. The main building contains approximately 23,000 square feet and has on-site parking facilities. The Company’s subsidiaries, principally ITIC and NITIC, lease office space in 37 locations throughout North Carolina, South Carolina, Texas and Nebraska. The Company believes that each of the office facilities occupied by the Company and its subsidiaries are in good condition, adequately insured and sufficient for its present operations.
There are two basic types of title insurance policies - one for the mortgage lender and one for the real property owner. A lender often requires the property owner to purchase a lender’s title insurance policy to protect its position as a holder of a mortgage loan, but the lender’s title insurance policy does not protect the property owner. The property owner has to purchase a separate owner’s title insurance policy to protect its investment. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a covered claim is made against real property, title insurance provides indemnification against insured defects.
Title insurance premiums vary from state to state and are subject to extensive regulation. Statutes generally provide that rates must not be excessive, inadequate or unfairly discriminatory. The process of implementing a rate change in most states involves pre-approval by the applicable state insurance regulator.
Volume is a factor in the Company’s profitability due to fixed operating costs which are incurred by the Company regardless of title insurance premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on the Company’s profitability. The Company’s profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and to minimize risks such as interest rate changes, defaults and impairments of assets.
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 serves as a qualified intermediary in like-kind exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended. 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 sale of the old property and the purchase of the new property, and accepting the formal identification of the replacement property within the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. An exchange accommodation offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property.
ITMS offers various consulting services to provide clients with the technical expertise to start and successfully operate a title insurance agency.
On July 7, 2017, the Consumer Financial Protection Bureau (“CFPB”) released final amendments to federal mortgage disclosure requirements under the Real Estate Settlement Procedures Act (“RESPA”) and the Truth in Lending Act that are implemented in Regulation Z. The final rules were published in the Federal Register on August 11, 2017. The amendments reinforce the CFPB’s informal guidance on various issues and include clarifications and technical amendments. The CFPB rule creates tolerances for the total of payments; adjusts a partial exemption that mainly affects housing finance agencies and nonprofits; provides a uniform rule regarding application of the integrated mortgage disclosure requirements to cooperative units; and provides guidance on sharing the disclosures with various parties involved in the mortgage origination process. The final rule did not have a material impact on the Company.
In recent years, the CFPB, Office of the Comptroller of Currency and the Federal Reserve have issued memorandums to banks that communicated those agencies’ heightened focus on vetting third party providers. Such increased regulatory involvement may affect the Company's agents and approved providers. Further proposals to change regulations governing insurance holding companies and the title insurance industry are often introduced in Congress, in state legislatures and before various insurance regulatory agencies. Although the Company regularly monitors such proposals, the likelihood and timing of passage of any such regulation, and the possible effects of any such regulation on the Company and its subsidiaries, cannot be determined at this time.
In recent months, both the President and certain members of Congress have indicated a desire for reform of the CFPB. The timing and nature of any reforms are currently unknown; however, any changes to the CFPB could affect the Company and its results of operations.
The MBA January 20, 2018 Mortgage Finance Forecast (“MBA Forecast”) projects 2018 purchase activity to increase 6.6% to $1,183 billion and refinance activity to decrease 29.0% to $426 billion, resulting in a decrease in total mortgage originations of 5.9% to $1,609 billion, all from 2017 levels. In 2017, purchase activity accounted for 64.9% of all mortgage originations and is projected to represent 73.5% of all mortgage originations in 2018.
According to data published by Freddie Mac, the average 30-year fixed mortgage interest rate in the United States was 4.0%, 3.6% and 3.8% for the years ended December 31, 2017, 2016 and 2015, respectively. Per the MBA Forecast, refinancing is expected to be lower in 2018 as mortgage interest rates continue to climb to a projected 4.8% in the fourth quarter of 2018.
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, 2017 is represented by the reserve for claims totaling $34,801,000 in the accompanying Consolidated Balance Sheets. Of that total, approximately $4,646,000 was reserved for specific claims which have been reported to the Company, and approximately $30,155,000 was reserved for IBNR claims.
Management also considers actuarial analyses in evaluating the claims reserve. The actuarial methods used to evaluate the reserve are loss development methods, Bornhuetter-Ferguson methods and Cape Cod methods, all of which are accepted actuarial methods for estimating ultimate losses and, therefore, loss reserves. In the loss development method, each policy year’s paid or incurred losses are projected to an “ultimate” level using loss development factors. In the Bornhuetter-Ferguson method, a type of expected loss method, losses for each policy year are estimated based on an expected loss ratio derived directly from a previous estimate of ultimate loss for each policy year plus an additional provision for losses that have not been reported or paid as of the evaluation date. Bornhuetter-Ferguson methods produce more stable ultimate loss estimates than do loss development methods, which are more responsive to the current loss data but can lead to volatile results. The Cape Cod method, a special case of the Bornhuetter-Ferguson method, blends the results of the loss development and expected loss methods. For more recent policy years, the Cape Cod methods give more weight to the results of the expected loss methods; for older policy years, more weight is given to the loss development method results.
Despite the variability of such estimates, management believes that, based on historical claims experience and actuarial analysis, the Company’s reserve is adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2017. The ultimate settlement of claims will likely vary from the reserve estimates included in the Company’s Consolidated Financial Statements. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. There are no known claims that are expected to have a material adverse effect on the Company’s financial position or operating results.
Securities held principally for resale in the near term are classified as trading securities and recorded at fair value. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading or held-to-maturity are classified as available-for-sale and reported at estimated fair value with unrealized gains and losses, net of tax, adjusted for other-than-temporary declines in estimated fair value, reported as accumulated other comprehensive income. As of December 31, 2017 and 2016, all of the Company’s invested securities were classified as available-for-sale. Realized gains and losses on the sales of investments are determined using the specific identification method.
Real estate activity, home sales and mortgage lending are cyclical in nature. Title insurance premiums are closely related to the level of real estate activity and the average price of real estate sales. Factors directly impacting real estate sales include mortgage interest rates and the availability of funds, consumer confidence, economic conditions, supply and demand and family income levels. The Company’s premiums in future periods are likely to fluctuate due to these and other factors which are beyond management’s control.
Insurance and other services revenues include net premiums written plus commission income, other fee income, trust income, management services income, exchange services income, and income related to the Company’s equity method investments. Investment income and realized investment gains and losses are not included in insurance and other service revenues and are discussed separately under “Investment-Related Revenues” below. The following is a summary of the Company’s insurance and other services revenues with intersegment eliminations netted with each segment; therefore, the individual segment amounts will not agree to Note 12 in the accompanying Consolidated Financial Statements.
Title insurance companies typically issue title insurance policies directly through home and branch offices or through title agencies. Following is a breakdown of premiums generated by branch and agency operations for the years ended December 31:
When a policy is written through a title agency, the premium is shared between the agency and the underwriter. Total premiums include an estimate of premiums for policies that have been issued by agents, but not reported to the Company as of the balance sheet date. To determine the estimated premiums, the Company uses historical experience, as well as other factors, to make certain assumptions about the average elapsed time between the policy effective date and the date the policies are reported. From time to time, the Company adjusts the inputs to the estimation process as agents report transactions and new information becomes available. In addition to estimating revenues, the Company also estimates and accrues agent commissions, claims provision, premium taxes, income taxes, and other expenses associated with the estimated revenues that have been accrued. The Company reflects any adjustments to the accruals in the results of operations in the period in which new information becomes available.
Agency net premiums written increased 12.9% in 2017 to $98,344,483 compared with $87,086,997 in 2016, and increased 3.6% in 2016 compared with $84,074,592 in 2015. The increases in 2017 and 2016 compared with their respective prior years were primarily attributable to the addition of new title insurance agents in the Company's Texas and southeast markets, higher levels of real estate activity from existing agents and overall higher home prices. The increase in 2017 was partially offset by lower refinance activity.
The Company derives a substantial portion of its income from investments in municipal and corporate bonds and equity securities. The Company's title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. 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. Bonds totaling approximately $7,119,000 and $6,843,000 at December 31, 2017 and 2016, 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 bonds and, to a lesser extent, equity securities. The average effective maturity of the majority of the bonds 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 bonds, tax-exempt bonds and equity securities. The Company also invests in short-term investments that include commercial paper, money-market funds and certificates of deposit. In addition, the Company holds other investments that are primarily investments in partnerships structured as limited liability companies. 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.
Following is a summary of the Company’s operating expenses for 2017, 2016 and 2015. Intersegment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 12 in the accompanying Consolidated Financial Statements.
On a combined basis, the after-tax profit margins were 15.9%, 14.1% and 9.9% in 2017, 2016 and 2015, respectively. The Company continually strives to enhance its competitive strengths and market position, including ongoing initiatives to manage its operating expenses.
Salaries, Employee Benefits and Payroll Taxes: Personnel costs include base salaries, benefits and payroll taxes and bonuses paid to employees. Salaries, employee benefits and payroll taxes were $39,012,354, $31,372,099 and $28,041,213 for 2017, 2016 and 2015, respectively. Salaries and related costs increased by approximately 24.4% in 2017 from 2016 and 11.9% in 2016 from 2015. The increase in 2017 compared with 2016 primarily related to increases in salaries, benefits and payroll expenses associated with the acquisition of a title agency that was acquired in the fourth quarter of 2016 and other staffing and inflationary increases. The increase in 2016 compared with 2015 was primarily related to higher levels of incentive compensation, inflationary increases in salaries and benefits, payroll expenses associated with the acquisition of a title agency and increases in staffing levels to accommodate higher volume. On a consolidated basis, salaries and employee benefits as a percentage of total revenues were 24.1%, 22.7% and 22.0% in 2017, 2016 and 2015, respectively.
Filing Fees, Franchise and Local Taxes: Filing fees, franchise and local tax expenses include insurance filing and licensing fees, franchise taxes, excise taxes and local taxes. Filing fees, franchise and local tax expenses were $1,198,013 in 2017 compared with $907,225 in 2016 and $732,985 in 2015.
Other Expenses: Other operating expenses primarily include amortization of intangible assets, other miscellaneous expenses of the title segment and miscellaneous operating expenses of the trust division. These amounts typically fluctuate with transaction volume of the title segment and the trust division. Other expenses increased to $2,585,074 in 2017, compared with $1,099,408 in 2016 and $884,438 in 2015. Other operating expenses increased in 2017 and 2016 primarily due to the amortization of intangible assets and miscellaneous expenses of the title segment.
After-Tax Profit Margin: The Company’s title insurance after-tax profit margin varies according to a number of factors, including the volume and type of real estate activity. After-tax profit margins for the title insurance segment were 16.9% 15.0% and 10.9% in 2017, 2016 and 2015, respectively. The increase in after-tax profit margin in 2017 compared with 2016 was primarily related to an increase in operating revenues and a lower provision for taxes, partially offset by increases in salaries, employee benefits and payroll expenses, commissions to agents and the provision for claims. The increase in after-tax profit margin in 2016 compared with 2015 was primarily related to an increase in operating revenues and, a lower provision for claims, partially offset by an increase in salaries, employee benefits and payroll expenses.
The increase in the loss provision rate in 2017 from the 2016 level resulted in approximately $3,032,000 more in reserves than would have been recorded at the lower 2016 level. Loss provision ratios are subject to variability and are reviewed and adjusted as experience develops.
The provision for income taxes was $4,570,000, $8,616,000 and $5,228,000 for the years ended December 31, 2017, 2016 and 2015, respectively. Income tax expense as a percentage of earnings before income taxes was 15.1%, 30.6% and 29.4% for the years ended December 31, 2017, 2016 and 2015, respectively. On December 22, 2017, the TCJA was enacted into law, reducing the federal corporate income tax rate from 35% to 21% effective January 1, 2018. The decrease in the effective rate in 2017 compared with 2016 was primarily due to the revaluation of deferred tax assets and liabilities to the newly enacted tax rate of 21%. The revaluation resulted in a tax benefit of approximately $5,300,000 recognized in the fourth quarter of 2017. The increase in the effective rate in 2016 compared with 2015 was primarily due to a lower proportion of tax-exempt to taxable income. The effective income tax rate for 2017 was below the U.S. federal statutory tax rate (34%) primarily due to the effects of the tax rate deduction and tax-exempt income, while the effective income tax rates for 2016 and 2015 were below the statutory income tax rate primarily due to the effects of tax-exempt income.
Cash Flows: Net cash flows provided by operating activities were $19,893,180, $22,567,262 and $16,916,506 for 2017, 2016 and 2015, respectively. Cash flows from operating activities decreased in 2017 from 2016 primarily due to a benefit in deferred income taxes, and changes in other assets and income taxes payable, partially offset by increases in net income and the provision for claims. Cash flows from operating activities increased in 2016 from 2015 primarily due to a decrease in other assets and an increase in net income, partially offset by the timing of payable disbursements and a lower provision for claims.
The Company maintains a high degree of liquidity within its investment portfolio, classified as available for sale, in the form of cash, short-term investments, and other readily marketable securities. As of December 31, 2017, the Company held cash and cash equivalents of $20,214,468, short-term investments of $23,779,672, fixed maturity securities of $103,341,083 and equity securities of $47,366,826. The net effect of all activities on total cash and cash equivalents was a decrease of $7,714,004 for 2017, an increase of $6,138,404 for 2016, and an increase of $5,963,553 for 2015.
Capital Resources: The amount of capital resources the Company maintains is influenced by state regulation, the need to maintain superior financial ratings from third-party rating agencies and other marketing and operational considerations.
A strong financial position provides necessary flexibility to fund potential acquisition activity, to invest in the Company's core business, and to minimize the financial impact of potential adverse developments. Adverse developments that generally require additional capital include adverse financial results, changes in statutory accounting requirements by regulators, reserve charges, investment losses or costs incurred to adapt to a changing regulatory environment, including costs related to CFPB regulation of the real estate industry.
Purchase of Company Stock: On November 9, 2015, the Board of Directors of the Company approved the purchase of an additional 163,335 shares pursuant to the Company’s repurchase plan, such that there was authority remaining under the plan to purchase up to an aggregate of 500,000 shares of the Company’s common stock pursuant to the plan immediately after this approval. Unless terminated earlier by resolution of the Board of Directors, the plan will expire when all shares authorized for purchase under the plan have been purchased. Pursuant to the Company’s ongoing purchase program, the Company has purchased 1,333 shares in the twelve months ended December 31, 2017, 66,803 shares in the twelve months ended December 31, 2016, and 75,665 shares in the twelve months ended December 31, 2015 at average per share prices of $183.67, $93.10 and $72.48, respectively. The Company anticipates making further purchases under this plan from time to time in the future, depending on such factors as the prevailing market price of the Company’s common stock, the Company’s available cash and then existing alternative uses for such cash.
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 limited liability companies 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 $184,985,000 and $202,184,000 as of December 31, 2017 and 2016, respectively. These exchange deposits are held at third-party financial institutions. These amounts are not considered assets of the Company for accounting purposes and, therefore, are excluded from the accompanying Consolidated Balance Sheets. Exchange services revenue includes earnings on these deposits; therefore, investment income is shown as exchange services revenue, rather than investment income. The Company remains contingently liable to customers for the transfers of property, disbursements of proceeds, and the return on the proceeds at the agreed upon rate.
In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715). This update requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost (the "other components") and present it with other current compensation costs for related employees in the income statement and (2) present the other components elsewhere in the income statement and outside of income from operations if that subtotal is presented. In addition, the ASU requires entities to disclose the income statement lines that contain the other components if they are not presented on appropriately described separate lines. The update is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. None of these amendments will have a material impact on the Company’s financial position or results of operations.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). This update removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, under the ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount
We have audited the accompanying consolidated balance sheets of Investors Title (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017 and the related consolidated notes and schedules (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
Management of Investors Title Company and Subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15(d)-15(f). The Company’s internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of the Company’s financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
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, 2017.
We have audited Investors Title Company’s (the Company’s) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. 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.
Description of Business - Investors Title Company’s (the “Company”) primary business, and only reportable segment, is title insurance. The title insurance segment, through its two subsidiaries, Investors Title Insurance Company (“ITIC”) and National Investors Title Insurance Company (“NITIC”), is licensed to insure titles to residential, institutional, commercial and industrial properties. The Company issues title insurance policies primarily through approved attorneys from underwriting offices and through independent issuing agents in 22 states and the District of Columbia, primarily in the eastern half of the United States. The majority of the Company’s business is concentrated in Georgia, North Carolina, South Carolina, Texas and Virginia.
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”). Earnings attributable to noncontrolling interests in majority-owned insurance agencies are recorded in the Consolidated Statements of Income. Noncontrolling interests representing the portion of equity not related to the Company's ownership interests are recorded in separate sections of the Consolidated Balance Sheets. All intercompany balances and transactions have been eliminated in consolidation.
Immaterial Classification Corrections - In previous periods, certain commission revenue was improperly classified as net premiums written. The issue was identified in 2017 and, accordingly, the Consolidated Statements of Income have been corrected. The correction resulted in a decrease to previously reported net premiums written and an increase to other revenues of $1,526,230 and $566,213 for 2016 and 2015, respectively. The immaterial classification correction had no impact to the Company’s financial position or results of operations as previously reported.
Securities for which the Company has the intent and ability to hold to maturity are classified as held-to-maturity and reported at cost, adjusted for amortization of premiums or accretion of discounts, and other-than-temporary declines in fair value. Securities held principally for resale in the near term are classified as trading securities and recorded at fair values. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading or held-to-maturity are classified as available-for-sale and reported at 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. As of December 31, 2017 and 2016, all investments in securities are classified as available-for-sale. 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. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include the duration and extent to which the fair value has been less than cost and the Company’s ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value. Such 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. Fair values of the majority of investments are based on quoted market prices. Realized gains and losses are determined on the specific identification method. Refer to Note 3 for further information regarding investments in securities and fair value.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2017 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. Despite the variability of such estimates, management believes that the reserve is adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2017. 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.
Company management continually evaluates the collectability of receivables and provides an allowance for doubtful accounts equal to estimated losses expected to be incurred in the collection of premiums and fees receivable. Changes to the allowance for doubtful accounts are reflected within net premiums written in the Consolidated Statements of Income. Amounts are charged off in the period they are deemed to be uncollectible.
The excess tax benefit related to stock appreciation rights included in income taxes payable was $142,280, $32,293 and $26,875 in 2017, 2016 and 2015, respectively.
Goodwill represents the excess of cost over fair value of identifiable net assets acquired and assumed in a business combination. The fair value of the Company’s goodwill is principally based on values obtained from a third party valuation service. Goodwill is reviewed for impairment at least annually or when events or changes in circumstances indicate the carrying value may not be recoverable.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 updated guidance to improve financial reporting for leasing transactions. The core principle of the guidance is that lessees will be required to recognize assets and liabilities on the balance sheet for all leases with terms of more than twelve months. A lessee would recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from current GAAP, with some targeted improvements. Disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. In transition, both lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption was permitted for all entities upon issuance. 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, but does not expect it to have a material impact. As of December 31, 2017, future minimum lease payments with terms of more than twelve months were approximately $3.6 million.
Claims - The Company’s reserve for claims 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”). A provision for estimated future claims payments is recorded at the time policy revenue is recorded as a percentage of premium income. By their nature, title claims can often be complex, vary greatly in dollar amounts, vary in number due to economic and market conditions such as an increase in mortgage foreclosures, and involve uncertainties as to ultimate exposure. In addition, some claims may require a number of years to settle and determine the final liability for indemnity and loss adjustment expense. The payment experience may extend for more than 20 years after the issuance of a policy. Events such as fraud, defalcation and multiple property defects can substantially and unexpectedly cause increases in estimates of losses. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, these estimates are subject to variability.
The Company’s reserve for claims 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 have been incurred but not reported (“IBNR”).
The Company has designated approximately $57,301,000 and $53,190,000 of retained earnings as of December 31, 2017 and 2016, respectively, as appropriated to reflect the required statutory premium and supplemental reserves. See Note 8 for the tax treatment of the statutory premium reserve.
As of December 31, 2017 and 2016, approximately $102,082,000 and $88,323,000, respectively, of consolidated stockholders’ equity represents net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior insurance department approval. During 2018, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $18,960,000.
The special revenue category for both periods presented includes approximately 60 individual bonds with revenue sources from a variety of industry sectors.
The scheduled maturities of fixed maturity securities at December 31, 2017 were as follows:
The decline in estimated fair value of the fixed maturity securities can be attributed primarily to changes in market interest rates and changes in credit spreads over Treasury securities. Because the Company does not have the intent to sell these securities and will likely not be compelled to sell them before it can recover its cost basis, the Company does not consider these investments to be other-than-temporarily impaired.
Factors considered in determining whether a loss is temporary include the length of time and extent to which 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 32 and 36 securities had unrealized losses at December 31, 2017 and December 31, 2016, respectively. Reviews of the values of 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. During 2017, the Company recorded other-than-temporary impairment charges in the amount of $25,411 related to securities. During 2016, the Company recorded other-than-temporary impairment charges in the amount of $233,941 related to securities. During 2015, the Company recorded other-than-temporary impairment charges in the amount of $751,059 related to securities. Other-than-temporary impairment charges are included in net realized gain (loss) on investments in the Consolidated Statements of Income.
The Level 1 category includes equity securities that are measured at estimated fair value using quoted active market prices.
The Level 2 category includes fixed maturity investments such as corporate bonds, U.S. government and agency bonds and municipal bonds. 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 estimated 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, 2017 and December 31, 2016, the Company did not adjust any Level 2 fair values.
The following table presents, by level, the financial assets carried at estimated fair value measured on a recurring basis as of December 31, 2017 and 2016. The table does not include cash on hand and also does not include assets that are measured at historical cost or any basis other than fair value.
The estimated fair value of cost-basis investments is calculated from the book value of the underlying entities, which is not materially different from the fair value of the underlying entity. These items are included in other investments in the Consolidated Balance Sheets.
The provision for claims as a percentage of net premiums written was 2.4%, 0.2% and 4.0% in 2017, 2016 and 2015, respectively.
A summary of the Company’s loss reserve, broken down into its components of known title claims and IBNR, follows:
In management’s opinion, the reserve is adequate to cover claim losses which might result from pending and future claims.
Basic earnings per common share is computed by dividing net income attributable to the Company by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive potential common stock, comprised of shares issuable under the Company’s share-based compensation plans and the weighted average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money share-based awards, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, when share-based awards are exercised, (a) the exercise price of a share-based award; and (b) the amount of compensation cost, if any, for future services that the Company has not yet recognized.
The Company historically has adopted employee stock award plans under which restricted stock, and options or stock appreciation rights ("SARs") of the Company's stock may be granted to key employees or directors of the Company at a price not less than the market value on the date of grant. There is currently one active plan from which the Company may grant share-based awards. The awards eligible to be granted under the active plan are limited to SARs, and the maximum aggregate number of shares of common stock of the Company available pursuant to the plan for the grant of SARs is 250,000 shares.
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, 2017. The intrinsic values of SARs exercised during 2017, 2016 and 2015 were approximately $473,000, $117,000 and $104,000, respectively.
There were no options outstanding at December 31, 2017. The following table summarizes information about SARs outstanding at December 31, 2017:
There was approximately $219,000, $132,000 and $138,000 of compensation expense relating to SARs or options vesting on or before December 31, 2017, 2016 and 2015, respectively, included in salaries, employee benefits and payroll taxes in the Consolidated Statements of Income. As of December 31, 2017, there was approximately $62,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s stock award plans. That cost is expected to be recognized over a weighted average period of approximately 3 months.
On December 22, 2017, the TCJA, was enacted into law. The new tax legislation, among other changes, reduces the federal corporate income tax rate from 35% to 21%, effective January 1, 2018. As required under generally accepted accounting principles, the Company’s deferred tax assets and liabilities were revalued at the newly enacted U.S. corporate income tax rate. The impact was recognized in the Company’s provision for income taxes in the fourth quarter of 2017. The revaluation resulted in a benefit of approximately $5.3 million, or $2.82 per diluted share.
The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal or state and local examinations by taxing authorities for years before 2014.
The Company leases certain office facilities and equipment under operating leases. Rental expense also includes occasional rental of automobiles. Rent expense totaled approximately $1,232,000, $896,000, and $793,000 in 2017, 2016 and 2015, respectively. The future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2017, are summarized as follows:
Cost of the Company’s postretirement benefits included the following components and is presented in the salaries, employee benefits and payroll taxes line of its Consolidated Statements of Income:
Development of the accumulated postretirement benefit obligation for the years ended December 31, 2017 and 2016 includes the following:
Like-Kind Exchange Proceeds. In administering tax-deferred property exchanges, the Company’s subsidiary, Investors Title Exchange Corporation (“ITEC”), serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. Another Company subsidiary, Investors Title Accommodation Corporation (“ITAC”), serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property totaled approximately $184,985,000 and $202,184,000 as of December 31, 2017 and 2016, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying 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.
The title insurance segment primarily issues title insurance policies through approved attorneys from underwriting offices and through independent issuing agents. Title insurance policies insure titles to real estate.
Provided below is selected financial information about the Company’s operations by segment for the periods ended December 31, 2017, 2016 and 2015:
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 $250,000 at each institution are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Of the $20.2 million in cash and cash equivalents at December 31, 2017, $19.3 million was not insured by the FDIC. Of the $27.9 million in cash and cash equivalents at December 31, 2016, $27.1 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.
In October 2016, National Investors Holdings, LLC ("NIH"), a subsidiary of the Company, acquired all of the outstanding shares of a title insurance agency doing business in Texas. NIH paid $10 million plus a $918,000 adjustment for the title insurance agency’s net cash position at closing.
The following tables provide changes in the balances of each component of accumulated other comprehensive income, net of tax, for the periods ended December 31, 2017, 2016 and 2015: