One of our subsidiaries in the title insurance and services segment leases an aggregate of approximately 188,000 square feet of office space in three buildings of the International Technology Park in Bangalore, India pursuant to various lease agreements. All of the space is leased pursuant to agreements that expire no later than 2017.
The process of assessing the loss provision rate and the resulting IBNR reserve involves evaluation of the results of an in-house actuarial review. The Company’s in-house actuary performs a reserve analysis utilizing generally accepted actuarial methods that incorporate cumulative historical claims experience and information provided by in-house claims and operations personnel. Current economic and business trends are also reviewed and used in the reserve analysis. These include conditions in the real estate and mortgage markets, changes in residential and commercial real estate values, and changes in the levels of defaults and foreclosures that may affect claims levels and patterns of emergence, as well as any company-specific factors that may be relevant to past and future claims experience. Results from the analysis include, but are not limited to, a range of IBNR reserve estimates and a single point estimate for IBNR as of the balance sheet date.
For recent policy years at early stages of development (generally the last three years), IBNR is estimated using a combination of expected loss rate and multiplicative loss development factor calculations. For more mature policy years, IBNR generally is estimated using multiplicative loss development factor calculations. The expected loss rate method estimates IBNR by applying an expected loss rate to total title insurance premiums and escrow fees, and adjusting for policy year maturity using estimated loss development patterns. Multiplicative loss development factor calculations estimate IBNR by applying factors derived from loss development patterns to losses realized to date. The expected loss rate and loss development patterns are based on historical experience and the relationship of the history to the applicable policy years.
The provision transferred from IBNR title claims related to current year decreased by $16.4 million in 2015 from 2014 and increased by $12.2 million in 2014 from 2013 and payments, net of recoveries, related to current year decreased by $11.0 million in 2015 from 2014 and increased by $6.9 million in 2014 from 2013, reflecting variability in claims volumes characteristic of a policy year during its first year of development. In addition, 2014 experienced a higher level of fraud losses when compared to 2015 and 2013.
The provision transferred from IBNR title claims related to prior years decreased by $90.0 million, or 32.8%, in 2015 from 2014 and decreased $5.9 million, or 2.1%, in 2014 from 2013. Payments, net of recoveries, related to prior years decreased by $6.3 million, or 2.5%, in 2015 from 2014 and decreased $30.8 million, or 11.0%, in 2014 from 2013. Generally, the provision transferred from IBNR title claims and payments are expected to decline with the runoff of older policy years that have higher expected ultimate losses, particularly policy years 2005 through 2008. This trend was partially impacted by the timing of the provision transferred from IBNR title claims and payments associated with certain large claims. During 2014, the Company transferred provision of $56.0 million from IBNR title claims related to these large claims, and the Company paid $35.0 million, net of $21.0 million recovered through reinsurance, during the first quarter of 2015 to settle these claims.
The provision related to current year decreased by $5.5 million, or 2.8%, in 2014 from 2013. This decrease was attributable to a 7.7% decline in title premiums and escrow fees in 2014 from 2013, partly offset by a higher current year loss rate in 2014 when compared to 2013. The current year loss rate in 2014 was 5.3% compared to 5.0% in 2013.
If the Company does not expect to recover the amortized cost basis of a debt security with declines in fair value (even if the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security), the losses the Company considers to be the credit portion of the other-than-temporary impairment loss (“credit loss”) is recognized in earnings and the non-credit portion is recognized in other comprehensive income. The credit loss is the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security. The cash flows expected to be collected are discounted at the rate implicit in the security immediately prior to the recognition of the other-than-temporary impairment.
The fair values of equity securities, including preferred and common stocks, were based on quoted market prices for identical assets that are readily and regularly available in an active market.
Impairment assessment for other intangible assets. Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of intangible assets with finite lives, whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value.
Impairment of property and equipment. Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value. The Company recognized impairment losses on software of $10.9 million, $1.2 million and $1.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Income taxes. The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is considered more likely than not that some or all of the deferred tax assets will not be realized.
Employee benefit plans. The Company recognizes the overfunded or underfunded status of its defined benefit pension and supplemental benefit plans as an asset or liability on its consolidated balance sheets and recognizes changes in the funded status in the year in which changes occur, through accumulated other comprehensive loss. The funded status is measured as the difference between the fair value of plan assets and benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for the other postretirement plans). Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive loss. Plan assets and obligations are measured annually as of December 31.
The assumptions that have had the most significant impact to net periodic costs are the discount rate and expected long-term rate of return on plan assets. The discount rate assumption reflects the yield available on high-quality, fixed-income debt securities that match the expected timing of the benefit obligation payments. Assumptions for the expected long-term rate of return on assets of the defined benefit pension plans are based on future expectations for returns for each asset class based on the calculated market-related value of plan assets and the effect of periodic target asset allocation rebalancing, adjusted for the payment of reasonable expenses of the plan from plan assets. See Note 13 Employee Benefit Plans to the consolidated financial statements for a further description of the expected long-term rate of return on plan assets as well as asset allocation targets.
In May 2015, the FASB issued updated guidance intended to eliminate the diversity in practice surrounding how investments measured at net asset value under the practical expedient with future redemption dates have been categorized in the fair value hierarchy. Under the updated guidance, investments for which fair value is measured at net asset value per share using the practical expedient should no longer be categorized in the fair value hierarchy. The updated guidance requires retrospective adoption for all periods presented and is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. Except for the disclosure requirements, the Company does not expect the adoption of this guidance to impact its consolidated financial statements.
According to the Mortgage Bankers Association’s February 18, 2016 Mortgage Finance Forecast (the “MBA Forecast”), residential mortgage originations in the United States (based on the total dollar value of the transactions) increased 29.3% in 2015 when compared with 2014. According to the MBA Forecast, the dollar amount of purchase originations increased 16.1% and refinance originations increased 49.2%. The higher volume of domestic residential mortgage origination activity in 2015 contributed to a 4.7% increase in domestic residential purchase orders closed per day and a 24.7% increase in domestic refinance orders closed per day by the Company’s direct title operations in 2015 when compared to 2014.
Despite uncertainties in the economy, the Company remains optimistic that the housing market will continue to strengthen in 2016. The Company anticipates growth in the residential purchase market and is benefiting from the recent decline in mortgage rates, which is positively impacting residential refinance volumes. The Company’s direct title operations opened 1,700 refinance orders per day in January 2016 and have opened approximately 2,300 refinance orders per day so far in February 2016 (measured through February 17, 2016). It is uncertain how long this level of elevated refinance activity will continue. The Company expects growth rates in the commercial market to moderate relative to those experienced in 2015.
During the fourth quarter of 2015, the Company recorded certain reclassifications and revisions to its consolidated statements of income for the years ended December 31, 2014 and 2013. For further discussion of these reclassifications and revisions, see Note 1 Description of the Company to the consolidated financial statements, pages 53 and 54.
Agent premiums increased $230.9 million, or 12.4%, in 2015 from 2014 and decreased $194.0 million, or 9.4%, in 2014 from 2013. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums typically reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The increase in agent premiums in 2015 from 2014 was consistent with the 16.9% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2015 as compared with the twelve months ended September 30, 2014. The decrease in agent premiums in 2014 from 2013 was consistent with the 13.4% decrease in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2014 as compared with the twelve months ended September 30, 2013.
Net investment income increased $37.7 million, or 63.1%, in 2015 from 2014 and decreased $16.8 million, or 22.0%, in 2014 from 2013. The increase in 2015 from 2014 was primarily attributable to higher interest income from the investment portfolio primarily due to higher average balances in the title insurance and services segment’s debt securities portfolio in 2015 when compared to 2014 and lower impairment losses related to investments accounted for using the equity method when compared to 2014. The decrease in 2014 from 2013 was primarily attributable to higher impairment losses and lower equity in earnings related to investments accounted for using the equity method, partially offset by higher interest income from the investment portfolio primarily due to higher average balances in the title insurance and services segment’s debt securities portfolio in 2014 when compared to 2013. Net investment income for 2015, 2014 and 2013 included impairment losses recognized on investments accounted for using the equity method of $2.0 million, $22.5 million and $5.8 million, respectively.
Personnel costs increased $153.9 million, or 11.5%, in 2015 from 2014 and decreased $42.5 million, or 3.1%, in 2014 from 2013. Excluding the $19.3 million impact of new acquisitions for the year ended December 31, 2015, personnel costs increased $134.6 million, or 10.1%, in 2015 compared to 2014. The increase in 2015, adjusted for the impact of new acquisitions, was primarily attributable to higher incentive compensation costs, which include commissions, bonuses and 401(k) savings plan matches, due to higher revenue and profitability; higher salary expense due to higher headcount levels; and higher overtime and temporary labor costs driven by higher order volumes. Excluding the $37.8 million impact of new acquisitions for the year ended December 31, 2014, personnel costs decreased $80.3 million, or 5.8%, in 2014 compared to 2013. The decrease in 2014, adjusted for the impact of new acquisitions, was primarily attributable to lower salary, payroll taxes, employee benefit, temporary labor, overtime, and severance costs. The lower salary and payroll tax costs were attributable to reduced headcount when compared to the prior year. The lower employee benefit costs were due to changes in the Company’s medical and dental insurance plans, lower incurred medical claims and lower headcount when compared to the prior year. The lower temporary labor and overtime costs were due to lower order volumes when compared to the prior year. The lower severance costs were due to a lower level of employee reductions made during 2014 when compared to 2013. Personnel costs included severance expense of $5.6 million, $8.9 million and $17.5 million for 2015, 2014 and 2013, respectively.
The Company continues to closely monitor order volumes and related staffing levels and intends to adjust staffing levels as considered necessary. The Company’s direct title operations opened 1,261,700, 1,155,500 and 1,384,600 domestic title orders in 2015, 2014 and 2013, respectively, representing an increase of 9.2% in 2015 from 2014 and a decrease of 16.5% in 2014 from 2013.
Depreciation and amortization expense increased $2.5 million, or 3.3%, in 2015 from 2014 and $10.9 million, or 16.2%, in 2014 from 2013. Excluding the $2.4 million impact of new acquisitions for the year ended December 31, 2015, depreciation and amortization expense increased $0.1 million, or 0.1%, in 2015 compared to 2014. The increase in 2014 was primarily attributable to the depreciation and amortization expense associated with developed technology and other intangible assets recorded in connection with new acquisitions completed during the first quarter of 2014. Excluding the $8.6 million impact of new acquisitions for the year ended December 31, 2014, depreciation and amortization expense increased $2.3 million, or 3.4%, in 2014 compared to 2013.
The profit margins for the title insurance business reflect the high cost of performing the essential services required before insuring title, whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to this relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. Title insurance profit margins are also affected by the percentage of title insurance premiums generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. The pre-tax margins were 10.2%, 8.7% and 7.6% for the years ended December 31, 2015, 2014 and 2013, respectively.
Direct premiums increased $26.5 million, or 7.5%, in 2015 from 2014 and $24.6 million, or 7.5%, in 2014 from 2013. The increases were driven by higher premiums earned in the home warranty business and, to a lesser extent, higher premiums earned in the property and casualty business. The increase in 2015 from 2014 in the home warranty business was in its real estate, direct to consumer and renewal channels and was driven by an increase in the number of home warranty residential service contracts issued. The increase in 2014 from 2013 in the home warranty business was in its real estate, direct to consumer and renewal channels and was driven by an increase in the price charged for home warranty residential service contracts and an increase in the number of contracts issued. The increases in the property and casualty business were primarily in its independent broker and direct channels.
The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 56.5% in 2015, 53.3% in 2014 and 57.5% in 2013. The increase in rate in 2015 from 2014 was primarily attributable to higher contract servicing costs due to an increase in the frequency of higher cost claims related to more severe weather conditions and less efficient claims management. The efficiency of claims management was adversely impacted by the increased level of claims opened in 2015 as a result of the higher volume of home warranty residential service contracts outstanding in 2015 when compared to 2014. The decrease in rate in 2014 from 2013 was primarily attributable to lower claims frequency and lower contract servicing costs due to milder weather conditions during the second and third quarters of 2014 when compared to the respective quarters of 2013. The rate in 2014 also benefited from an improvement in claims management in 2014 when compared to 2013.
Premium taxes as a percentage of specialty insurance segment premiums were 1.8% in 2015 and 1.7% in 2014 and 2013.
A large part of the revenues for the specialty insurance businesses are generated by renewals and are not dependent on the level of real estate activity in the year of renewal. With the exception of loss expense, the majority of the expenses for this segment are variable in nature and therefore generally fluctuate consistent with revenue fluctuations. Accordingly, profit margins for this segment (before loss expense) are relatively constant, although as a result of some fixed expenses, profit margins (before loss expense) should nominally improve as premium revenues increase. Pre-tax margins were 10.0%, 14.4% and 12.4% for 2015, 2014 and 2013, respectively.
Net investment losses totaled $5.4 million in 2015 and net investment income totaled $5.5 million and $8.6 million in 2014 and 2013, respectively. The change in net investment income for all three years is primarily attributable to fluctuations in earnings on investments associated with the Company’s deferred compensation plan. Net investment losses for 2015 were impacted by a one-time non-cash charge of $4.0 million, recorded during the first quarter of 2015, related to the investments associated with the Company’s deferred compensation plan. Net investment income for 2013 included impairment losses recognized on investments accounted for using the equity method of $2.0 million.
Corporate personnel costs and other operating expenses were $63.3 million, $61.1 million and $76.2 million in 2015, 2014 and 2013, respectively. The increase for 2015 was primarily attributable to increased expense related to the Company’s defined benefit pension and supplemental benefit plans, partially offset by decreased expense related to the Company’s deferred compensation plan. The decrease for 2014 was primarily attributable to decreased expense associated with the Company’s defined benefit pension, supplemental benefit and deferred compensation plans.
Interest expense increased $9.0 million in 2015 from 2014 and $2.7 million in 2014 from 2013. Interest expense increased in both 2015 and 2014 primarily due to the Company’s issuance of $300.0 million of debt in November 2014. Interest expense related to intercompany notes payable to the title insurance and services and specialty insurance segments was $0.4 million, $1.5 million and $2.6 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The substantial majority of the Company’s business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. Periods of increasing interest rates and reduced mortgage financing availability generally have an adverse effect on residential real estate activity and therefore typically decrease the Company’s revenues. In contrast, periods of declining interest rates and increased mortgage financing availability generally have a positive effect on residential real estate activity which typically increases the Company’s revenues. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months. Residential refinance activity is typically more volatile than purchase activity and is highly impacted by changes in interest rates. Commercial real estate volumes are less sensitive to changes in interest rates, but fluctuate based on local supply and demand conditions for space and mortgage financing availability.
Cash provided by operating activities amounted to $551.3 million, $360.6 million and $378.5 million for the years ended December 31, 2015, 2014 and 2013, respectively, after claim payments, net of recoveries, of $476.5 million, $469.8 million and $479.3 million, respectively. The principal nonoperating uses of cash and cash equivalents for the year ended December 31, 2015 were purchases of debt and equity securities, capital expenditures and dividends to common stockholders. The principal nonoperating uses of cash and cash equivalents for the year ended December 31, 2014 were purchases of debt and equity securities, repayment of debt, business acquisitions, capital expenditures and dividends to common stockholders. The principal nonoperating uses of cash and cash equivalents for the year ended December 31, 2013 were purchases of debt and equity securities, repayment of debt, capital expenditures, purchase of Company shares and payment of dividends to common stockholders. The most significant nonoperating sources of cash and cash equivalents for the year ended December 31, 2015 were proceeds from the sales and maturities of debt and equity securities and increases in the deposit balances at the Company’s banking operations. The most significant nonoperating sources of cash and cash equivalents for the year ended December 31, 2014 were proceeds from the sales and maturities of debt and equity securities, increases in the deposit balances at the Company’s banking operations, proceeds from the issuance of debt and paydowns and net proceeds related to the sale of loans receivable. The most significant nonoperating sources of cash and cash equivalents for the year ended December 31, 2013 were proceeds from the sales and maturities of debt and equity securities, increases in the deposit balances at the Company’s banking operations, proceeds from the issuance of debt and paydowns of loans receivable. The net effect of all activities on total cash and cash equivalents was a decrease of $162.8 million, and increases of $355.2 million and $164.3 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. In January 2016, the Company’s board of directors approved a first quarter cash dividend of 26 cents per common share. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.
The Company completed acquisitions in 2015 for an aggregate purchase price of $32.3 million.
Investment portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of December 31, 2015, 93% of the Company’s investment portfolio consisted of fixed income securities, of which 65% were United States government-backed or rated AAA and 95% were rated or classified as investment grade. Percentages are based on the estimated fair values of the securities. Credit ratings reflect published ratings obtained from S&P, DBRS, Inc., Fitch Ratings, Inc. and Moody’s. If a security was rated differently among the rating agencies, the lowest rating was selected. For further information on the credit quality of the Company’s investment portfolio at December 31, 2015, see Note 3 Debt and Equity Securities to the consolidated financial statements.
Capital expenditures. Capital expenditures primarily consist of capitalized software development costs, additions to property and equipment, additions to title plants and purchases of real estate data. Capital expenditures were $127.6 million, $99.4 million and $87.1 million for the years ended December 31, 2015, 2014 and 2013, respectively. The increase in 2015 from 2014 primarily reflected increased spending in 2015 on software, real estate data, title plants and property and equipment. The increase in software in 2015 was mainly driven by the Company’s effort to comply with the Consumer Financial Protection Bureau’s TILA-RESPA integrated disclosure rule. The increase in 2014 from 2013 primarily related to increased spending in 2014 on software, real estate data and title plants, partially offset by lower spending in 2014 on property and equipment.
Trust assets held or managed by First American Trust, FSB totaled $3.0 billion at December 31, 2015 and 2014. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.
The Company maintains investments in debt securities in accordance with certain statutory requirements for the funding of statutory premium reserves and state deposits. At December 31, 2015 and 2014, the fair value of such investments totaled $122.4 million and $120.7 million, respectively. See Note 2 Statutory Restrictions on Investments and Stockholders’ Equity for additional discussion of the Company’s statutory restrictions.
The following table presents the change in the credit portion of the other-than-temporary impairments recognized in earnings on debt securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive income (loss) for the years ended December 31, 2015, 2014 and 2013.
Cumulative credit loss on debt securities held at beginning of period
When a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such security is written down to its fair value. When assessing if a decline in fair value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
When an equity security has been in an unrealized loss position and its fair value is less than 80% of cost for twelve consecutive months, the Company’s review of the security includes the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company did not record other-than-temporary impairment losses related to its equity securities for the years ended December 31, 2015, 2014 and 2013.
Other investments consist primarily of investments in affiliates, which are accounted for under either the equity method or the cost method of accounting, investments in real estate and notes receivable.
Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value. The Company recognized impairment losses on software of $10.9 million, $1.2 million and $1.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Title plants and other indexes at December 31, 2015 included title plants of $528.7 million and capitalized real estate data of $26.2 million, and at December 31, 2014 included title plants of $514.6 million and capitalized real estate data of $16.0 million. Title plants are carried at original cost, with the costs of daily maintenance (updating) charged to expense as incurred. Because properly maintained title plants have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation or amortization. The Company analyzes its title plants at least annually for impairment. This analysis includes, but is not limited to, the effects of obsolescence, duplication, demand and other economic factors. Capitalized real estate data is carried at cost, less amortization. Capitalized real estate data is amortized using the straight-line method over estimated useful lives of 3 to 15 years.
The Company is required to perform an annual goodwill impairment assessment for each reporting unit. The Company’s four reporting units are title insurance, home warranty, property and casualty insurance and trust and other services. The Company has elected to perform this annual assessment in the fourth quarter of each fiscal year or sooner if circumstances indicate possible impairment. Based on current guidance, the Company has the option to perform a qualitative assessment to determine if the fair value is more likely than not (i.e., a likelihood of greater than 50%) less than the carrying amount as a basis for determining whether it is necessary to perform a quantitative impairment test, or may choose to forego the qualitative assessment and perform the quantitative impairment test. The qualitative factors considered in this assessment may include macroeconomic conditions, industry and market considerations, overall financial performance as well as other relevant events and circumstances as determined by the Company. The Company evaluates the weight of each factor to determine whether it is more likely than not that impairment may exist. If the results of the qualitative assessment indicate the more likely than not threshold was not met, the Company may choose not to perform the quantitative impairment test. If, however, the more likely than not threshold is met, the Company performs the quantitative test as required and discussed below.
The Company provides for property and casualty insurance losses when the insured event occurs. The Company provides for claims losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per home warranty claim is calculated using the average of the most recent 12 months of claims experience adjusted for estimated future increases in costs.
Premiums on home warranty contracts and property and casualty insurance policies are generally recognized ratably over the 12-month duration of the contract or policy.
Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company.
Information and other revenues primarily consist of revenues generated from fees associated with title search and related reports, title and other real property records and images, other non-insured settlement services, and risk mitigation products and services. For those products and services that are delivered at a point in time and for which there is no ongoing obligation, revenue is recognized upon delivery. For those products and services that are delivered at a point in time and for which there is an ongoing obligation, and for products and services where delivery occurs over time, revenue is recognized ratably over the duration of the contract.
Basic earnings per share is computed by dividing net income available to the Company’s stockholders by the weighted-average number of common shares outstanding. The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the weighted-average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if dilutive stock options had been exercised and RSUs were vested. The dilutive effect of stock options and unvested RSUs is computed using the treasury stock method, which assumes any proceeds that could be obtained upon the exercise of stock options and vesting of RSUs would be used to purchase common shares at the average market price for the period. The assumed proceeds include the purchase price the grantee pays, the hypothetical windfall tax benefit that the Company receives upon assumed exercise or vesting and the hypothetical average unrecognized compensation expense for the period. The Company calculates the assumed proceeds from excess tax benefits based on the “as-if” deferred tax assets calculated under share based compensation standards.
Certain unvested RSUs contain nonforfeitable rights to dividends as they are eligible to participate in undistributed earnings without meeting service condition requirements. These awards are considered participating securities under the guidance which requires the use of the two-class method when computing basic and diluted earnings per share. The two-class method reduces earnings allocated to common stockholders by dividends and undistributed earnings allocated to participating securities.
The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $6.6 billion and $6.3 billion at December 31, 2015 and 2014, respectively, of which $2.6 billion and $2.2 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.
In April 2014, the Financial Accounting Standards Board (“FASB”) issued updated guidance which changes the criteria for determining which disposals are required to be presented as discontinued operations and modifies related disclosure requirements. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2014, with early adoption permitted. The adoption of this guidance had no impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within and across industries, and across capital markets. The new revenue standard contains principles that an entity will apply to determine the measurement of revenue and the timing of recognition. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. Revenue from insurance contracts is not within the scope of this guidance. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption prohibited. In August 2015, the FASB issued updated guidance which defers the effective date of this guidance by one year to interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted as of the original effective date. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
Investments totaling $127.1 million and $133.0 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2015 and 2014, respectively.
The Company’s principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), maintained total statutory capital and surplus of $1.1 billion and $978.7 million as of December 31, 2015 and 2014, respectively. Statutory net income for the years ended December 31, 2015, 2014 and 2013 was $191.8 million, $393.1 million and $199.1 million, respectively. FATICO was in compliance with the minimum statutory capital and surplus requirements as of December 31, 2015.
FATICO, which was previously domiciled in the state of California, redomesticated to Nebraska effective July 1, 2014. FATICO’s statutory-based financial statements were prepared in accordance with accounting practices prescribed or permitted by the Nebraska Department of Insurance for the years ended December 31, 2015 and 2014. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures Manual (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by the state of Nebraska. The state of Nebraska has adopted certain prescribed accounting practices that differ from those found in the NAIC SAP. Specifically, the timing of amounts released from the statutory premium reserve under Nebraska’s required practice differs from NAIC SAP resulting in total statutory capital and surplus that was lower by $61.7 million and $11.7 million at December 31, 2015 and 2014, respectively, than if reported in accordance with NAIC SAP. Additionally, for the years ended December 31, 2015 and 2014, the state of Nebraska granted a permitted accounting practice to FATICO that differs from Nebraska’s prescribed accounting practices; specifically, the determination to not record a bulk reserve within the known claims reserve resulting in total statutory capital and surplus that was higher by $58.9 million and $8.2 million at December 31, 2015 and 2014, respectively, than if reported in accordance with Nebraska’s required practice.
Sales of debt and equity securities resulted in realized gains of $8.7 million, $34.1 million and $17.2 million and realized losses of $10.0 million, $9.1 million and $15.5 million for the years ended December 31, 2015, 2014 and 2013, respectively.
As of December 31, 2015, the estimated fair value of total debt securities included $117.8 million of bank loans, of which $111.4 million was non-investment grade; $99.0 million of high yield corporate debt securities, all of which was non-investment grade; and $44.3 million of emerging market debt securities, of which $6.1 million was non-investment grade.
The table below outlines the composition of the investment portfolio in an unrealized loss position, by credit rating, as of December 31, 2015:
A summary of the changes in the carrying amount of goodwill, by operating segment, for the years ended December 31, 2015 and 2014, is as follows:
The Company’s goodwill impairment assessments for 2015, 2014 and 2013 did not indicate impairment to any of its reporting units. There is no accumulated impairment for goodwill as the Company has never recognized impairment to any of its reporting units.
Current year payments include $198.6 million, $174.4 million and $167.3 million in 2015, 2014 and 2013, respectively, that primarily relate to the Company’s specialty insurance segment. Prior year payments, net of recoveries, include $23.1 million, $23.2 million and $16.0 million in 2015, 2014 and 2013, respectively, that relate to the Company’s specialty insurance segment.
“Other” primarily includes foreign currency translation gains and losses, assets acquired in connection with claim settlements, and recoveries. Included for the year ended December 31, 2015, are recoveries of $23.8 million on reinsured losses related to a large commercial title claim. Payments and recoveries on reinsured losses for the Company’s title insurance and property and casualty businesses were immaterial during the years ended December 31, 2014 and 2013.
The provision for title insurance losses, expressed as a percentage of title insurance premiums and escrow fees, was 6.6%, 7.1% and 8.9% for the years ended December 31, 2015, 2014 and 2013, respectively.
The 2013 rate of 8.9% reflected an ultimate loss rate of 5.0% for policy year 2013 and a net increase in loss reserve estimates for prior policy years of $150.2 million. The increase in loss reserve estimates for prior policy years reflected claims development above expected levels during 2013, primarily from domestic lenders policies, commercial policies and the Company’s guaranteed valuation product offered in Canada. The reserve strengthening associated with domestic lenders policies was $67.4 million and was primarily attributable to increased claims frequency for policy years 2004 through 2008. The increased claims frequency was primarily due to mortgage lenders and servicers processing a large volume of foreclosures during 2013. As foreclosure processing increases, lenders claims generally increase, because lenders claims typically come from foreclosures in which the lender suffers a loss. At December 31, 2013, the Company expected the high level of foreclosure processing to continue in the near term as mortgage lenders and servicers worked through their foreclosure inventory. The reserve strengthening associated with domestic lenders policies reflected these expectations. The reserve strengthening associated with commercial policies was $38.8 million and was primarily attributable to several large commercial claims, mainly from mechanics liens, and primarily related to policy years 2007 and 2008. The reserve strengthening associated with the guaranteed valuation product offered in Canada was $21.7 million and was primarily attributable to claims frequency exceeding the Company’s expectations during 2013. The increase in frequency primarily related to policy years 2007 and 2010.
The Company’s reserve for known title claims was $87.5 million at December 31, 2015, a decline of $77.8 million, or 47.0%, from the balance at December 31, 2014. This decline is primarily attributable to settlement payments associated with certain large claims during the first quarter of 2015. The reserve for known title claims associated with these claims recorded at December 31, 2014 was $56.0 million. The Company paid $35.0 million, net of $21.0 million recovered through reinsurance, during the first quarter of 2015 to settle these claims.
4.60% senior unsecured notes due November 15, 2024, net of unamortized discount of $66 and $74 at December 31, 2015 and 2014, respectively, effective interest rate of 4.60%
4.30% senior unsecured notes due February 1, 2023, net of unamortized discount of $680 and $760 at December 31, 2015 and 2014, respectively, effective interest rate of 4.35%
Other notes and contracts payable with maturities through 2032, weighted-average interest rate of 4.21% and 5.30% at December 31, 2015 and 2014, respectively
For the years ended December 31, 2015, 2014 and 2013, domestic and foreign pretax income from continuing operations before noncontrolling interests was $383.5 million and $49.3 million, $301.8 million and $48.8 million, and $286.2 million and $24.5 million, respectively.
In connection with the Company’s June 2010 spin-off from its prior parent, which subsequently assumed the name CoreLogic, Inc. (“CoreLogic”), it entered into a tax sharing agreement which governs the Company’s and CoreLogic’s respective rights, responsibilities and obligations for certain tax related matters. At December 31, 2015 and 2014, the Company had a net payable to CoreLogic of $36.5 million and $35.1 million, respectively, related to tax matters prior to the spin-off. This amount is included in the Company’s consolidated balance sheets in accounts payable and accrued liabilities. The increase during the current year was primarily the result of an additional accrual for tax matters prior to the spin-off.
At December 31, 2015, the Company had available a foreign tax credit carryover of $1.8 million. The Company expects to utilize these credits within the carryover period.
As of December 31, 2015 and 2014, U.S. taxes were not provided for on the cumulative earnings of the Company’s foreign subsidiaries of $155.7 million and $132.8 million, respectively, as the Company has invested or expects to invest the undistributed earnings indefinitely. If in the future these earnings are repatriated to the United States, or if the Company determines that the earnings will be remitted in the foreseeable future, additional tax provisions may be required. It is not practicable to calculate the deferred taxes associated with these earnings because of the variability of multiple factors that would need to be assessed at the time of any assumed repatriation; however, foreign tax credits may be available to reduce federal income taxes in the event of distribution.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various state jurisdictions, and various non-U.S. jurisdictions. The primary non-federal jurisdictions are California, Canada, India and the United Kingdom. During 2015, the Company concluded U.S. federal income tax examinations for calendar years 2010 and 2011. No material adjustments resulted from these examinations. The Company is generally no longer subject to U.S. federal, state and non-U.S. income tax examinations by taxing authorities for years prior to 2005.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions may significantly decrease within the next 12 months. These changes may be the result of ongoing audits or the expiration of federal and state statutes of limitations for the assessment of taxes.
The First American Financial Corporation 401(k) Savings Plan (the “Savings Plan”) allows for employee-elective contributions up to the maximum amount as determined by the Internal Revenue Code. The Company makes discretionary contributions to the Savings Plan based on profitability, as well as the contributions of participants. Effective July 1, 2015, participants in the Savings Plan can no longer make additional investments in common stock of the Company. The Savings Plan held 3,129,000 shares and 3,528,000 shares of the Company’s common stock, representing 2.9% and 3.3% of the Company’s total common shares outstanding at December 31, 2015 and 2014, respectively.
The Company maintains a deferred compensation plan for certain employees that allows participants to defer up to 100% of their salary, commissions and certain bonuses. Participants can allocate their deferrals among a variety of investment crediting options (known as “deemed investments”). The term deemed investments means that the participant has no ownership interest in the funds they select; the funds are only used to measure the gains or losses that will be attributed to each participant’s deferral account over time. Participants can elect to have their deferral balance paid out while they are still employed or after their employment ends. The deferred compensation plan is exempt from most provisions of the Employee Retirement Income Security Act (“ERISA”) because it is only available to a select group of management and highly compensated employees and is not a qualified employee benefit plan. To preserve the tax-deferred savings advantages of a nonqualified deferred compensation plan, federal law requires that it be unfunded or informally funded. Participant deferrals, and any earnings on those deferrals, are general unsecured obligations of the Company. The Company informally funds the deferred compensation plan through a tax-advantaged investment known as variable universal life insurance. Deferred compensation plan assets are held as an asset of the Company within a special trust, called a “Rabbi Trust.” At December 31, 2015 and 2014, the value of the assets in the Rabbi Trust of $73.1 million and $78.6 million, respectively, and the unfunded liabilities of $76.3 million and $76.4 million, respectively, were included in the consolidated balance sheets in other assets and pension costs and other retirement plans, respectively.
The principal components of employee benefit plan expenses are as follows:
Net actuarial loss and prior service credit for the defined benefit pension and supplemental benefit plans expected to be amortized from accumulated other comprehensive loss into net periodic cost over the next fiscal year include an expense of $28.2 million and a credit of $4.8 million, respectively.
The Company has an investment policy which governs the management of, and strategy for, assets of the plan. The policy’s investment objective is to increase the pension plan’s funding status such that the plan becomes fully funded on a plan termination basis by taking progressively less risk through aligning a greater percentage of plan assets with plan liabilities as the plan becomes more fully funded.
Under the investment policy, asset allocation targets are segmented into liability tracking assets and return seeking assets. The objective of this allocation strategy is to increase the percentage of assets in liability tracking investments as settlement funded status improves. Return seeking assets generally include pooled investment vehicles, foreign and domestic equities, fixed income securities, cash, REITs, and commodities. Liability tracking assets generally include fixed income securities and pooled investment vehicles. The plan maintains a level of cash and cash equivalents appropriate for the timely disbursement of benefits and payment of expenses.
Asset allocation targets, based on settlement funded status, are as follows:
Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign government bonds, governmental agency bonds, governmental agency mortgage-backed securities and U.S. and foreign corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. Non-agency mortgage-backed securities and certain corporate debt securities were not actively traded and there were fewer observable inputs available requiring the use of more judgment in determining their fair values, which resulted in their classification as Level 3.
The following table presents the fair values of the Company’s assets, measured on a recurring basis, as of December 31, 2015 and 2014:
There were no transfers between levels during the years ended December 31, 2015 and 2014. Transfers into or out of the Level 3 category occur when unobservable inputs become more or less significant to the fair value measurement. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments not measured at fair value as of December 31, 2015 and 2014:
As of December 31, 2015, there was $23.2 million of total unrecognized compensation cost related to unvested RSUs that is expected to be recognized over a weighted-average period of 2.6 years. The fair value of RSUs is generally based on the market value of the Company’s shares on the date of grant. The total fair value of shares vested and not distributed for the years ended December 31, 2015, 2014 and 2013 was $3.3 million, $3.2 million and $4.3 million, respectively.
The following table summarizes stock option activity for the year ended December 31, 2015:
As of December 31, 2015, there was $0.5 million of total unrecognized compensation cost related to unvested stock options of the Company that is expected to be recognized over a weighted-average period of 2.0 years.
Total rental expense for all operating leases and month-to-month rentals was $93.3 million, $93.5 million and $94.6 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The class originally certified in Gale was subsequently decertified. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.
These lawsuits are putative class actions for which a class has not been certified. For the reasons described above, as well as the applicability of certain indemnification rights the Company may have, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.
As other investments are not publicly traded, reasonable estimates of the fair values could not be made without incurring excessive costs.
The holding company received cash dividends from subsidiaries of $142.5 million, $79.1 million and $125.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.