This management analysis of financial position and results of operations pertains to the consolidated accounts of Old Republic International Corporation ("Old Republic", "ORI" or "the Company"). The Company conducts its operations principally through three major regulatory segments, namely, its General (property and liability), Title, and the RFIG (mortgage guaranty and consumer credit indemnity) Run-off Business. A small life and accident insurance business, accounting for .3% of consolidated operating revenues for the year ended December 31, 2018 and .7% of consolidated assets as of that date, is included within the corporate and other caption of this report.
Effective January 1, 2018, two significant events transpired that have a bearing on the year-over-year comparability of consolidated pretax and net income. One arises from a rule of the Financial Accounting Standards Board (“FASB”) that requires the inclusion of unrealized investment gains or losses emanating from changes in the fair value of equity (but not fixed maturity) securities in the determination of pre and post-tax income. The second relates to a reduction in nominal Federal corporate income tax rates from 35% to 21%. The impact of the 2018 rate change on the reported 2017 and 2016 effective tax rates is discussed at the bottom of this page.
The Financial Highlights table on the previous page shows the components of consolidated pretax and net income to reflect the impact that total realized and, beginning in 2018, unrealized investment gains or losses of equity securities have on period-to-period comparisons. Management uses income exclusive of all investment gains (losses) to analyze, evaluate, and establish accountability for the results of Old Republic’s basic insurance operating performance. Net income, however, is the measure of total profitability according to the tenets of generally accepted accounting principles (“GAAP”).
In the table on the following page, the amounts shown for: (1) underwriting and related services income (loss) represent net premiums, fees, and other income reduced by claim costs and sales and general expenses; and (2) segmented and consolidated pretax income (loss), excluding investment gains (losses), represent the combination of underwriting and related services income (loss) and net investment income, reduced by interest and other charges.
In the final quarter of 2017, deferred income tax adjustments were made as required to reflect the lower Federal income tax rates which took effect at the beginning of 2018. The adjustments amounted to a deferred income tax charge of $41.8 applied to income excluding investment gains or losses, and a deferred income tax credit of $104.9 applied to investment gains or losses. The 2017 As Adjusted effective income tax rates in the above table reflect the exclusion of such required adjustments.
(a) Includes general administrative expenses. / (b) Includes net external and internal debt interest costs and consolidation/elimination entries. / (c) See the table at the bottom of the previous page for information about year-end 2017 deferred tax adjustments.
General Insurance Segment Results - The table below reflects the major elements affecting this segment’s financial performance for the periods shown.
In connection with the run-off mortgage guaranty ("MI") and consumer credit indemnity ("CCI") combination, $3.8, ($121.1) and ($33.8) of pretax operating income (loss) for 2018, 2017, and 2016, respectively, were retained by certain general insurance companies pursuant to various quota share and stop loss reinsurance agreements. All of these amounts, however, have been reclassified such that 100% of the CCI run-off business is reported in the RFIG run-off segment.
ranging between 23 and 25 percent. The expense ratio for 2017 was slightly above this long-term operating objective due to additional charges for estimated employee incentive awards. The slightly higher sales and general expense ratio in 2016 resulted mostly from greater costs incurred in the above-noted underwriting facility, additional litigation cost provisions in the year's second quarter, and by a slightly different premium mix and attendant production costs associated with the business’ responses to recurring changes in insurance market conditions and opportunities.
Title Insurance Segment Results - The table below reflects the major elements affecting this segment’s financial performance for the periods shown.
RFIG Run-off Segment Results - The table below reflects the major elements affecting this segment’s financial performance for the periods shown.
In connection with the run-off mortgage guaranty ("MI") and consumer credit indemnity ("CCI") combination, $3.8, ($121.1), and ($33.8) of pretax operating income (loss) for 2018, 2017, and 2016, respectively, were retained by certain general insurance companies pursuant to various quota share and stop loss reinsurance agreements. All of these amounts, however, have been reclassified such that 100% of the CCI run-off business is reported in the RFIG run-off segment.
The much more favorable CCI claim ratios for 2018 reflect the absence of the aforementioned litigation-induced claim costs and favorable development of previously established claim reserves. During 2017's third quarter, additional claim provisions in the amount of $107.0 were made to cover the final settlements and probable dispositions of all known litigated and other claim costs incurred during the Great Recession and its aftermath.
As of December 31, 2018, the consolidated investment portfolio reflected an allocation of approximately 74% to fixed-maturity and short-term investments, and 26% to high quality, dividend-paying equity securities. The asset quality of the fixed maturity portfolio has remained at high levels.
Changes in shareholders' equity per share are reflected in the following table. As shown, these resulted mostly from net income, dividend payments to shareholders, and changes in the value of invested assets carried at fair value.
Full year 2017 includes a special cash dividend of $1.00 per share.
This section of the Management Analysis of Financial Position and Results of Operations is additive to and should be read in conjunction with the Executive Summary which precedes it.
Loss trend factors that are considered when establishing the above noted expected claim ratios. These factors take into account such variables as judgments and estimates relative to premium rate trends and adequacy, current and expected interest rates, current and expected social and economic inflation trends, and insurance industry statistical claim trends.
The Company's financial position at December 31, 2018 reflected decreases in assets and liabilities of .4% and 3.3%, respectively, and an increase in common shareholders' equity of 8.7% when compared to the immediately preceding year-end. Cash and invested assets represented 68.2% and 69.8% of consolidated assets as of December 31, 2018 and 2017, respectively. As of year-end 2018, the cash and invested asset base decreased by 2.6% to $13,187.4.
Investments - During 2018 and 2017, the Company committed the majority of investable funds to short to intermediate-term fixed maturity securities and higher yielding publicly traded large capitalization equity securities. At both December 31, 2018 and 2017, approximately 99% of the Company's investments consisted of marketable securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities. The investment portfolio contains no significant insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, hybrid securities, or illiquid private equity and hedge fund investments. Moreover, the Company does not engage in hedging or securities lending transactions, nor does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes. At December 31, 2018, the Company had no fixed maturity investments in default as to principal and/or interest.
The Company does not own or utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its debt obligations. With regard to its equity portfolio, the Company does not own any options nor does it engage in any type of option writing. Traditional investment management tools and techniques are employed to address the yield and valuation exposures of the invested assets base. The long-term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through asset diversification and the purchase of investment grade securities. Reinvestment rate risk is reduced by concentrating on non-callable issues, and by taking asset-liability matching considerations into account. Purchases of mortgage and asset backed securities, which have variable principal prepayment options, are generally avoided. Market value risk is limited through the purchase of bonds of intermediate maturity. The combination of these investment management practices is expected to produce a more stable long-term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration.
Possible future declines in fair values for Old Republic's available for sale fixed maturity portfolio would negatively affect the common shareholders' equity account at any point in time, but would not necessarily result in the recognition of realized investment losses. The status and fair value changes of each of the fixed maturity (and prior to 2018, its equity security) investments are reviewed at least once per quarter during the year, and estimates of other-than-temporary impairments in the portfolio's value are evaluated and established at each quarterly balance sheet date. In reviewing investments for other-than-temporary impairment, the Company, in addition to a security's market price history, considers the totality of such factors as the issuer's operating results, financial condition and liquidity, its ability to access capital markets, credit rating trends, most current audited financial statements, industry and securities markets conditions, and analyst expectations to reach its conclusions. Sudden fair value declines caused by such adverse developments as newly emerged or imminent bankruptcy filings, issuer default on significant obligations, or reports of financial accounting developments that bring into question the validity of the issuer's previously reported earnings or financial condition, are recognized as realized losses as soon as credible publicly available information emerges to confirm such developments. Prior to 2018, absent issuer-specific circumstances that would result in a contrary conclusion, any equity security with an unrealized investment loss amounting to a 20% or greater decline consecutively during a six month period was considered other-than-temporarily-impaired. In the event the Company's estimate of other-than-temporary impairments is insufficient at any point in time, future periods' net income (loss) would be affected adversely by the recognition of additional impairment losses, but its financial condition would not necessarily be affected adversely inasmuch as such losses, or a portion of them, could have been recognized previously as unrealized losses in shareholders' equity.
Represents 5.8% of the cost of the total equity portfolio, while gross unrealized gains represent 17.0% of the equity portfolio.
At December 31, 2018 the number of issues in an unrealized loss position represent 68.1% of the total number of such fixed maturity issues held by the Company.
The aging of issues with unrealized losses employs balance sheet date fair value comparisons with an issue's cost. The percentage reduction from such cost reflects the decline as of a specific point in time (December 31, 2018 in the above table) and, accordingly, is not indicative of a security's value having been consistently below its cost at the percentages shown nor throughout the periods shown.
Liquidity - The parent holding company meets its liquidity and capital needs principally through dividends and interest on intercompany financing arrangements paid by its subsidiaries. The insurance subsidiaries' ability to pay cash dividends to the parent company is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. The Company can receive up to $507.8 in dividends from its subsidiaries in 2019 without the prior approval of regulatory authorities. The liquidity achievable through such permitted dividend payments is considered sufficient to cover the parent holding company's currently expected cash outflows represented mostly by interest and scheduled repayments on outstanding debt, reasonably anticipated cash dividend payments to shareholders, modest operating expenses, and the near-term capital needs of its operating company subsidiaries.
Capitalization - Old Republic's total capitalization of $6,127.6 at December 31, 2018 consisted of debt of $981.4 and common shareholders' equity of $5,146.2. Changes in the common shareholders' equity account reflect primarily net income for the year then ended, changes in the fair value of fixed maturity securities, dividend payments and the conversion of all the 2018 Convertible Senior Notes into the Company's common stock.
Under state insurance regulations, the Company's three mortgage guaranty insurance subsidiaries are required to operate at a maximum risk to capital ratio of 25:1 or otherwise hold minimum amounts of capital based on specified formulas. Since the Company's mortgage insurance subsidiaries have discontinued writing new business the risk-to-capital ratio considerations are therefore no longer of consequence.
Contractual Obligations - The following table shows certain information relating to the required reporting of contractual obligations as of December 31, 2018:
Represents estimated minimum funding of contributions for the Old Republic International Salaried Employees Retirement Plan. Funding of the plan is dependent on a number of factors including actual performance versus actuarial assumptions made at the time of the actuarial valuation, as well as the maintenance of certain funding levels relative to regulatory requirements.
Title Group premium and fee revenues grew by 2.1%, 3.6% and 7.9% in 2018, 2017, and 2016 respectively. 2018 premiums and fees reflect a slowdown in housing and mortgage lending activity during the year. The continuation of a generally positive mortgage rate environment and reasonably strong housing and commercial property markets were major factors in the year-over-year gain in premiums and fees in 2017.
Results of the run-off MI and CCI business reflect the expected, continuing drop in net earned premiums from declining risk in force. For the CCI coverage in particular, the much lower premiums in 2018 resulted mostly from the 2017 elimination of a major bank business relationship which had been a significant source of both earned premiums and substantially higher litigated claim costs.
The Company's flagship mortgage guaranty insurance carrier ceased the underwriting of new policies effective August 31, 2011 and the existing book of business was placed in run-off operating mode.
The Company's consumer credit indemnity ("CCI") earned premiums and related risk in force included in the table below have reflected a generally declining trend. The decline is largely due to a discontinuation of active sales efforts since 2008 and from the elimination of a major bank as a source of significant premiums and claims in the third quarter of 2017.The following table shows CCI net premiums earned during the indicated periods and the maximum calculated risk in force at the end of the respective periods. Net earned premiums include additional premium adjustments arising from the variable claim experience of individual policies subject to retrospective rating plans. Risk in force reflects estimates of the maximum risk exposures at the inception of individual policies adjusted for cumulative claim costs and the lower outstanding loan balances attributed to such policies through the end of the periods shown below.
(a) These balances include fixed maturity securities classified as held to maturity which are reported and reflected herein at amortized cost.
The following table reflects the composition of net investment gains or losses for the periods shown. Gains realized in 2017 were substantially higher than those realized in recent years and stem from managed sales of investment portfolio securities whose values had risen to higher than expected levels over the course of 2017's strong securities market.
Most of Old Republic's consolidated claim and related expense reserves stem from its general insurance business. At December 31, 2018, such reserves accounted for 92.5% and 89.2% of consolidated gross and net of reinsurance reserves, respectively, while similar reserves at December 31, 2017 represented 90.8% and 86.6% of the respective consolidated amounts.
variety of coverages or classes of commercial insurance; it has negligible exposure to personal insurance coverages such as homeowners or private passenger automobile insurance that exhibit wide diversification of risks, significant frequency of claim occurrences, and high degrees of statistical credibility. Additionally, the Company's insurance subsidiaries do not provide significant amounts of insurance protection for premises; most of its property insurance exposures relate to cargo, incidental property, and insureds' inland marine assets. Consequently, the wide variety of policies issued and commercial insurance customers served require that loss reserves be analyzed and established in the context of the unique or different attributes of each block or class of business produced by the Company. For example, accident liability claims emanating from insured trucking companies or from general aviation customers become known relatively quickly, whereas claims of a general liability nature arising from the building activities of a construction company may emerge over extended periods of time. Similarly, claims filed pursuant to errors and omissions or directors and officers' liability coverages are usually not prone to immediate evaluation or quantification inasmuch as many such claims may be litigated over several years and their ultimate costs may be affected by the vagaries of judged or jury verdicts. Approximately 92% of the general insurance group's claim reserves stem from liability insurance coverages for commercial customers which typically require more extended periods of investigation and at times protracted litigation before they are finally settled. As a consequence of these and other factors, Old Republic does not utilize a single, overarching loss reserving approach.
Overall, reserves pertaining to several hundred large individual commercial insurance accounts that exhibit sufficient statistical credibility, and at times may be subject to retrospective premium rating plans or the utilization of varying levels or types of self-insured retentions through captive insurers and similar risk management mechanisms are established on an account by account basis using case reserves and applicable formula-driven methods. Large account reserves are usually set and analyzed for groups of coverages such as workers' compensation, commercial automobile (trucking) and general liability that are typically underwritten jointly for many customers. For certain so-called long-tail categories of insurance such as retained or assumed excess liability or excess workers' compensation, officers and directors' liability, and commercial umbrella liability relative to which claim development patterns are particularly long, more volatile, and immature in their early stages of development, the Company judgmentally establishes the most current accident years' loss reserves on the basis of expected claim ratios. Such expected claim ratios typically reflect currently estimated claim ratios from prior accident years, adjusted for the effect of actual and anticipated rate changes, actual and anticipated changes in coverage, reinsurance, mix of business, and other anticipated changes in external factors such as trends in loss costs or the legal and claims environment. Expected claim ratios are generally used for the two to three most recent accident years depending on the individual class or category of business. As actual claims data emerges in succeeding interim and annual periods, the original accident year claim ratio assumptions are validated or otherwise adjusted sequentially through the application of statistical projection techniques such as the Bornhuetter/Ferguson method which utilizes data from the more mature experience of prior years to arrive at a likely indication of more recent years' loss trends and costs.
Rescissions reduced the Company's paid losses by an estimated $4.4, $13.1, and $1.4 for 2018, 2017, and 2016, respectively.
The consolidated claim ratio reflects the changing effects of period-to-period contributions of each segment to consolidated results, and this ratio's variances within each segment. For the three most recent calendar years, the above table indicates that the one-year development of consolidated reserves at the beginning of each year produced favorable developments in 2018, 2017, and 2016 which on average decreased the consolidated claim ratio by 1.9%.
The general insurance claim ratios have been on a fairly consistent downtrend during the past five years. The improvement has arisen from slightly lower estimates of current accident years' claim provisions, and by the lessening impacts from developments of prior years' reserve estimates as more fully described in the Executive Summary of the Management Analysis of Financial Position and Results of Operations.
Title insurance claim ratios have remained in the single digits for a number of years due to a continuation of favorable trends in claims frequency and severity. 2018's claim costs trended higher as favorable development of prior years’ claim reserve estimates edged down as more fully described in the Executive Summary of the Management Analysis of Financial Position and Results of Operations.
The ratios of RFIG Run-off - mortgage guaranty incurred claim costs to earned premiums reflect favorable developments of prior years' claim reserves as further discussed in the Executive Summary of the Management Analysis of Financial Position and Results of Operations. MI claim costs for 2017 rose most significantly, however, due to an additional claim provision of $23.0 which added 20.9 percentage points to the claim ratio for the year.
The much more favorable RFIG Run-off - CCI claim ratio for 2018 reflects the absence of the litigation-induced claim costs and favorable development of previously established claim reserves. The 2017 year-over-year claim ratio comparison was most significantly affected by the additional $107.0 claim and related expense provisions related to the final settlement and probable dispositions of all known litigated and other claim costs.
With respect to Old Republic's small life and accident insurance operations, reserve adequacy may be impacted adversely by greater than anticipated medical care cost inflation as well as greater than expected frequency and severity of claims. In life insurance, as in general insurance, concentrations of insured lives coupled with a catastrophic event would represent the Company's largest exposure.
On a consolidated basis, which includes all coverages provided by the Company, the cumulative development on prior year loss reserves over the past ten years through December 31, 2018 has ranged from 7.0% unfavorable in 2010 to 6.3% favorable in 2014 and averaged 2.0% favorable for the ten years. Although management does not have a practical business reason for making projections of likely outcomes of future loss developments, its analysis and evaluation of Old Republic's existing business mix, current aggregate loss reserve levels, and loss development patterns suggests a reasonable likelihood that 2018 year-end loss reserves could ultimately develop within a range of +/- 5%. The most significant factors impacting the potential reserve development for each of the Company's insurance segments is discussed above. Old Republic has generally experienced favorable overall loss developments for the latest ten-year period. While General Insurance has experienced unfavorable developments of previously established reserves during four of the last five years, the current analysis of loss development factors and economic conditions influencing the Company's insurance coverages point to a position of reserve adequacy. In management's opinion, the other segments' loss reserve development patterns (most notably those associated with title and mortgage insurance) show greater variability due to changes in economic conditions which cannot be reasonably anticipated. Consequently, management believes that using a 5% potential range of reserve development provides a reasonable benchmark for a sensitivity analysis of the Company's consolidated reserves as of December 31, 2018.
Variations in the Company's consolidated expense ratios reflect a continually changing mix of coverages sold and attendant costs of producing business in the Company's three largest operating segments. To a significant degree, expense ratios for both the general and title insurance segments are mostly reflective of variable costs, such as commissions or similar charges, that rise or decline along with corresponding changes in premium and fee income. Moreover, general operating expenses can contract or expand in differing proportions due to varying levels of operating efficiencies and expense management opportunities in the face of changing market conditions. The General Insurance expense ratio has remained aligned with earned premiums trends while the 2017 ratio was impacted by charges for estimated employee incentive awards. The Title Insurance expense ratio for the periods reported upon remained aligned with revenues from premiums and fees. Finally, the trends in the RFIG Run-off operating expense ratio are primarily reflective of the continuing decline in net premiums inherent in this run-off operation.
The effective consolidated income tax rates were 15.4%, 22.7%, and 31.9% in 2018, 2017, and 2016, respectively. The rates for each year reflect primarily the varying proportions of pretax operating income (loss) derived from partially tax sheltered investment income (principally tax-exempt interest and dividend income), the combination of fully taxable investment income, investment gains or losses, underwriting and service income, judgments about the recoverability of deferred tax assets, and changes in the federal corporate tax rate.
The insurance laws of the respective states in which the Company’s insurance subsidiaries are incorporated prescribe minimum capital and surplus requirements for the lines of business they are licensed to write. For domestic property and casualty and life and accident insurance companies the National Association of Insurance Commissioners also prescribes risk-based capital ("RBC") requirements. The RBC is a measure of statutory capital in relationship to a formula-driven definition of risk relative to a company’s balance sheet and mix of business. The combined RBC ratio of our primary General insurance subsidiaries was 657% and 651% of the company action level RBC at December 31, 2018 and 2017, respectively. The minimum capital requirements for the Company’s Title Insurance subsidiaries are established by statute in the respective states of domicile. The minimum regulatory capital requirements are not significant in relationship to the recorded statutory capital of the Company’s Title and Life & Accident insurance subsidiaries. At December 31, 2018 and 2017 each of the Company’s General, Title, RFIG and Life and Accident insurance subsidiaries exceeded the minimum statutory capital and surplus requirements. Refer to Note 1(s) - Regulatory Matters for a discussion regarding the RFIG Run-off group.
In the above tables the unrealized losses on fixed income securities are primarily deemed to reflect changes in the interest rate environment. As part of its assessment of other-than-temporary impairments, the Company considers its intent to continue to hold the securities, and the likelihood that it will not be required to sell investment securities in an unrealized loss position until cost recovery, principally in consideration of its asset and liability maturity matching objectives.
Investment gains and losses, which result from sales or write-downs of securities, are reflected as revenues in the income statement and are determined on the basis of amortized value at date of sale for fixed maturity securities, and cost in regard to equity securities; such bases apply to the specific securities sold. Effective January 1, 2018, as above noted, unrealized gains and (losses) from changes in fair value of equity securities are recorded as investment gains (losses) in the income statement. Unrealized investment gains (losses) on fixed maturity securities, net of any deferred income taxes, are recorded directly as a component of accumulated other comprehensive income in shareholders' equity. At December 31, 2018, the Company and its subsidiaries had no non-income producing fixed maturity or equity securities.
Investment expenses largely consist of personnel costs and investment management and custody service fees.
Reflects primarily the combination of fully taxable investment gains or losses and judgments about the recoverability of deferred tax assets.
Includes $104.9, for 2017, of deferred income tax credits to adjust to the new 21% tax rate of 2018 pertaining to unrealized gains (losses) as of December 31, 2017. Deferred income taxes on unrealized gains (losses) would normally be a part of the statement of comprehensive income rather than the income statement.
In June 2016, the FASB issued guidance on accounting for credit losses on financial instruments which will be effective in 2020. The guidance will require immediate recognition of expected credit losses for certain financial instruments including (1) reinsurance recoverables, (2) held to maturity securities and (3) accounts and notes receivable. Additionally, the guidance modified the impairment model for available for sale fixed maturity securities. The Company is currently evaluating the guidance to determine the potential impact of its adoption on the Company's consolidated financial statements.
Title premium and fee revenues stemming from the Company's direct operations (which include branch offices of its title insurers and wholly owned agency subsidiaries) represent 26% of 2018, 27% of 2017 and 28% of 2016 consolidated title business revenues. Such premiums are generally recognized as income at the escrow closing date which approximates the policy effective date. Fee income related to escrow and other closing services is recognized when the related services have been performed and completed. The remaining title premium and fee revenues are produced by independent title agents and underwritten title companies. Rather than making estimates that could be subject to significant variance from actual premium and fee production, the Company recognizes revenues from those sources upon receipt. Such receipts can reflect a three to four month lag relative to the effective date of the underlying title policy, and are offset concurrently by production expenses and claim reserve provisions.
General Insurance reserves are established to provide for the ultimate expected cost of settling unpaid losses and claims reported at each balance sheet date. Such reserves are based on continually evolving assessments of the facts available to the Company during the settlement process which may stretch over long periods of time. Long-term disability or pension type workers' compensation reserves are discounted to present value based on interest rates ranging from 3.5% to 4.0%. The amount of discount reflected in the year-end net reserves totaled $216.5, $240.7, and $231.9 as of December 31, 2018, 2017, and 2016, respectively. Interest accretion of $49.0, $20.4 and $24.2 for the years ended December 31, 2018, 2017, and 2016, respectively, was recognized as unfavorable development of prior year reserves within benefits, claims and settlement expenses in the consolidated statements of income. Losses and claims incurred but not reported ("IBNR"), as well as expenses required to settle losses and claims are established on the basis of a large number of formulas that take into account various criteria, including historical cost experience and anticipated costs of servicing reinsured and other risks. As applicable, estimates of possible recoveries from salvage or subrogation opportunities are considered in the establishment of such reserves. Overall claim and claim expense reserves incorporate amounts covering net estimates of unusual claims such as those emanating from asbestosis and environmental ("A&E") exposures as discussed below. Such reserves can affect claim costs and related claim ratios for such insurance coverages as general liability, commercial automobile (truck), workers' compensation, and property.
For the three most recent calendar years, the above table indicates that the one-year development of consolidated reserves at the beginning of each year produced favorable developments of 1.2%, 2.4%, and 1.3% for 2018, 2017 and 2016, respectively, with average favorable annual developments of 1.7%. The Company believes that the factors most responsible, in varying and continually changing degrees, for favorable or unfavorable reserve developments include, as to many general insurance coverages, the effect of reserve discounts applicable to workers' compensation claims, higher than expected severity of litigated claims in particular, governmental or judicially imposed retroactive conditions in the settlement of claims such as noted above in regard to black lung disease claims, greater than anticipated inflation rates applicable to repairs and the medical portion of claims in particular, and higher than expected claims incurred but not reported due to the slower and highly volatile emergence patterns applicable to certain types of claims such as those stemming from litigated, assumed reinsurance, or the A&E types of claims noted above. In 2018, 2017, and 2016, the Company experienced unfavorable developments of previously established reserves concentrated in its largest insurance coverages. Title claim costs were lower in the face of declining claims activity since the Great Recession years. As to mortgage guaranty and the CCI coverage, changes in favorable or unfavorable reserve development result from differences in originally estimated salvage and subrogation recoveries, sales and prices of homes that can impact claim costs upon the disposition of foreclosed properties, changes in regional or local economic conditions and employment levels, the number of coverage rescissions and claims denials due to material misrepresentation in key underwriting information or non-compliance with prescribed underwriting guidelines, the extent of loan refinancing activity that can reduce the period of time over which a policy remains at risk, and lower than expected frequencies of claims incurred but not reported.
The amount of discount reflected in the year-end net reserves totaled $216.5 and $240.7 as of December 31, 2018 and 2017, respectively.
The Tax Cuts and Jobs Act ("TCJA") was enacted into law on December 22, 2017, thereby requiring that various accounting adjustments be reflected in the consolidated financial statements at year-end 2017. The TCJA, among its many elements, lowered the nominal federal corporate tax rate to 21.0% from 35.0%. Accordingly, the Company revalued its deferred tax items in 2017 to reflect the lower tax rate, resulting in a $63.1 income tax credit reflected in the consolidated statements of income.
elected to follow the IRS industry average tables. The TCJA requires the IRS to publish tables linking the interest rates used to discount loss reserves to the corporate bond yield curve as opposed to the Federal mid-term rates used under the old law. In December of 2018, the IRS published the updated tables. Accordingly, the Company recorded an adjustment based on the application of the new IRS published discount rates to ending December 31, 2017 loss reserves which resulted in an increase to deferred tax assets of approximately $36.5 and a corresponding increase to deferred tax liabilities. The deferred tax liability is being amortized into taxable income over 8 years, with no impact to the Company's effective tax rate.
Furthermore, the Company elected to early adopt income tax accounting guidance issued by the FASB in February 2018, which allows for the reclassification of the income tax effects of TCJA on items within accumulated other comprehensive income to retained earnings. The reclassification adjustment, which consisted of the revaluation of net deferred taxes on net unrealized gains (losses) on securities and pension adjustments, resulted in an increase to accumulated other comprehensive income and a corresponding decrease to retained earnings of $85.1 as of December 31, 2017.
At December 31, 2018, the Company had available net operating loss ("NOL") carryforwards of $75.6 which will expire in years 2022 through 2029, and a $9.0 alternative minimum tax ("AMT") credit carryforward which does not expire. The NOL carryforward is subject to the limitations set by Section 382 of the Internal Revenue Code and is available to reduce future years' taxable income by a maximum of $9.8 each year until expiration.
Pursuant to special provisions of the Internal Revenue Code pertaining to mortgage guaranty insurers, a contingency reserve (established in accordance with insurance regulations designed to protect policyholders against extraordinary volumes of claims) is deductible from gross income. The deduction is allowed only to the extent that U.S. government non-interest bearing tax and loss bonds are purchased and held in an amount equal to the tax benefit attributable to such deduction. For Federal income tax purposes, amounts deducted from the contingency reserve are taken into gross statutory taxable income in the period in which they are released. Contingency reserves may be released when incurred losses exceed thresholds established under state law or regulation, upon special request and approval by state insurance regulators, or in any event, upon the expiration of ten years. For 2018 tax purposes, the Company recognized a contingency reserve deduction of $41.0 and consequently, will acquire the necessary U.S. Treasury Tax and Loss Bonds in 2019.
(m) Goodwill and Intangible Assets - The following table presents the components of the Company's goodwill balance:
The funded status of a pension plan is measured as of December 31 of each year, as the difference between the fair value of plan assets and the projected benefit obligation. The underfunded status of the Plan is recognized as a net pension liability; offsetting entries are reflected as a component of shareholders' equity in accumulated other
comprehensive income, net of deferred taxes. The effects of these measurements and the resulting funded status of the Plan are reflected below.
Funding of the plan is dependent on a number of factors including actual performance versus actuarial assumptions made at the time of the actuarial valuation, as well as the maintenance of certain funding levels relative to regulatory requirements. The Company expects to make cash contributions of $6.5 in calendar year 2019.
A majority of the Company's employees participate in the ESSOP. Company contributions are provided in the form of Old Republic common stock. Dividends on shares are allocated to participants as earnings, and likewise invested in Company stock; dividends on unallocated shares are used to pay debt service costs. The Company's annual contributions are based on a formula that takes the growth in net operating income per share over consecutive five year periods into account. During 2015, the ESSOP purchased 2,200,000 shares of Old Republic common stock for $34.0. The purchases were financed by a loan from the Company. During 2018, the ESSOP purchased 2,383,625 shares of Old Republic common stock for $50.0. The purchases were financed by loans to the ESSOP from participating subsidiaries. As of December 31, 2018, there were 15,522,110 Old Republic common shares owned by the ESSOP, of which 11,040,882 were allocated to employees' account balances. There are no repurchase obligations in existence. See Note 3(b).
(o) Escrow Funds - Segregated cash deposit accounts and the offsetting liabilities for escrow deposits in connection with Title Insurance Group real estate transactions in the same amounts ($1,701.0 and $1,502.6 at December 31, 2018 and 2017, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(p) Earnings Per Share - Consolidated basic earnings per share excludes the dilutive effect of common stock equivalents and is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares actually outstanding for the year. Diluted earnings per share are similarly calculated with the inclusion of dilutive common stock equivalents. The following table provides a reconciliation of net income (loss) and the number of shares used in basic and diluted earnings per share calculations.
(r) Stock Based Compensation - As periodically amended, the Company has had a stock based compensation plan in effect for certain eligible key employees since 1978. Under the 2016 Incentive Compensation Plan (the "Plan"), 15.0 million shares became available for future awards. The maximum number of options available as of December 31, 2018 for future issuance under this amended plan was approximately 10.5 million shares.
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes-Merton Model. The following table presents the key assumptions used to value the awards granted during the periods presented. Expected volatilities are based on the historical experience of Old Republic's common stock. The expected term of stock
options represents the period of time that stock options granted are assumed to be outstanding. The Company uses historical data to estimate the effect of stock option exercise and employee departure behavior; groups of employees that have similar historical behavior are considered separately for valuation purposes. The risk-free rate of return for periods within the contractual term of the share option is based on the U.S. Treasury rate in effect at the time of the grant.
A summary of stock option activity under the plan as of December 31, 2018, 2017 and 2016, and changes in outstanding options during the years then ended is presented below:
As of December 31, 2018, there was $3.0 of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted average period of approximately 3 years.
At December 31, 2018, the Company had restricted common stock issued to certain employees which are expected to vest over a weighted average period of approximately 3 years. During the vesting period, restricted shares are nontransferable and subject to forfeiture. Compensation expense for the restricted stock award is recognized over the vesting period of the award and was immaterial for the years ended December 31, 2018, 2017 and 2016.
On July 1, 2014, the NCDOI issued a Final Order approving an Amended and Restated Corrective Plan (the "Amended Plan") submitted jointly on April 16, 2014, by RMIC and RMGIC. Under the Amended Plan, RMIC and RMGIC were authorized to pay 100% of their DPOs accrued as of June 30, 2014, and to settle all subsequent valid claims entirely in cash, without establishing any DPOs. In anticipation of receiving this Final Order, ORI invested $125.0 in cash and securities in RMIC in June 2014. In mid-July 2014, in furtherance of the Final Order, RMIC and RMGIC processed payments of their accumulated DPO balances of approximately $657.0 relating to fully settled claims charged to periods extending between January 19, 2012 and June 30, 2014. The NCDOI subsequently terminated the summary orders which placed RMIC and RMGIC under administrative supervision effective December 8, 2017, thereby releasing both companies from its supervision as they were eminently solvent.
As of December 31, 2018, RFIG's mortgage insurance subsidiaries had total statutory capital, inclusive of a contingency reserve of $433.1, of $515.0, which was $395.5 above the required MPP of $119.5.
In early March, 2011 the Company completed a public offering of $550.0 aggregate principal amount of Convertible Senior Notes with a maturity date of March 15, 2018. During 2017, $79.0 of the Notes were converted into 5,146,127 common shares and during the first quarter 2018, the Company's outstanding aggregate principal amount was converted into 32,229,787 shares of common stock.
Except as noted in the following paragraph, reinsurance protection on property and liability coverages generally limits the net loss on most individual claims to a maximum of: $5.2 for workers' compensation; $6.4 for commercial automobile (trucking) liability; $6.4 for general liability; $12.0 for executive protection (directors & officers and errors & omissions); $2.0 for aviation; and $5.0 for property coverages. Title insurance risk assumptions are generally limited to a maximum of $500.0 as to any one policy. The vast majority of title policies issued, however, carry exposures of less than $1.0. The average direct primary mortgage guaranty exposure is (in whole dollars) $37,700 per insured loan.
The TRIA automatically voided all policy exclusions which were in effect for terrorism related losses and obligated insurers to offer terrorism coverage with most commercial property and casualty insurance lines. The TRIREA revised the definition of "property and casualty insurance" to exclude commercial automobile, burglary and theft, surety, professional liability and farm owners multi-peril insurance. TRIPRA did not make any further changes to the definition of property and casualty insurance, however, it did include domestic acts of terrorism within the scope of the program. Although insurers are permitted to charge an additional premium for terrorism coverage, insureds may reject the coverage. Under TRIPRA, the program's protection is not triggered for losses arising from an act of terrorism until the industry first suffers losses in excess of a prescribed aggregate deductible during any one year. The program deductible trigger is $180 and $200 for 2019 and 2020, respectively. Once the program trigger is met, the program will be responsible for a fixed percentage of the Company's terrorism losses that exceed its deductible which ranges from 85% in 2015 and declines by one percentage point per year until it reaches 80% in 2020. The Company's deductible amounts to 20% of direct earned premium on eligible property and casualty insurance coverages. The Company currently reinsures limits on a treaty basis of $195.0 in excess of $5.0 for claims arising from certain acts of terrorism for casualty clash and catastrophe workers' compensation liability insurance coverages. The Company also purchases facultative reinsurance on certain accounts in excess of $200.0 to manage the Company's net exposure.
Reinsurance recoverable asset balances represent amounts due from or credited by assuming reinsurers for paid and unpaid claims and premium reserves. Such reinsurance balances are recoverable from non-admitted foreign and certain other reinsurers such as captive insurance companies owned by assureds, as well as similar balances or credits arising from policies that are retrospectively rated or subject to assureds' high deductible retentions, are substantially collateralized by letters of credit, securities, and other financial instruments. Old Republic evaluates on a regular basis the financial condition of its assuming reinsurers and assureds who purchase its retrospectively rated or self-insured deductible policies. Estimates of unrecoverable amounts totaling $- and $15.9 at December 31, 2018 and 2017, respectively, are included in the Company's net claim and claim expense reserves since reinsurance, retrospectively rated, and self-insured deductible policies and contracts do not relieve Old Republic from its direct obligations to assureds or their beneficiaries.
At December 31, 2018, the Company's General Insurance Group's ten largest reinsurers represented approximately 53% of the total consolidated reinsurance recoverable on paid and unpaid losses, with Munich Re America, Inc. the largest reinsurer representing 10.9% of the total recoverable balance. Of the balances due from these ten reinsurers, 57.2% was recoverable from A or better rated reinsurance companies, 5.9% from an industry-wide insurance assigned risk pool, 30.3% from foreign unrated companies, and 6.6% from domestic unrated companies.
(d) Legal Proceedings - Legal proceedings against the Company and its subsidiaries routinely arise in the normal course of business and usually pertain to claim matters related to insurance policies and contracts issued by its insurance subsidiaries. At year-end 2018, the Company did not have material non-claim litigation exposures in its consolidated business for which adequate claim and related expense provisions had not been made.
Note 5 - Consolidated Quarterly Results - Unaudited - Old Republic's consolidated quarterly operating results for the two years ended December 31, 2018 is presented below. In management's opinion, however, quarterly operating results for insurance enterprises such as the Company is not indicative of results to be achieved in succeeding quarters or years. The long-term nature of the insurance business, seasonal and cyclical factors affecting premium production, the fortuitous nature and, at times, delayed emergence of claims, and changes in yields on invested assets are some of the factors necessitating a review of operating results, changes in shareholders' equity, and cash flows for periods of several years to obtain a proper indicator of performance trends. The data below should be read in conjunction with the "Management Analysis of Financial Position and Results of Operations".
In management's opinion, normal recurring adjustments necessary for a fair statement of quarterly results have been reflected in the data which follows.
General Insurance income before taxes (credits) for 2017 includes hurricane-related claim costs of $8.0.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The Company’s management is responsible for these consolidated financial statements, 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 under Item 9A of the 2018 Annual Report on Form 10-K. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“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.