The Company owns two adjacent office buildings and property located on the corner of North Columbia and West Rosemary streets in Chapel Hill, North Carolina, which serve as the Company’s corporate headquarters. The main building contains approximately 23,000 square feet and has on-site parking facilities. The Company’s subsidiaries, principally ITIC and NITIC, lease office space in 32 locations throughout North Carolina, South Carolina, Texas and Nebraska. The Company believes that each of the office facilities occupied by the Company and its subsidiaries are in good condition, adequately insured and sufficient for its present operations.
Investors Title Company (the “Company”) is a holding company that engages primarily in issuing title insurance through two subsidiaries, Investors Title Insurance Company (“ITIC”) and National Investors Title Insurance Company (“NITIC”). Total revenues from the title segment accounted for 95.5% of the Company’s revenues in 2014. Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Title insurance protects against loss or damage resulting from title defects that affect real property.
The Company issues title insurance policies through home and branch offices, independent agents, and issuing agencies. Issuing agents are typically real estate attorneys or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company’s marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company’s growth in title insurance premiums written.
Revenues for this segment primarily result from purchases of new and existing residential and commercial real estate, refinance activity and certain other types of mortgage lending such as home equity lines of credit.
In efforts to stimulate the economy, the Federal Reserve announced in September 2012 Quantitative Easing, “QE3,” in which it would purchase mortgage-backed securities and longer-term Treasury securities. Through QE3, the Federal Reserve initially purchased mortgage-backed securities at a rate of $40 billion per month and longer-term Treasury securities at a rate of $45 billion per month. Beginning in 2014, the Federal Open Market Committee ("FOMC") of the Federal Reserve has been steadily tapering the purchases of securities, and, voted at its October 2014 meeting to conclude the QE3 program at the end of October 2014. The FOMC is also issuing disclosures on a periodic basis that include projections of the federal funds rate and expected actions. At the January 2015 meeting, the FOMC reaffirmed its intent to keep the federal funds rate exceptionally low, between 0% and 0.25%, so long as progress is made toward its employment and inflation objectives.
In an effort to expand home ownership for lower-income buyers, the Federal Housing Authority (“FHA”) announced in January 2015 that it would cut its rates on mortgage insurance premiums. A 30-year FHA insured mortgage with a less than 5% down payment will see mortgage insurance premium rates decrease from 1.35% to 0.85%. A 30-year FHA insured mortgage with more than 5% down payment will see mortgage insurance premium rates decrease from 1.30% to 0.80%. The new rates will take effect on January 26, 2015 and will not apply to borrowers with existing mortgages, unless refinanced, or to 15-year mortgages.
In 2008, the federal government took control of Fannie Mae and Freddie Mac in an effort to keep these government-sponsored entities from failing. The primary functions of Fannie Mae and Freddie Mac are to provide liquidity to the nation's mortgage finance system by purchasing mortgages on the secondary market, pooling them and selling them as mortgage-backed securities. In order to securitize, Fannie Mae and Freddie Mac typically require the purchase of title insurance for loans they acquire. Since taking control, there have been various discussions and proposals regarding their reform. Changes to these entities could impact the entire mortgage loan process and, as a result, could affect the demand for title insurance. The timing and results of reform are currently unknown; however, any changes to these entities could affect the Company and its results of operations.
proposals to change regulations governing insurance holding companies and the title insurance industry are often introduced in Congress, in state legislatures and before various insurance regulatory agencies. The Company regularly monitors such proposals, but the likelihood and timing of passage of any such regulation, and the possible effects of any such regulation on the Company and its subsidiaries, cannot be determined at this time.
Overall, the economy has been recovering from the downturn with positive projections going forward. The Mortgage Bankers Association's (“MBA”) January 2015 Economic and Mortgage Finance Commentary predicts 2015 overall economic growth of approximately 2.8% and a decline in the unemployment rate to 5.3% by the end of 2015. While recovery in the housing sector remains slow, improvements are predicted with increases in both housing starts and existing home sales, primarily a result of the economic growth and improved employment conditions.
The MBA January 20, 2015 Mortgage Finance Forecast (“MBA Forecast”) projects 2015 purchase activity to increase 14.7% to $732 billion and refinance activity to decrease 2.7% to $471 billion, combining for total mortgage originations to increase 7.2% to $1,203 billion, all from 2014 levels. In 2014, refinance activity accounted for 43.1% of all mortgage originations and is projected to represent 39.2% of all mortgage originations in 2015.
The Company’s reserves for claims are established using estimates of amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future (incurred but not reported, or “IBNR”). The total reserve for all losses incurred but unpaid as of December 31, 2014 is represented by the reserve for claims totaling $36,677,000 in the accompanying Consolidated Balance Sheets. Of that total, approximately $5,365,000 was reserved for specific claims which have been reported to the Company, and approximately $31,312,000 was reserved for IBNR claims.
There are key assumptions that materially affect the reserve estimates. During the third quarter of 2013, certain actuarial inputs were changed to provide a more refined IBNR reserve estimate. The Company considered these modifications in actuarial inputs to be a change in estimate. The Company believes that these changes in actuarial inputs were necessary in response to favorable reserve development and claims experience incurred in several policy years reported in the 2013 calendar year. The approximate impact of the change in estimate for the year ended December 31, 2013 was a reduction of $2,200,000 to the reserves for claims in the Consolidated Balance Sheets, and in the Consolidated Statements of Income, a decrease of $2,200,000 to the provision for claims, an increase of approximately $750,000 in the provision for income taxes and an increase of approximately $1,450,000 in net income, or $0.71 per basic share and $0.70 per diluted share, compared with the amounts that would have been recorded under the Company’s prior estimate. This change in estimate, coupled with several historical policy years which continued to emerge favorably in comparison with prior expectations, contributed to a benefit in the claims provision for 2013. The change in estimate was primarily driven by the following:
Adjusting for premium rate changes and the Company’s improved underwriting efforts related to construction business; and
Increasing the ratios used to estimate projected payments of unallocated loss adjustment expenses to more accurately reflect expected payments.
Management also considers actuarial analyses in evaluating claims reserves. The actuarial methods used to evaluate reserves are loss development methods, expected loss methods and Cape Cod methods, all of which are accepted actuarial methods for estimating ultimate losses and, therefore, loss reserves. In the loss development method, each policy year’s paid or incurred losses are projected to an “ultimate” level using loss development factors. In the expected loss method, losses for each policy year are estimated based on the loss development results for all policy years, trended to the level of the policy year being estimated. Expected loss methods produce more stable ultimate loss estimates than do loss development methods, which are more responsive to the current loss data but can lead to volatile results. The Cape Cod method, a special case of the Bornhuetter-Ferguson method, blends the results of the loss development and expected loss methods. For more recent policy years, the Cape Cod method gives more weight to the results of the expected loss methods; for older policy years, more weight is given to the loss development method results.
The key actuarial assumptions are principally loss development factors and expected loss ratios. The selected loss development factors are based on a combination of the Company’s historical loss experience and title industry loss experience. Expected loss ratios are estimated for each policy year based on the Company’s own experience and title industry loss ratios. When updated data is incorporated into the actuarial models, the resulting loss development factors and expected loss ratios will likely change from the prior values. Changes in these values from 2012 through 2014 have been the result of actual Company and industry experience during the calendar year in addition to changes in assumptions for 2013.
If one or more of the variables or assumptions used changed such that the Company’s recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased three loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2014 would be as follows:
Net Premiums and Title Orders: Net premiums written decreased 3.4% in 2014 to $109,963,556 compared with $113,886,266 in 2013, and increased 11.3% in 2013 compared with $102,331,102 in 2012. The volume of title orders decreased 15.4% in 2014 to 203,657 compared with 240,639 in 2013, and increased 0.2% in 2013 compared with 240,233 in 2012. The 2014 decrease in net premiums and title orders versus the prior year is primarily attributable to a decline in the number of refinance transactions. Title orders did not move proportionally with premiums due to an increasing proportion of purchase transactions. Purchase transactions typically have higher premium rates than refinance transactions. The increase in net premiums written and title orders in 2013 compared with 2012 is primarily attributable to an increase in purchase transactions.
Home and Branch Office Net Premiums: In the Company’s home and branch operations, the Company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. Net premiums written from home and branch operations decreased 3.0% in 2014 to $24,057,032 compared with $24,811,602 in 2013, and increased 4.4% in 2013 compared with $23,762,885 in 2012. The decrease in 2014 net premiums for home and branch operations primarily reflects a decrease in refinance transactions, partially offset by an increase in purchase transactions. The increase in 2013 home and branch operations primarily reflects increased purchase transactions and higher average home values. All of the Company’s home office operations and the majority of branch offices are located in North Carolina; as a result, the home and branch office net premiums written are primarily for North Carolina title insurance policies.
Agency Net Premiums: When a policy is written through a title agency, the premium is shared between the agency and the underwriter. Total premiums include an estimate of premiums for policies which have been issued, but not reported as of the balance sheet date. To determine the estimated premiums, the Company uses historical experience, as well as other factors, to make certain assumptions about the average elapsed time between the policy effective date and the date the policies are reported. From time to time, the Company adjusts the inputs to the estimation as agents report transactions and new information becomes available. In addition to estimating revenues, the Company also estimates and accrues agent commissions, claims provision, premium taxes, income taxes, and other expenses associated with the estimated revenues which have been accrued. The Company reflects any adjustments to the accruals in the results of operations in the period in which new information becomes available.
For the year ended December 31, 2014, Texas premiums written have increased due to an increase in the number of purchase transactions, while the declines in most states primarily related to the decline in the number of refinance transactions.
Other revenues primarily include other fee income, trust income, management services income, exchange services income, and income related to the Company’s equity method investments. Other revenues were $8,627,935, $8,274,823 and $7,701,340 in 2014, 2013 and 2012, respectively. Other revenues increased in 2014 compared with 2013 primarily due to increases in management services income, exchange services income, earnings of unconsolidated affiliates and trust and investment management services, partially offset by a decrease in fee income. Other revenues increased in 2013 compared with 2012 primarily due to increases in other fee income and income from trust and investment management services, partially offset by a decline in earnings of unconsolidated affiliates.
The Company derives a substantial portion of its income from its investment portfolio. The Company’s investment policy is designed to comply with regulatory requirements and to balance the competing objectives of asset quality and investment returns. The Company’s title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. Bonds totaling approximately $7,060,000 and $7,022,000 at December 31, 2014 and 2013, respectively, are deposited with the insurance departments of the states in which business is conducted.
The net realized gain on investments was $268,294 for 2014 compared with $195,800 for 2013 and $1,066,239 for 2012. The net realized gain on investments included impairment charges of $24,604, $34,070, and $99,940 on certain investments and other assets that were deemed to be other-than temporarily-impaired in 2014, 2013 and 2012, respectively, offset by net realized gains on the sales of investments and other assets of $292,898, $229,870 and $1,166,179 in 2014, 2013, and 2012, respectively. Management believes unrealized losses on remaining fixed income and equity securities at December 31, 2014 are temporary in nature.
Provision (Benefit) for Claims: The provision (benefit) for claims as a percentage of net premiums written was 4.8%, (0.5)% and 5.9% in 2014, 2013 and 2012, respectively. The increase in 2014 compared with 2013 was primarily attributable to a reduction in reserves and favorable claims experience in 2013. The 2013 reduction in the reserves for claims was approximately $2,200,000, reflecting a change in certain actuarial assumptions that stemmed from improved claims experience in recent post-recession policy years. In addition to the change in estimate, claims experience for several recent policy years continued to emerge favorably in comparison with prior period expectations, resulting in further reductions to the claims provision. A more detailed discussion related to the adjustment can be found in the Critical Accounting Estimates and Policies section of this Management’s Discussion and Analysis.
Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $3,912,716, $3,146,404 and $4,990,115 in 2014, 2013 and 2012, respectively.
Salaries, Employee Benefits and Payroll Taxes: Personnel costs include base salaries, benefits and bonuses paid to employees. Salaries, employee benefits and payroll taxes were $25,218,225, $25,386,511 and $21,881,540 for 2014, 2013 and 2012, respectively. Salaries and related costs decreased by approximately 0.7% in 2014 from 2013 and increased 16.0% in 2013 from 2012. The decrease in 2014 primarily relates to a reduction in incentive compensation, partially offset by an increase in salaries. The increase in 2013 was primarily due to higher staffing levels to support increased business and ongoing software development, and increased benefits and incentive compensation. On a consolidated basis, salaries and employee benefits as a percentage of total revenues were 20.5%, 20.1% and 19.0% in 2014, 2013 and 2012, respectively.
Office Occupancy and Operations: Office occupancy and operations expenses primarily include office rent and utilities, depreciation, maintenance, telecommunications and insurance expenses. Overall office occupancy and operations expenses were $5,049,962, $4,430,220 and $3,994,244 for 2014, 2013 and 2012, respectively. As a percentage of total revenues, office occupancy and operations expenses were 4.1% in 2014 and 3.5% for both 2013 and 2012. The dollar increase in office occupancy and operations expense in 2014 compared with 2013 was primarily related to increases in hardware upgrade projects, depreciation, and building rent and utilities. The dollar increase in office occupancy and operations expense in 2013 compared with 2012 was primarily related to increases in depreciation, insurance and maintenance expense.
Premium and Retaliatory Taxes: Title insurance companies are generally not subject to state income or franchise taxes. However, in most states they are subject to premium and retaliatory taxes, as defined by statute. Premium tax rates vary from state to state; accordingly, the total premium tax incurred is dependent upon the geographical mix of insurance revenues. Premium and retaliatory taxes as a percentage of net premiums written were 1.7%, 2.2% and 1.8% in 2014, 2013 and 2012, respectively.
Professional and Contract Labor Fees: Professional and contract labor fees were $2,676,483 in 2014 compared with $2,171,606 in 2013 and $2,420,387 in 2012. The increase in 2014 primarily related to increases in consulting fees associated with the Company's ongoing software initiatives. The decrease in 2013 compared with 2012 primarily related to replacing contract labor resources with salaried personnel to support ongoing software development initiatives.
Other Expenses: Other operating expenses primarily include miscellaneous operating expenses of the trust division and other miscellaneous expenses of the title segment. These amounts typically fluctuate with transaction volume of the title segment and the trust division. Other expenses increased to $820,882 in 2014, compared with $755,407 in 2013 and $615,053 in 2012.
The Company reported net income attributable to the Company of $9,648,975, $14,708,210 and $11,102,496, or $4.74, $7.08 and $5.24 per share on a diluted basis in 2014, 2013 and 2012, respectively. Net income attributable to the Company declined in 2014 compared with 2013 primarily due to an increase in operating expenses of 4.7% and a decrease in premiums written of 3.4%. Operating expenses increased primarily as a result of a reduction in the reserves for claims in the prior year period. The prior period reduction reflected a change in estimate related to certain actuarial assumptions stemming from improved claims experience in recent policy years. Office and occupancy expenses, as well as professional fees and contract labor, also increased largely as a result of long-term software development initiatives. The 2014 decrease in premiums written compared with 2013 primarily related to a decline in refinance transactions. Net income attributable to the Company increased in 2013 compared with 2012 primarily due to an increase in premiums written of 11.3%, partially offset by an increase in operating expenses of 5.8%. The increase in revenues and expenses in 2013 compared with 2012 primarily related to higher premiums and commissions associated with higher levels of purchase transactions and increased home values. Additionally, the benefit for claims contributed to net income attributable to the Company.
Net cash flows provided by operating activities were $9,683,980, $15,304,485 and $8,685,413 for 2014, 2013 and 2012, respectively. Cash flows from operating activities decreased from 2013 to 2014 due to the timing of payable disbursements, declines in net income and deferred tax expense, and an increase in claim payments, partially offset by an increase in the provision for claims. Cash flows from operating activities increased from 2012 to 2013, primarily due to increases in net income and the deferred tax provision, accelerated collection of receivables, the timing of payable disbursements and lower claims payments, partially offset by a benefit in the provision for claims and increases in other assets and taxes payable. Cash flows from operations have historically been the primary source of financing for expanding operations, additions to property and equipment, dividends to shareholders, and operating requirements.
Cash flows from non-operating activities have historically consisted of purchases and proceeds from investing activities, repurchases of common stock and the issuance of dividends. In 2014, the Company had a higher level of investment purchase activity, a comparable level of proceeds from sales and maturities of investments, and a lower level of common stock repurchases compared with 2013. In 2013, the Company had higher levels of investment purchase activity and lower levels of investment sales and maturities compared with 2012.
The net effect of all activities on total cash and cash equivalents was a decrease of $7,800,246 for 2014, an increase of $2,816,743 for 2013, and an increase of $2,767,760 for 2012. As of December 31, 2014, the Company held cash and cash equivalents of $15,826,515, short-term investments of $2,576,993, fixed maturity securities of $109,048,290 and equity securities of $39,254,981.
As noted previously, the Company’s operating results and cash flows are heavily dependent on the real estate market. The Company’s business has certain fixed costs such as personnel; therefore, changes in the real estate market are monitored closely and operating expenses such as staffing levels are managed and adjusted accordingly. The Company believes that its significant working capital position and management of operating expenses will aid its ability to manage cash resources through fluctuations in the real estate market.
Receipt of Dividends from Subsidiaries: The Company believes that all anticipated cash requirements for current operations will be met from internally generated funds, through cash dividends and distributions from subsidiaries and cash generated by investment securities. The Company’s significant sources of funds are dividends and distributions from its subsidiaries. The Company receives cash from its subsidiaries in the form of dividends and as reimbursements for operating and other administrative expenses that it incurs. The reimbursements are executed within the guidelines of management agreements between the Company and its subsidiaries.
As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $18,674,000 and $11,824,000 as of December 31, 2014 and 2013, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
In addition, in administering tax-deferred property exchanges, ITEC serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. ITAC serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property held by the Company for the purpose of completing such transactions totaled approximately $82,477,000 and $76,037,000 as of December 31, 2014 and 2013, respectively. These exchange deposits are held at third-party financial institutions. These amounts are not considered assets of the Company for accounting purposes and, therefore, are excluded from the accompanying Consolidated Balance Sheets. Exchange services revenues include earnings on these deposits; therefore, investment income is shown as exchange services revenue, rather than investment income. The Company remains contingently liable to customers for the transfers of property, disbursements of proceeds, and the return on the proceeds at the agreed upon rate.
The following table summarizes the Company’s future estimated cash payments under existing contractual obligations at December 31, 2014, including, payments due by period:
Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2014.
Immaterial Classification Correction - During the years ended December 31, 2013 and 2012, the Company realized $946,605 and $22,101, respectively, in excess tax benefits associated with the exercise of stock options and stock appreciation rights (“SARs”). Such amounts were mistakenly classified as part of operating activities rather than financing activities. Accordingly, the Consolidated Statements of Cash Flows have been corrected. The correction resulted in a decrease to previously reported operating cash flows and an increase to financing cash flows in the amount of $946,605 and $22,101 for the years ended December 31, 2013 and 2012, respectively. There was no impact to the Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Comprehensive Income, Consolidated Statements of Stockholders’ Equity or to the Company’s cash position.
Total reserves for all reported and unreported losses the Company incurred through December 31, 2014 is represented by the reserves for claims. The Company’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserves are adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2014. The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains/losses on available-for-sale securities, net of tax, and unrecognized prior service cost and unrealized gains/losses associated with postretirement benefit liabilities, net of tax. Accumulated other comprehensive income as of December 31, 2014 consists of $12,934,497 of unrealized holding gains on available-for-sale securities and $77,988 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2013 consists of $11,395,757 of unrealized holding gains on available-for-sale securities and $48,353 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2012 consists of $8,920,884 of unrealized holding gains on available-for-sale securities and $102,454 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities.
In May 2014, the FASB updated guidance to improve the comparability of revenue recognition practices for entities that either enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards such as insurance contracts or lease standards. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, this update becomes effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but, does not expect it to have a material impact.
Impairments - Securities are regularly evaluated and reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in fair value is other-than-temporary. When, in the opinion of management, a decline in the fair value of an investment is considered to be other-than-temporary, such investment is written down to its fair value. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include the duration and extent to which the fair value has been less than cost; the probability that the Company will be unable to collect all amounts due under the contractual terms of the security; with respect to equity securities, whether the Company’s ability and intent to retain the investment for a period of time is sufficient to allow for a recovery in value; with respect to fixed maturity securities, whether the Company has the intent to sell or will more likely than not be required to sell a particular security before recovery in value; and the financial condition and prospects of the issuer (including credit ratings). These factors are reviewed quarterly and any material degradation in the prospect for recovery will be considered in the other-than-temporary impairment analysis. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. The fair values of the majority of the Company’s investments are based on quoted market prices from independent pricing services.
As of December 31, 2014 and 2013, approximately $90,384,000 and $83,311,000, respectively, of consolidated stockholders’ equity represents net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior insurance department approval. During 2015, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators is approximately $9,937,000.
The aggregate estimated fair value, gross unrealized holding gains, gross unrealized holding losses, and amortized cost for securities by major security type at December 31 were as follows:
The special revenue category for both periods presented includes over 30 individual bonds with revenue sources from a variety of industry sectors.
Gross realized gains and losses on sales of investments for the years ended December 31 are summarized as follows:
Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been below cost, the financial condition and prospects of the issuer (including credit ratings and analyst reports) and macro-economic changes. A total of 25 and 26 securities had unrealized losses at December 31, 2014 and December 31, 2013, respectively. Reviews of the values of securities are inherently uncertain and the value of the investment may not fully recover, or may decline in future periods resulting in a realized loss. During 2014, the Company recorded other-than-temporary impairment charges in the amount of $14,542 related to securities. During 2013, the Company did not record any other-than-temporary impairment charges related to securities. During 2012, the Company recorded other-than-temporary impairment charges in the amount of $93,436 related to securities. Other-than-temporary impairment charges are included in net realized gain on investments in the Consolidated Statements of Income.
The Level 3 category only includes the Company’s investments in student loan auction rate securities (“ARS”) because quoted prices are unavailable due to the failure of auctions. The Company’s ARS portfolio is comprised entirely of investment grade student loan ARS. The par value of these securities was $1,000,000 as of December 31, 2014 and December 31, 2013, with approximately 97.0% as of December 31, 2014 and December 31, 2013, guaranteed by the U.S. Department of Education.
Significant increases or decreases in any of the inputs in isolation could result in significant changes to the fair value measurement. Generally, increases in default probabilities and liquidity risk premiums lower the fair market value while increases in principal being returned and earning maximum rates increase fair market values.
The fair value of the contingent consideration was estimated based on the discounted value of the future cash flows. Contingent consideration consists of additional monies the Company may become obligated to pay based on the future performance of a business the Company acquired, as discussed in Note 17. This item is included in accounts payable and accrued liabilities in the Consolidated Balance Sheets.
The carrying amounts and fair values of these financial instruments (please note investments are disclosed in a previous table) as of December 31, 2014 and 2013 are presented in the following table:
Included within furniture, fixtures and equipment is software developed by the Company for internal use. Capitalized costs include both direct and indirect costs, such as payroll costs of employees associated with developing software, incurred during the software development stage.
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $38,000 and $140,000, respectively, for 2014, $6,000 and $211,000, respectively, for 2013 and $16,000 and $233,000, respectively, for 2012. Ceded reinsurance is comprised of excess of loss treaties, which outline the conditions in which the reinsurance company will pay claims and protect against losses over certain agreed amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event that the assuming insurance companies are unable to meet their obligations under these contracts. The Company has not paid or recovered any reinsured losses during the three years ended December 31, 2014.
The Company continually refines its reserve estimates as current loss experience develops and credible data emerges. Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data. The 2014 calendar year change in the provision relating to prior years resulted mostly from changes to certain actuarial inputs and favorable development in 2014 versus the prior year related primarily to policy years 2009 through 2013. Due to variances between actual and expected loss payments, loss development is subject to significant variability.
During 2013 certain actuarial inputs were changed to reflect recent trends. The Company considers these modifications in actuarial inputs to be a change in estimate. The Company believes that these changes in actuarial inputs were necessary in response to favorable reserve development and claims experience incurred in several recent reporting periods. The approximate impact of this change in estimate for the year ended December 31, 2013 was a reduction of $2,200,000 to the reserves for claims in the Consolidated Balance Sheets, and in the Consolidated Statements of Income a decrease of $2,200,000 to the provision for claims, an increase of $750,000 in the provision for income taxes and an increase of $1,450,000 in net income, or $0.71 per basic share and $0.70 per diluted share, compared with the amounts that would have been recorded under the Company’s prior estimate. This change in estimate, coupled with several recent policy years which continued to emerge favorably in comparison with prior expectations, contributed to a benefit in the claims provision for the 2013 year. The change in estimate was primarily driven by the following:
Changing the specific weightings used in performing certain actuarial methods, including weighting between policy years and weighting of title industry loss data;
A summary of the Company’s loss reserves, broken down into its components of known title claims and IBNR, follows:
Basic earnings per common share is computed by dividing net income attributable to the Company by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive potential common stock, comprised of shares issuable under the Company’s share-based compensation plans and the weighted average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money share-based awards, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, when share-based awards are exercised, (a) the exercise price of a share-based award; (b) the amount of compensation cost, if any, for future service that the Company has not yet recognized; and (c) the amount of estimated tax benefits that would be recorded in additional paid-in capital, if any, are assumed to be used to repurchase shares in the current period. The incremental dilutive potential common shares, calculated using the treasury stock method, were 5,774, 20,459 and 35,090 for 2014, 2013 and 2012, respectively.
There were no potential shares excluded from the computation of diluted earnings per share in 2014, 2013 and 2012.
In 2014, 4,125 options and SARs vested with a fair value of $118,462.
During the second quarters of 2014, 2013 and 2012, the Company issued share-settled SARs to the directors of the Company. SARs give the holder the right to receive stock equal to the appreciation in the value of shares of stock from the grant date for a specified period of time, and as a result, are accounted for as equity instruments. The fair value of each award is estimated on the date of grant using the Black-Scholes option valuation model with the weighted average assumptions noted in the table shown below. Expected volatilities are based on both the implied and historical volatility of the Company’s stock. The Company uses historical data to project SAR exercises and pre-exercise forfeitures within the valuation model. The expected term of awards represents the period of time that SARs granted are expected to be outstanding. The interest rate assumed for the expected life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted average fair values for the SARs issued during 2014, 2013 and 2012 were $28.98, $27.55 and $18.84, respectively, and were estimated using the weighted average assumptions shown in the table below.
The estimated weighted average grant-date fair value of SARs granted for the years ended December 31 was as follows:
At December 31, 2014 and 2013, no valuation allowance was recorded. Based upon the Company’s historical results of operations, the existing financial condition of the Company and management’s assessment of all other available information, management believes that it is more likely than not that the benefit of these deferred income tax assets will be realized.
The Company leases certain office facilities and equipment under operating leases. Rental expense also includes occasional rental of automobiles. Rent expense totaled approximately $766,000, $699,000, and $692,000 in 2014, 2013 and 2012, respectively. The future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2014, are summarized as follows:
The Company has a 401(k) savings plan. In order to participate, individuals must be employed for one full year and work at least 1,000 hours annually. The Company makes a 3% Safe Harbor contribution and also has the option annually to make a discretionary profit share contribution. Individuals may elect to make contributions up to the maximum deductible amount as determined by the Internal Revenue Code. Expenses related to the 401(k) plan were approximately $676,000, $579,000 and $518,000 for 2014, 2013 and 2012, respectively.
In addition, during the second quarter of 2004, ITIC entered into nonqualified deferred compensation plan agreements with these executives. The amount accrued for all agreements at December 31, 2014 and 2013 was approximately $7,111,000 and $6,580,000, respectively, which includes postretirement compensation and health benefits, and was calculated based on the terms of the contract. Both the 2014 and 2013 accruals are included in the accounts payable and accrued liabilities line item of the Consolidated Balance Sheets. These executive contracts are accounted for on an individual contract basis. On December 24, 2008, the executive contracts were amended effective January 1, 2009 to bring them into compliance with Section 409A of the Internal Revenue Code, and were amended and restated to provide for an annual cash payment to the officers equal to the amounts the Company would have contributed to their accounts under its 401(k) plan if such contributions were not limited by the federal tax laws, less the amount of any contributions that the Company actually makes to their accounts under the Company’s 401(k) plan.
Development of the accumulated postretirement benefit obligation for the years ended December 31, 2014 and 2013 includes the following:
The amounts currently in accumulated other comprehensive income, pre-tax, that will be reclassified to the Consolidated Statements of Income and recognized as components of net periodic benefit costs in 2015 are:
Escrow and Trust Deposits. As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $18,674,000 and $11,824,000 as of December 31, 2014 and 2013, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.
On November 12, 2002, the Company’s Board of Directors amended the Company’s Articles of Incorporation, creating a series of Class A Junior Participating Preferred Stock (the “Class A Preferred Stock”). The Class A Preferred Stock is senior to common stock in dividends or distributions of assets upon liquidations, dissolutions or winding up of the Company. Dividends on the Class A Preferred Stock are cumulative and accrue from the quarterly dividend payment date. Each share of Class A Preferred Stock entitles the holder thereof to 100 votes on all matters submitted to a vote of shareholders of the Company. These shares were reserved for issuance under the Shareholder Rights Plan (the “Plan”), which was adopted on November 21, 2002, by the Company’s Board of Directors. Under the terms of the Plan, the Company’s common stock acquired by a person or a group buying 15% or more of the Company’s common stock would be diluted, except in transactions approved by the Board of Directors.
On October 31, 2012, the Plan was amended to, among other things, extend the expiration date of the plan from November 11, 2012 to October 31, 2022 and increase the exercise price of the stock purchase rights from $80 per unit to $220 per unit. In connection with the amendments to the shareholders’ rights plan, the Board of Directors of the Company also amended the Company’s Articles of Incorporation to increase the number of shares designated under the rights plan as Series A Participating Preferred Stock from 100,000 shares to 200,000 shares. There were 1,000,000 shares of Preferred Stock authorized as of December 31, 2014 and 2013, with 200,000, being designated Class A Junior Participating Preferred Stock.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company invests its cash and cash equivalents into high credit quality security instruments. Deposits which exceed $250,000 at each institution are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Of the $15.8 million in cash and cash equivalents at December 31, 2014, $15.3 million was not insured by the FDIC. Of the $23.6 million in cash and cash equivalents at December 31, 2013, $23.1 million was not insured by the FDIC.
The Company generates a significant amount of title insurance premiums in Texas, North Carolina and South Carolina. In 2014, 2013 and 2012, Texas accounted for 36.5%, 26.8% and 24.8% of total title premiums, respectively. In 2014, 2013 and 2012, North Carolina accounted for 28.4%, 27.4% and 30.5% of total title premiums, respectively. In 2014, 2013 and 2012, South Carolina accounted for 7.7%, 11.4% and 8.6% of total title premiums, respectively.
In 2014, 2013 and 2012, the Company had one agent that accounted for 23.6%, 16.4% and 14.0% of net premiums written, respectively.
In January 2012, a subsidiary of the Company, ITIC, entered into a membership interest purchase and sale agreement under which it agreed to acquire a majority ownership interest of United Title Agency Co., LLC (“United”). United, a Michigan limited liability company, is an insurance agency doing business in the State of Michigan. On April 2, 2012, ITIC purchased a 70% ownership interest in United, with both ITIC and the seller having the option to require ITIC to purchase the remaining 30% interest at a later date.
The contingent payment arrangement required that the purchase price for the 70% majority interest was to be paid over a two year period and was determined by multiplying United’s actual GAAP net income for the first full 24 calendar months subsequent to closing by an agreed upon factor. In no event was the purchase price for the majority interest to exceed $1,041,250. The acquisition date fair value of the total consideration to be transferred was $1,041,250. This fair value total was equal to $350,000 ITIC had already paid toward the purchase price, as well as $691,250 in estimated contingent payments. During the second quarter of 2013, ITIC paid an additional $350,000 toward the purchase price. During the second quarter of 2014, ITIC paid the remaining $341,250 of the purchase price. The resulting contingent payments of $0 and $341,250 are categorized in the Consolidated Balance Sheets as accounts payable and accrued liabilities as of December 31, 2014 and 2013, respectively.
On May 21, 2014, ITIC purchased the remaining 30% ownership interest in United, making United a wholly owned subsidiary of ITIC. The purchase price of the redeemable noncontrolling interest was calculated by multiplying United’s GAAP net income for the full 24 calendar months immediately preceding the written notice of the option exercise by an agreed upon factor. The calculated purchase price of $515,275 was paid during the second quarter of 2014.
The following table provides a reconciliation of total redeemable equity for the periods ended December 31, 2014, 2013 and 2012:
Fair valuation methods used for the identifiable tangible net assets acquired in the acquisition make use of discounted cash flows using current interest rates. The fair value of identifiable net tangible assets at the acquisition date was $5,600. Identifiable assets acquired included cash and fixed assets. Liabilities assumed consisted of notes payable.
The following tables provide changes in the balances of each component of accumulated other comprehensive income, net of tax, for the periods ended December 31, 2014, 2013 and 2012:
The following tables provide significant amounts reclassified out of each component of accumulated other comprehensive income for the periods ended December 31, 2014, 2013 and 2012: