The Company's specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and the District of Columbia and actively issues policies in 46 states. In certain markets it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems, such as heating and air conditioning systems, and certain appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 39 states and the District of Columbia.
Activity in the reserve for incurred but not reported title claims is summarized as follows:
Level 1-Valuations based on unadjusted quoted market prices in active markets for identical securities.
The fair value of debt securities was based on the market values obtained from independent pricing services that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and price quotes from well-established independent broker-dealers. The independent pricing services monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants. The pricing services utilize the market approach in determining the fair value of the debt securities held by the Company. The Company obtains an understanding of the valuation models and assumptions utilized by the services and has controls in place to determine that the values provided represent fair value. The Company’s validation procedures include comparing prices received from the pricing services to quotes received from other third party
sources for certain securities with market prices that are readily verifiable. If the price comparison results in differences over a predefined threshold, the Company will assess the reasonableness of the changes relative to prior periods given the prevailing market conditions and assess changes in the issuers’ credit worthiness, performance of any underlying collateral and prices of the instrument relative to similar issuances. To date, the Company has not made any material adjustments to the fair value measurements provided by the pricing services.
Expected future cash flows for debt securities are based on qualitative and quantitative factors specific to each security, including the probability of default and the estimated timing and amount of recovery. The detailed inputs used to project expected future cash flows may be different depending on the nature of the individual debt security. Specifically, the cash flows expected to be collected for each non-agency mortgage-backed security are estimated by analyzing loan-level detail to estimate future cash flows from the underlying assets, which are then applied to the security based on the underlying contractual provisions of the securitization trust that issued the security (e.g. subordination levels, remaining payment terms, etc.). The Company uses third-party software to determine how the underlying collateral cash flows will be distributed to each security issued from the securitization trust. The primary assumptions used in estimating future collateral cash flows are prepayment speeds, default rates and loss severity. In developing these assumptions, the Company considers the financial condition of the borrower, loan to value ratio, loan type and geographical location of the underlying property. The Company utilizes publicly available information related to specific assets, generally available market data such as forward interest rate curves and securities, loans and property data and market analytics tools provided through a third party.
When a decline in the fair value of an equity security including common and preferred stock is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
Impairment assessment for other indefinite-lived intangible assets. The Company’s other indefinite-lived intangible assets consist of licenses which are not amortized but rather assessed for impairment by comparing the fair value of the license with its carrying value at least annually or when an indicator of potential impairment has occurred. Management’s impairment assessment involves calculating the fair value by using a discounted cash flow analysis and market approach valuations. If the fair value of the asset exceeds its carrying amount, the asset is not considered impaired and no additional analysis is required. However, if the carrying amount is greater than the fair value, an impairment loss is recorded equal to the excess. The impairment loss establishes a new basis and the subsequent reversal of impairment losses is not permitted.
The Company’s primary means of providing share-based compensation is through the granting of restricted stock units (“RSUs”). RSUs granted generally have graded vesting and include a service condition; and for certain key employees and executives may also include either a performance or market condition. RSUs receive dividend equivalents in the form of RSUs having the same vesting requirements as the RSUs initially granted.
In February 2013, the Financial Accounting Standards Board (“FASB”) issued updated guidance requiring entities to present, either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. If the component is not required to be reclassified to net income in its entirety, entities should instead cross reference to the related footnote for additional information. The updated guidance was effective prospectively for interim and annual reporting periods beginning after December 15, 2012, with early adoption permitted. Except for the disclosure requirements, the adoption of the guidance had no impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued updated guidance requiring entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The updated guidance was effective for interim and annual reporting periods beginning on or after January 1, 2013. The adoption of the guidance had no impact on the Company’s consolidated financial statements.
A substantial portion of the revenues for the Company’s title insurance and services segment results from the sale and refinancing of residential and commercial real estate. In the Company’s specialty insurance segment, revenues associated with the initial year of coverage in both the home warranty and property and casualty operations are impacted by volatility in residential purchase transactions. Traditionally, the greatest volume of real estate activity, particularly residential purchase activity, has occurred in the spring and summer months. However, changes in interest rates, as well as other economic factors, can cause fluctuations in the traditional pattern of real estate activity. In addition, future actions or inaction of the United States government or related agencies, such as a failure to increase the United States debt ceiling, a shutdown of the federal government, or actions to tighten monetary policy, may lead to significant increases in interest rates or otherwise negatively impact consumer spending and the overall economy or may make it more difficult to originate and/or close real estate transactions. These circumstances may adversely impact real estate markets where the Company operates.
The interest rate environment for much of the first half of 2013 was historically low, which coupled with a gradual improvement in both the general economy and availability of mortgage credit, resulted in an increase in mortgage origination activity during the first half of 2013 when compared to the first half of 2012. However, interest rates increased beginning in May 2013, which significantly reduced refinance activity during the third and fourth quarters of 2013.
Agent premiums increased 19.6% in 2013 from 2012 and 14.6% in 2012 from 2011. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a one quarter delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums typically reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The increase in agent premiums in 2013 from 2012 was consistent with the 19.7% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2013 as compared with the twelve months ended September 30, 2012. The increase in agent premiums in 2012 from 2011 was consistent with the 16.6% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2012 as compared with the twelve months ended September 30, 2011. The Company continuously analyzes the terms and profitability of its title agency relationships and, where it deems it necessary, amends agent agreements to the extent possible.
Information and other revenues decreased 2.7% in 2013 from 2012 and increased 3.8% in 2012 from 2011. The decrease in 2013 from 2012 was primarily attributable to lower demand for title related services in Canada due to a decline in mortgage transactions resulting primarily from lower refinance transactions and lower demand for the Company’s title information products as a result of the decrease in domestic mortgage origination activity, partially offset by higher demand for the Company’s default information products as a result of the increase in domestic loss mitigation activity. The increase in 2012 from 2011 was primarily attributable to higher demand for the Company’s title and default information products as a result of the increase in domestic mortgage origination activity, partially offset by lower demand for title related services in Canada due to a decline in mortgage transactions resulting primarily from tightening of lending requirements.
Investment income increased 7.4% in 2013 from 2012 and decreased 0.9% in 2012 from 2011. The increase in 2013 from 2012 was primarily attributable to increased dividend and interest income from the investment portfolio due to higher average volumes of equity and debt securities and investments in equity funds with higher dividend yields when comparing 2013 to 2012. The slight decrease in 2012 compared to 2011 was primarily attributable to increased impairment losses on non-marketable investments accounted for using the equity method and lower interest income from the investment portfolio due to lower yields, partially offset by higher equity earnings from non-marketable investments accounted for using the equity method and increased dividend income. Investment income for 2013, 2012 and 2011 included impairment losses recognized on certain non-marketable investments accounted for using the equity method of $5.8 million, $5.9 million and $3.8 million, respectively.
Net realized investment gains for the title insurance and services segment totaled $3.3 million, $33.7 million and $5.8 million for 2013, 2012 and 2011, respectively, and were primarily from the sales of debt and equity securities. The 2012 net realized investment gains included $15.0 million in gains resulting from the sale of CoreLogic common stock during the third quarter of 2012. Net realized investment gains for 2013, 2012 and 2011 included impairment losses of $1.1 million, $0.8 million and $4.8 million, respectively, primarily related to certain non-marketable investments accounted for using the cost method of accounting, notes receivable and software.
The title insurance and services segment recognized no other-than-temporary impairment losses in 2013. Other-than-temporary impairment losses totaled $3.6 million and $9.1 million for 2012 and 2011, respectively. The net other-than-temporary impairment losses recognized in 2012 and 2011 related to the Company’s non-agency mortgage-backed securities portfolio.
Personnel costs increased 8.5% in 2013 from 2012 and 13.6% in 2012 from 2011. The increase in 2013 compared with 2012 was primarily attributable to higher staffing levels and incentive compensation driven by increased revenues when compared to the prior year. The increase in 2012 compared with 2011 was primarily attributable to higher incentive compensation driven by improved revenues and profitability and higher staffing levels required to support increased order volume. Personnel costs included severance expense of $17.5 million, $5.5 million and $13.2 million for 2013, 2012 and 2011, respectively.
Other operating expenses (principally related to direct operations) increased 6.2% in 2013 from 2012 and 9.5% in 2012 from 2011. The increase in 2013 from 2012 was primarily attributable to increased production related expenses and higher legal and software related costs. The increase in 2012 from 2011 was primarily attributable to increased production related expenses and higher temporary labor driven by the increase in order volumes, partially offset by a decline in legal expenses.
The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 8.8%, 6.9% and 9.5% for the years ended December 31, 2013, 2012 and 2011, respectively.
The current year rate of 8.8% reflected an ultimate loss rate of 5.0% for the current policy year and a net increase in the loss reserve estimates for prior policy years of $148.5 million. The increase in loss reserve estimates for prior policy years reflected claims development above expected levels during 2013, primarily from domestic lenders policies, commercial policies and the Company’s guaranteed valuation product offered in Canada. The reserve strengthening associated with domestic lenders policies was $67.4 million and was primarily attributable to increased claims frequency for policy years 2004 through 2008. The increased claims frequency was primarily due to mortgage lenders and servicers processing a large volume of foreclosures during 2013. As foreclosure processing increases, lenders claims generally increase, because lenders claims typically come from foreclosures in which the lender suffers a loss. The Company expects the high level of foreclosure processing to continue in the near term as mortgage lenders and servicers work through their foreclosure inventory. The reserve strengthening associated with domestic lenders policies reflects these expectations. The reserve strengthening associated with commercial policies was $38.8 million and was primarily attributable to several large commercial claims, mainly from mechanics liens, and primarily related to policy years 2007 and 2008. The reserve strengthening associated with the guaranteed valuation product offered in Canada was $21.7 million and was primarily attributable to claims frequency exceeding the Company’s expectations during 2013. The increase in frequency primarily related to policy years 2007 and 2010. There is substantial uncertainty as to the ultimate loss emergence for the guaranteed valuation product due to the following factors, among others, (i) claims associated with this product are generally made only
As of December 31, 2013, the title insurance and services segment’s IBNR reserve was $840.1 million, which reflected management’s best estimate. The Company’s internal actuary determined a range of reasonable estimates of $729.7 million to $1.0 billion. The range limits are $110.4 million below and $201.0 million above management’s best estimate, respectively, and represent an estimate of the range of variation among reasonable estimates of the IBNR reserve. Actuarial estimates are sensitive to assumptions used in models, as well as the structures of the models themselves, and to changes in claims payment and incurral patterns, which can vary materially due to economic conditions, among other factors.
Direct premiums increased 11.2% in 2013 from 2012 and 8.2% in 2012 from 2011. These increases were primarily due to increases in the number of home warranty residential service contracts issued and, to a lesser extent, increases in property and casualty policies issued. The increases in the home warranty division were primarily in the real estate and renewal channels and the increases in the property and casualty division were primarily in the independent broker and renter insurance channels.
Net realized investment gains for the specialty insurance segment totaled $1.4 million in 2013, $8.6 million in 2012 and $1.4 million in 2011. The net gains were primarily driven by the sale of debt and equity securities.
The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 55.4% in 2013, 51.1% in 2012 and 52.0% in 2011. The increase in rate in 2013 from 2012 was due to an increase in seasonal fire and storm claim events and an increase in the frequency and severity of routine or non-event core losses. The decrease in rate in 2012 from 2011 was primarily due to a reduction in seasonal claim events.
Premium taxes as a percentage of specialty insurance segment premiums were 1.7% in 2013, 2012 and 2011.
Net realized investment gains totaled $4.5 million in 2013 and were primarily attributable to the sale of a non-marketable investment. Net realized investment gains totaled $25.8 million in 2012 and were attributable to the sale of CoreLogic stock during the third quarter of 2012. Net realized investment losses totaled $2.3 million in 2011 and were primarily attributable to the sale of a corporate fixed asset.
Interest expense increased $5.5 million in 2013 from 2012 and decreased $3.6 million in 2012 from 2011. Interest expense increased in 2013 from 2012 primarily due to the Company’s issuance of $250.0 million of debt in January 2013. Interest expense decreased in 2012 from 2011 primarily due to the refinancing of the Company’s credit facility to a lower interest rate in April 2012, a lower average outstanding balance on the credit facility and the pay down in December 2011 of an intercompany note payable to the title insurance and services segment. Interest expense related to intercompany notes payable to the title insurance and services and specialty insurance segments was $2.6 million, $3.2 million and $4.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Holding company. First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other potential factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As of December 31, 2013, under such regulations, the maximum amount of dividends, loans and advances available to the holding company from its insurance subsidiaries in 2014, without prior approval from applicable regulators, was $314.9 million. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.
In the event that the rating by Standard & Poor’s Ratings Services (“S&P”) is below BBB- (or there is no rating from S&P) and, in addition, such rating by Moody’s Investor Services, Inc. (“Moody’s”) is lower than Baa3 (or there is no rating from Moody’s), then the loan commitments are subject to mandatory reduction from (a) 50 percent of the net proceeds of certain equity issuances by any of the Company or certain subsidiaries of the Company (collectively, the “Designated Parties”), and (b) 50 percent of the net proceeds of certain debt incurred or issued by any of the Designated Parties, provided that the commitment reductions described above are only required to the extent necessary to reduce the total loan commitments to $300.0 million. The Company is only required to prepay loans to the extent that, after giving effect to any mandatory commitment reduction, the aggregate principal amount of all outstanding loans exceeds the remaining total loan commitments.
The credit agreement includes representations and warranties, reporting covenants, affirmative covenants, negative covenants, financial covenants and events of default customary for financings of this type. Upon the occurrence of certain insolvency and bankruptcy events of default the loans automatically accelerate. As of December 31, 2013, the Company was in compliance with the financial covenants under the credit agreement.
In addition to amounts available under its credit facility, certain subsidiaries of the Company are parties to master repurchase agreements which are used as part of the Company’s liquidity management activities and to support its risk management activities. In particular, securities loaned or sold under repurchase agreements may be used as short-term funding sources. During 2013, the Company financed securities for funds received totaling $31.4 million under these agreements. As of December 31, 2013, no amounts remained outstanding under these agreements.
Investment portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of December 31, 2013, the Company’s portfolio of debt and equity investment securities consisted of approximately 90% of fixed income securities. As of that date, approximately 68% of the Company’s fixed income investments were held in securities that are United States government-backed or rated AAA, and approximately 99% of the fixed income portfolio was rated or classified as investment grade. Percentages are based on the amortized cost basis of the securities. Credit ratings are based on S&P and Moody’s published ratings. If a security was rated differently by both rating agencies, the lower of the two ratings was selected.
Capital expenditures. Capital expenditures primarily consist of additions to property and equipment, capitalized software development costs and additions to title plants. Capital expenditures were $87.1 million, $83.9 million and $75.4 million for the years ended December 31, 2013, 2012 and 2011, respectively. The increase in 2013 over 2012 was primarily related to higher property and equipment additions, partially offset by lower title plant additions in 2013 when compared to 2012. The increase in 2012 over 2011 was primarily related to higher capitalized software development costs in 2012 when compared to 2011.
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $4.7 billion and $4.2 billion at December 31, 2013 and 2012, respectively, of which $1.6 billion and $1.2 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB, are included in the accompanying consolidated balance sheets in cash and cash equivalents and debt and equity securities, with offsetting liabilities included in deposits. The remaining escrow deposits were held at third-party financial institutions.
Trust assets totaled $3.0 billion and $2.8 billion at December 31, 2013 and 2012, respectively, and were held or managed by First American Trust, FSB. Escrow deposits held at third-party financial institutions and trust assets are not the Company’s assets under U.S. generally accepted accounting principles and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.
At December 31, 2013 and 2012, the Company was contingently liable for guarantees of indebtedness owed by affiliates and third parties to banks and others totaling $14.7 million and $23.2 million, respectively. The guarantee arrangements relate to promissory notes and other contracts, and contingently require the Company to make payments to the guaranteed party based on the failure of debtors to make scheduled payments according to the terms of the notes and contracts. The Company’s maximum potential amount of future payments under these guarantees totaled $14.7 million and $23.2 million at December 31, 2013 and 2012, respectively, and is limited in duration to the terms of the underlying indebtedness. The Company has not incurred any costs as a result of these guarantees and has not recorded a liability on its consolidated balance sheets related to these guarantees at December 31, 2013 and 2012.
Authorized-300,000 shares; Outstanding-105,900 shares and 107,239 shares as of December 31, 2013 and 2012, respectively
Certain 2011 and 2012 amounts have been reclassified to conform to the 2013 presentation.
The Company has revised its December 31, 2012 consolidated balance sheet and consolidated statements of cash flows for the years ended December 31, 2012 and 2011, for an error which resulted in an adjustment between cash and cash equivalents and deposits with banks. These adjustments are not considered material, individually or in the aggregate, to the previously issued consolidated financial statements. The table below illustrates the effects of these adjustments on the Company's consolidated financial statements for those line items affected.
The Company maintains investments in debt securities in accordance with certain statutory requirements for the funding of statutory premium reserves and state deposits. At December 31, 2013 and 2012, the fair value of such investments totaled $124.0 million and $105.8 million, respectively. See Note 2 Statutory Restrictions on Investments and Stockholders’ Equity to the consolidated financial statements for additional discussion of the Company’s statutory restrictions.
The performance of the Company’s loan portfolio is evaluated on an ongoing basis by management. Loans receivable are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans receivable are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral-dependent. No indications of material impairment to loans receivable were identified during the three-year period ended December 31, 2013.
Loans, including impaired loans, are generally classified as non-accrual if they miss more than three contractual payments, which usually represent past due between 60 to 90 days or more. The Company’s general policy is to reverse from income previously accrued but unpaid interest. While a loan is classified under non-accrual status and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. Income on such loans is subsequently recognized only to the extent that cash is received and future collection of principal is probable. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time. Interest income on non-accrual loans that would have been recognized during the years ended December 31, 2013, 2012 and 2011, if all of such loans had been current in accordance with their original terms, totaled $134 thousand, $138 thousand and $163 thousand, respectively.
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged to, and recoveries are credited to, the allowance for loan losses. The provision for loan losses is determined after considering various factors, such as loan loss experience, maturity of the portfolio, size of the portfolio, borrower credit
history, the existing allowance for loan losses, current charges and recoveries to the allowance for loan losses, the overall quality of the loan portfolio, and current economic conditions, as determined by management, regulatory agencies and independent credit review specialists. While many of these factors are essentially a matter of judgment and may not be reduced to a mathematical formula, the Company believes that, in light of the collateral securing its loan portfolio, the current allowance for loan losses is an adequate allowance against probable losses incurred as of December 31, 2013.
The adequacy of the allowance for loan losses is based on formula allocations and specific allocations. Formula allocations are made on a percentage basis, which is dependent on the underlying collateral, the type of loan and general economic conditions. Specific allocations are made as problem or potential problem loans are identified and are based upon an evaluation by management of the status of such loans. Specific allocations may be revised from time to time as the status of problem or potential problem loans changes.
Property and equipment includes computer software acquired or developed for internal use and for use with the Company’s products. Software development costs, which include capitalized interest costs and certain payroll-related costs of employees directly associated with developing software, in addition to incremental payments to third parties, are capitalized from the time technological feasibility is established until the software is ready for use.
The Company’s intangible assets consist of covenants not to compete, customer lists, trademarks, patents and licenses. Each of these intangible assets, excluding licenses, is amortized on a straight-line basis over its useful life ranging from 1 to 20 years and is subject to impairment assessments when there is an indication of a triggering event or abandonment. Licenses are an intangible asset with an indefinite life and are therefore not amortized but rather assessed for impairment by comparing the fair value of the license with its carrying value at least annually and when an indicator of potential impairment has occurred.
grantee pays, the hypothetical windfall tax benefit that the Company receives upon assumed exercise or vesting and the hypothetical average unrecognized compensation expense for the period. The Company calculates the assumed proceeds from excess tax benefits based on the “as-if” deferred tax assets calculated under share based compensation standards.
The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $4.7 billion and $4.2 billion at December 31, 2013 and 2012, respectively, of which $1.6 billion and $1.2 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB, are included in the accompanying consolidated balance sheets in cash and cash equivalents and debt and equity securities, with offsetting liabilities included in deposits. The remaining escrow deposits were held at third-party financial institutions.
Trust assets totaled $3.0 billion and $2.8 billion at December 31, 2013 and 2012, respectively, and were held or managed by First American Trust, FSB. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.
Investments totaling $128.9 million and $111.9 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2013 and 2012, respectively.
FATICO is domiciled in California and its statutory-basis financial statements are prepared in accordance with accounting practices prescribed or permitted by the California Department of Insurance. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures Manual (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by the state of California. The state of California has adopted certain prescribed accounting practices that differ from those found in NAIC SAP. Specifically, 1) the timing of amounts released from the statutory premium reserve under California’s required practice differs from NAIC SAP resulting in total statutory capital and surplus that was lower by $193.8 million and $204.1 million at December 31, 2013 and 2012, respectively, than if reported in accordance with NAIC SAP and 2) the amount of title plant assets admitted under California’s required practice differs from NAIC SAP resulting in no impact to total statutory capital and surplus at December 31, 2013 and total statutory capital and surplus that was lower by $19.0 million at December 31, 2012 than if reported in accordance with NAIC SAP. Additionally, for the year ended December 31, 2012 the state of California granted a permitted accounting practice to FATICO that differs from NAIC SAP; specifically, the determination to not record a bulk reserve within the known claims reserve differs from NAIC SAP resulting in total statutory capital and surplus that was higher by $101.4 million at December 31, 2012 than if reported in accordance with NAIC SAP. During 2013, a non-substantive change was adopted by the NAIC whereby bulk reserves were no longer required under NAIC SAP; accordingly, no permitted accounting practice was requested by FATICO as of December 31, 2013.
In connection with the Separation, TFAC issued to the Company and FATICO a number of shares of its common stock that resulted in the Company and FATICO collectively owning 12.9 million shares of CoreLogic’s common stock immediately following the Separation. During 2011 the Company sold 4.0 million shares for an aggregate cash price of $75.8 million and during 2012 the Company and FATICO sold the remaining 8.9 million shares for an aggregate cash price of $207.9 million. At December 31, 2012, the Company no longer owned any CoreLogic common stock.
Substantially all securities in the Company’s non-agency mortgage-backed portfolio are senior tranches and all were investment grade at the time of purchase, however, all have been downgraded to below investment grade since initial purchase. The table below summarizes the composition of the Company’s non-agency mortgage-backed securities by collateral type and year of issuance. All amounts are as of December 31, 2013.
The amortized cost and estimated fair value of debt securities at December 31, 2013, by contractual maturities, are as follows:
If the Company intends to sell a debt security in an unrealized loss position or determines that it is more likely than not that the Company will be required to sell a debt security before it recovers its amortized cost basis, the debt security is other-than-temporarily impaired and it is written down to fair value with all losses recognized in earnings. As of December 31, 2013, the Company did not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell debt securities before recovery of their amortized cost basis.
The Company determines if a non-agency mortgage-backed security in a loss position is other-than-temporarily impaired by comparing the present value of the cash flows expected to be collected from the security to its amortized cost basis. If the present value of the cash flows expected to be collected exceed the amortized cost of the security, the Company concludes that the security is not other-than-temporarily impaired. The Company performs this analysis on all non-agency mortgage-backed securities in its portfolio that are in an unrealized loss position. For the securities that were determined not to be other-than-temporarily impaired at December 31, 2013, the present value of the cash flows expected to be collected exceeded the amortized cost of each security.
The table below summarizes the primary assumptions used at December 31, 2013 in estimating the cash flows expected to be collected for these securities.
As a result of the Company’s security-level review, it did not recognize any other-than-temporary impairments considered to be credit related for the year ended December 31, 2013, and recognized $3.6 million and $9.1 million in earnings for the years ended December 31, 2012 and 2011, respectively. It is possible that the Company could recognize additional other-than-temporary impairment losses on some securities it owns at December 31, 2013 if future events or information cause it to determine that a decline in value is other-than-temporary.
The following table presents the change in the credit portion of the other-than-temporary impairments recognized in earnings on debt securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive income (loss) for the years ended December 31, 2013, 2012, and 2011.
Addition to credit loss for which an other-than-temporary impairment was not previously recognized
When a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
When an equity security has been in an unrealized loss position for greater than twelve months, the Company’s review of the security includes the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. For the years ended December 31, 2013, 2012 and 2011, the Company did not record other-than-temporary impairment losses related to its equity securities.
The Company did not have any transfers in and out of Level 1, Level 2 and Level 3 measurements during the years ended December 31, 2013 and 2012. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.
Unrealized gains (losses) included in earnings for the period relating to Level 3 available-for-sale investments that were still held at the end of the period:
The Company did not purchase any non-agency mortgage-backed securities during the years ended December 31, 2013 and 2012.
During the third quarter of 2011, the Company began the multi-year process of winding-down the operations of its industrial bank, First Security Business Bank (“FSBB”). Prior to initiating the wind-down, FSBB accepted deposits and used these deposits to purchase or originate loans secured by commercial properties primarily in Southern California. Currently, FSBB continues to accept and service deposits and to service its existing loan portfolio, but is generally no longer originating or purchasing new loans.
Aging analysis of loans and notes receivable at December 31, 2013, is as follows:
Aging analysis of loans and notes receivables at December 31, 2012, is as follows:
The aggregate annual maturities for loans and notes receivable at December 31, 2013, are as follows:
The Company’s goodwill impairment assessments for 2013, 2012 and 2011 did not indicate impairment to any of its reporting units. There is no accumulated impairment for goodwill as the Company has never recognized impairment to any of its reporting units.
“Other” primarily represents reclassifications to the reserve for foreign currency gains/losses and assets acquired in connection with claim settlements. Claims activity associated with reinsurance is not material and, therefore, not presented separately. Current year payments include $167.3 million, $144.1 million and $135.1 million in 2013, 2012 and 2011, respectively, that primarily relate to the Company’s specialty insurance segment. Prior year payments include $16.0 million, $16.7 million and $20.5 million in 2013, 2012 and 2011, respectively, that relate to the Company’s specialty insurance segment.
The provision for title insurance losses, expressed as a percentage of title insurance premiums and escrow fees, was 8.8%, 6.9% and 9.5% for the years ended December 31, 2013, 2012 and 2011, respectively.
Other notes and contracts payable with maturities through 2020, weighted-average interest rate of 2.96% and 2.84% at December 31, 2013 and 2012, respectively
The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. (“JPMorgan”) as administrative agent, and a syndicate of lenders. The credit agreement is comprised of a $600.0 million revolving credit facility, which will terminate on April 17, 2016, unless terminated earlier. Proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2013, the Company had no outstanding borrowings under the facility.
In the event that the rating by Standard & Poor’s Ratings Services (“S&P”) is below BBB- (or there is no rating from S&P) and, in addition, such rating by Moody’s Investor Services, Inc. (“Moody’s”) is lower than Baa3 (or there is no rating from Moody’s), then the loan commitments are subject to mandatory reduction from (a) 50 percent of the net proceeds of certain equity issuances by any of the Company or certain subsidiaries of the Company (collectively, the “Designated Parties”), and (b) 50 percent of the net proceeds of certain debt incurred or issued by any of the Designated Parties, provided
that the commitment reductions described above are only required to the extent necessary to reduce the total loan commitments to $300.0 million. The Company is only required to prepay loans to the extent that, after giving effect to any mandatory commitment reduction, the aggregate principal amount of all outstanding loans exceeds the remaining total loan commitments.
At December 31, 2013, the Company had available net operating loss carryforwards for income tax purposes totaling $152.0 million, consisting of federal, state and foreign losses of $1.1 million, $11.2 million and $139.7 million, respectively. Of the aggregate net operating losses, $40.9 million has an indefinite expiration and the remaining $111.1 million expire at various times beginning in 2014. The Company carries a valuation allowance of $18.1 million against its deferred tax assets. Of this amount, $14.2 million relates to net operating losses; the remaining $3.9 million relates to other foreign deferred tax assets. The year-over-year increase in the overall valuation allowance relates to current year foreign losses and other foreign deferred tax assets for which no future tax benefit is expected to be realized.
The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. Failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.
During 2012, the Company released a valuation allowance of $5.3 million previously recorded against certain of its deferred tax assets. Specifically, management determined that it was more likely than not that all of its tax capital loss items will be realized prior to expiration as the result of realized gains from sales of securities and favorable market value activity in its securities portfolio. Application of the accounting guidance related to intraperiod tax allocations resulted in the valuation allowance being credited to tax expense in the amount of $5.3 million during the year ended December 31, 2012. As of December 31, 2013, no significant capital loss carryover remains in the Company’s deferred tax inventory.
As of December 31, 2013, 2012 and 2011, the liability for income taxes associated with uncertain tax positions was $47.8 million, $47.9 million and $17.3 million, respectively. The decrease in the liability during 2013 was primarily attributable to the Company’s effective settlement of a prior year tax return position. The increase in the liability during 2012 was primarily attributable to the Company’s claim for a timing adjustment in a prior year tax return. As of December 31, 2013, 2012 and 2011, the liabilities could be reduced by $32.6 million, $32.6 million and $2.9 million, respectively, of offsetting tax benefits associated with the correlative effects of potential adjustments including timing adjustments and state income taxes. The net amounts of $15.2 million, $15.3 million and $14.4 million as of December 31, 2013, 2012 and 2011, respectively, if recognized, would favorably affect the Company’s effective tax rate.
For the years ended December 31, 2013, 2012 and 2011, 11 thousand, 0.7 million and 1.4 million, respectively, of stock options and RSUs were excluded from the weighted-average diluted common shares outstanding due to their antidilutive effect.
The following table provides the principal components of employee benefit plan expenses related to the Company’s benefit plans:
The Company’s net actuarial loss and prior service credit for defined benefit pension and supplemental benefit plans that will be amortized from accumulated other comprehensive loss into net periodic cost over the next fiscal year are expected to be an expense of $22.4 million and a credit of $4.2 million, respectively.
Weighted-average actuarial assumptions used to determine benefit obligations for the plans were as follows:
Assumptions for the expected long-term rate of return on plan assets are based on future expectations for returns for each asset class based on the calculated market-related value of plan assets and the effect of periodic target asset allocation rebalancing, adjusted for the payment of reasonable expenses of the plan from plan assets. The expected long-term rate of return on assets was selected from within a reasonable range of rates determined by (1) historical real and expected returns for the asset classes covered by the investment policy and (2) projections of inflation over the long-term period during which benefits are payable to plan participants. The Company believes the assumptions are appropriate based on the investment mix and long-term nature of the plan’s investments. The use of expected long-term returns on plan assets may result in recognized pension income that is greater or less than the actual returns of those plan assets in any given year. Over time, however, the expected long-term returns are designed to approximate the actual long-term returns, and therefore result in a pattern of income and cost recognition that more closely matches the pattern of the services provided by the employees.
The Company has a pension investment policy designed to meet or exceed the expected rate of return on plan asset assumptions. The policy’s investment objective is to increase the pension plan’s funding status such that the plan becomes fully funded on a plan termination basis by taking progressively less risk through aligning a greater percentage of plan assets with plan liabilities as the plan becomes more fully funded.
A summary of the asset allocations as of December 31, 2013 and 2012 are as follows:
Accounting guidance requires disclosure of fair value information about financial instruments, whether or not recognized at fair value on the balance sheet, for which it is practical to estimate that value. In the measurement of the fair value of certain financial instruments, other valuation techniques were utilized if quoted market prices were not available. These derived fair value estimates are significantly affected by the assumptions used. Additionally, the guidance excludes certain financial instruments including those related to insurance contracts, pension and other postretirement benefits, and equity method investments.
The carrying amounts and fair values of the Company’s financial instruments as of December 31, 2013 and 2012 are presented in the following table.
The First American Financial Corporation 2010 Incentive Compensation Plan (the “Incentive Compensation Plan”), effective May 28, 2010, permits the granting of stock options, stock appreciation rights, restricted stock, RSUs, performance units, performance shares and other stock-based awards. Eligible participants in the Incentive Compensation Plan include the Company’s directors and officers, as well as other employees. At December 31, 2013, 6.7 million shares of common stock remain available to be issued from either authorized and unissued shares or previously issued shares acquired by the Company, subject to certain annual limits based on the type of award granted. The Incentive Compensation Plan terminates 10 years from the effective date unless cancelled prior to that date by the Company’s board of directors.
The First American Financial Corporation 2010 Employee Stock Purchase Plan (the “ESPP”) allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each quarterly offering period. There were 350,000 and 323,000 shares issued in connection with this plan for the years ended December 31, 2013 and 2012, respectively. At December 31, 2013, there were 3.8 million shares reserved for future issuances.
Future minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year as of December 31, 2013 are as follows:
Total rental expense for all operating leases and month-to-month rentals was $94.6 million, $96.8 million and $102.6 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The Company also guarantees the obligations of certain of its subsidiaries. These obligations are included in the Company’s consolidated balance sheets as of December 31, 2013 and 2012.
Pretax change in other-than-temporary impairments for which credit-related portion was recognized in earnings
Company’s activities, the making of factual allegations sufficient to suggest that the Company’s activities exceeded the limits of the law and a determination by the court-known as class certification-that the law permits a group of individuals to pursue the case together as a class. In certain instances the Company may also be able to compel the plaintiff to arbitrate its claim on an individual basis. If these procedural requirements are not met, either the lawsuit cannot proceed or, as is the case with class certification or compelled arbitration, the plaintiffs lose the financial incentive to proceed with the case (or the amount at issue effectively becomes de minimus). Frequently, a court’s determination as to these procedural requirements is subject to appeal to a higher court. As a result of, among other factors, ambiguities and inconsistencies in the myriad laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements.
Hamilton v. First American Title Insurance Company, et al., filed on August 25, 2008 and pending in the Superior Court of the State of North Carolina, Wake County.
overcharged or improperly charged fees for products and services provided in connection with the closing of real estate transactions, denied home warranty claims, recorded telephone calls, and gave items of value to developers, builders and others as inducements to refer business in violation of certain other laws, such as consumer protection laws and laws generally prohibiting unfair business practices, and certain obligations, including
Bushman v. First American Title Insurance Company, et al., filed on November 21, 2013 and pending in the Circuit Court of the State of Michigan, County of Washtenaw,
Carrera v. First American Home Buyers Protection Corporation, filed on September 23, 2009 and pending in the United States District Court for the Southern District of California,
Tavenner v. Talon Group, filed on August 18, 2009 and pending in the United States District Court for the Western District of Washington, and
The Company’s title insurance, property and casualty insurance, home warranty, banking, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to examination or investigation by such governmental agencies. Currently, governmental agencies are examining or investigating certain of the Company’s operations. These exams or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry, real estate settlement service customer acquisition and retention practices and agency relationships. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on known facts. While the ultimate disposition of each such exam or investigation is not yet determinable, the Company does not believe that individually or in the aggregate they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These exams or investigations could, however, result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.
In addition to the acquisitions discussed above, during the year ended December 31, 2013, the Company purchased additional noncontrolling interests in companies already included in the Company’s consolidated financial statements for a total purchase price of $1.0 million in cash.
Unrealized gain on securities for which credit-related portion was recognized in earnings
The Company has revised its condensed statements of cash flows for the years ended December 31, 2012 and 2011 for errors which resulted in adjustments between cash provided by operating activities, the effect of exchange rate changes on cash and net activity related to noncontrolling interests, which was previously classified as financing activities. In addition, the Company revised the condensed statement of cash flows for the year ended December 31, 2012 for an error to correct the classification of contributions to subsidiaries as investing activities versus the previous classification as financing activities. These adjustments are not considered material, individually or in the aggregate, to the previously issued condensed statements of cash flows. The table below illustrates the effects of these adjustments on the condensed statements of cash flows for those line items affected.
The Company received cash dividends from subsidiaries of $125.1 million, $11.8 million and $75.6 million for the years ended December 31, 2013, 2012 and 2011, respectively.