The principal executive offices of the Company are located in the Company-owned Old Republic Building in Chicago, Illinois. In addition to its Chicago building, the Company owns one other major office building. A subsidiary of the Title Insurance Group owns and partially occupies its operations headquarters building in Minneapolis, Minnesota. Certain smaller buildings are owned by Old Republic and its subsidiaries in various parts of the nation and are primarily used for its business.
In addition to income arising from Old Republic's basic underwriting and related services functions, significant investment income is earned from invested funds generated by those functions and from capital resources. Investment management aims for stability of income from interest and dividends, protection of capital, and for sufficiency of liquidity to meet insurance underwriting and other obligations as they become payable in the future. Securities trading and the realization of capital gains are not primary objectives. The investment philosophy is therefore best characterized as emphasizing value, credit quality, and relatively long-term holding periods. The Company's ability to hold both fixed maturity and equity securities for long periods of time is in turn enabled by the scheduling of maturities in contemplation of an appropriate matching of assets and liabilities, and by investments in large capitalization, highly liquid equity securities.
Growth in 2020's net income, exclusive of all investment gains and (losses) was driven by greater profitability in both the General and Title Insurance segments. Overall, the business produced a consolidated combined ratio of 93.3%, improved from 95.3% and 94.9% registered in 2019 and 2018, respectively. Total and per share net income continue to be significantly impacted by changes in the fair value of equity securities.
Net investment income decreased in 2020 as the ongoing moderate growth in the invested asset base was more than offset by lower investment yields whereas 2019 investment income growth was fueled by higher dividends on equity securities. Financial market performance experienced significant volatility and reductions in market values in the last several weeks of 2020's first quarter, but continued to improve throughout the remainder of the year. The favorable valuation of the investment portfolio, coupled with positive earnings, outpaced cash dividends to shareholders, resulting in book value per share rising to $20.75 at December 31, 2020 compared to $19.98 at December 31, 2019.
Management believes the information in sections A to G and J of the table on the following page highlight the most meaningful, realistic indicators of ORI's segmented and consolidated financial performance. The information underscores the necessity of reviewing reported results by separating the inherent volatility of securities markets and their above-noted impact on reported net income (loss).
Effective July 1, 2019, the results of the CCI run-off business are being classified in the General Insurance Segment for and all future periods.
The consolidated General Insurance claim ratio generally trended down in all periods presented and for 2020 was primarily driven by better performance in most coverages, primarily due to prior periods' favorable reserve developments. Expense ratios remained relatively consistent with the comparable 2019 and 2018 periods and are generally reflective of ongoing coverage mix dynamics and the variability of sales and general expenses among such coverages. Together, these factors produced significantly greater pretax operating income for 2020.
The following table shows recent annual claim ratios and the effects of claim development trends:
Annual claim ratios and trends may not be particularly meaningful indicators of future outcomes for an insurance company with a liability-oriented coverage mix and its relatively long claim payment patterns. Management's long-term targets, assuming the current coverage mix, are for annually reported claim ratio averages in the high 60% to low 70% range, expense ratio averages of 25% or below, and a combined ratio ranging between 90% and 95%.
Pretax operating results of RFIG Run-off reflect the expected, continuing drop in net earned premiums from declining risk in force. Claim costs for 2020 reflect greater reserve provisions necessitated by elevated delinquencies and the evolving economic impacts of the COVID-19 pandemic. Investment income declined primarily as a result of a lower invested asset base and lower investment yields.
Prior to the onset of the COVID-19 pandemic, as indicated in the far right column of the following table, the RFIG Run-off claim ratios had experienced a fairly consistent decline in recent annual periods largely due to a combination of declining new loan defaults and stable-to-improving cure rates for outstanding delinquent loans.
This segment includes the combination of a small life and accident insurance business and the net costs associated with the parent holding company and its internal corporate services subsidiaries. The segment tends to produce highly variable results stemming from volatility inherent to the small scale of the life and accident insurance line, net investment income, and net interest charges (credits) pertaining to external and intra-system financing arrangements.
For the past several years, a significant portion of ORI's investable funds have been directed toward purchasing high-quality common stocks of U.S. companies (currently limited to fewer than 100 issues). We favor those with long-term records of reasonable earnings growth and steadily increasing dividends. Periodic stress tests of this portfolio are made pursuant to enterprise risk management guidelines and controls. Their purpose is to gain reasonable assurance that periodic downdrafts in market prices would not seriously undermine ORI's financial strength and the long-term continuity and prospects of the business.
The Company's annual financial statements incorporate a large number and types of estimates relative to matters which are highly uncertain at the time the estimates are made. The estimation process required of an insurance enterprise such as Old Republic is by its very nature highly dynamic inasmuch as it necessitates a continuous evaluation, analysis, and quantification of factual data as it becomes known to the Company. As a result, actual experienced outcomes can differ from the estimates made at any point in time and thus affect future periods' reported revenues, expenses, net income or loss, and financial condition.
Old Republic believes that its most critical accounting estimates relate to: a) the determination of other-than-temporary impairments ("OTTI") in the value of fixed maturity investments; b) the recoverability of reinsured outstanding losses; and c) the establishment of reserves for losses and loss adjustment expenses. The major assumptions and methods used in setting these estimates are discussed in the pertinent sections of this Management Analysis and are summarized as follows:
The Company completes a detailed analysis each quarter to assess whether the decline in the value of any fixed maturity investment below its cost basis is deemed other-than-temporary. This assessment is subject to a great deal of judgment and all securities in an unrealized loss position are reviewed. The decline in value of a security deemed OTTI is included as a realized investment loss in the determination of net income and effective January 1, 2020 is established as an allowance for credit loss for financial reporting purposes.
The Company recognized no OTTI adjustments or allowances for credit losses for the year ended December 31, 2020. OTTI adjustments of $2.0 and $- were recorded during the years ended December 31, 2019 and 2018, respectively.
Assets consisting of balance sheet date reserve estimates recoverable from assuming reinsurers in future periods as gross losses are settled and paid, are established at the same time as the gross losses are recorded as reserves. Accordingly, these assets are subject to the same estimation processes and valuations as the related gross amounts as is discussed below. As of the three most recent year ends, outstanding reinsurance recoverable balances ranged between 31.7% and 34.2% and averaged 32.9% of the related gross reserves. See Part I, Item 1(d) for further discussion regarding recoverability of the Company's reinsurance balances.
•The establishment of expected claim ratios for at least the two to five most recent accident years, particularly for so-called long-tail coverages as to which information about covered losses emerges and becomes more accurately quantifiable over long periods of time. Long-tail coverages generally include workers' compensation, commercial automobile (trucking) liability, general liability, errors and omissions and directors and officers' liability, as well as title insurance. Gross loss reserves related to such long-tail coverages ranged between 94.6% and 95.2%, and averaged 95.0% of gross consolidated claim reserves as of the three most recent year ends. Net of reinsurance recoverables, such reserves ranged between 94.4% and 95.0% and averaged 94.7% as of the same dates.
•Loss trends that are considered when establishing the above noted expected claim ratios which take into account such variables as: judgments and estimates relative to premium rate trends and adequacy, current and expected interest rates, current and expected social and economic inflation trends, and insurance industry statistical claim trends. The Company applies these expected claim ratios to earned premiums when estimating the periodic reserve for losses and loss adjustment expenses.
Consolidated claim costs developed favorably in the three most recent calendar years. This development had the consequent effect of reducing consolidated annual loss costs for the three most recent years within a range of 1.2% and 3.3%, or by an average of approximately 2.5% per annum. As a percentage of each of these years' consolidated
earned premiums and fees, the favorable developments have ranged between .5% and 1.3%, and have averaged 1.0%. The variances in prior years' positive or negative claim developments are further discussed within the Incurred Loss Experience section of this document.
In all the above regards the Company anticipates that future periods' financial statements will continue to reflect changes in estimates. As in the past such changes generally result from altered circumstances, the continuum of newly emerging information and its effect on past assumptions and judgments, the effects of securities markets valuations, and changes in inflation rates and future economic conditions beyond the Company's control. As a result, Old Republic cannot predict, quantify, or guaranty the likely impact that probable changes in estimates will have on its future financial condition or results of operations.
The economic impacts from the COVID-19 pandemic could affect future premium and fee revenues in the General Insurance and Title Insurance segments, and conversely underwriting expense ratios could rise. In the RFIG Run-off business, future claims experience could depend upon the continued, mitigating effects of loan forbearance programs mandated by the Federal government, and the rate at which employment levels recover as well as trends in home prices and mortgage interest rates. These outcomes notwithstanding, management firmly believes that the Company’s strong financial condition will enable it to weather these challenges, and most importantly allow its insurance subsidiaries to meet their obligations to customers, policyholders and their beneficiaries.
Impact on business operations. Old Republic’s concern for the health of its associates continues to result in the reduction in activity at many of the Company’s offices. Throughout the second half of the year, relaxed governmental restrictions meant that several of Old Republic’s business operations were permitting more associates to return to the office. Even so, most of Old Republic’s associates continue to work remotely. Old Republic experienced no meaningful interruption in its ability to continue to service the needs of customers.
Influenced by concerns around COVID-19, U.S. equity markets experienced significant volatility and reductions in market values in the last several weeks of the first quarter. Since then, financial markets have partially rebounded. For the year ended December 31, 2020, the equity portfolio has recognized a $156.2 unrealized loss. Old Republic’s fixed maturity securities portfolio experienced an increase in fair value of $342.7 during the year and no other-than-temporary impairments were identified as of December 31, 2020.
Even with the broad improvement in financial markets, volatility could continue as long as the economy is impacted by COVID-19 and major sectors of the U.S. economy remain under significant pressure. The Company continues to review its fixed maturity investments to monitor the creditworthiness of the issuer. This is especially important in the current environment, where even highly rated issuers are subject to unprecedented stress and certain sectors may be more impacted than others. Old Republic’s portfolio includes exposure to the energy sector, and as a result of reduced energy demand arising from COVID-19, many issuers in this sector are experiencing financial and operating stresses. While these investments remain consistent with the Company’s investment philosophy, they are subject to regular and on-going review.
Old Republic has historically performed stress-testing of the investment portfolio, modeling the impact of significant declines in overall market values on the capital and surplus of its insurance subsidiaries. The investment portfolio’s performance through the pandemic has been largely in-line with the results of these stress tests, and surplus levels remain strong. Old Republic does not contemplate any changes to its investment strategy as a result of COVID-19 and expects the composition of its investment portfolio to remain consistent with the long-term needs of the business.
Internal Controls. Old Republic maintains a system of internal controls designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. While certain updates have been made to reflect a primarily remote work environment, the Company's internal controls over financial reporting have not materially changed.
Claims. Claims experience reflects changes in pricing and risk selection together with variability in loss severity and frequency trends. The overall impact of COVID-19 on 2020 claims experience was not significant as increased workers’ compensation claims were largely offset by reduced frequency and severity of non-COVID related claims.
Claims activity for certain coverages is correlated with U.S. economic activity, therefore claims frequency and severity for these coverages could both be affected by COVID-19. However, as noted below, Old Republic’s risk sharing arrangements should mitigate the negative effects of increases in frequency and severity.
Reserves. Establishing claims reserves for the General Insurance business is a complex and dynamic process that requires a significant amount of judgment in an ordinary operating environment. That process and the judgment involved are made more complicated by the disruptions caused by COVID-19. Old Republic has not made significant changes to reserves or reserving practices during the year. That approach may change as clarity emerges over time about the actual effects of COVID-19 on the various businesses. The Company may adjust its expected claims rates, loss development factors and average claim costs for certain products if those factors look to be significantly impacted by COVID-19. To the extent any such loss development factor adjustments cause a change to reserves, earnings could be impacted in the period of such change.
Reinsurance and Retention Limits. Old Republic uses external reinsurance and other risk-sharing arrangements to limit the maximum losses for which it may be liable under its policies. Old Republic has risk-sharing arrangements in place for many of the coverages that have been impacted by COVID-19. In addition, Old Republic’s reinsurance arrangements may limit the negative impact of the pandemic for certain other coverages.
Consistent with its existing practices, Old Republic monitors on an on-going basis the financial condition of its assuming reinsurers and assureds who purchase its retrospectively rated or self-insured deductible policies and obtains sufficient collateral in the form of letters of credit, securities and other financial instruments. Old Republic continuously monitors the sufficiency of this collateral and the credit risk of its counterparties.
premium, the cancellation or non-renewal of policies, presumption of coverage and notice periods relating to claims. These regulatory initiatives did not have a significant impact on Old Republic during 2020.
The demand for title insurance products is correlated with the strength of the residential and commercial real estate markets. While COVID-19 and the resulting restrictions on in-person gatherings and reduction in business activity had a negative impact on the broader U.S. economy, the residential real estate markets, and thus the demand for title insurance, remained robust during 2020. The impact continues to be felt however in the commercial real estate markets with COVID-19 uncertainties creating a reduction in business activity. Many of the key indicators used to evaluate the Title business, such as open orders, were at elevated levels at December 31, 2020. However, if COVID-19 continues to have a negative effect on the U.S. economy, it could lead to an eventual reduction in demand for our products and lower operating revenues.
Claims. The effects of COVID-19 on the U.S. real estate market did not materially affect claims experience for the year ended December 31, 2020.
Operating environment and product demand. As noted elsewhere, Old Republic’s RFIG run-off business, led by its principal insurance carriers Republic Mortgage Insurance Company ("RMIC") and Republic Mortgage Guaranty Insurance Corporation ("RMGIC"), ceased writing new mortgage guaranty insurance in 2011. The operating results for all periods presented reflect the expected, continuing drop in net earned premiums from declining risk in force.
Regulation. The North Carolina Department of Insurance ("NCDOI") performs regulatory oversight of RMIC and RMGIC. Based on their capital position as of December 31, 2019 and on updated projections as to future operating results and capital levels, RMIC and RMGIC sought and received approval from the NCDOI to pay extraordinary dividends amounting to $37.5 to ORI, its ultimate parent, during the first quarter of 2020. Neither company has paid dividends subsequent to the first quarter of 2020.
Capital. As of December 31, 2020, total statutory capital for the group, inclusive of a contingency reserve, totaled $435.2. Old Republic continually monitors its capital position based on financial estimates of operating results over the remaining run-off period. Given the adverse effects of COVID-19 on the U.S. economy, unemployment levels, and housing markets, it could be necessary to retain more capital in the mortgage insurance business than previously thought until the true effects on operations and capital become more apparent. In any event, the payment of future extraordinary dividends will require regulatory approval from the NCDOI.
The Company's financial position at December 31, 2020 reflected increases in assets, liabilities and common shareholders' equity of 8.3%, 10.3% and 3.1%, respectively, when compared to the immediately preceding year-end. Cash and invested assets represented 68.1% and 68.9% of consolidated assets as of December 31, 2020 and 2019, respectively. As of year-end 2020, the cash and invested asset base increased by 6.9% to $15,535.3.
does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes. At December 31, 2020, the Company had no fixed maturity investments in default as to principal and/or interest.
(f) Represents 7.4% of the cost of the total equity portfolio, while gross unrealized gains represent 31.4% of the equity portfolio.
(g) At December 31, 2020 the number of issues in an unrealized loss position represent 4.1% of the total number of such fixed maturity issues held by the Company.
The aging of issues with unrealized losses employs balance sheet date fair value comparisons with an issue's cost. The percentage reduction from such cost reflects the decline as of a specific point in time (December 31, 2020 in the above table) and, accordingly, is not indicative of a security's value having been consistently below its cost at the percentages shown nor throughout the periods shown.
(i) Unrealized gains and losses from changes in fair value of equity securities are included in total realized and unrealized investment gains (losses) in the consolidated statements of income.
Other Assets - Among other major assets, substantially all of the Company's receivables are not past due. Reinsurance recoverable balances on paid or estimated unpaid losses are deemed recoverable from solvent reinsurers or have otherwise been reduced by allowances for estimated credit losses. Deferred policy acquisition costs are estimated by taking into account the direct costs relating to the successful acquisition of new or renewal insurance contracts and evaluating their recoverability on the basis of recent trends in claims costs. The Company's deferred policy acquisition cost balances have not fluctuated substantially from period-to-period, and do not represent significant percentages of assets or shareholders' equity.
(a) Represents estimated minimum funding of contributions for the Old Republic International Salaried Employees Retirement Plan. Funding of the plan is dependent on a number of factors including actual performance versus actuarial assumptions made at the time of the actuarial valuation, as well as the maintenance of certain funding levels relative to regulatory requirements.
(b) Amounts are reported gross of reinsurance. As discussed herein with respect to the nature of loss reserves and the estimating process utilized in their establishment, the Company's loss reserves do not have a contractual maturity date. Estimated gross loss payments are based primarily on historical claim payment patterns, are subject to change due to a wide variety of factors, do not reflect anticipated recoveries under the terms of reinsurance contracts, and cannot be predicted with certainty. Actual future loss payments may differ materially from the current estimates shown in the table above.
General insurance net premiums earned were down slightly for 2020. The economic impacts of the COVID-19 pandemic and tightened underwriting standards were mitigated by strong premium rate increases for most insurance products. Declining workers' compensation and general liability premiums were largely offset by rising premiums in commercial auto, financial indemnity and property coverages. With few exceptions, 2019 premiums grew for most types of coverages and markets served. The largest contributions principally stemmed from commercial automobile (trucking), national accounts and executive indemnity coverages.
(a) Bulk pool risk in-force, which represented 6.8% of total bulk risk in-force at December 31, 2020, has been allocated pro-rata based on insurance in-force.
(a) The December 31, 2019 balance includes fixed maturity securities classified as held to maturity which are reported and reflected herein at amortized cost.
Consolidated net investment income decreased by 2.6% in 2020 and increased 4.4% in 2019. This revenue source is affected by changes in the invested asset base which are mainly driven by consolidated operating cash flows, by a concentration of investable assets in interest-bearing securities, and by changes in market rates of return. The yields for 2020 reflect a lower interest rate environment whereas previous years' reflect an increasingly greater commitment to high quality dividend paying equity securities.
The following table reflects the composition of net investment gains or losses for the periods shown.
The following table shows a breakdown of gross and net of reinsurance claim reserve estimates for major types of insurance coverages as of December 31, 2020 and 2019:
Most of Old Republic's consolidated claim and related expense reserves stem from its general insurance business. At December 31, 2020, such reserves accounted for 93.5% and 90.1% of consolidated gross and net of reinsurance reserves, respectively, while similar reserves at December 31, 2019 represented 93.3% and 90.1% of the respective consolidated amounts.
The Company prepares periodic analyses of its loss reserve estimates for its significant insurance coverages. It establishes point estimates for most losses on an insurance coverage line-by-line basis for individual subsidiaries, sub-classes, individual accounts, blocks of business or other unique concentrations of insurance risks such as directors and officers' liability, that have similar attributes. Actuarially or otherwise derived ranges of reserve levels are not utilized as such in setting these reserves. Instead the reported reserves encompass the Company's best point estimates at each reporting date and the overall reserve level at any point in time therefore represents the compilation of a very large number of reported reserve estimates and the results of a variety of formula calculations largely driven by analysis of historical data. Favorable or unfavorable developments of prior year reserves are implicitly covered by the point estimates incorporated in total reserves at each balance sheet date. The Company does not project future variability or make an explicit provision for uncertainty when determining its best estimate of loss reserves. Over the most recent decade actual incurred losses have developed within a reasonable range of their original estimates.
Aggregate loss reserves consist of liability estimates for claims that have been reported ("case") to the Company's insurance subsidiaries and reserves for claims that have been incurred but not yet reported ("IBNR") or whose ultimate costs may not become fully apparent until a future time. Additionally, the Company establishes unallocated loss adjustment expense reserves for loss settlement costs that are not directly related to individual claims. Such reserves are based on prior years' cost experience and trends, and are intended to cover the unallocated costs of claim departments' administration of case and IBNR claims over time. Long-term, disability-type workers' compensation reserves are discounted to present value based on interest rates that generally range from 3.0% to 4.0%. The amount of discount reflected in the year-end net reserves totaled $196.9, $209.6 and $216.5 as of December 31, 2020, 2019, and 2018, respectively. Interest accretion of $35.7, $34.5, and $49.0 for the years ended December 31, 2020, 2019, and 2018, respectively, was recognized as unfavorable development of prior year reserves within benefits, claims and settlement expenses in the consolidated statements of income.
prevailing practice throughout the insurance industry. In the case of mortgage guaranty insurance, rescissions have occurred regularly over the years but have been generally immaterial. During the period of the great recession, the Company experienced a much greater incidence of rescissions due to increased levels of observed fraud and misrepresentations in insurance applications pertaining to business underwritten between 2004 and the first half of 2008. As a result, the Company has incorporated certain assumptions regarding the expected levels of coverage rescissions and claim denials in its reserving methodology since 2008. Such estimates, which are evaluated at each balance sheet date, take into account observed as well as historical trends in rescission and denial rates. The table below shows the estimated effects of coverage rescissions and claim denials on loss reserves and settled and incurred losses.
A summary of changes in aggregate reserves for claims and related costs is included in Note 1(h) of the Consolidated Financial Statements.
The general insurance claim ratio trended down in both periods presented and for 2020 was primarily driven by better performance in most coverages, primarily due to prior periods' favorable reserve developments as more fully described in the Executive Summary of the Management Analysis of Financial Position and Results of Operations.
Title insurance claim ratios have remained in the single digits for a number of years due to a continuation of favorable trends in claims frequency and severity. Favorable developments of reserves established in prior years continued to reduce the claim ratios as more fully described in the Executive Summary of the Management Analysis of Financial Position and Results of Operations.
(b) As determined by risk in force as of December 31, 2020, these 10 states represent approximately 55.1% of total risk in force.
Subsidiaries within the general insurance segment have generally obtained reinsurance coverage from independent insurance or reinsurance companies pursuant to excess of loss agreements. Under excess of loss reinsurance agreements the Company is generally reimbursed for claim costs exceeding contractually agreed-upon levels. During the three year period ended December 31, 2020, the Company's net retentions have risen gradually within the general insurance segment; however, such changes have not had a material impact on the Company's consolidated financial statements.
(*) Reclassification adjustments were made to certain Title segment revenues and expenses in prior periods to conform to the presentation adopted in 2020. See Note 1(c) to the accompanying Notes to Consolidated Financial Statements.
(1) At December 31, 2020 and 2019, there were 75,000,000 shares of $0.01 par value preferred stock authorized, of which no shares were outstanding. As of the same dates, there were 500,000,000 shares of common stock, $1.00 par value, authorized, of which 304,122,180 and 303,652,553 were issued as of December 31, 2020 and 2019, respectively. At December 31, 2020 and 2019, there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued.
(a) Accounting Principles - The Company's insurance subsidiaries are managed pursuant to the laws and regulations of the various states in which they operate. As a result, the subsidiaries operate their business in the context of such laws and regulation, and maintain their accounts in conformity with accounting practices prescribed or permitted by various states' insurance regulatory authorities. Federal income taxes and dividends to shareholders are based on financial statements and reports complying with such practices. The statutory accounting requirements vary from the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") of accounting principles generally accepted in the United States of America ("GAAP") in the following major respects: (1) the costs of selling insurance policies are charged to operations immediately, while the related premiums are recognized as income over the terms of the policies; (2) investments in fixed maturity securities designated as available for sale are generally carried at amortized cost rather than their estimated fair value; (3) changes in the fair value of equity securities are recorded directly in earned surplus and not through the income statement as required under GAAP unless such securities are determined to be other-than-temporarily impaired for statutory reporting purposes; (4) certain assets classified as "non-admitted assets" are excluded from the balance sheet through a direct charge to earned surplus; (5) changes in deferred income tax assets or liabilities are recorded directly in earned surplus and not through the income statement; (6) mortgage guaranty contingency reserves intended to provide for future catastrophic losses are established as a liability through a charge to earned surplus whereas, GAAP does not allow provisions for future catastrophic losses; (7) title insurance premium reserves, which are intended to cover losses that will be reported at a future date are based on statutory formulas, and changes therein are charged in the income statement against each year's premiums written; (8) certain required formula-derived reserves for general insurance in particular are established for claim reserves in excess of amounts considered adequate by the Company as well as for credits taken relative to reinsurance placed with other insurance companies not licensed in the respective states, all of which are charged directly against earned surplus; and (9) surplus notes are classified as surplus rather than a liability. In consolidating the statutory financial statements of its insurance subsidiaries, the Company has therefore made necessary adjustments to conform their accounts with GAAP. The following table reflects a summary of all such adjustments:
Reclassifications - Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to the most current presentation.
Immaterial Adjustment - The Company recorded immaterial adjustments to present revenues gross of the applicable commission expense in the 2019 and 2018 consolidated statements of income and comprehensive income by: increasing net premiums earned by $421.5 and $397.7, respectively; decreasing title, escrow and other fees by $174.7 and $160.6, respectively, and; increasing underwriting, acquisition, and other expenses by $246.8 and $237.0, respectively. These immaterial adjustments were made to conform all prior periods to the presentation adopted in 2020 and had no impact on net income (loss), comprehensive income (loss) or shareholders' equity in any period presented.
(d) Investments - The Company classifies its fixed maturity securities in terms of those assets relative to which it either (1) has the positive intent and ability to hold until maturity, (2) has available for sale or (3) has the intention of trading. As of June 30, 2020 the Company changed its intent to hold its tax exempt municipal bond portfolio until maturity and consequently, reclassified these securities from their previous held to maturity designation to available for sale. As a result, cumulative net of tax unrealized gains of $48.5 were recognized in other comprehensive income as of that date. The Company's entire fixed maturity portfolio is now classified as available for sale.
The status and fair value changes of each of the fixed maturity investments are reviewed at least once per quarter during the year, and estimates of other-than-temporary impairments ("OTTI") and resulting allowances for credit losses in the portfolio's value are evaluated and established at each quarterly balance sheet date. In reviewing investments for OTTI, the Company, in addition to a security's market price history, considers the totality of such factors as the issuer's operating results, financial condition and liquidity, its ability to access capital markets, credit rating trends, most current audited financial statements, industry and securities markets conditions, and analyst expectations to reach its conclusions. Sudden fair value declines caused by such adverse developments as newly emerged or imminent bankruptcy filings, issuer default on significant obligations, or reports of financial accounting developments that bring into question the validity of the issuer's previously reported earnings or financial condition, are recognized as realized losses as soon as credible publicly available information emerges to confirm such developments. In the event the Company's estimate of OTTI is insufficient at any point in time, future periods' net income (loss) would be adversely affected by the recognition of additional impairment losses, but its financial position would not necessarily be affected adversely inasmuch as such losses, or a portion of them, could have been recognized previously as unrealized losses in shareholders' equity. The Company recognized no OTTI adjustments or allowances for credit losses for the year ended December 31, 2020. OTTI adjustments of $2.0 and $- were recorded during the years ended December 31, 2019 and 2018, respectively.
Bonds and other investments with a statutory carrying value of $929.3 as of December 31, 2020 were on deposit with governmental authorities by the Company's insurance subsidiaries to comply with insurance laws.
In the above tables the unrealized losses on fixed maturity securities are primarily deemed to reflect changes in the interest rate environment. As part of its assessment of other-than-temporary impairments, the Company considers its intent to continue to hold the securities, and the likelihood that it will not be required to sell investment securities in an unrealized loss position until cost recovery, principally in consideration of its asset and liability maturity matching objectives.
2019 and 2018 were $(130.9), $586.9 and $(244.8), for the years ended December 31, 2020, 2019 and 2018, respectively.
Fair Value Measurements - Fair value is defined as the estimated price that is likely to be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price) at the measurement date. A fair value hierarchy is established that prioritizes the sources ("inputs") used to measure fair value into three broad levels: Level 1 inputs are based on quoted market prices in active markets; Level 2 observable inputs are based on corroboration with available market data; and Level 3 unobservable inputs are based on uncorroborated market data or a reporting entity's own assumptions. Following is a description of the valuation methodologies and general classification used for financial instruments measured at fair value.
Level 1 securities include U.S. and Canadian Treasury notes, publicly traded common stocks, mutual funds, and short-term investments in highly liquid money market instruments. Level 2 securities generally include corporate bonds, municipal bonds, and certain U.S. and Canadian government agency securities. Securities classified within Level 3 include non-publicly traded bonds and equity securities. There were no significant changes in the fair value of Level 3 assets as of December 31, 2020 and December 31, 2019.
Investment gains and losses, which result from sales or write-downs of securities, are reflected as revenues in the income statement and are determined on the basis of amortized value at date of sale for fixed maturity securities, and cost in regard to equity securities; such bases apply to the specific securities sold. Unrealized gains and (losses) from changes in fair value of equity securities are recorded as investment gains (losses) in the income statement. Unrealized investment gains (losses) on fixed maturity securities, net of any deferred income taxes, are recorded directly as a component of accumulated other comprehensive income in shareholders' equity. At December 31, 2020, the Company and its subsidiaries did not have significant amounts of non-income producing fixed maturity or equity securities.
With respect to most coverages, deferred acquisition costs are amortized on the same basis as the related premiums are earned or, alternatively, over the periods during which premiums will be paid. To the extent that future revenues on existing policies are not adequate to cover related costs and expenses, deferred policy acquisition costs are charged to earnings. The Company considers investment income when evaluating the recoverability of deferred acquisition costs.
General Insurance reserves are established to provide for the ultimate expected cost of settling unpaid losses and claims reported at each balance sheet date. Such reserves are based on continually evolving assessments of the facts available to the Company during the settlement process which may stretch over long periods of time. Long-term disability or pension type workers' compensation reserves are discounted to present value based on interest rates generally ranging from 3.0% to 4.0%. The amount of discount reflected in the year-end net reserves totaled $196.9, $209.6, and $216.5 as of December 31, 2020, 2019, and 2018, respectively. Interest accretion of $35.7, $34.5 and $49.0 for the years ended December 31, 2020, 2019, and 2018, respectively, was recognized as unfavorable development of prior year reserves within benefits, claims and settlement expenses in the consolidated statements of income. Losses and claims incurred but not reported ("IBNR"), as well as expenses required to settle losses and claims are established on the basis of a large number of formulas that take into account various criteria, including historical cost experience and anticipated costs of servicing reinsured and other risks. As applicable, estimates of possible recoveries from salvage or subrogation opportunities are considered in the establishment of such reserves. Overall claim and claim expense reserves incorporate amounts covering net estimates of unusual claims such as those emanating from asbestosis and environmental ("A&E") exposures as discussed below. Such reserves can affect claim costs and related claim ratios for such insurance coverages as general liability, commercial automobile (truck), workers' compensation, and property.
Old Republic's reserve estimates also include provisions for indemnity and settlement costs for various asbestosis and environmental impairment ("A&E") claims that have been filed in the normal course of business against a number of its insurance subsidiaries. Many such claims relate to policies incepting prior to 1985, including many issued during
a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. Over the years, the Company's property and liability insurance subsidiaries have typically issued general liability insurance policies with face amounts ranging between $1.0 and $2.0 and rarely exceeding $10.0. Such policies have, in turn, been subject to reinsurance cessions which have typically reduced the subsidiaries' net retentions to $.5 or less as to each claim. Old Republic's exposure to A&E claims cannot, however, be calculated by conventional insurance reserving methods for a variety of reasons, including: a) the absence of statistically valid data inasmuch as such claims generally involve long reporting delays and very often uncertainty as to the number and identity of insureds against whom such claims have arisen or will arise; and b) the litigation history of such or similar claims for insurance industry members which has produced inconsistent court decisions with regard to such questions as when an alleged loss occurred, which policies provide coverage, how a loss is to be allocated among potentially responsible insureds and/or their insurance carriers, how policy coverage exclusions are to be interpreted, what types of environmental impairment or toxic tort claims are covered, when the insurer's duty to defend is triggered, how policy limits are to be calculated, and whether clean-up costs constitute property damage. Over time, the Executive Branch and/or the Congress of the United States have proposed or considered changes in the legislation and rules affecting the determination of liability for environmental and asbestosis claims. As of December 31, 2020, however, there is no solid evidence to suggest that possible future changes might mitigate or reduce some or all of these claim exposures. Because of the above issues and uncertainties, estimation of reserves for losses and allocated loss adjustment expenses for A&E claims in particular is much more difficult or impossible to quantify with a high degree of precision. Accordingly, no representation can be made that the Company's reserves for such claims and related costs will not prove to be overstated or understated in the future. At December 31, 2020 and 2019, Old Republic's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to $127.6 and $126.8 gross, respectively, and $82.4 and $83.3 net of reinsurance, respectively. Old Republic's average five year paid loss survival ratios stood at 6.3 years (gross) and 7.1 years (net of reinsurance) as of December 31, 2020 and 6.3 years (gross) and 7.2 years (net of reinsurance) as of December 31, 2019. Fluctuations in this ratio between years can be caused by the inconsistent pay out patterns associated with these types of claims.
RFIG Run-off insurance reserves for unpaid claims and claim adjustment expenses are recognized only upon an instance of default, defined as an insured mortgage loan for which two or more consecutive monthly payments have been missed. Loss reserves are based on statistical calculations that take into account the number of reported insured mortgage loan defaults as of each balance sheet date, as well as experience-based estimates of loan defaults that have occurred but have not as yet been reported. Further, the loss reserve estimating process takes into account a large number of variables including trends in claim severity, potential salvage recoveries, expected cure rates for reported loan delinquencies at various stages of default, the level of coverage rescissions and claims denials due to material misrepresentation in key underwriting information or non-compliance with prescribed underwriting guidelines, and management judgments relative to future employment levels, housing market activity, and mortgage loan interest costs, demand, and extensions.
For the three most recent calendar years, the above table indicates that the one-year development of consolidated reserves at the beginning of each year produced favorable developments of 1.3%, .5%, and 1.2% for 2020, 2019 and 2018, respectively, with average favorable annual developments of 1.0%. The Company believes that the factors most responsible, in varying and continually changing degrees, for favorable or unfavorable reserve developments include, as to many general insurance coverages, the effect of reserve discounts applicable to workers' compensation claims, changes in severity of litigated claims in particular, governmental or judicially imposed retroactive conditions in the settlement of claims such as noted above in regard to black lung disease claims, changes in inflation rates applicable to repairs and the medical portion of claims in particular, and changes in claims incurred but not reported due to the slower and highly volatile emergence patterns applicable to certain types of claims such as those stemming from litigated, assumed reinsurance, or the A&E types of claims noted above. Title claim costs were lower in the face of declining claims activity since the Great Recession years. As to mortgage guaranty and the CCI coverage, changes in favorable or unfavorable reserve development result from differences in originally estimated salvage and subrogation recoveries, sales and prices of homes that can impact claim costs upon the disposition of foreclosed properties, changes in regional or local economic conditions and employment levels, the number of coverage rescissions and claims denials due to material misrepresentation in key underwriting information or non-compliance with prescribed underwriting guidelines, the extent of loan refinancing activity that can reduce the period of time over which a policy remains at risk, and lower than expected frequencies of claims incurred but not reported.
The following represents the Company's incurred and paid loss development tables for the major types of insurance coverages as of December 31, 2020. The information about incurred and paid claims development for the years ended December 31, 2011 to 2019 is presented as supplementary information.
(i) Reinsurance - The cost of reinsurance is recognized over the terms of reinsurance contracts. Amounts recoverable from reinsurers for loss and loss adjustment expenses are estimated in a manner consistent with the claim liability associated with the reinsured business. The Company evaluates the financial condition of its reinsurers on a regular basis. Allowances are established for estimated credit losses and are included in the Company's net claim and claim expense reserves. See Note 1(t) - Credit Losses for further discussion.
In valuing the deferred tax assets, the Company considered certain factors including primarily the scheduled reversals of certain deferred tax liabilities, estimates of future taxable income, the impact of available carryback and carryforward periods, as well as the availability of certain tax planning strategies. The Company estimates that all gross deferred tax assets at year-end 2020 will more likely than not be fully realized.
Insurance regulations require mortgage guaranty insurance companies to establish a statutory contingency reserve designed to protect policyholders against extraordinary volumes of claims. Pursuant to special provisions of the Internal Revenue Code a mortgage guaranty insurance company may, at its discretion, take a current deduction for amounts added to the statutory contingency reserve in an amount not to exceed taxable income in any given tax year or, cumulatively, the total amount of contingency reserves carried under the aforementioned insurance regulations. The deduction is allowed only to the extent that U.S. government non-interest bearing tax and loss bonds are purchased and held in an amount equal to the tax benefit attributable to such deduction. For Federal income tax purposes, amounts deducted from the contingency reserve are taken into gross statutory taxable income in the period in which they are released. During 2019, the Company released $412.2 from the tax basis contingency reserve account and redeemed all outstanding U.S. Treasury Tax and Loss Bonds.
Tax positions taken or expected to be taken in a tax return by the Company are recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. To the best of management's knowledge there are no tax uncertainties that are expected to result in significant increases or decreases to unrecognized tax benefits within the next twelve month period. The Company views its income tax exposures as primarily consisting of timing differences whereby the ultimate deductibility of a taxable amount is highly certain but the timing of its deductibility is uncertain. Such differences relate principally to the timing of deductions for loss and premium reserves. As in prior examinations, the Internal Revenue Service (IRS) could assert that claim
(k) Property and Equipment - Property and equipment is generally depreciated or amortized over the estimated useful lives of the assets, (2 to 27 years), substantially by the straight-line method. Depreciation and amortization expenses related to property and equipment were $26.9, $26.8 and $27.6 in 2020, 2019, and 2018, respectively. Expenditures for maintenance and repairs are charged to income as incurred, and expenditures for major renewals and additions are capitalized.
Funding of the plan is dependent on a number of factors including actual performance versus actuarial assumptions made at the time of the actuarial valuation, as well as the maintenance of certain funding levels relative to regulatory requirements. The Company currently does not expect to make cash contributions in calendar year 2021 based on minimum funding requirements.
(o) Escrow Funds - Segregated cash deposit accounts and the offsetting liabilities for escrow deposits in connection with Title Insurance Group real estate transactions in the same amounts ($1,718.1 and $1,743.0 at December 31, 2020 and 2019, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(a) In calculating earnings per share, accounting standards require that common shares owned by the Company's Employee Savings and Stock Ownership Plan that are as yet unallocated to participants in the plan be excluded from the calculation. Such shares are issued and outstanding, and have the same voting and other rights applicable to all other common shares.
The exercise price of stock options is equal to the closing market price of the Company's common stock on the date of grant, and the contractual life of the grant is generally ten years from the date of the grant. Options granted may be exercised to the extent of 10% of the number of shares covered thereby as of December 31st of the year of the grant and, cumulatively, to the extent of an additional 15%, 20%, 25% and 30% on and after the second through fifth calendar years, respectively. Options granted to employees who meet certain retirement eligibility provisions are fully vested on the date of grant.
Scheduled maturities of the above debt at the respective year ends are as follows: 2021: $21.7; 2022: $0; 2023: $0; 2024: $400.0; 2025 and after: $550.0. During 2020, 2019 and 2018, $42.5, $43.2 and $47.2, respectively, of interest expense on debt was charged to consolidated operations.
(d) Cash Dividends - In December 2020, the Board declared a special cash dividend of $1.00 per share payable on January 15, 2021. In September 2019, the Company paid a special cash dividend of $1.00 per share. In late
December 2017 the Board declared a special cash dividend of $1.00 per share which was paid on January 31, 2018.
Except as noted in the following paragraph, reinsurance protection on property and liability coverages generally limits the net loss on most individual claims to a maximum of: $5.2 for workers' compensation; $6.4 for commercial automobile (trucking) liability; $6.4 for general liability; $12.0 for executive protection (directors & officers and errors & omissions); $2.0 for aviation; and $5.0 for property coverages. Title insurance risk assumptions are generally limited to a maximum of $500.0 as to any one policy. The vast majority of title policies issued, however, carry exposures of less than $1.0. The average direct primary mortgage guaranty exposure is (in whole dollars) $37,000 per insured loan.
The TRIA automatically voided all policy exclusions which were in effect for terrorism related losses and obligated insurers to offer terrorism coverage with most commercial property and casualty insurance lines. The TRIREA revised the definition of "property and casualty insurance" to exclude commercial automobile, burglary and theft, surety, professional liability and farm owners multi-peril insurance. TRIPRA did not make any further changes to the definition of property and casualty insurance, however, it did include domestic acts of terrorism within the scope of the program. Although insurers are permitted to charge an additional premium for terrorism coverage, insureds may reject the coverage. Under TRIPRA, the program's protection is not triggered for losses arising from an act of terrorism until the industry first suffers losses in excess of a prescribed aggregate deductible during any one year. The program deductible trigger was $200 for 2020. Once the program trigger is met, the program will be responsible for a fixed percentage of the Company's terrorism losses that exceed its deductible which ranges from 85% in 2015 and declines by one percentage point per year until it reached 80% in 2020. The Company's deductible amounts to 20% of direct earned premium on eligible property and casualty insurance coverages. The Company currently reinsures limits on a treaty basis of $195.0 in excess of $5.0 for claims arising from certain acts of terrorism for casualty clash and catastrophe workers' compensation liability insurance coverages. The Company also purchases facultative reinsurance on certain accounts in excess of $200.0 to manage the Company's net exposure.
Reinsurance recoverable asset balances represent amounts due from or credited by assuming reinsurers for paid and unpaid claims and premium reserves. Such reinsurance balances are recoverable from non-admitted foreign and certain other reinsurers such as captive insurance companies owned by assureds, as well as similar balances or credits arising from policies that are retrospectively rated or subject to assureds' high deductible retentions, are substantially collateralized by letters of credit, securities, and other financial instruments. Old Republic evaluates on a regular basis the financial condition of its assuming reinsurers and assureds who purchase its retrospectively rated or self-insured deductible policies. Estimates of credit losses are included in the Company's net claim and claim expense reserves since reinsurance, retrospectively rated, and self-insured deductible policies and contracts do not relieve Old Republic from its direct obligations to assureds or their beneficiaries. See Note 1(t).
The following information relates to reinsurance and related data for the General Insurance and RFIG Run-off Groups for the three years ended December 31, 2020. Reinsurance transactions of the Title Insurance Group and small life and accident insurance operation are not material.
(b) Leases - Several of the Company's subsidiaries maintain their offices in leased premises. A number of these leases provide for the payment of real estate taxes, insurance, and other operating expenses. In addition, many of the subsidiaries also lease equipment for use in their businesses. Substantially all of the Company's leases are classified as operating leases.
The Company has made certain elections available under the guidance, primarily regarding lease classification and the treatment of certain lease executory costs resulting in an immaterial effect on the Company’s consolidated financial statements. In determining the lease liability, the Company estimated the discount rate (weighted average 5.37%) for each lease based upon the type of underlying asset and remaining term (weighted average 7.6 years). Total lease costs were $73.9, $73.0 and $69.0 in 2020, 2019 and 2018, respectively. Fixed lease payments for 2020 and 2019 were $64.0 and $64.9, respectively.
The following table presents a summary of future undiscounted lease payments as of the dates shown.
(d) Legal Proceedings - Legal proceedings against the Company and its subsidiaries routinely arise in the normal course of business and usually pertain to claim matters related to insurance policies and contracts issued by its insurance subsidiaries. At year-end 2020, the Company had no material non-claim litigation exposures in its consolidated business.
Note 5 - Consolidated Quarterly Results - Unaudited - Old Republic's consolidated quarterly operating results for the two years ended December 31, 2020 is presented below. In management's opinion, however, quarterly operating results for insurance enterprises such as the Company are not indicative of results to be achieved in succeeding quarters or years. The long-term nature of the insurance business, seasonal and cyclical factors affecting premium production, the fortuitous nature and, at times, delayed emergence of claims, and changes in yields on invested assets are some of the factors necessitating a review of operating results, changes in shareholders' equity, and cash flows for periods of several years to obtain a proper indicator of performance trends. The information below should be read in conjunction with the "Management Analysis of Financial Position and Results of Operations".
In management's opinion, normal recurring adjustments necessary for a fair statement of quarterly results have been reflected in the information which follows.
(a)Reclassification adjustments were made to certain Title segment revenues and expenses in prior periods to conform to the presentation adopted in the fourth quarter 2020. See Note 1(c).
(a) Results for the Consumer Credit Indemnity ("CCI") run-off business are expected to be immaterial in the remaining run-off periods. Effective July 1, 2019, these results have been reclassified to the General Insurance segment for all future periods. Previously these results were reflected as part of the RFIG Run-off Business.
(d) Reclassification adjustments were made to certain Title segment revenues and expenses in prior periods to conform to the presentation adopted in 2020. See Note 1(c).
We have audited the accompanying consolidated balance sheets of Old Republic International Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, preferred stock and common shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I to VI (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
As discussed in Note 1(h) to the consolidated financial statements, the Company estimates the liability for losses, claims, and settlement expenses using a number of considerations to determine its best estimate of the cost of settling claims reported and claims incurred but not reported. The Company estimates the liability by applying expected claim ratios by line of business to the related earned premium revenue. The Company’s liability for losses, claims, and settlement expenses (reserves) at December 31, 2020 was $10,671.0 million.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s process for estimating the liability for losses, claims, and settlement expense. This included controls related to the development of the expected claim ratios as well as comparison of the recorded reserves based on expected claim ratios to the Company’s actuarially derived reserves. We involved actuarial professionals with specialized skills and knowledge, who assisted in:
•Evaluating the Company’s estimates by developing independent analyses for certain reserve groups using the Company’s underlying historical claims data
•Developing an independent consolidated range of reserves based on actuarial methodologies and comparing to the Company’s recorded reserves