There are two basic types of title insurance policies - one for the mortgage lender and one for the real estate owner. A lender often requires property owners to purchase title insurance to protect its position as a holder of a mortgage loan, but the lender’s title insurance policy does not protect the property owner. The property owner has to purchase a separate owner’s title insurance policy to protect their investment. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a claim is made against real property, title insurance provides indemnification against insured defects.
ITIC issues title insurance policies through issuing agencies and also directly through home and branch offices. Issuing agents are typically real estate attorneys or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company’s marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company’s growth in premiums written.
Volume is a factor in the Company’s profitability due to the existence of fixed operating costs. These expenses will be incurred by the Company regardless of the level of premiums written. The resulting operating leverage has historically tended to amplify the impact of changes in volume on the Company’s profitability. The Company’s profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and minimize risks such as interest rate changes or defaults or impairments of assets.
Another important factor in the level of residential and commercial real estate activity is the effect of changes in interest rates. According to data published by Freddie Mac, the annual average 30-year fixed mortgage interest rates in the United States were reported to be 6.03%, 6.34% and 6.41% for the years 2008, 2007 and 2006, respectively.
the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. As exchange accommodation titleholder, ITAC offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property.
Factors that influence the title insurance industry will also generally affect the exchange services industry. In addition, the services provided by the Company’s exchange services segment are pursuant to provisions in the Internal Revenue Code. From time to time, these exchange provisions are subject to review and changes, which may negatively affect the demand for tax-deferred exchanges in general, and consequently the revenues and profitability of the Company’s exchange segment.
Historically, activity in real estate markets has varied over the course of market cycles in response to evolving economic factors. The Company anticipates that current market conditions, including the sub prime lending crisis, rising foreclosures, weakening home sales and falling home prices, will be primary influences on the Company’s operations until some stabilization occurs. Operating results can vary from year to year based on cyclical market conditions and do not necessarily indicate the Company’s future operating results and cash flows.
In addition, the credit market disruptions in 2008 resulted in an increase in the Company’s realized capital losses, which are reflected in net income, and unrealized capital losses, which are reflected in accumulated other comprehensive income. The carrying amount, which approximates fair value, of investments at December 31, 2008 and 2007 was approximately $115.9 million and $129.0 million, respectively.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2008 is represented by the reserve for claims of $39,238,000 on the accompanying consolidated balance sheet. Of that total, $6,447,345 was reserved for specific claims, and $32,790,655 was reserved for claims for which the Company had no notice. The Company’s reserves for claims are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future (incurred but not reported, “IBNR”).
There are key assumptions that materially affect the reserve estimates. The Company assumes the aggregate reported liability for known claims and IBNR, in the aggregate, will be comparable to its historical claims experience unless factors, such as loss experience, change significantly. The factors the Company considered for the recently completed fiscal year did not cause any of its key assumptions to change from assumptions used in the immediately preceding period. Also affecting the Company’s assumptions are large losses related to fraud and defalcation, as these can cause significant variances in loss emergence patterns. Management defines a large loss as one where incurred losses exceed $250,000. Due to the small volume of large claims, the long-tail nature of title insurance claims and the inherent uncertainty in loss emergence patterns, large claim activity can vary significantly between policy years. The estimated development of large claims by policy year is therefore subject to significant changes as experience develops. The Company has generally followed the same methodology for estimating loss reserves. The loss provision rate is set to provide for losses on current year policies and to provide for estimated positive or negative development on prior year loss estimates.
If one or more of the variables or assumptions used changed such that the Company’s recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased two loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2008, would be as follows. Company management believes that using a sensitivity of two loss percentage points for the loss ratio provides a reasonable benchmark for analysis of the calendar year loss provision of the Company based on historical loss ratios by year.
analysis. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. The fair values of the majority of the Company’s investments are based on quoted market prices from independent pricing services. Over the past several months, the Company has seen credit market disruption as the result of illiquid markets and widening spreads. Auction rate securities, where quoted market prices are not available and the Company relies on discounted cash flow models for valuation purposes, have been particularly affected due to their thinly traded markets. All of the Company’s auction rate securities are rated investment grade and are substantially guaranteed by government-sponsored enterprises. Management believes these values reasonably reflect the fair value of these securities, but the key assumptions do involve qualitative inputs. Realized gains and losses are determined on the specific identification method.
Operating revenues include net premiums written plus other fee income and exchange services segment income. Investment income and realized investment gains and losses are not included in operating revenues and are discussed separately following operating revenues. Following is a summary of the Company’s operating revenues. Intersegment eliminations have been netted with each segment; therefore, the individual segment amounts will not agree to Note 13 in the accompanying Consolidated Financial Statements.
Title insurance premiums decreased 9.0% to $63,662,187 in 2008 compared with 2007. The decrease in 2008 was made up of a $5,832,678 decrease in branch premiums and a $489,124 decrease in premiums from agency operations.
In July 2008, the IRS finalized its proposed regulations regarding treatment of funds held by qualified intermediaries. As originally proposed, these rules would have negatively affected the ability of qualified intermediaries to retain a portion of the interest income earned on exchange fund deposits held by the Company during exchange transactions, which could have had a material adverse effect upon the profitability of the Company’s exchange segment. As adopted however, the new regulations apply only to individual exchange account balances over $2 million. The regulations have only recently been adopted, and therefore the Company has had only limited experience under this new regime; it is possible that these new regulations may have unanticipated consequences on the revenues and profitability of the Company’s exchange services segment.
Title insurance premiums are closely related to the level of real estate activity and the average price of real estate sales. The availability of funds to finance purchases directly affects real estate sales. Home sales and mortgage lending are highly cyclical businesses. Other factors include mortgage interest rates, consumer confidence, economic conditions, supply and demand, and family income levels. Historically, residential real estate activity has been generally slower in the winter because fewer real estate transactions occur, while the spring and summer are more active. Refinance activity is generally less seasonal, but it is subject to interest rate volatility. Fluctuations in mortgage interest rates, as well as other economic factors, can cause shifts in real estate activity outside of the normal seasonal pattern.
As new funds become available, they are invested in accordance with the Company’s investment policy and corporate goals. Securities purchased may include a combination of taxable fixed-income securities, tax-exempt securities and equities. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment.
Net realized loss on investments totaled $2,922,376 in 2008. Net realized gain on the sales of investment securities totaled $921,871 and $551,058 in 2007 and 2006, respectively. The 2008 net loss included impairment charges totaling $1,226,932 on certain equity and fixed income securities in the Company’s portfolio that were deemed to be other than temporarily impaired and net realized losses on sales of investments of $1,695,444. Management has determined that the unrealized losses from remaining fixed income and equity securities at December 31, 2008 are temporary in nature. The net realized gains in 2007 and 2006 resulted primarily from the sale of equity securities and other investments in the Company’s investment portfolio.
The securities in the Company’s portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other than temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been below cost, the financial condition and prospects of the issuer (including credit ratings and analyst reports) and macro-economic changes. Reviews of the values of securities are inherently uncertain and the value of the investment may not fully recover, or may decline in future periods resulting in a realized loss.
The Company’s operating expenses consist primarily of commissions to agents, salaries, employee benefits and payroll taxes, provisions for claims and office occupancy and operations. Operating expenses in 2008 increased 1.7% compared with 2007 and 2007 increased 8.6% compared with 2006 primarily due to increases in the provision for claims. Partially offsetting these increases in 2008 were decreases in professional and contract labor fees, commissions to agents and salaries, employee benefits and payroll taxes. Following is a summary of the Company’s operating expenses. Intersegment eliminations have been netted with each segment; therefore, the individual segment amounts will not agree to Note 13 in the accompanying Consolidated Financial Statements.
On a combined basis, loss margin was (1.7%) in 2008 and profit margins were 9.9% and 15.6% in 2007 and 2006, respectively.
Commissions: Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. Commissions to agents decreased 2.5% from 2007 to 2008 primarily due to decreased premiums from agency operations in 2008 and increased 6.4% from 2006 to 2007 primarily due to an increasing percentage of premiums originating from agency operations in 2007. Commission expense as a percentage of net premiums written by agents was 70.4%, 71.3% and 70.6% in 2008, 2007 and 2006, respectively. Commission rates vary geographically.
The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Payments of claims, net of recoveries, were $12,943,637, $10,065,719 and $5,356,211 in 2008, 2007 and 2006, respectively.
Reserves for Claims: At December 31, 2008, the total reserves for claims were $39,238,000. Of that total, $6,447,345 was reserved for specific claims, and $32,790,655 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions, and the fact that many claims do not materialize for several years, reserve estimates are subject to variability. Changes in the expected liability for claims for prior periods reflect the uncertainty of the claim environment, as well as the limited predicting power of historical data. The Company continually updates and refines its reserve estimates as current experience develops and credible data emerges. Adjustments may be required as new information develops which often varies from past experience.
Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data, rather than as a result of material changes to underlying key actuarial assumptions or methodologies. Such changes include payments on claims closing during the year, new details that emerge on still-open cases that cause claims adjusters to increase or decrease the case reserve and the impact that these types of changes have on the Company’s total loss provision.
salary increases and additional personnel costs related to staff hired by Investors Trust Company. On a consolidated basis, salaries and employee benefits as a percentage of total revenues were 27.6%, 24.5% and 23.7% in 2008, 2007 and 2006, respectively. The increase in salaries and employee benefits as a percentage of total revenues in 2008 was primarily due to declining revenues outpacing cost reductions. The title insurance segment’s total salaries and employee benefits accounted for 83.8%, 84.9% and 85.3% of total salaries for 2008, 2007, and 2006, respectively.
Office Occupancy and Operations: Overall office occupancy and operations as a percentage of total revenues was 7.2%, 6.6% and 6.6% in 2008, 2007 and 2006, respectively. The title insurance segment’s total office occupancy and operations expense accounted for 88.6%, 90.2% and 90.9% in 2008, 2007 and 2006, respectively, of total office occupancy and operations expense.
Liquidity: Although cash flow generated from operating activities declined from 2007 to 2008, primarily due to the decrease in net income between periods, cash and cash equivalents at year end increased 72% to approximately $5.2 million, due mainly to significant cash provided by investing activities for 2008. The net increase in cash provided by investing activities for 2008 was, in turn, due primarily to significantly reduced purchases of investment securities. The Company’s ability to offset reductions in cash provided by operations by reducing securities investments, however, is limited by the need to maintain adequate financial condition, capital and claims-paying ability.
Due to the Company’s historical consistent ability to generate positive cash flows from its consolidated operations and investment income, management believes that funds generated from operations will enable the Company to adequately meet its current operating needs for the foreseeable future. However, there can be no assurance that future experience will be similar to historic experience, since they are influenced by such factors as the interest rate environment, the Company’s claims-paying ability and its financial strength ratings. The Company is unaware of any trend that is likely to result in material adverse liquidity changes, but continually assesses its capital allocation strategy. The Company’s cash requirements include general operating expenses, income taxes, capital expenditures, dividends on its common stock declared by the Board of Directors and share repurchases. In addition to operational liquidity, the Company maintains a high degree of liquidity within its investment portfolio in the form of short-term investments and other readily marketable securities.
The majority of the Company’s investment portfolio is considered as available-for-sale. The Company reviews the status of each of its securities quarterly to determine whether an other-than-temporary impairment has occurred. The Company’s criteria generally includes the degree to which the fair value of a security is less than 80% of its amortized cost and the investment grade of the security, as well as how long the security has been in an unrealized loss position. The Company’s securities that have had an unrealized loss in excess of one year are primarily investment-grade, long-term bonds and equities that the Company has the ability and intent to hold until a recovery of fair value, which may be until maturity for fixed income securities.
Cash Flows: Net cash flows provided by operating activities were $1,309,473, $10,354,960 and $18,554,831 in 2008, 2007 and 2006, respectively. Cash flows from operations have been the primary source of financing for expanding operations, additions to property and equipment, dividends to shareholders, and other requirements. The net decrease in cash flow from operations in 2008 and 2007 was primarily the result of the decrease in net income.
As noted previously, the Company’s operating results and cash flows are heavily dependent on the real estate market, particularly in the title insurance segment. The Company’s business has certain fixed costs such as personnel, and changes in the real estate market are monitored closely and operating expenses such as staffing levels are managed and adjusted accordingly. The Company believes that its significant working capital position and management of operating expenses, along with its product diversification efforts will aid its ability to manage cash resources through declines in the real estate market.
Purchase of Company Stock: On November 10, 2008, the Board of Directors of the Company approved the purchase of an additional 394,582 shares pursuant to the Plan, such that there was authority remaining under the Plan to purchase up to an aggregate of 500,000 shares of the Company’s common stock pursuant to the Plan immediately after the approval. Pursuant to this approval, the Company purchased 130,450 shares in the twelve months ended December 31, 2008, 111,437 shares in the twelve months ended December 31, 2007 and 51,949 shares in the twelve months ended December 31, 2006 at an average per share price of $45.78, $41.82 and $43.85, respectively.
As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $14,492,000 and $23,665,000 as of December 31, 2008 and 2007, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying consolidated balance sheets. However, the Company remains contingently liable for the disposition of these deposits.
External assets managed by the Investors Trust Company totaled over $500,000,000 for the years ended December 31, 2008 and 2007. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying consolidated balance sheets.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in accordance with GAAP. With the issuance of this Statement, the FASB concluded that the GAAP hierarchy should be directed toward the entity and not its auditor, and reside in the accounting literature established by the FASB. This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to Audit Standards AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company is currently evaluating the effect of adopting this new Statement and anticipates that the Statement will not have a significant impact on the reporting of the Company’s results of operations.
The financial statements schedules meeting the requirements of Regulation S-X are attached hereto as Schedules I, II, III, IV and V.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Investors Title Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 6, 2009 expressed an unqualified opinion.
Management of Investors Title Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f) and 15(d)-15-(f). The Company’s internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of the Company’s financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 has been audited by Dixon Hughes PLLC as independent registered public accounting firm, as stated in their report which follows.
In our opinion, Investors Title Company and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The total reserve for all reported and unreported losses the Company incurred through December 31, 2008 is represented by the reserves for claims. The Company’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserves are adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2008. The Company continually reviews and adjusts its reserve estimates as necessary to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, short-term investments, premiums receivable, accrued interest and dividends, accounts payable, commissions and reinsurance payable and current income taxes payable approximate cost, which is what is reflected on the consolidated balance sheets due to the short-term nature of these assets and liabilities. Fair values for the majority of investment securities are based on quoted market prices. Auction Rate Securities, (“ARS”) are valued using discounted cash flow models to determine the estimated fair value of these investments. Some of the inputs to ARS model are unobservable in the market and are significant.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains on available-for-sale securities, net of tax, and unrecognized prior service cost and unrealized gains/losses associated with FASB Statement No. 158 related to postretirement benefit liabilities, net of tax.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin (“ARB”) No. 51” (“SFAS 160”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. It also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS 141(R). SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption prohibited. The Company is currently evaluating the effect of adopting this new Statement and anticipates that the Statement will not have a significant impact on the reporting of the Company’s results of operations.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period and accompanying notes. Actual results could differ materially from those estimates and assumptions used.
available, the loss reserve estimate related to prior periods will change to more accurately reflect updated and improved emerging data. The Company reflects any adjustments to reserves in the results of operations in the period in which new information (principally claims experience) becomes available.
The Company considers relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other than temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost.
The Company has designated approximately $40,638,016 and $39,879,000 of retained earnings as of December 31, 2008 and 2007, respectively, as appropriated to reflect the required statutory premium reserve. See Note 8 for the tax treatment of the statutory premium reserve.
Bonds totaling approximately $6,540,000 and $6,471,000 at December 31, 2008 and 2007 respectively, are on deposit with the insurance departments of the states in which business is conducted.
Also included in net realized (loss) gain on sales of investments in the Consolidated Statements of Income for the years ended December 31, 2008, 2007 and 2006 is ($120,093), $410,148 and $16,250, respectively, of gains (losses) from the sale of other investments.
The following table presents the gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position at December 31, 2008 and 2007.
Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been below cost, the financial condition and prospects of the issuer (including credit ratings and analyst reports) and macro-economic changes. A total of 67 and 57 securities had unrealized losses at December 31, 2008 and December 31, 2007, respectively. Reviews of the values of securities are inherently uncertain and the value of the investment may not fully recover, or may decline in future periods resulting in a realized loss. During 2008, the Company recorded an other-than-temporary impairment charge in the amount of approximately $1.2 million related to securities.
Valuation Hierarchy. SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs to the valuation methodology are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.
Valuation Techniques. A financial instrument’s classification within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Equity securities are measured at fair value using quoted active market prices and are classified within Level 1 of the valuation hierarchy. The fair value of fixed maturity investments included in the Level 2 category was based on the market values obtained from pricing services.
The Level 2 category generally includes corporate bonds, agency bonds and municipal bonds. A number of the Company’s investment grade corporate bonds are frequently traded in markets that are not active or use valuation models, which use observable market inputs, in addition to traded prices. Substantially all of these model input assumptions are directly observable in the marketplace or can be derived or supported by observable market data.
The Company’s investments in student loan auction rate securities (“ARS”) are its only Level 3 assets, and were transferred from Level 2 because quoted prices from broker-dealers were unavailable due to the failure of auctions. Valuations using discounted cash flow models were used to determine the estimated fair value of these investments as of December 31, 2008. Some of the inputs to this model are unobservable in the market and are significant.
The Company assumes and cedes reinsurance with other insurance companies in the normal course of business. Premiums assumed and ceded were approximately $167,000 and $275,000, respectively, for 2008, $43,000 and $264,000, respectively, for 2007 and $22,000 and $442,000, respectively, for 2006. Ceded reinsurance is comprised of excess of loss treaties, which protects against losses over certain amounts. The Company remains liable to the insured for claims under ceded insurance policies in the event that the assuming insurance companies are unable to meet their obligations under these contracts. The Company has not paid or recovered any reinsured losses during the three years ended December 31, 2008.
The Company continually refines its reserve estimates as current loss experience develops and credible data emerges. Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data.
The provision for claims as a percentage of net premiums written was 23.9%, 14.5% and 10.5% in 2008, 2007 and 2006, respectively. The change in estimate for calendar year 2008 resulted primarily from policy year 2008, which incurred three large claims totaling approximately $6,800,000. In addition, the Company incurred unfavorable experience during 2008 for claims related to policy year 2006. The change in estimate for calendar year 2007 resulted primarily from policy year 2006, which incurred two large fraud-related claims. The change in estimate for calendar year 2006 resulted primarily from lower than expected large claims payments for 2005. Due to variances between actual and expected loss payments, loss development is subject to significant variability. A large claim is defined as a claim with incurred losses exceeding $250,000. Due to the small volume of large claims, the long-tail nature of title insurance claims and the inherent uncertainty in loss emergence patterns, large claim activity can vary significantly between policy years. The estimated development of large claims by policy year is therefore subject to significant changes as experience develops.
The Company has adopted Employee Stock Option Purchase Plans (the “Plans”) under which options or SARS to purchase shares (not to exceed 500,000 shares) of the Company’s stock may be granted to key employees or directors of the Company at a price not less than the market value on the date of grant. SARS and options, which are predominantly incentive stock options, are exercisable and vest immediately or within one year or at 10% to 20% per year beginning on the date of grant and generally expire in five to ten years. All SARS issued to date have been share settled only. There were not any shares issued from SARS exercised in 2008, 2007 or 2006.
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock at December 31, 2008. In 2006 and 2007, there were no options or SARS excluded from the calculation as all options and SARS were in the money. The intrinsic value of options exercised during 2008 was approximately $327,000.
The estimated weighted-average grant-date fair value of SARS granted for the years ended December 31 was as follows:
The components of income tax (benefit) expense for the years ended December 31 are summarized as follows:
For state income tax purposes, ITIC and NE-ITIC generally pay only a gross premium tax found in premium and retaliatory taxes in the consolidated statements of income (loss).
During the fourth quarter of 2007, the Company discovered certain understatements in the provision for income taxes in its financial statements in 2006 and the first three quarters of 2007 relating to taxable municipal bonds that had been previously misclassified as tax exempt by the Company’s custodian bank.
The amount of unrecognized tax benefit or liability may increase or decrease in the future for various reasons, including adding amounts for current tax year positions, expiration of open income tax returns due to the statute of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the additions or eliminations of uncertain tax positions.
The Company’s policy is to report interest and penalties related to unrecognized tax benefits or liabilities in the Consolidated Statements of Income. As of December 31, 2008, there was $14,710 related to interest and $10,258 related to penalties recorded in other operating expenses.
In the balance of unrecognized tax benefits at December 31, 2008, approximately $87,000 relates to tax positions and interest for which the statute of limitations will expire within the next 12 months. Of the total unrecognized tax benefits, approximately $62,000 represents the amount that if recognized, would favorably affect the effective tax rate in future periods. Included in the $87,000 are penalties and interest in the amount of approximately $25,000.
In November 2003, ITIC, a wholly owned subsidiary of the Company, entered into employment agreements with the Chief Executive Officer, Chief Financial Officer and the Chief Operating Officer of ITIC. These individuals also serve as the Chief Executive Officer, President and Executive Vice President, respectively, of the Company. The agreements provide compensation and life, health, dental and vision benefits upon the occurrence of specific events, including death, disability, retirement, termination without cause or upon a change in control. The agreements provide for annual salaries to be fixed by the Compensation Committee and, among other benefits, ITIC shall make quarterly contributions pursuant to a supplemental executive retirement account on behalf of each executive equal to 22% of the base salary and bonus paid to each during such quarter through September 30, 2008. The obligation to make contributions to the supplemental executive retirement agreements has expired and has been removed from
Development of the accumulated postretirement benefit obligation for the years ended December 31, 2008 and 2007 includes the following:
Assumed health care cost trend rates do have an effect on the amounts reported for the postretirement benefit plan. The following illustrates the effects on the net periodic postretirement benefit cost and the accumulated postretirement benefit obligation of a one percentage point increase and one percentage point decrease in the assumed health care cost trend rate as of December 31, 2008:
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America which differ in some respects from statutory accounting practices prescribed or permitted in the preparation of financial statements for submission to insurance regulatory authorities.
Consolidated stockholders’ equity on a statutory basis was $82,305,151 and $93,079,819 as of December 31, 2008 and 2007, respectively. Net (loss) income on a statutory basis was $(3,148,117), $7,980,954 and $11,684,065 for the twelve months ended December 31, 2008, 2007 and 2006.
On November 12, 2002, the Company’s Board of Directors amended the Company’s Articles of Incorporation, creating a series of Class A Junior Participating Preferred Stock (the “Class A Preferred Stock”). There are 1,000,000 shares of Preferred Stock authorized and 100,000 of these shares have been designated Class A Junior Participating Preferred Stock. The Class A Junior Participating Preferred Stock is senior to common stock in dividends or distributions of assets upon liquidations, dissolutions or winding up of the Company. Dividends on the Class A Preferred Stock are cumulative and accrue from the quarterly dividend payment date. Each share of Class A Preferred Stock entitles the holder thereof to 100 votes on all matters submitted to a vote of shareholders of the Company. These shares were reserved for issuance under the Shareholder Rights Plan (the “Plan”), which was adopted on November 21, 2002, by the Company’s Board of Directors. Under the terms of the Plan, the Company’s common stock acquired by a person or a group buying 15% or more of the Company’s common stock would be diluted, except in transactions approved by the Board of Directors.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company invests its cash and cash equivalents into high credit quality security instruments. Deposits which exceed $250,000 at each institution are not insured by the Federal Deposit Insurance Corporation. Of the $5.2 million in cash and cash equivalents on the Consolidated Balance Sheets at December 31, 2008, $5.4 million was not insured by the Federal Deposit Insurance Corporation. The total amount not insured is higher than cash and cash equivalents due to larger bank than book balances.
The Company generates a significant amount of title insurance premiums in North Carolina. In 2008, 2007 and 2006, North Carolina accounted for 47.9%, 49.2% and 49.8% of total direct title premiums, respectively.