The principal executive offices of the Company are located in the Old Republic Building in Chicago, Illinois. This Company owned building contains 151,000 square feet of floor space of which approximately 50% is occupied by Old Republic, and the remainder is leased to others. In addition to the Company-owned principal executive offices, a subsidiary of the Title Insurance Group partially occupies its headquarters building. This building contains 110,000 square feet of floor space of which approximately 65% is occupied by the Old Republic National Title Insurance Company. The remainder of the building is leased to others. Eleven smaller buildings are owned by Old Republic and its subsidiaries in various parts of the country and are primarily used for its business. The carrying value of all buildings and related land at December 31, 1997 was approximately $13.7 million. Certain other operations of the Company and its subsidiaries are directed from leased premises. See Note 5(b) of the Notes to Consolidated Financial Statements for a summary of all material lease obligations.
(a) Consists of cash, investments and investment income due and accrued. (b) Total capitalization consists of debt and debt equivalents, preferred stock, and common shareholders' equity. (c) Effective January 1, 1993, the Company adopted Financial Accounting Statement (FAS) No. 109 "Accounting for Income Taxes" that required a change to the asset and liability method of calculating deferred income taxes. The cumulative effect of this change resulted in net income of $13.3, or $.11 per share ($.09 diluted) in 1993. In addition, effective January 1, 1993 the Company adopted FAS No. 106 "Employers' Accounting for Post-retirement Benefits Other than Pensions" for health care and life insurance benefit plans. A few Old Republic subsidiaries made available post-retirement health benefits for employees that retired prior to November 30, 1992. The Company recognized the accumulated post-retirement benefit liability of $7.0 as of January 1, 1993; this resulted in an after tax charge to net income of $4.6 or $.04 per share ($.03 diluted. (d) In February 1996, the Company called for the redemption of its 10% debentures maturing in 2018 ($75.0 principal amount), and its 5.75% convertible subordinated debentures maturing in 2002 ($110.0 principal amount). In April 1996, the Company called for redemption its 11.5% debentures maturing in 2015 ($30.0 principal amount). Redemption of the debentures was effected with internally available funds, while the subordinated debentures were converted by their terms into approximately 9.6 million Old Republic common shares. The early retirement of the Company's debentures produced a net of tax charge of $4.4 or $.03 per share that has been reflected as an extraordinary item in 1996. (e) Effective in 1997, the Company adopted Financial Accounting Statement (FAS) No. 128 "Earnings Per Share" which establishes a new methodology for computing earnings per share. It replaces Primary Earnings Per Share with Basic Earnings Per Share. Basic Earnings Per Share excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the period. Diluted Earnings Per Share per FAS-128 is computed in a fashion similar to the former Fully Diluted Earnings Per Share as required by prior authoritative FASB pronouncements. Prior year data has been retroactively restated. Common share data has been retroactively adjusted to reflect a 50% stock dividend of the Company's common shares approved by the Board of Directors on March 12, 1998. FAS-128 requires this stock dividend be reflected in the 1997 year-end financial statements. Excludes 10,110,690 issued and outstanding common shares, held by a consolidated affiliate, which are eliminated in consolidation and in the calculation of outstanding shares for financial accounting purposes only. (f) Calculated after deduction of preferred stock dividend requirements of $1.7 in 1997, $7.5 in 1996, $6.7 in 1995, $7.0 in 1994 and $7.2 in 1993. (g) Calculated after deduction of preferred stock dividend requirements and, as applicable, after adjustment for post-tax convertible debentures interest of $4.0 in 1996, $.6 in 1995, $.9 in 1994 and $1.0 in 1993.
FAS-128 establishes a new methodology for computing earnings per share. Primary Earnings Per Share is replaced by Basic Earnings Per Share. The latter excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the period. Diluted Earnings Per Share per FAS-128 is computed in a fashion similar to the former Fully Diluted Earnings Per Share as required by prior authoritative FASB pronouncements.
In the second quarter of 1997, several life insurance subsidiaries recovered income taxes and related accumulated interest due to favorable resolution with the Internal Revenue Service of various outstanding issues pertaining to income tax returns for the years 1979 through 1982. These cash recoveries, net of miscellaneous charges, increased other income by $12.6, reduced income tax expense by $5.9 and increased after-tax consolidated earnings by $14.2 ($0.10 per diluted common share) for the year ended December 31, 1997.
a more stable long term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration. The market value of the Company's long term fixed maturity investment portfolio is sensitive, however, to fluctuations in the level of interest rates, but not materially effected by changes in anticipated cash flows caused by any prepayments. The impact of interest rate movements on the long term fixed maturity investment portfolio generally affects net realized gains or losses when securities are sold. With a market value of $4,316.1, the long term fixed maturity investment portfolio has an average maturity of 5.1 years and an indicated duration of 4.2. This implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the market value of the long term fixed maturity investment portfolio of approximately 4.2%, or $180. With regard to its $113.8 common stock portfolio, the Company does not own nor engage in any type of option writing. A 10% decrease in the U.S. equity market prices could result in a decrease of $11.4 in the market value of the Company's common stock portfolio. These possible declines in values for Old Republic's bond and stock portfolios would affect negatively the common shareholders' equity at any point in time, but would not necessarily result in the recognition of realized investment losses as long as operating cash flow and the ongoing emergence of bond maturities continued to provide sufficient funds to meet obligations to policyholders and claimants.
The parent holding company has met its liquidity and capital needs principally through dividends paid by its subsidiaries. The insurance subsidiaries' ability to pay cash dividends to the parent company is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. Additionally, the terms of guarantees by the Company of bank loans to the trustee of the Company's Employees Savings and Stock Ownership Plan restrict the amount of debt the Company may incur. This covenant is being met.
In February 1996, the Company called for the redemption of its 10% debentures maturing in 2018 ($75.0 principal amount ) and its 5.75% convertible subordinated debentures maturing in 2002 ($110.0 principal amount). In April 1996, the Company called for the redemption of its 11.5% debentures maturing in 2015 ($30.0 principal amount); redemption of these debentures was financed with internally available funds, while the subordinated debentures were converted by their terms into approximately 9.6 million Old Republic common shares. As a result of these redemptions and conversions, the Company's debt declined by $215.0 while its common shareholders' equity account rose by $108.6 during 1996. The early retirement of the debentures produced a net of tax charge of $4.4 ($0.03 per diluted common share) that has been reflected as an extraordinary item in 1996. In December 1996, the Company redeemed all ($54.8) of its Series "H" cumulative preferred stock with available funds. During the second quarter of 1997, the Company issued $115.0 of 7% debentures maturing June 15, 2007; proceeds from this offering were used principally to redeem commercial paper debt.
Net investment income grew by 3.9%, 3.4% and 10.7% in 1997, 1996 and 1995, respectively. For each of the past three years, this revenue source was affected by positive consolidated operating cash flows and by a concentration of investable assets in interest-bearing, fixed maturity securities. The Company, as previously mentioned, used internal funds in 1997 for open market purchases of its common stock and in 1996 to redeem certain debt and preferred stock, thus reducing the size and earning power of its invested asset base. The average annual yield on investments was 5.9%, 6.0% and 6.2% for the years ended December 31, 1997, 1996 and 1995, respectively. This yield pattern reflects at once the relatively short maturity of Old Republic's fixed maturity securities portfolio, changes in interest rates at various times during the past three years, and the commitment of a larger percentage of investable funds to tax-exempt fixed maturity securities that typically bear lower pre-tax yields.
While the Company's investment policies have not been designed to maximize realized investment gains, such gains were higher in 1995 than those realized in 1997 and 1996. Dispositions of securities have been caused principally by calls prior to maturity by issuers of bonds and notes, and by sales of equity securities. In 1997, 76.9% of total fixed maturity securities dispositions represented contractual maturities and early calls of existing holdings; for the year 1996 and 1995 these amounted to 72.5% and 58.5%, respectively.
Income before taxes increased by 24.6%, 8.3% and 39.9% in 1997, 1996 and 1995, respectively. General insurance results have trended up during the past three years and have continued as the largest contributor to consolidated earnings, principally as a result of improved underwriting results and greater investment income. The mortgage guaranty segment reflected significantly improved earnings in each of the last three years due to increased revenues generating higher income from underwriting operations. Increases in title insurance earnings in 1997 and 1996 resulted from growth in premiums and fees and a reduction in loss and expense ratios, while the lower results in 1995 were due to the previously noted decline in revenues. Life and disability operations, excluding the aforementioned non-recurring tax recovery item, have posted relatively flat earnings in the past three years.
The effective consolidated income tax rates were 30.3% in 1997, 31.6% in 1996 and 32.7% in 1995. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from tax-exempt investment income, on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand. The lower rate in 1997 was also caused by the above noted income tax recoveries for prior years.
See last paragraph under "Financial Position" above for extraordinary charge recorded in 1996.
Any forward-looking statements contained in this report, of necessity, involve assumptions, uncertainties, and risks that may affect the Company's future performance. With regard to Old Republic's General insurance segment, its results can be affected in particular by the level of market competition which is typically a function of available capital and expected returns on such capital among competitors, the levels of interest and inflation rates, as well as periodic changes in claim frequency and severity patterns caused by natural disasters, weather conditions, accidents, illnesses and work-related injuries. Mortgage Guaranty and Title insurance results can be affected by such factors as changes in national and regional housing demand and values, the availability and cost of mortgage loans, employment trends, and default rates on mortgage loans; mortgage guaranty results may also be affected by various risk-sharing arrangements with business producers. Life and disability insurance results can be impacted by the levels of employment and consumer spending, as well as mortality and health trends. At the holding company level, results are generally affected by the amount of debt outstanding and its cost.
Any forward-looking statements speak only as of their dates. Old Republic undertakes no obligation to publicly update or revise such statements, whether as a result of new information, future events or otherwise, and accordingly they may not be unduly relied upon.
- ------------ (*) At December 31, 1997 and 1996, there were 75,000,000 shares of $0.01 par value preferred stock authorized, of which 237,551 in 1997 and 50,591,157 in 1996 were redeemable and/or convertible preferred shares issued and outstanding. As of the same dates, there were 250,000,000 shares of common stock, $1.00 par value, authorized, of which 154,699,842 in 1997 and 144,017,414 in 1996 were issued and outstanding. At December 31, 1997 and 1996 there were 50,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. Common shares classified as treasury stock were 16,630,075 and 13,609,269 as of December 31, 1997 and 1996, respectively.
Old Republic International Corporation and Subsidiaries Notes to Consolidated Financial Statements ($ in Millions, Except as Otherwise Indicated) - ------------------------------------------------------------------------------
The amortized cost and estimated fair value at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
are earned on an accelerated basis over the policy term. Title insurance premiums are recognized as income upon the substantial completion of the policy issuance process. Title abstract, escrow, service, and other fees are taken into income at the time of closing of the related escrow. Ordinary life and annuity premiums are recognized as revenue when due. Decreasing term credit life and credit disability/accident & health insurance premiums are generally earned on a sum-of-the-years-digits or similar method.
At December 31, 1997 and 1996, the Life Insurance Group had $4,912.9 and $3,969.6, respectively, of net life insurance in force. Future policy benefits and unearned premiums, consisted of the following:
The Company has previously issued directly or assumed as a reinsurer certain insurance policies generally categorized as financial guarantees. The major types of guarantees pertain to (a) state, municipal and other general or special revenue bonds, (b) variable interest rate guarantees, and (c) insurance of the future residual value of fixed assets. The types of risks involved include failure by the bond issuer to make timely payment of principal and interest, changes in interest rates, and changes in the future value of fixed assets. The degree of risk pertaining to these insurance products is largely dependent on the effects of general economic cycles and changes in the credit worthiness of issuers whose obligations have been guaranteed. During the past three years, new commitments have been limited to reinsuring the risks identified at (a) immediately above.
With respect to mortgage guaranty insurance (net insurance in force of $50,362.3 and $45,651.6, at December 31, 1997 and 1996, respectively) the Company's reserving policies are set forth below in Note 1(g).
Life insurance companies domiciled in the United States and qualifying as life insurers for tax purposes are taxed under special provisions of the Internal Revenue Code. As a result of legislation, 1983 and prior years' tax deferred earnings (cumulatively $19.6 at December 31, 1997) credited to the former memorandum "policyholders' surplus account" will generally not be taxed unless they are subsequently distributed to shareholders. The Company does not presently anticipate any distribution or payment of taxes on such earnings in the future.
As a result of regular examinations of the tax returns for the Corporation and its subsidiaries, the Internal Revenue Service ("IRS") has proposed certain adjustments for additional taxes applicable to the years 1982 to 1995. The proposed adjustments pertain to the timing of certain deductions, the IRS's contention that contractually obligated premium refunds should be treated as dividends, deductions for certain loss and related reserves, a reinsurance transaction, and several other issues not involving material amounts. The Company and its tax counsel believe that substantially all of the proposed material adjustments are without merit, that the Company will be successful in vigorously defending its positions, and that the ultimate adjustments, if any, will not significantly affect its financial condition or results of operations.
The Financial Accounting Standards Board (FASB) issued, in January, 1998, Statement of Financial Accounting Standards No. 132 (FAS-132) "Employers' Disclosures about Pensions and Other Postretirement Benefits." FAS-132 revises the Company's disclosures about pension and other postretirement benefit plans. The Statement does not change the measurements or recognition of pension or other postretirement benefit plans. FAS-132 is effective for fiscal years beginning after December 15, 1997.
(m) 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 ($541.7 and $390.2 at December 31, 1997 and 1996, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(n) Earnings Per Share-In 1997, the Company adopted Statement of Financial Accounting Standard No. 128 "Earnings Per Share" which establishes a new methodology for computing earnings per share. Consolidated basic earnings per share, which replaces primary earnings per share, excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the year. Diluted earnings per share per FAS-128 is computed in a fashion similar to the former fully diluted earnings per share as required by prior authoritative FASB pronouncements. Common share data has been retroactively adjusted to reflect a 50% stock dividend of the Company's common shares approved by the Board of Directors on March 12, 1998. FAS-128 requires this stock dividend be reflected in the 1997 year-end financial statements. The following tables provide a reconciliation of the income before extraordinary items and number of shares used in basic and diluted earnings per share calculations.
(q) Statement Presentation-Amounts shown in the consolidated financial statements and applicable notes are stated (except as otherwise indicated and as to share data) in millions, which amounts may not add to totals shown due to rounding. Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to the most current presentation.
Scheduled maturities of the above debt (including common stock classified as a debt equivalent see (a)below) at December 31, 1997 are as follows: 1998: $12.8; 1999: $4.4; 2000: $3.8; 2001: $.6; 2002: $.1; 2003 and after $121.1. During 1997, 1996 and 1995, $9.6, $10.8 and $23.0, respectively, of interest expense on debt was charged to consolidated operations.
- ------------ (1) Series D redeemable convertible preferred stock, substantially all of which was held by the Corporation's employee benefit plans, was adjustable proportionately as to redemption value, dividend rate, and number of shares to reflect any stock dividends or splits declared on the Corporation's common stock, and had a preference as to dividend payments and upon liquidation of the Corporation. The Series D redeemable convertible stock was converted into common shares as of August 22, 1997. (2) The Corporation has authorized up to 1,000,000 shares of Series G Convertible Preferred Stock ("Series G") for issuance pursuant to the Corporation's Stock Option Plan. Series G has been issued under two different designations; the most recent designation being Series G-2 (except as otherwise stated, Series G and Series G-2 are collectively referred to as Series G). Each share of Series G pays a floating rate dividend based on the prime rate of interest. At December 31, 1997, the annual dividend rate for Series G was $.82 per share. Each share of Series G is convertible at any time, after being held six months, into 0.95 shares of Common Stock (See 4(d)). Unless previously converted, Series G shares may be redeemed at the Corporation's sole option five years after their issuance.
(c) Debt Restrictions-Under the most restrictive covenants, the terms of Old Republic's guaranties relative to loan agreements described in Note 3(a) provide that while loans under such agreements are outstanding, Old Republic is restricted from, among other things, permitting "Debt" to exceed 25% of its consolidated tangible net worth (as adjusted for goodwill and net unrealized investment gains or losses, but including title plants and records) without approval of the lenders.
For financial reporting purposes, Old Republic records the exercise of stock options directly in its capital accounts as permitted under existing accounting pronouncements. The following table shows a comparison of net income and related per share information as reported, and on a pro-forma basis on the assumption that the estimated value of stock options was treated as compensation costs. In estimating the compensation cost of options, the fair value of options at date of grant has been calculated using a Black-Scholes options pricing model that takes the assumptions shown below into account.
A summary of stock options outstanding and exercisable at December 31, 1997 follows:
(e) Common Stock-There were 250,000,000 shares of common stock authorized at December 31, 1997. At the same date, there were 50,000,000 shares of Class "B" common stock authorized but none were issued or outstanding. Class "B" common shares have the same rights as common shares except for being entitled to 1/10th of a vote per share.
(f) Undistributed Earnings-The equity of the Corporation in the undistributed earnings, determined in accordance with generally accepted accounting principles, and in the net unrealized investment gains (losses) of its respective subsidiaries at December 31, 1997 amounted to $1,332.2 and $72.8, respectively. Cash dividends declared during 1997, 1996 and 1995, to the Corporation by its subsidiaries amounted to $199.1, $152.8 and $106.8, respectively.
(g) Treasury Stock-A total of 12,465,810 common shares issued and outstanding are held by consolidated affiliates. See "Related Party Transactions" herein.
Note 6-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 1997 is presented below. In the second quarter 1997, several life insurance subsidiaries recovered income taxes and related accumulated interest due to favorable resolutions with the Internal Revenue Service of various outstanding issues pertaining to income tax returns for the years 1979 through 1982. These cash recoveries, net of miscellaneous charges, increased other income by $12.6, reduced income tax expense by $5.9 and increased net income by $14.2 (10 cents per share).
In February 1996, the Company called for the redemption of its 10% debentures maturing in 2018 ($75.0 principal amount); in April 1996, the Company called for redemption of its 11.5% debentures maturing in 2015 ($30.0 principal amount); redemption of these debentures was effected with internally available funds. The early retirement of the Company's 10% debentures of 2018 produced a net of tax charge of $3.3 (2 cents per share) that has been reflected as an extraordinary item in the first quarter of 1996, while the retirement of the Company's 11.5% debentures of 2015 produced an additional net of tax charge of $1.1 (1 cent per share) that was reflected as an extraordinary item in the second quarter of 1996. Accordingly, the total extraordinary item reflected in the results for 1996 was $4.4 (3 cents per share).
In computing the income or loss before taxes and extraordinary item for each segment, the following items have not been added or deducted: general corporate revenues and expenses, parent company interest expense, income taxes, and equity in operating results of, or dividends from, unconsolidated subsidiaries and affiliates. To reconcile the total assets shown for the General, Mortgage Guaranty, Title and Life Groups with total consolidated assets at December 31, 1997 and 1996, adjustments must be made for the parent company assets of $2,302.1 and $2,079.6, and consolidating eliminations of $2,556.9 and $2,477.6, respectively.
- ----------- In the above tables, net premiums earned on a GAAP basis differ from statutory amounts as a result of differences in the calculations of unearned premium reserves under each accounting method. (a) Including unallocated investment income derived from invested capital and surplus funds./(b) Represents results of holding company parent, consolidation eliminating adjustments, and general corporate expenses, as applicable./ (c) Includes $12.6 of interest income from settlement of prior years' tax issues.
The Financial Accounting Standards Board (FASB) issued, in June, 1997, Statement of Financial Accounting Standards No. 131 (FAS-131) "Disclosure about Segments of an Enterprise and Related Information." FAS-131 establishes standards for the way the Company reports information about operating segments. This statement shall be effective for fiscal years beginning after December 15, 1997. The Company has not as of yet determined the effect of this statement on its definition of operating segments. FAS-131 does not impact the Company's financial position or results of its operation.
Note 8-Related Party Transactions - At December 31, 1997 and 1996, the Corporation owned 100.0% and 98.85% of the non-voting common shares, respectively, and 40% of the voting common and preferred shares of the American Business & Mercantile Insurance Group, Inc., ("AB&M Group" or "Group"), an affiliated insurance holding company engaged in the property and liability reinsurance business. American Business & Personal Insurance Mutual, Inc. ("Mutual"), a property & liability mutual insurer owned by its policyholders, held directly or through a subsidiary .04% of the Group's non-voting common shares at December 31, 1996 and 60% of the Group's voting common and preferred shares at December 31, 1997 and 1996. At December 31, 1996, 1.11% of the Group's non-voting common shares were held by public shareholders. In the fourth quarter 1997, the Corporation acquired the non-voting common shares.
Pursuant to underwriting and investment management agreements, Old Republic receives management fees for administering the affairs of the Group's reinsurance subsidiary and those of Mutual. Pursuant to reinsurance treaties, the Group and Mutual are quota share participants in various types of primary or assumed reinsurance contracts produced through Old Republic underwriting facilities. Fees received in the past three years by Old Republic were immaterial. The following table shows reinsurance cessions, retrocessions, and assumptions to or from the Group's reinsurance subsidiary and the Mutual for the last three years.
At December 31, 1997, the Corporation owned 96.9% of the voting common stock of Employers General Insurance Group, Inc. ("EGI") an affiliated insurance holding company engaged in property and liability insurance, primarily in Texas and Oklahoma. At such date, 3.1% of EGI's voting common stock was held by public shareholders.
We have audited the accompanying consolidated balance sheets of Old Republic International Corporation and subsidiaries (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of income, preferred stock and common shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.