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, 1999 was approximately $18.3 million.
Relatively high short-term maturity investment positions are generally maintained to provide necessary liquidity for specific operating needs and to enhance flexibility in investment strategy. Changes in short-term investments reflect a large variety of seasonal and intermediate-term factors including operating cash needs and investment strategy. Accordingly, the future level of short-term investments will vary and respond to the interplay of these factors and may, as a result, increase or decrease from current levels. During 1999 and 1998, the Corporation committed substantially all investable funds in short to intermediate-term fixed maturity securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; investable funds have not been directed to so-called "junk bonds" or types of securities categorized as derivatives. Old Republic's commitment to equity securities during 1999 decreased slightly vis-a-vis the related invested balance at year-end 1998. At December 31, 1999, the Company had no bond and note investments in default as to principal and/or interest.
Consolidated net premiums and fees earned decreased by 1.6% and increased by 11.2% and 8.0% in 1999, 1998 and 1997, respectively. Property and liability earned premiums decreased 5.4% and 0.4% in 1999 and 1998, respectively, and increased 4.5% in 1997; premium production trends in this segment in the past three years were generally affected by the continuation of a soft pricing environment for most insurance coverages. Growth in mortgage guaranty premiums for the past three years was enhanced principally by a rise in the amount of renewal business, by territorial expansion, and by relatively strong mortgage lending activity nationwide. Title Group premiums and fee revenues increased 2.8% in 1999, 38.9% in 1998 and 9.4% in 1997. Greater housing and mortgage finance activity were the main reasons for the rise in revenues in these years, though in 1999 a lower volume of mortgage refinancings held down revenue growth. Life and disability premiums decreased in 1999 due to lower volume of Canadian travel accident insurance, and increased during 1998 and 1997 as a result of greater term life and accident insurance production.
The Company's investment policies have not been designed to maximize realized investment gains. Such gains were higher in 1998 than those registered in 1999 and 1997, mostly due to the sale of equity securities. Dispositions of securities were principally the result of scheduled maturities of bonds and notes and sales of equity securities. In 1999, 71.0% of total dispositions represented contractual maturities and early calls of existing holdings; for the years 1998 and 1997 these amounted to 58.3% and 76.9%, respectively.
Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 46.8% in 1999, 43.2% in 1998 and 48.4% in 1997. The general insurance portion of the claim ratio was much more adverse in 1999 and was relatively stable in 1998 and 1997; greater severity for the most recent loss occurrences was mainly responsible for the higher general insurance claim ratio in 1999. While the rise in this ratio is largely attributable to commercial automobile (truck) insurance coverages, smaller parts of Old Republic's risk transfer business also experienced increases. The loss ratio for mortgage guaranty insurance decreased in each of the last three years; the improvement was mostly attributable to the stable economic conditions of the past several years which have led to reduced mortgage defaults particularly in the California market. The title insurance loss ratio has been relatively flat in low single digits in each of the past three years due in part to more favorable trends in claims frequency and severity for business underwritten since 1992.
The ratio of consolidated underwriting, acquisition, and insurance expenses to net premiums and fees earned was approximately 52.6% in 1999, 50.2% in 1998 and 45.2% in 1997. Variations in these ratios reflect a continually changing mix of coverages underwritten and attendant costs of producing business. The property and liability segment's expense ratio increased in 1999 compared to 1998 and 1997 due in part to the previously noted premium production trends. During the past three years, the mortgage guaranty segment experienced higher operating expenses due to costs associated with contract underwriting operations and enhancement of information systems in particular. The title insurance expense ratio was approximately the same in 1999 and 1997 due in part to premium and fees growth being less than that of expenses. Consumer and regulatory litigation and disputes in Old Republic's California title insurance subsidiary added litigation costs of $16.2 and $19.5 in 1999 and 1998, respectively. Consolidated interest and other corporate charges were approximately the same in each of the last three years.
The costs of identifying, implementing and testing the required changes were not material to the Company's consolidated operating results. A significant portion of these costs were not incremental as the Company and its subsidiaries generally used existing resources.
Historical data pertaining to the operating performance, liquidity, and other financial matters applicable to an insurance enterprise such as Old Republic are not necessarily indicative of results to be achieved in succeeding years. In addition to the factors cited below, the long-term nature of the insurance business, seasonal and annual patterns in premium production and incidence of claims, changes in yields obtained on invested assets, changes in government policies and free markets affecting inflation rates and general economic conditions, and changes in legal precedents or the application of law affecting the settlement of disputed claims can have a bearing on period- to-period comparisons and future operating results.
Any forward-looking commentary or inferences contained in this report involve, of necessity, 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 as well as the risk management and pricing policies of government sponsored enterprises. 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, operating earnings or losses are generally affected by the amount of debt outstanding and its cost, as well as interest income on temporary short-term investments.
- Financial Statements Listed below are the financial statements included herein: OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES
Old Republic International Corporation and Subsidiaries Consolidated Balance Sheets ($ in Millions) (Continued)
Old Republic International Corporation and Subsidiaries Consolidated Statements of Comprehensive Income ($ in Millions)
Old Republic International Corporation and Subsidiaries Consolidated Statements of Preferred Stock and Common Shareholders' Equity ($ in Millions)
Old Republic International Corporation and Subsidiaries Consolidated Statements of Cash Flows ($ in Millions)
The amortized cost and estimated fair values of fixed maturity securities are as follows:
General insurance (property and liability) and level-term credit life insurance premiums are reflected in income on a pro-rata basis. Earned but unbilled premiums are generally taken into income on the billing date, and adjustments for retrospective premiums, commissions and similar charges are accrued on the basis of periodic evaluations of current underwriting experience and contractual obligations. First year and renewal mortgage guaranty premiums are recognized as income on a straight-line basis except that a portion of first year premiums received for certain high risk policies is deferred and reported as earned over the estimated policy life, including renewal periods. Single premiums for mortgage guaranty policies covering more than one year 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 December 31, 1999 and 1998, the Life Insurance Group had $7,896.5 and $6,740.5, respectively, of net life insurance in force. Future policy benefits and unearned premiums, consisted of the following:
- ------------ (1) In the first quarter of 1999, the Company sold its New York subsidiary and with it, its annuity book of business; this had no material effect on Old Republic's consolidated results or financial position.
All reserves are necessarily based on estimates which are periodically reviewed and evaluated in the light of emerging claim experience and changing circumstances. The resulting changes in estimates are recorded in operations of the periods during which they are made. Return and additional premiums and policyholders dividends, all of which tend to be affected by development of claims in future years, may offset, in whole or in part, developed claim redundancies or deficiencies for certain coverages such as workers' compensation.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to provide for normal claim occurrences as well as unusual exposures such as those pertaining to A&E claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves to cover claims such as those emanating from A&E exposures. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 1999, the Corporation's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to approximately $63.8 gross, and $33.3 net of reinsurance. Based on average annual claims payments during the five most recent calendar years, such reserves represented 8.9 years (gross) and 13.6 years (net) of average annual claims payments.
Individual insurance companies and others who have evaluated the potential costs of litigating and settling A&E claims have noted with increasing concern the possibility that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, could likely bankrupt or undermine seriously the financial condition of the property and liability insurance industry. In the light of this substantial public policy issue, the Corporation is of the view that the courts will not resolve in the near future the litigation gridlock stemming from the non-resolution to date of many environmental claims in particular. In recent times, the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting the determination of liability for environmental claims. As of December 31, 1999, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
(k) Goodwill-The costs of certain purchased subsidiaries in excess of related book values (goodwill) at date of acquisition are being amortized against operations principally over 40 years using the straight-line method. Amortization of goodwill amounted to $3.5 in 1999, $3.6 in 1998 and $3.2 in 1997.
The Company sponsors a leveraged Employees Savings and Stock Ownership Plan (ESSOP) in which a majority of its employees participate. The ESSOP acquired all of its stock of the Company in 1987 and prior years. Accordingly, it is not required to adopt the American Institute of Certified Public Accountants' SOP No. 93-6, "Employers' Accounting for Employee Stock Ownership Plans." Shares of Company stock owned by the ESSOP are released to participants based on a formula prescribed by the Employee Retirement Income Security Act of 1974, and dividends on released shares are allocated to participants as earnings. The Company's contributions are based on a formula considering growth in net income per share over consecutive five year periods. As of December 31, 1999, there were 7,349,384 Common Shares owned by the ESSOP of which 364,537 were unreleased and unallocated. There are no repurchase obligations in existence. (See Note 2).
- ------------ (a) The Company has guaranteed bank loans (balance at December 31, 1999 was $2.5) to a Trust established by the Old Republic Employees Savings and Stock Ownership Plan ("ESSOP"). The loans were used to fund the purchase of Series D Redeemable Convertible Preferred Stock from the Company by the Trust for the original amount of the loans. All Series D Preferred Stock shares were fully converted into Common Stock by August 22, 1997. The Trust's loan principal repayment (currently scheduled at $2.5 in 2000) is expected to be met by annual profit sharing contributions by the Corporation and its participating subsidiaries, while interest payments are to be covered by Trust income, including dividends on the Corporation's stock held by the ESSOP. The interest on the Trust's loan is payable quarterly at 80% of the prime rate. See Notes 3a and 3c.
Note 3-Shareholders' Equity - All common and preferred share data herein has been retroactively adjusted as applicable for stock dividends or splits declared through December 31, 1999.
- ------------ (1) 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. Each share of Series G pays a floating rate dividend based on the prime rate of interest. At December 31, 1999, the annual dividend rate for Series G was $.77 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 3(d)). Unless previously converted, Series G shares may be redeemed at the Corporation's sole option five years after their issuance.
(d) Stock Option Plan-The Corporation has a stock option plan for certain eligible key employees. Outstanding options at any one time may not exceed 5% of the Old Republic common stock then issued and outstanding. The exercise price of options is equal to the market price of the Corporation's stock on the date of grant; the term of each option is generally ten years from such date. Options may be exercised to the extent of 10% of the number of shares covered thereby on and after the date of grant, and cumulatively to the extent of an additional 10% on and after each of the first through ninth subsequent calendar years. In the event the market closing price of the Old Republic common stock reaches a pre-established value ("the vesting acceleration price"), however, optionees may exercise their options to the extent of 10% of the number of shares covered by the option for each year of employment by the optionee. The Corporation may extend 15 year loans at a prevailing market rate of interest for a portion of the exercise price. The option plan also enables optionees to, alternatively, exercise their options into Series "G" Convertible Preferred Stock. The exercise of options into such Preferred Stock reduces by 5% the number of equivalent common shares which would otherwise be obtained from the exercise of options into common shares.
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 cost. 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.
(e) Common Stock-There were 500,000,000 shares of common stock authorized at December 31, 1999. At the same date, there were 100,000,000 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.
The Corporation issued a total of 514,626 common shares valued at $4.6 in 1998 to effect acquisitions which were not material to Old Republic's financial position or operating results.
(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, 1999 amounted to $1,536.4 and $(9.1), respectively. Dividends declared during 1999, 1998 and 1997, to the Corporation by its subsidiaries amounted to $178.9, $158.2 and $226.6, respectively.
Most of the reinsurance ceded by the Corporation's insurance subsidiaries in the ordinary course of business is placed on a quota share or excess of loss basis. Under quota share reinsurance, the companies remit an agreed upon percentage of their premiums written to assuming companies and are reimbursed for a pro-rata share of claims and commissions incurred and for a ceding commission to cover expenses and costs for underwriting and claim services performed. Under excess of loss reinsurance agreements, the companies are generally reimbursed for losses exceeding contractually agreed-upon levels.
The following information relates to reinsurance and related data for the General Insurance, Mortgage Guaranty and Life Insurance Groups for the three years ended December 31, 1999. For the years 1997 to 1999, reinsurance transactions of the Title Insurance Group have not been material.
(c) General-In the normal course of business, the Corporation and its subsidiaries are subject to various contingent liabilities, including possible income tax assessments resulting from tax law interpretations or issues raised by taxing authorities in their regular examinations. Management does not anticipate any significant losses or costs to result from any known or existing contingencies.
In December 1999, a class action lawsuit was filed against one of the Company's mortgage guaranty insurance subsidiaries in the Federal District Court for the Southern District of Georgia. The suit alleges that the subsidiary provided pool insurance and other services to mortgage lenders at preferential, below market prices in return for mortgage insurance business, and that such practices violated the Real Estate Settlement Procedures Act. The Company denies any liability in these regards, has retained legal counsel, and intends to defend itself vigorously. Due in part to the early stages of this lawsuit, the ultimate outcome of this litigation is unknown at the present time. Accordingly, no provision for any liability, including the cost of defense, has been included in the Company's financial statements.
Note 6-Information About Segments of Business - The Corporation's business segments are organized as the General Insurance (property and liability insurance), Mortgage Guaranty, Title Insurance and Life Insurance Groups. The contributions of Old Republic's insurance industry segments to consolidated revenues and operating results, and certain balance sheet data pertaining thereto are shown in the following tables on the basis of generally accepted accounting principles ("GAAP"). Each of the Corporation's segments underwrites and services only those insurance coverages which may be written by it pursuant to state insurance regulations and corporate charter provisions.
The Corporation does not derive over 10% of its revenue from any one customer. Revenues and assets connected with foreign operations are not significant in relation to consolidated totals.
The Life Insurance Group markets and writes consumer credit life and disability insurance primarily through automobile dealers. Old Republic has also written various conventional life and disability/accident and health insurance coverages for many years, principally on a direct marketing basis through banks and other financial services institutions. Old Republic sells ordinary term life insurance through independent agents and brokers for relatively large face amounts, in both the United States and Canada.
- --------- In the above tables, net premiums earned on a GAAP basis differ slightly from statutory amounts due to certain differences in 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) 1997 includes $12.6 of interest income from settlement of prior years' tax issues./(d) In the first quarter of 1999, the Company sold its New York subsidiary and with it, its annuity book of business; this had no material effect on Old Republic's consolidated results or financial position. (see Note 1(f))
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, preferred stock and common shareholders' equity and cash flows present fairly, in all material respects, the financial position of Old Republic International Corporation and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.