The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto.
During the three year period from 1994 to 1996, the Company benefited from three distinct portions of its business strategy. Operations were expanded through the acquisition of title insurance agents and underwriters, expenses were tightly monitored and controlled, and claims experience improved due to quality control efforts and an improved claims environment.
Revenues - The Company's operating revenues are dependent on overall levels of real estate activity which are influenced by a number of factors including interest rates, access to capital, housing starts, housing resales, and the general state of the economy. In addition, the Company's revenues are affected by the Company's sales and marketing efforts, its acquisition program and its
strategic decisions based on the rate structure and claims environment in particular markets.
In addition to the premiums and related fees, the Company has historically earned investment income from its portfolio of fixed- maturity and equity securities. Investment income includes dividends and interest as well as realized capital gains or losses on the portfolio. The Company regularly reexamines its portfolio strategies in light of changing earnings or tax situations. In the fourth quarter of 1996 the Company shifted its investment strategy, eliminating its investment in equity securities and beginning to move all of its investment portfolio into fixed-maturity securities. The repositioning of the portfolio will eliminate the exposure of the regulated surplus of the Company's insurance subsidiaries to market fluctuations inherent in equity portfolios. Additionally, the commensurate increase in fixed-maturity securities will increase the level of more stable, predictable interest income earned.
Because the change in accounting principle to no longer discount policy and contract claims is inseparable from the change in estimate, both have been accounted for as a change in estimate. Accordingly, the net effect of the two changes, a decrease of $2 million in the provision for policy and contract claims, has been included in operations for the fourth quarter. The above changes were both made to conform with general industry practice. The changes are included in the provision for policy and contract claims and no prior amounts have been restated.
Contingencies - Refer to "Legal Proceedings" for a discussion of pending legal proceedings. Management believes that amounts, if any, recovered by plaintiffs in these actions will not have a material adverse effect on the Company's financial position or operating results.
is typically lower in the first six months than at year end because of this seasonal variance. See "Business-Seasonality; Backlog." In recent years low levels of mortgage interest rates have caused fluctuations in real estate activity levels outside of the usual, seasonal pattern. The Company cannot predict whether or when the historical seasonal pattern of real estate activity will resume.
The 1996 year benefited from a favorable economic environment. Average mortgage rates were 7.0% in January 1996 and, although fluctuating, never exceeded 8.3% for any month in 1996. The favorable economic environment led to increased levels of housing starts and housing resales in 1996 compared to 1995. Business volumes for direct and agency business improved approximately 18% from 670,000 transactions in 1995 to 790,000 in 1996.
Investment Income - Investment income increased significantly to $36.4 million in 1996 compared to $15.5 million in 1995 after increasing from $14.1 million in 1994. The increase was due principally to increased levels of capital gains which were $23.4 million in 1996, $3.0 million in 1995 and $1.7 million in 1994.
In the fourth quarter of 1996 the Company changed its investment strategy, selling all of its equity portfolio and beginning to move the proceeds into fixed-maturity securities. This sale resulted in capital gains of $17.4 million. The remaining components of investment income, dividends and interest, amounted to $14.2 million, $14.0 million and $13.2 million in 1996, 1995 and 1994, respectively.
Agents' Commissions: Commissions paid to title insurance agents are the largest single expense incurred by the Company. The commission rate varies by geographic area in which the commission was earned. Commissions as a percentage of agency revenue were 74.2%, 73.9% and 75.4% in 1996, 1995 and 1994, respectively.
General, Administrative and Other Expenses: The most significant components of other expenses are rent for office space, outside costs of title production, travel, communications and taxes levied by states on premiums. Portions of these expenses vary with the volume of business transacted by the Company.
Provision for Policy and Contract Claims: The Company's claims experience has shown improvement in recent years. As a percentage of its operating revenues, the provision for policy and contract claims was 5.2%, 5.2% and 9.6% in 1996, 1995 and 1994, respectively. As previously discussed, the Company changed its method of reporting policy and contract claims in the fourth quarter of 1996.