The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes in this report. Forward-looking statements are based on certain assumptions and expectations of future events that are subject to a number of risks and uncertainties. Actual results may vary.
Investors Title Company (the “Company”) is a holding company that engages primarily in issuing title insurance through two subsidiaries, Investors Title Insurance Company (“ITIC”) and National Investors Title Insurance Company (“NITIC”). Total revenues from the title segment accounted for 95.3% of the Company’s revenues in 2016. Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Title insurance protects against loss or damage resulting from title defects that affect real property.
Title insurance policies for mortgage lenders and real estate owners are the two basic types of title insurance policies. A lender often requires the property owner to purchase a lender’s title insurance policy 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 its 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 covered claim is made against real property, title insurance provides indemnification against insured defects.
The Company’s exchange services division, consisting of the operations of ITEC and ITAC, provides customer services in connection with tax-deferred real property exchanges. ITEC serves as a qualified intermediary in like-kind exchanges of real or personal property under Section 1031 of the Internal Revenue Code of 1986, as amended. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction, and its duties include drafting standard exchange documents, holding the exchange funds between the sale of the old property and the purchase of the new property, and accepting the formal identification of the replacement property within the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. An exchange accommodation offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property.
In efforts to provide transparency, the Federal Open Market Committee (“FOMC”) of the Federal Reserve issues disclosures on a periodic basis that include projections of the federal funds rate and expected actions. At the December 2015 meeting, the FOMC voted to raise the federal funds rate for the first time since December 2008 to a target range between 0.25% and 0.50%. The FOMC voted at the December 2016 meeting to increase interest rates to a target range between 0.50% and 0.75%. Any future adjustments to the rate are expected to be based on realized and expected economic developments to achieve maximum employment and 2.0% inflation. The FOMC anticipates future economic conditions to evolve in ways that will warrant gradual increases, and that for some time, the federal funds rate is expected to be below long range levels.
In an effort to expand home ownership for lower-income buyers, the Federal Housing Authority (“FHA”) announced in January 2015 that it would cut its rates on mortgage insurance premiums. Mortgage insurance premium rates for 30-year FHA insured mortgages with less than a 5.0% down payment decreased from 1.35% to 0.85%. Mortgage insurance premium rates for 30-year FHA insured mortgages with more than a 5.0% down payment decreased from 1.30% to 0.80%. The new rates took effect on January 26, 2015 and will not apply to borrowers with existing mortgages, unless refinanced, or to 15-year mortgages.
On August 15, 2016, the Consumer Financial Protection Bureau (“CFPB”) proposed various amendments to federal mortgage disclosure requirements under the Real Estate Settlement Procedures Act and the Truth in Lending Act that are implemented in Regulation Z. The proposed amendments would reinforce the CFPB’s informal guidance on various issues and include clarifications and technical amendments. The CFPB also proposed changes that would create tolerances for the total of payments; adjust a partial exemption that mainly affects housing finance agencies and nonprofits; provide a uniform rule regarding application of the integrated mortgage disclosure requirements to cooperative units; and provide guidance on sharing the disclosures with various parties involved in the mortgage origination process. The comment period on the proposed rule changes closed October 18, 2016. The proposed rules, if adopted, are not expected to have a material impact on the Company.
Overall, the economy is expanding and there has been a steady reduction in unemployment in recent years. The Mortgage Bankers Association's (“MBA”) January 2017 Economic and Mortgage Finance Commentary predicts 2017 overall growth in the gross domestic product of approximately 2.1% with continued improvement in the employment rate as the economy adds approximately 150,000 jobs per month. As the economy continues to improve, higher inflation will likely ensue, leading to higher interest rates. It is projected that the FOMC will raise the federal funds rate 3 times during 2017.
According to data published by Freddie Mac, the average 30-year fixed mortgage interest rate in the United States was 3.6%, 3.8% and 4.2% for the years ended December 31, 2016, 2015 and 2014, respectively. Per the MBA Forecast, refinancing is expected to be lower in 2017 as mortgage interest rates continue to climb to a projected 4.7% in the fourth quarter of 2017.
The Company’s reserve for claims is established using estimates of 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, or “IBNR”). The total reserve for all losses incurred but unpaid as of December 31, 2016 is represented by the reserve for claims totaling $35,305,000 in the accompanying Consolidated Balance Sheets. Of that total, approximately $4,405,000 was reserved for specific claims which have been reported to the Company, and approximately $30,900,000 was reserved for IBNR claims.
Management considers factors such as the Company’s historical claims experience, case reserve estimates on reported claims, large claims, actuarial projections and other relevant factors in determining its loss provision rates and the aggregate recorded expected liability for claims. In establishing the reserve, actuarial projections are compared with recorded reserves to evaluate the adequacy of such recorded claims reserves and any necessary adjustments are then recorded in the current period’s income statement. As the most recent claims experience develops and new information becomes 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 the reserve in the results of operations in the period in which new information (principally claims experience) becomes available.
Management also considers actuarial analyses in evaluating the claims reserve. The actuarial methods used to evaluate the reserve are loss development methods, Bornhuetter-Ferguson methods and Cape Cod methods, all of which are accepted actuarial methods for estimating ultimate losses and, therefore, loss reserves. In the loss development method, each policy year’s paid or incurred losses are projected to an “ultimate” level using loss development factors. In the Bornhuetter-Ferguson method, a type of expected loss method, losses for each policy year are estimated based on an expected loss ratio derived directly from a previous estimate of ultimate loss for each policy year plus an additional provision for losses that have not been reported or paid as of the evaluation date. Bornhuetter-Ferguson methods produce more stable ultimate loss estimates than do loss development methods, which are more responsive to the current loss data but can lead to volatile results. The Cape Cod method, a special case of the Bornhuetter-Ferguson method, blends the results of the loss development and expected loss methods. For more recent policy years, the Cape Cod method gives more weight to the results of the expected loss methods; for older policy years, more weight is given to the loss development method results.
The key actuarial assumptions are principally loss development factors and expected loss ratios. The selected loss development factors are based on a combination of the Company’s historical loss experience and title industry loss experience. Expected loss ratios are estimated for each policy year based on the Company’s own experience and title industry loss ratios. When updated data is incorporated into the actuarial models, the resulting loss development factors and expected loss ratios will likely change from the prior values. Changes in these values from 2014 through 2016 have been the result of actual Company and industry experience during the calendar years.
Generally, title insurance premiums are recognized at the time of settlement of the related real estate transaction, as the earnings process is then considered complete, irrespective of the timing of the issuance of a title insurance policy or commitment. Expenses typically associated with premiums, including agent commissions, premium taxes, and the provision for future claims are recognized concurrent with recognition of related premium revenue.
Securities are regularly evaluated and reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in estimated fair value is other-than-temporary. When, in the opinion of management, a decline in the estimated fair value of an investment is considered to be other-than-temporary, such investment is written down to its estimated fair value. Some factors considered in evaluating whether or not a decline in estimated fair value is other-than-temporary include, but are not limited to:
The Company recorded net deferred tax liabilities at December 31, 2016 and 2015. The deferred tax liabilities recorded during both periods primarily relate to net unrealized gains on investments, the recorded reserve for claims, net of statutory premium reserves and the excess of tax over book depreciation. The 2016 balance also includes deferred tax liabilities related to intangible assets. See Note 8 to the Consolidated Financial Statements in this Annual Report on Form 10-K for further information on the Company’s deferred taxes.
The following table presents certain income statement data for the years ended December 31, 2016, 2015 and 2014:
Insurance and other services revenues include net premiums written plus other fee income, trust income, management services income, and exchange services income. Investment income and realized investment gains and losses are not included in insurance and other service revenues and are discussed separately under “Investment-Related Revenues” below. The following is a summary of the Company’s insurance and other services revenues with intersegment eliminations netted with each segment; therefore, the individual segment amounts will not agree to Note 12 in the accompanying Consolidated Financial Statements.
Net Premiums: Net premiums written increased 8.6% in 2016 to $122,095,381 compared with $112,475,686 in 2015, and increased 2.3% in 2015 compared with $109,963,556 in 2014. The increase in 2016 net premiums versus the prior year is primarily attributable to growth in average real estate values, coupled with growth in transaction volumes stemming from higher levels of home sales and refinance activity. The 2015 increase in net premiums versus the prior year is primarily attributable to an increase in the level of both purchase and refinance transactions.
Home and Branch Office Net Premiums: In the Company’s home and branch operations, the Company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. Net premiums written from home and branch operations increased 19.9% in 2016 to $34,063,187 compared with $28,400,531 in 2015, and increased 18.1% in 2015 compared with $24,057,032 in 2014. The increase in 2016 net premiums was primarily related to revised premium rates filed in North Carolina and higher levels of real estate activity and overall higher home prices. Real estate activity increased due to favorable interest rates and economic conditions. The increase in 2015 net premiums was primarily attributable to higher levels of real estate activity and overall higher home prices.
Agency Relationship: The Company received a significant percentage of its net premiums written from a single title agent in 2015 and 2014 that was acquired by another title insurer in 2015. Net premiums written by this agent are for title insurance policies written in Texas. For further details, refer to Note 11 to the Notes to Consolidated Financial Statements herein.
The Company derives a substantial portion of its income from investments in municipal and corporate bonds and equity securities. The Company's title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. The Company’s investment policy is designed to comply with regulatory requirements and to balance the competing objectives of asset quality and investment returns. The Company’s title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. Bonds totaling approximately $6,843,000 and $7,159,000 at December 31, 2016 and 2015, respectively, are deposited with the insurance departments of the states in which business is conducted.
Investment income was $4,684,489 in 2016 compared with $4,531,319 in 2015 and $4,259,501 in 2014. The increases in investment income year over year were primarily due to higher average portfolio balances for both fixed maturities and equity securities compared with the previous years. See Note 3 in the accompanying Consolidated Financial Statements for the major categories of investments, scheduled maturities, amortized cost, fair values of investment securities and earnings by security category.
Dispositions of equity securities at a realized gain or loss reflect such factors as industry sector allocation decisions, ongoing assessments of issuers’ business prospects and tax planning considerations. Additionally, the amounts of net realized investment gains and losses are affected by assessments of securities’ valuation for other-than-temporary impairment. As a result of the interaction of these factors and considerations, the net realized investment gain or loss can vary significantly from period to period.
The net realized gain (loss) on investments was $768,436 for 2016 compared with $(116,163) for 2015 and $268,294 for 2014. The net realized gain (loss) on investments included impairment charges of $233,941, $984,128 and $24,604, on certain investments and other assets that were deemed to be other-than-temporarily impaired in 2016, 2015 and 2014, respectively, offset by a net realized gain on the sales of investments and other assets of $1,002,377, $867,965 and $292,898 in 2016, 2015, and 2014, respectively. Management believes unrealized losses on remaining fixed income and equity securities at December 31, 2016 are temporary in nature.
The Company’s operating expenses consist primarily of commissions to agents, salaries, employee benefits and payroll taxes, office occupancy and operations and the provision for claims. Operating expenses increased 0.9% in 2016 compared with 2015 primarily due to increases in salaries, employee benefits and payroll taxes and commissions to agents, mostly offset by a decrease in the provision for claims. Operating expenses decreased 0.2% in 2015 compared with 2014 primarily due to decreases in commissions to agents and the provision for claims, partially offset by increases in salaries, employee benefits and payroll taxes and office occupancy and operations.
Office Occupancy and Operations: Office occupancy and operations expenses primarily include office rent and utilities, depreciation, maintenance, telecommunications and insurance expenses. Overall office occupancy and operations expenses were $6,265,908, $5,885,336 and $5,049,962 for 2016, 2015 and 2014, respectively. The increase in office occupancy and operations expense in 2016 compared with 2015 was primarily related to increases in maintenance and depreciation, partially offset by decreases in printing and telecommunications. The increase in office occupancy and operations expense in 2015 compared with 2014 was primarily related to increases in depreciation, maintenance and telecommunications. Office occupancy and operations expenses as a percentage of total revenues were 4.5%, 4.6% and 4.1% for 2016, 2015 and 2014, respectively.
Filing Fees, Franchise and Local Taxes: Filing fees, franchise and local tax expenses include insurance filing and licensing fees, franchise taxes, excise taxes and local taxes. Filing fees, franchise and local tax expenses were $907,225 in 2016 compared with $732,985 in 2015 and $817,909 in 2014.
Professional and Contract Labor Fees: Professional and contract labor fees were $2,115,754 in 2016 compared with $2,691,411 in 2015 and $2,676,483 in 2014. The decrease in professional and contract labor fees for 2016 was primarily attributable to a decrease in legal fees and consulting fees associated with the Company's ongoing software initiatives. Professional and contract labor fees remained virtually unchanged for 2015 compared with 2014.
Other Expenses: Other operating expenses primarily include amortization of intangible assets, miscellaneous operating expenses of the trust division and other miscellaneous expenses of the title segment. These amounts typically fluctuate with transaction volume of the title segment and the trust division. Other expenses increased to $1,099,408 in 2016, compared with $884,438 in 2015 and $820,882 in 2014. Other operating expenses increased in 2016 and 2015 primarily due to the amortization of intangible assets.
After-Tax Profit Margin: The Company’s title insurance after-tax profit margin varies according to a number of factors, including the volume and type of real estate activity. After-tax profit margins for the title insurance segment were 15.0% 10.9% and 8.5% in 2016, 2015 and 2014, respectively. The increase in after-tax profit margin in 2016 compared with 2015 is primarily related to an increase in operating revenues and, a lower provision for claims, partially offset by an increase in salaries, employee benefits and payroll expenses. The increase in after-tax profit margin in 2015 compared with 2014 is primarily related to an increase in operating revenues, lower commission expenses and a lower provision for claims, partially offset by an increase in salaries, employee benefits and payroll taxes. Also impacting both the 2016 and 2015 after-tax profit margins was a higher proportion of branch business as compared with the prior year.
The provision for income taxes was $8,616,000, $5,228,000 and $3,816,000 for the years ended December 31, 2016, 2015 and 2014, respectively. Income tax expense as a percentage of earnings before income taxes was 30.6%, 29.4% and 28.3%, for the years ended December 31, 2016, 2015 and 2014, respectively. The increases in the effective rate in 2016 and 2015 compared with their respective prior years was primarily due to a lower proportion of tax-exempt to taxable income. The effective income tax rate for 2016, 2015 and 2014 was below the U.S. federal statutory income tax rate (34%), primarily due to the effect of tax-exempt income.
The Company reported net income attributable to the Company of $19,523,118, $12,533,905 and $9,648,975, or $10.19, $6.30 and $4.74 per share on a diluted basis in 2016, 2015 and 2014, respectively. Net income attributable to the Company increased in 2016 compared to 2015 primarily due to an 8.9% increase in total revenues while operating expenses increased 0.9%. The increase in revenues was attributable to an 8.6% increase in premiums written primarily due to growth in average real estate values, revised premium rates filed in North Carolina, growth in transaction volumes stemming from higher levels of home sales and refinance activity, and an increase in net realized gain on investments. Operating expenses increased 0.9% primarily due to an 11.9% increase in payroll expenses as a result of higher levels of incentive compensation, inflationary increases in salaries and benefits, payroll expenses associated with University Title and increases in staffing levels to accommodate higher volume, and a 2.4% increase in commissions to agents, mostly offset by a 94.6% decrease in the provision for claims due to favorable claims experience in recent policy years and fewer new claims filings. Net income attributable to the Company increased in 2015 compared with 2014 primarily due to a 3.3% increase in total revenues, while operating expenses remained virtually flat. The increase in revenues was attributable to a 2.3% increase in net premiums written due to higher levels of purchase and refinance activity and a 19.5% increase in other income attributable to an increase in earnings from unconsolidated affiliates, title fees and exchange services income, partially offset by a decline in trust and investment management services. The slight decrease in operating expenses was primarily attributable to a 5.3% decrease in commissions due to a favorable mix of direct business and a 14.4% decrease in the provision for claims related to fewer new claims filings and favorable claims experience in recent years, partially offset by an 11.2% increase in payroll expenses due to inflationary increases in salaries and benefits, higher staffing level needs to support ongoing software development activities and higher levels of incentive compensation.
The Company’s operating results and cash flows are heavily dependent on the real estate market. The Company’s business has certain fixed costs such as personnel; therefore, 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 will improve its ability to manage cash resources through fluctuations in the real estate market.
The Company maintains a high degree of liquidity within its investment portfolio, classified as available for sale, in the form of cash, short-term investments, and other readily marketable securities. As of December 31, 2016, the Company held cash and cash equivalents of $27,928,472, short-term investments of $6,558,840, fixed maturity securities of $101,934,077 and equity securities of $41,179,259. The net effect of all activities on total cash and cash equivalents was an increase of $6,138,404 for 2016, an increase of $5,963,553 for 2015, and a decrease of 7,800,246 for 2014.
As of December 31, 2016, approximately $88,323,000 of the consolidated stockholders’ equity represented net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior approval from the respective state insurance department. These regulations require prior regulatory approval of the payment of dividends and other intercompany transfers. The Company believes, however, that amounts available for transfer from the insurance and other subsidiaries are adequate to meet the Company’s current operating needs.
During 2017, the maximum distributions the insurance subsidiaries can make to the Company without prior approval from applicable regulators total approximately $18,234,000.
The Company bases its capitalization levels in part on net coverage retained. Since the Company's geographical focus has been and continues to be concentrated in states with average premium rates that are typically lower than the national average, capitalization relative to premiums will usually appear higher than industry averages.
Purchase of Company Stock: On November 9, 2015, the Board of Directors of the Company approved the purchase of an additional 163,335 shares pursuant to the Company’s repurchase 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 this approval. Unless terminated earlier by resolution of the Board of Directors, the plan will expire when all shares authorized for purchase under the plan have been purchased. Pursuant to the Company’s ongoing purchase program, the Company has purchased 66,803 shares in the twelve months ended December 31, 2016, 75,665 shares in the twelve months ended December 31, 2015, and 15,372 shares in the twelve months ended December 31, 2014 at an average per share price of $93.10, $72.48 and $68.68, respectively. The Company anticipates making further purchases under this plan from time to time in the future, depending on such factors as the prevailing market price of the Company’s common stock, the Company’s available cash and then existing alternative uses for such cash.
Capital Expenditures: Capital expenditures were approximately $2,457,000, $2,743,000 and $2,017,000 during 2016, 2015 and 2014, respectively. The Company has plans for various capital improvement projects, including increased investment in a number of technology and system development initiatives and hardware purchases which are anticipated to be funded via cash flows from operations. All material anticipated capital expenditures are subject to periodic review and revision and may vary depending on a number of factors.
In addition, in administering tax-deferred property exchanges, ITEC serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. ITAC serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property held by the Company for the purpose of completing such transactions totaled approximately $202,184,000 and $171,010,000 as of December 31, 2016 and 2015, respectively. These exchange deposits are held at third-party financial institutions. These amounts are not considered assets of the Company for accounting purposes and, therefore, are excluded from the accompanying Consolidated Balance Sheets. Exchange services revenues include earnings on these deposits; therefore, investment income is shown as exchange services revenue, rather than investment income. The Company remains contingently liable to customers for the transfers of property, disbursements of proceeds, and the return on the proceeds at the agreed upon rate.
External assets under management by the Investors Trust Company totaled approximately $440,000,000 for the years ended December 31, 2016 and 2015. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets.
The following table summarizes the Company’s future estimated cash payments under existing contractual obligations at December 31, 2016, including, payments due by period:
As of December 31, 2016, the Company had a claims reserve totaling $35,305,000. The amounts and timing of these obligations are estimated and not set contractually. Nonetheless, based on historical insurance claims experience, the Company anticipates the payments shown in the Contractual Obligations table. Events such as fraud, defalcation, and multiple property title defects can substantially and unexpectedly cause increases in both the amount and timing of estimated title insurance loss payments and loss cost trends whereby increases or decreases in inflationary factors (including the value of real estate) will influence the ultimate amount of title insurance loss payments and could increase total obligations and influence claim payout patterns. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, claim estimates are subject to variability and future payments could increase or decrease from these estimated amounts in the future.
Because of its inherent limitation, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
We have audited Investors Title Company’s (the Company) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded University Title Company (University) from its assessment of internal control over financial reporting as of December 31, 2016 because it was acquired by the Company in October 2016. We have also excluded University from the scope of our audit of internal control over financial reporting. University was acquired by National Investors Holdings, LLC, a wholly-owned subsidiary of the Company. University constituted 0.9% of consolidated revenue for the year ended December 31, 2016 and 6.0% of consolidated total assets as of December 31, 2016.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of December 31, 2016, and 2015, and for each of the years in the three-year period ended December 31, 2016, and our report dated March 10, 2017, expressed an unqualified opinion on those consolidated financial statements.
Other investments consist primarily of investments in title insurance agencies structured as limited liability companies (“LLCs”), which are accounted for under the equity or cost methods of accounting. The aggregate cost of the Company’s cost method investments totaled $4,744,402 and $3,572,914 at December 31, 2016 and 2015, respectively. The Company monitors any events or changes in circumstances that may have had a significant adverse effect on the fair value of these investments and makes any necessary adjustments.
Claims and losses paid are charged to the reserve for claims. Although claims losses are typically paid in cash, occasionally claims are settled by purchasing the interest of the insured or the claimant in the real property. When this event occurs, the acquiring company carries assets at the lower of cost or estimated realizable value, net of any indebtedness on the property.
The Company’s accumulated other comprehensive income is comprised of unrealized holding gains/losses on available-for-sale securities, net of tax, and unrecognized prior service cost and unrealized gains/losses associated with postretirement benefit liabilities, net of tax. Accumulated other comprehensive income as of December 31, 2016 consists of $11,870,647 of unrealized holding gains on available-for-sale securities and $109,200 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2015 consists of $11,597,741 of unrealized holding gains on available-for-sale securities and $114,726 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities. Accumulated other comprehensive income as of December 31, 2014 consists of $12,934,497 of unrealized holding gains on available-for-sale securities and $77,988 of unrecognized prior service cost and unrecognized actuarial losses associated with postretirement benefit liabilities.
The Company’s other intangible assets consist of non-compete agreements, referral relationships and a tradename resulting from agency acquisitions; all of which are recorded at the acquisition date fair value. The fair value of the Company’s other intangible assets is principally based on values obtained from a third party valuation service. These assets are amortized on a straight-line basis over their useful lives, which range from 1 to 30 years; noting that the amortization of certain non-compete contracts will start at a future date when the related employment agreements are terminated. Other intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable and at least annually.
In June 2016, the FASB issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326). ASU 2016-13 is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The update broadens the information that an entity must consider in developing its expected credit loss estimates, and is meant to better reflect an entity’s current estimate of all expected credit losses. In addition, this update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The update is effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that the recently issued accounting standard will have on the Company's financial position and results of operations, but does not expect it to have a material impact.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. ASU 2015-02 updated guidance to change the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments: modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities; eliminate the presumption that a general partner should consolidate a limited partnership; affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and provide a scope exception from consolidation guidance for reporting entities that are required to comply with or operate in accordance with certain requirements similar to those for registered money market funds. For public entities, this update was effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. The Company adopted this update on January 1, 2016 with no impact to the Company's financial position or results of operations. Certain investments previously considered voting interest entities are considered VIEs under this update. However, since the Company is not considered the primary beneficiary, none of the investments are consolidated. Refer to Note 3 for additional disclosure.
Management considers factors such as the Company’s historical claims experience, case reserve estimates on reported claims, large claims, actuarial projections and other relevant factors in determining loss provision rates and the aggregate recorded expected liability for claims. In establishing the reserve, actuarial projections are compared with recorded reserves to evaluate the adequacy of such recorded claims reserves and any necessary adjustments are then recorded in current operations. As the most recent claims experience develops and new information becomes 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 the reserve in the results of operations in the period in which new information (principally claims experience) becomes available.
Premiums written - Premium revenues from certain agency operations include accruals for transactions which have settled but have not been reported as of the balance sheet date. These accruals are based on estimates of the typical lag time between settlement of real estate transactions and the agent’s reporting of these transactions to the Company. Reporting lag times vary by market. In certain markets, the lag time may be very short, but in others, can be as high as 100 days. The Company reviews and adjusts lag time estimates periodically, using historical experience and other factors, and reflects any adjustments in the result of operations in the period in which new information becomes available.
Impairments - Securities are regularly evaluated and reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in estimated fair value is other-than-temporary. When, in the opinion of management, a decline in the estimated fair value of an investment is considered to be other-than-temporary, such investment is written down to its estimated fair value. Some factors considered in evaluating whether or not a decline in estimated fair value is other-than-temporary include the duration and extent to which the estimated fair value has been less than cost; the probability that the Company will be unable to collect all amounts due under the contractual terms of the security; with respect to equity securities, whether the Company’s ability and intent to retain the investment for a period of time is sufficient to allow for a recovery in value; with respect to fixed maturity securities, whether the Company has the intent to sell or will more likely than not be required to sell a particular security before recovery in value; and the financial condition and prospects of the issuer (including credit ratings). These factors are reviewed quarterly and any material degradation in the prospect for recovery will be considered in the other-than-temporary impairment 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 estimated fair values of the majority of the Company’s investments are based on quoted market prices from independent pricing services.
Combined capital and surplus on a statutory basis was $152,700,227 and $133,363,375 as of December 31, 2016 and 2015, respectively. Net income on a statutory basis was $17,863,815, $13,621,174 and $9,737,634 for the twelve months ended December 31, 2016, 2015 and 2014, respectively.
The scheduled maturities of fixed maturity securities at December 31, 2016 were as follows:
The Company holds investments in VIEs that are not consolidated in the Company's financial statements as the Company is not the primary beneficiary. These entities are considered VIEs as the equity investors at risk, including the Company, do not have the power over the activities that most significantly impact the economic performance of the entities; this power resides with a third-party general partner or managing member that cannot be removed except for cause. The following table sets forth details about the Company's variable interest investments in VIEs, which are structured either as limited partnerships ("LPs") or limited liability companies ("LLCs"), as of December 31, 2016:
Maximum potential loss is calculated as the total investment in the LLC or LP including any capital commitments that may have not yet been called. The Company is not exposed to any loss beyond the total commitment of its investment.
Some of the inputs to ARS valuation are unobservable in the market and are significant; therefore, the Company utilized another third party pricing service to assist in the determination of the estimated fair market value of these securities. This service used a proprietary valuation model that considered factors such as the following: the financial standing of the issuer; reported prices and the extent of public trading in similar financial instruments of the issuer or comparable companies; the ability of the issuer to obtain required financing; changes in the economic conditions affecting the issuer; pricing by other dealers in similar securities; time to maturity; and interest rates. The pricing service provided a range of values to the Company for its ARS. The Company recorded the estimated fair value based on the midpoint of the range and believes that this valuation is the most reasonable estimate of fair value. In 2015, the difference in the low and high values of the ranges was approximately one to four percent of the carrying value of the Company’s ARS.
The following table presents, by level, the financial assets carried at estimated fair value measured on a recurring basis as of December 31, 2016 and 2015. The table does not include cash on hand and also does not include assets that are measured at historical cost or any basis other than fair value. Level 3 assets are comprised solely of ARS.
The following table presents a reconciliation of the Company’s assets measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3), which are all ARS securities, for the twelve months ended December 31, 2016 and 2015:
Certain cost-basis investments are measured at estimated fair value on a non-recurring basis, such as investments that are determined to be other-than temporarily impaired during the period and recorded at estimated fair value in the Consolidated Financial Statements as of December 31, 2016 and 2015. The following table summarizes the corresponding estimated fair value hierarchy of such investments at December 31, 2016 and 2015 and the related impairments recognized:
The Company does not recognize claim recoveries until an actual payment has been received by the Company. The Company realized claim recoveries of approximately $1,040,000, $467,000 and $790,000 during 2016, 2015 and 2014, respectively.
Basic earnings per common share is computed by dividing net income attributable to the Company by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive potential common stock, comprised of shares issuable under the Company’s share-based compensation plans and the weighted average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money share-based awards, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, when share-based awards are exercised, (a) the exercise price of a share-based award; (b) the amount of compensation cost, if any, for future services that the Company has not yet recognized; and (c) the amount of estimated tax benefits that would be recorded in retained earnings, if any, are assumed to be used to repurchase shares in the current period.
There were no potential shares excluded from the computation of diluted earnings per share in 2016, 2015 and 2014.
The Company has adopted employee stock award plans under which restricted stock, and options or stock appreciation rights
("SARs") 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. There is currently one active plan from which the Company may grant share-based awards. The awards
eligible to be granted under the active plan are limited to SARs, and the maximum aggregate number of shares of common stock of the
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, 2016. The intrinsic values of options exercised during 2016, 2015 and 2014 were approximately $117,000, $104,000 and $82,000, respectively.
There were no options outstanding at December 31, 2016. The following tables summarize information about SARs outstanding at December 31, 2016:
The components of income tax expense for the years ended December 31 are summarized as follows:
In accounting for uncertainty in income taxes, the Company is required to recognize in its financial statements the impact of a tax position if that position is more likely than not of being sustained on an audit, based on the technical merits of the position. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. There were no unrecognized tax benefits or liabilities as of December 31, 2016.
The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal or state and local examinations by taxing authorities for years before 2013.
The Company leases certain office facilities and equipment under operating leases. Rental expense also includes occasional rental of automobiles. Rent expense totaled approximately $896,000, $793,000, and $766,000 in 2016, 2015 and 2014, respectively. The future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2016, are summarized as follows:
In November 2003, ITIC, a wholly owned subsidiary of the Company, entered into employment agreements with the Chief Executive Officer, Chief Financial Officer and Chief Operating Officer of ITIC. These individuals also serve as the Chairman, 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 employment agreements also prohibit each of these executives from competing with ITIC and its parent, subsidiaries and affiliates in North Carolina while employed by ITIC and for a period of two years following termination of their employment.
On November 17, 2003, ITIC entered into employment agreements with key executives that provide for the continuation of certain employee benefits upon retirement. The executive employee benefits include health insurance, dental insurance, vision insurance and life insurance. The benefits are unfunded. Estimated future benefit payouts expected to be paid for each of the next five years are $13,521 in 2017, $18,628 in 2018, $20,330 in 2019, $22,150 in 2020, $23,981 in 2021 and $216,988 in the next five years thereafter.
Development of the accumulated postretirement benefit obligation for the years ended December 31, 2016 and 2015 includes the following:
The amounts currently in accumulated other comprehensive income, pre-tax, that will be reclassified to the Consolidated Statements of Income and recognized as components of net periodic benefit costs in 2017 are:
Assumed health care cost trend rates do have an effect on the amounts reported for the postretirement benefit obligations. The following illustrates the effects on the net periodic postretirement benefit cost (“NPPBC”) and the accumulated postretirement benefit obligation (“APBO”) of a one percentage point increase and one percentage point decrease in the assumed health care cost trend rate as of December 31, 2016:
Escrow and Trust Deposits. 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 $18,032,000 and $20,510,000 as of December 31, 2016 and 2015, 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.
Like-Kind Exchange Proceeds. In administering tax-deferred property exchanges, the Company’s subsidiary, Investors Title Exchange Corporation (“ITEC”), serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. Another Company subsidiary, Investors Title Accommodation Corporation (“ITAC”), serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property totaled approximately $202,184,000 and $171,010,000 as of December 31, 2016 and 2015, 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 the transfers of property, disbursements of proceeds and the return on the proceeds at the agreed upon rate. Exchange services revenues include earnings on these deposits; therefore, investment income is shown as other revenue rather than investment income. These like-kind exchange funds are primarily invested in money market and other short-term investments.
Provided below is selected financial information about the Company’s operations by segment for the periods ended December 31, 2016, 2015 and 2014:
In connection with the Plan, the Company’s Board of Directors declared a dividend distribution of one right (a “Right”) for each outstanding share of the Company’s common stock paid on December 16, 2002, to shareholders of record at the close of business on December 2, 2002. Each Right entitles the registered holder to purchase from the Company a unit (a “Unit”) consisting of one one-hundredth of a share of Class A Preferred Stock. Under the Plan, the Rights detach and become exercisable upon the earlier of (a) ten (10) days following public announcement that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of the Company’s common stock, or (b) ten (10) business days following the commencement of, or first public announcement of the intent of a person or group to commence, a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of such outstanding shares of the Company’s common stock. The exercise price, the kind and the number of shares covered by each right are subject to adjustment upon the occurrence of certain events described in the Plan.
On October 31, 2012, the Plan was amended to, among other things, extend the expiration date of the plan from November 11, 2012 to October 31, 2022 and increase the exercise price of the stock purchase rights from $80 per unit to $220 per unit. In connection with the amendments to the shareholders’ rights plan, the Board of Directors of the Company also amended the Company’s Articles of Incorporation to increase the number of shares designated under the rights plan as Series A Participating Preferred Stock from 100,000 shares to 200,000 shares. There were 1,000,000 shares of Preferred Stock authorized as of December 31, 2016 and 2015, with 200,000, being designated Class A Junior Participating Preferred Stock.
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 (“FDIC”). Of the $27.9 million in cash and cash equivalents at December 31, 2016, $27.1 million was not insured by the FDIC. Of the $21.8 million in cash and cash equivalents at December 31, 2015, $21.3 million was not insured by the FDIC. The Company mitigates the risk of having cash and cash equivalents not insured by the FDIC by monitoring the credit quality of the financial institutions in which the funds are held.
The Company recognized the required identifiable intangible assets of University and United. The fair values of intangible assets, all Level 3 inputs, are principally based on values obtained from a third party valuation service. In accordance with ASC 350, Intangibles - Goodwill and Other, management determined that no events or changes in circumstances occurred that would indicate the carrying amounts may not be recoverable, and therefore determined that no identifiable intangible assets were impaired at December 31, 2016.
The Company recognized $4,349,851 in goodwill and $690,000 in a title plant as the result of the University acquisition. The fair values of goodwill and the title plant, both Level 3 inputs, are principally based on values obtained from a third party valuation service. In accordance with ASC 350, Intangibles - Goodwill and Other, management determined that no events or changes in circumstances occurred that would indicate the carrying amounts may not be recoverable, and therefore determined that goodwill and the title plant were not impaired at December 31, 2016.
The following tables provide significant amounts reclassified out of each component of accumulated other comprehensive income for the periods ended December 31, 2016, 2015 and 2014: