One of our subsidiaries in the title insurance and services segment leases an aggregate of approximately 127,000 square feet of office space in three buildings of the International Technology Park in Bangalore, India pursuant to various lease agreements. All of the space is leased pursuant to agreements that expire in 2017.
The selected historical consolidated financial data for First American Financial Corporation (the “Company”) as of and for the five-year period ended December 31, 2014, have been derived from the Company’s consolidated financial statements. The selected historical consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, “Item 1 - Business,” and “
The Company’s management uses the IBNR point estimate from the in-house actuary’s analysis and other relevant information it may have concerning claims to determine what it considers to be the best estimate of the total amount required for the IBNR reserve.
The provision transferred from IBNR title claims related to current year increased by $12.2 million in 2014 from 2013 and decreased by $0.9 million in 2013 from 2012 and payments, net of recoveries, related to current year increased by $6.9 million in 2014 from 2013 and decreased by $0.7 million in 2013 from 2012, reflecting variability in claims volumes characteristic of a policy year during its first year of development. In addition, 2014 experienced a higher level of fraud losses when compared to 2013 and 2012.
The provision transferred from IBNR title claims related to prior years decreased by $5.9 million and payments, net of recoveries, related to prior years decreased by $30.8 million in 2014 from 2013. The 11.0% decline in payments exceeded the 2.1% decline in provision transferred primarily due to the timing of a large commercial claim settlement payment. The provision for the large commercial claim was transferred from IBNR during 2014, while the settlement payment occurred in 2015.
The provision transferred from IBNR title claims related to prior years increased by $47.1 million and payments, net of recoveries, related to prior years increased by $11.5 million in 2013 from 2012. These increases were primarily attributable to increased domestic lenders claims for policy years 2004 through 2008 and, to a lesser extent, large commercial claims above expected levels, mainly from mechanics liens. The increase in domestic lenders claims was primarily due to mortgage lenders and servicers processing a large volume of foreclosures during 2013. As foreclosure processing increases, lenders claims generally increase, because lenders claims typically come from foreclosures in which the lender suffers a loss.
The provision related to current year decreased by $5.3 million, or 2.7%, in 2014 from 2013. This decrease was attributable to a 7.6% decline in title premiums and escrow fees in 2014 from 2013, partly offset by a higher current year loss rate in 2014 when compared to 2013. The current year loss rate in 2014 was 5.3% compared to 5.0% in 2013.
Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign bonds, governmental agency bonds, governmental agency mortgage-backed securities and corporate debt securities
include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. The fair value of non-agency mortgage-backed securities was obtained from the independent pricing services referenced above and subject to the Company’s validation procedures discussed above. However, since these securities were not actively traded and there were fewer observable inputs available requiring the pricing services to use more judgment in determining the fair value of the securities, they were classified as Level 3.
The table below summarizes the primary assumptions used at December 31, 2014 in estimating the cash flows expected to be collected for these securities.
Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows, useful lives, and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.
Impairment assessment for goodwill. The Company is required to perform an annual goodwill impairment assessment for each reporting unit. The Company’s four reporting units are title insurance, home warranty, property and casualty insurance and trust and other services. The Company has elected to perform this annual assessment in the fourth quarter of each fiscal year or sooner if circumstances indicate possible impairment. Based on current guidance, the Company has the option to perform a qualitative assessment to determine if the fair value is more likely than not (i.e. a likelihood of greater than 50%) less than the carrying amount as a basis for determining whether it is necessary to perform a quantitative impairment test, or may choose to forego the qualitative assessment and perform the quantitative impairment test. The qualitative factors considered in this assessment may include macroeconomic conditions, industry and market considerations, overall financial performance as well as other relevant events and circumstances as determined by the Company. The Company evaluates the weight of each factor to determine whether it is more likely than not that impairment may exist. If the results of the qualitative assessment indicate the more likely than not threshold was not met, the Company may choose not to perform the quantitative impairment test. If, however, the more likely than not threshold is met, the Company performs the quantitative test as required and discussed below.
The Company elected to perform qualitative assessments for 2014 and 2013, the results of which supported the conclusion that the fair values of the Company’s reporting units were not more likely than not less than their carrying amounts and, therefore, a quantitative assessment was not considered necessary. For 2012, the Company performed a quantitative assessment and determined that the fair values of its reporting units exceeded their carrying amounts and, therefore, no additional analysis was required. As a result of these assessments, the Company did not record any goodwill impairment losses for 2014, 2013 or 2012.
debt securities that match the expected timing of the benefit obligation payments. Assumptions for the expected long-term rate of return on assets of the defined benefit pension plans are based on future expectations for returns for each asset class based on the calculated market-related value of plan assets and the effect of periodic target asset allocation rebalancing, adjusted for the payment of reasonable expenses of the plan from plan assets. See Note 14 Employee Benefit Plans to the consolidated financial statements for a further description of the expected long-term rate of return on plan assets as well as asset allocation targets. Additionally, the Company adopted updated mortality tables published by the Society of Actuaries in October 2014. The revised RP-2014 tables reflect substantial life expectancy improvements relative to the last tables published in 2000.
In April 2014, the FASB issued updated guidance which changes the criteria for determining which disposals are required to be presented as discontinued operations and modifies related disclosure requirements. The updated guidance is
According to the Mortgage Bankers Association’s January 20, 2015 Mortgage Finance Forecast (the “MBA Forecast”), residential mortgage originations in the United States (based on the total dollar value of the transactions) decreased 39.2% in 2014 when compared with 2013. According to the MBA Forecast, the dollar amount of purchase originations decreased 13.1% and refinance originations decreased 56.4%. The lower volume of domestic residential mortgage origination activity in 2014 contributed to a 1.8% decrease in domestic residential purchase orders closed per day and a 45.2% decrease in domestic refinance orders closed per day by the Company’s direct title operations in 2014 when compared to 2013.
The Consumer Financial Protection Bureau (“CFPB”) has broad authority to regulate, among other areas, the mortgage and real estate markets in matters pertaining to consumers. In addition to other activities, the CFPB has proposed and implemented regulations related to the simplification of mortgage disclosures and the required delivery of documentation to consumers in connection with the closing of federally-regulated mortgage loans. Compliance with these integrated disclosure rules will require participants in the mortgage market, including the Company, to make significant changes to the manner in which they create, process, and deliver certain disclosures to consumers in connection with mortgage loan applications made on or after August 1, 2015. These changes could lead to lower mortgage volumes and/or delays in mortgage processing, particularly in the early stages of implementation. Readiness for, and compliance with, these rules, also requires extensive planning; changes to systems, forms and processes; as well as heightened coordination among market participants, including by settlement service providers, such as the Company and its agents, with lenders and others. While there can be no assurance that the Company, its agents or other market participants will be successful in their implementation efforts, the Company is actively preparing for compliance.
Agent premiums decreased 9.9% in 2014 from 2013 and increased 19.6% in 2013 from 2012. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums typically reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The decrease in agent premiums in 2014 from 2013 was consistent with the 10.3% decrease in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2014 as compared with the twelve months ended September 30, 2013. The increase in agent premiums in 2013 from 2012 was consistent with the 19.7% increase in the Company’s direct premiums and escrow fees in the twelve months ended September 30, 2013 as compared with the twelve months ended September 30, 2012.
Net investment income decreased 22.0% in 2014 from 2013 and increased 7.4% in 2013 from 2012. The decrease in 2014 from 2013 was primarily attributable to higher impairment losses and lower equity in earnings related to investments accounted for using the equity method, partially offset by higher interest income from the investment portfolio. The increase in 2013 from 2012 was primarily attributable to increased dividend and interest income from the investment portfolio due to higher average volumes of equity and debt securities and investments in equity funds with higher dividend yields when comparing 2013 to 2012. Net investment income for 2014, 2013 and 2012 included impairment losses recognized on investments accounted for using the equity method of $22.5 million, $5.8 million and $5.9 million, respectively.
Other-than-temporary impairment losses for the title insurance and services segment totaled $1.7 million and $3.6 million for 2014 and 2012, respectively. No other-than-temporary impairment losses were recognized in 2013. The net other-than-temporary impairment losses recognized in 2014 and 2012 related to the Company’s non-agency mortgage-backed securities portfolio.
Personnel costs decreased $24.3 million, or 1.8%, in 2014 from 2013 and increased $105.2 million, or 8.5%, in 2013 from 2012. Excluding the $37.0 million impact of new acquisitions for the year ended December 31, 2014, personnel costs decreased $61.3 million, or 4.6%, in 2014 compared to 2013. The decrease in 2014, adjusted for the impact of new acquisitions, was primarily attributable to lower salary, payroll tax, employee benefit, overtime, and severance costs. The lower salary and payroll tax costs were attributable to reduced headcount when compared to the prior year. The lower employee benefit costs were due to changes in the Company’s medical and dental insurance plans, lower incurred medical claims and lower headcount when compared to the prior year. The lower overtime costs were due to lower order volumes and revenues when compared to the prior year. The lower severance costs were due to a lower level of employee reductions made during 2014 when compared to 2013. The increase in 2013 compared with 2012 was primarily attributable to higher staffing levels and incentive compensation driven by increased revenues when compared to the prior year. Personnel costs included severance expense of $8.9 million, $17.5 million and $5.5 million for 2014, 2013 and 2012, respectively.
Other operating expenses (principally related to direct operations) decreased $55.3 million, or 6.8%, in 2014 from 2013 and increased $47.4 million, or 6.2%, in 2013 from 2012. Excluding the $29.9 million impact of new acquisitions for the year ended December 31, 2014, other operating expenses decreased $85.1 million, or 10.4%, in 2014 compared to 2013. The decrease in 2014 from 2013, adjusted for the impact of new acquisitions, was primarily attributable to lower production related expenses and temporary labor costs driven by lower order volumes. The increase in 2013 from 2012 was primarily attributable to increased production related expenses and higher legal and software related costs.
The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 7.0%, 8.8% and 6.9% for the years ended December 31, 2014, 2013 and 2012, respectively.
The current year rate of 7.0% reflects an ultimate loss rate of 5.3% for the current policy year and a net increase in the loss reserve estimates for prior policy years of $62.2 million. The increase in loss reserve estimates for prior policy years reflected claims development above expected levels during 2014, primarily from domestic commercial policies. The reserve strengthening associated with domestic commercial policies was $41.4 million and was primarily attributable to several large commercial claims, net of anticipated recoveries, mainly from mechanics liens, and primarily related to policy years 2003, 2005 and 2007. Other factors, including a large international commercial claim from policy year 2004, also contributed to the net increase in the loss reserve estimates for prior policy years.
Nevertheless, the current environment continues to create an increased potential for actual claims experience to vary significantly from projections, in either direction, which would directly affect the claims provision. If actual claims vary significantly from expected, reserves may be adjusted to reflect updated estimates of future claims.
The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 53.3% in 2014, 57.5% in 2013 and 55.8% in 2012. The decrease in rate in 2014 from 2013 was primarily attributable to lower severity and lower frequency of claims due to milder weather conditions during the second and third quarters of 2014 when compared to the respective quarters of 2013. The rate in 2014 also benefited from an improvement in claims management in 2014 when compared to 2013. The increase in rate in 2013 from 2012 was primarily attributable to higher weather related claims in the summer season as compared to the previous year, which resulted in an increase in more costly air conditioning claims when compared to 2012. In addition, the frequency and severity of other types of claims increased in 2013 when compared to 2012.
The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 60.1% in 2014, 55.4% in 2013 and 51.1% in 2012. The increase in rate in 2014 from 2013 was primarily attributable to higher claims severity and frequency. 2014 was impacted by the severe winter weather experienced in the first quarter and the California wildfires that occurred during the second quarter. The increase in rate in 2013 from 2012 was due to an increase in seasonal fire and storm claim events and an increase in the frequency and severity of routine or non-event core losses.
Premium taxes as a percentage of specialty insurance segment premiums were 1.7% in 2014, 2013 and 2012.
A large part of the revenues for the specialty insurance businesses are generated by renewals and are not dependent on the level of real estate activity in the year of renewal. With the exception of loss expense, the majority of the expenses for this segment are variable in nature and therefore generally fluctuate consistent with revenue fluctuations. Accordingly, profit
margins for this segment (before loss expense) are relatively constant, although as a result of some fixed expenses, profit margins (before loss expense) should nominally improve as premium revenues increase. Pre-tax margins were 14.4%, 12.4% and 15.1% for 2014, 2013 and 2012, respectively.
Net investment income totaled $5.5 million, $8.6 million and $4.1 million in 2014, 2013, and 2012, respectively. The change in net investment income for all three years is primarily attributable to fluctuations in earnings on investments associated with the Company’s deferred compensation plan. Net investment income for 2013 and 2012 included impairment losses recognized on investments accounted for using the equity method of $2.0 million and $1.2 million, respectively.
Corporate personnel costs and other operating expenses were $61.1 million, $76.2 million and $70.7 million in 2014, 2013 and 2012, respectively. The decrease for 2014 was primarily attributable to decreased costs associated with the Company’s defined benefit pension, supplemental benefit and deferred compensation plans. The increase for 2013 was attributable to increased costs associated with the Company’s deferred compensation plan and, to a lesser extent, increased expenses allocated to the corporate division. The Company expects to incur additional expenses of approximately $9 million in 2015 related to its defined benefit pension and supplemental benefit plans when compared to 2014. The expected increase in 2015 is primarily the result of a significant decline in interest rates at December 31, 2014 when compared to December 31, 2013, and to a lesser extent, the Company’s adoption of the updated mortality tables published by the Society of Actuaries in October 2014 which reflect substantial improvements to life expectancy.
Eliminations primarily represent interest income and related interest expense associated with intercompany notes between the Company’s segments, which are eliminated in the consolidated financial statements. The Company’s inter-segment eliminations were not material for the years ended December 31, 2014, 2013 and 2012.
The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. In March 2014, the Company’s board of directors approved an increase in the Company’s second quarter cash dividend to 24 cents per common share, representing a 100% increase from the prior level of 12 cents per common share. In January 2015, the Company’s board of directors approved a first quarter cash dividend of 25 cents per common share. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.
The Company completed acquisitions in 2014 for an aggregate purchase price of $162.5 million, which were partially funded through borrowings under the Company’s credit facility.
Holding company. First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other potential factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As of December 31, 2014, under such regulations, the maximum amount of dividends, loans and advances available to the holding company from its insurance subsidiaries in 2015, without prior approval from applicable regulators, was $570.0 million. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.
The Company’s principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), which was previously domiciled in the state of California, redomesticated to Nebraska effective July 1, 2014. While the redomestication did impact FATICO’s total statutory capital and surplus, statutory net income and the maximum amount of dividends
FATICO can pay to the holding company due to differences in prescribed accounting practices and other regulations between the two states, the impact of the redomestication was not material to the liquidity or capital resources of the holding company.
Notes and contracts payable as a percentage of total capitalization was 18.6% and 11.2% at December 31, 2014 and 2013, respectively. The increase in 2014 primarily reflected the Company’s issuance of the senior unsecured notes during the fourth quarter of 2014. Notes and contracts payable are further described in Note 10 Notes and Contracts Payable to the consolidated financial statements.
Investment portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of December 31, 2014, 90% of the Company’s investment portfolio consisted of fixed
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $6.3 billion and $4.7 billion at December 31, 2014 and 2013, respectively, of which $2.2 billion and $1.6 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt and equity securities, with offsetting liabilities included in deposits in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.
The Company facilitates tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code and tax-deferred reverse exchanges pursuant to Revenue Procedure 2000-37. As a facilitator and intermediary, the Company holds the proceeds from sales transactions and takes temporary title to property identified by the customer to be acquired with such proceeds. Upon the completion of each such exchange, the identified property is transferred to the customer or, if the exchange does not take place, an amount equal to the sales proceeds or, in the case of a reverse exchange, title to the property held by the Company is transferred to the customer. Like-kind exchange funds held by the Company totaled $2.4 billion and $1.4 billion at December 31, 2014 and 2013, respectively. The like-kind exchange deposits are held at third-party financial institutions and, due to the structure utilized to facilitate these transactions, the proceeds and property are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by the Federal Deposit Insurance Corporation. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the return on the proceeds.
Accounts and accrued income receivable, less allowances of $34,662 and $31,831
Changes in assets and liabilities excluding effects of acquisitions and noncash transactions:
The Company’s title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar or related products and services internationally. This segment also provides closing and/or escrow services; accommodates tax-deferred exchanges of real estate; provides products, services and solutions involving the use of real property related data designed to mitigate risk or otherwise facilitate real estate transactions; maintains, manages and provides access to title plant records and images; and provides banking, trust and investment advisory services. The Company, through its principal title insurance subsidiary and such subsidiary’s affiliates, transacts its title insurance business through a network of direct operations and agents. Through this network, the Company issues policies in the 49 states that permit the issuance of title insurance policies and the District of Columbia. The Company also offers title insurance and other insurance and guarantee products, as well as related settlement services in foreign countries, including Canada, the United Kingdom, Australia and various other established and emerging markets.
Certain 2012 and 2013 amounts have been reclassified to conform to the 2014 presentation.
The Company does not consider these adjustments to be material, individually or in the aggregate, to either the current year or any previously issued consolidated financial statements.
The Company maintains investments in debt securities in accordance with certain statutory requirements for the funding of statutory premium reserves and state deposits. At December 31, 2014 and 2013, the fair value of such investments totaled $120.7 million and $124.0 million, respectively. See Note 2 Statutory Restrictions on Investments and Stockholders’ Equity for additional discussion of the Company’s statutory restrictions.
The Company determines if a non-agency mortgage-backed security in a loss position is other-than-temporarily impaired by comparing the present value of the cash flows expected to be collected from the security to its amortized cost basis. If the present value of the cash flows expected to be collected exceed the amortized cost of the security, the Company concludes that the security is not other-than-temporarily impaired. The Company performs this analysis on all non-agency mortgage-backed securities in its portfolio that are in an unrealized loss position. For the securities that were determined not to be other-than-temporarily impaired at December 31, 2014, the present value of the cash flows expected to be collected exceeded the amortized cost of each security.
The following table presents the change in the credit portion of the other-than-temporary impairments recognized in earnings on debt securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive income (loss) for the years ended December 31, 2014, 2013, and 2012.
Accumulated losses on securities that matured or were sold during the year
When an equity security has been in an unrealized loss position for greater than twelve months, the Company’s review of the security includes the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company did not record other-than-temporary impairment losses related to its equity securities for the years ended December 31, 2014, 2013 and 2012.
Investments in real estate are classified as held for sale and carried at the lower of cost or fair value less estimated selling costs. An impairment loss is recognized when the carrying value exceeds the estimated undiscounted future cash flows from the investment.
Notes receivable are carried at cost less reserves for losses. Loss reserves are established for notes receivable based upon an estimate of probable losses for the individual notes. A loss reserve is established on an individual note when it is deemed probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the note. The loss reserve is based upon the Company’s assessment of the borrower’s overall financial condition, resources and payment record; and, if appropriate, the realizable value of any collateral. These estimates consider all available evidence including the expected future cash flows, estimated fair value of collateral on secured notes, general economic conditions and
trends, and other relevant factors, as appropriate. Notes are placed on non-accrual status when management determines that the collectibility of contractual amounts is not reasonably assured.
Property and equipment includes computer software acquired or developed for internal use and for use with the Company’s products. Software development costs, which include capitalized interest costs and certain payroll-related costs of employees directly associated with developing software, in addition to incremental payments to third parties, are capitalized from the time technological feasibility is established until the software is ready for use. Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of property and equipment whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value.
Title plants and other indexes at December 31, 2014 included title plants of $514.6 million and capitalized real estate data of $16.0 million, and at December 31, 2013 included title plants of $523.1 million and capitalized real estate data of $0.8 million. Title plants are carried at original cost, with the costs of daily maintenance (updating) charged to expense as incurred. Because properly maintained title plants have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation or amortization. The Company analyzes its title plants at least annually for impairment. This analysis includes, but is not limited to, the effects of obsolescence, duplication, demand and other economic factors. Capitalized real estate data is carried at cost, less amortization. Capitalized real estate data is amortized using the straight-line method over estimated useful lives of 3 to 15 years.
Amounts paid for acquisitions are allocated to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair value at the date of acquisition. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Acquisition-related costs are expensed in the periods in which the costs are incurred. The results of operations of acquired businesses are included in the consolidated financial statements from the date of acquisition.
The quantitative impairment test for goodwill utilizes a variety of valuation techniques, all of which require the Company to make estimates and judgments. Fair value is determined by employing an expected present value technique, which utilizes multiple cash flow scenarios that reflect a range of possible outcomes and an appropriate discount rate. The use of comparative market multiples (the “market approach”) compares the reporting unit to other comparable companies (if such comparables are present in the marketplace) based on valuation multiples to arrive at a fair value. In assessing the fair value, the Company utilizes the results of the valuations (including the market approach to the extent comparables are available) and considers the range of fair values determined under all methods and the extent to which the fair value exceeds the carrying amount of the equity or asset.
The Company’s intangible assets consist of noncompete agreements, customer relationships, trademarks, patents and licenses. Each of these intangible assets, excluding licenses, is amortized on a straight-line basis over its useful life ranging from 1 to 20 years and is subject to impairment assessments when there is an indication of a triggering event or abandonment. Licenses are an intangible asset with an indefinite life and are therefore not amortized but rather assessed for impairment by comparing the fair value of the license with its carrying value at least annually and when an indicator of potential impairment has occurred.
Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of intangible assets with finite lives, whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If the undiscounted cash flow analysis indicates that the carrying amount is not recoverable, an impairment loss is recorded for the excess of the carrying amount over its fair value.
Title insurance policies are long-duration contracts with the majority of the claims reported to the Company within the first few years following the issuance of the policy. Generally, 70% to 80% of claim amounts become known in the first six years of the policy life, and the majority of IBNR reserves relate to the six most recent policy years. Changes in expected ultimate losses and corresponding loss rates for recent policy years are considered likely and could result in a material adjustment to the IBNR reserves. Based on historical experience, management believes a 50 basis point change to the loss rates for the most recent policy years, positive or negative, is reasonably likely given the long duration nature of a title insurance policy. For example, if the expected ultimate losses for each of the last six policy years increased or decreased by 50 basis points, the resulting impact on the Company’s IBNR reserve would be an increase or decrease, as the case may be, of $98.7 million. A material change in expected ultimate losses and corresponding loss rates for older policy years is also possible, particularly for policy years with loss ratios exceeding historical norms. The estimates made by management in determining the appropriate level of IBNR reserves could ultimately prove to be materially different from actual claims experience.
In addition, the Company has an employee stock purchase plan that allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each offering period.
The Company recognizes the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability on its consolidated balance sheets and recognizes changes in the funded status in the year in which changes occur, through accumulated other comprehensive loss. The funded status is measured as the difference between the fair value of plan assets and the benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for the other postretirement plans). Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive loss. Plan assets and obligations are measured annually as of December 31.
storms, wildfires and earthquakes. In reinsurance arrangements, the primary insurer retains a certain amount of risk under a policy and cedes the remainder of the risk under the policy to the reinsurer. The primary insurer pays the reinsurer a premium in exchange for accepting this risk of loss. The primary insurer generally remains liable to its insured for the total risk, but is reinsured under the terms of the reinsurance agreement. The amount of premiums assumed and ceded is recorded as a component of direct premiums and escrow fees on the Company’s consolidated statements of income. The total amount of premiums assumed and ceded in connection with reinsurance was less than 1.0% of consolidated premium and escrow fees for each of the three years in the period ended December 31, 2014. Payments and recoveries on reinsured losses for the Company’s title insurance and property and casualty businesses were immaterial during the three years ended December 31, 2014. At December 31, 2014, a reinsurance receivable of $25.0 million, which related to a large commercial title claim, was included in the Company’s consolidated balance sheets in accounts and accrued income receivable. The Company collected $23.2 million of the receivable in February 2015 and expects to collect the remaining $1.8 million during the remainder of 2015. No reinsurance receivable was included in the consolidated balance sheets at December 31, 2013.
In July 2013, the Financial Accounting Standards Board (“FASB”) issued updated guidance intended to eliminate the diversity in practice regarding financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The updated guidance is effective for interim and annual
The Company’s principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), maintained total statutory capital and surplus of $971.3 million and $996.0 million as of December 31, 2014 and 2013, respectively. Statutory net income for the years ended December 31, 2014, 2013 and 2012 was $393.1 million, $199.1 million and $301.9 million, respectively. FATICO was in compliance with the minimum statutory capital and surplus requirements as of December 31, 2014.
FATICO, which was previously domiciled in the state of California, redomesticated to Nebraska effective July 1, 2014. FATICO’s statutory-based financial statements were prepared in accordance with accounting practices prescribed or permitted by the Nebraska Department of Insurance for the year ended December 31, 2014 and by the California Department of Insurance for the year ended December 31, 2013. The National Association of Insurance Commissioners’ (“NAIC”) Accounting Practices and Procedures Manual (“NAIC SAP”) has been adopted as a component of prescribed or permitted practices by the states of Nebraska and California. Both states have adopted certain prescribed accounting practices that differ from those found in the NAIC SAP. Specifically, the timing of amounts released from the statutory premium reserve under both Nebraska’s and California’s required practice differs from NAIC SAP resulting in total statutory capital and surplus that was lower by $11.7 million and $193.8 million at December 31, 2014 and 2013, respectively, than if reported in accordance with NAIC SAP. Additionally, for the year ended December 31, 2014, the state of Nebraska granted a permitted accounting practice to FATICO that differs from Nebraska’s prescribed accounting practices; specifically, the determination to not
record a bulk reserve within the known claims reserve resulting in total statutory capital and surplus that was higher by $8.2 million at December 31, 2014 than if reported in accordance with Nebraska’s required practice.
The Company had the following unrealized gains (losses) as of December 31, 2014, 2013 and 2012:
The amortized cost and estimated fair value of debt securities at December 31, 2014, by contractual maturities, are as follows:
Mortgage-backed securities, which include contractual terms to maturity, are not categorized by contractual maturity because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The aggregate annual maturities for notes receivable at December 31, 2014, is as follows:
For further discussion about the Company’s acquisitions in 2014 see Note 21 Business Combinations.
During the fourth quarter of 2014, the Company completed its multi-year process of winding-down the operations of its industrial bank, First Security Business Bank, which included the sale of the bank’s loan portfolio and transfer of its customer deposits to a third party bank. The Company received proceeds from the sale of $42.3 million, net of $8.1 million related to customer deposits, and recorded a gain of $0.5 million. Customer deposits were transferred at par value.
The provision for title insurance losses, expressed as a percentage of title insurance premiums and escrow fees, was 7.0%, 8.8% and 6.9% for the years ended December 31, 2014, 2013 and 2012, respectively.
The prior year rate of 8.8% reflected an ultimate loss rate of 5.0% for policy year 2013 and a net increase in the loss reserve estimates for prior policy years of $148.5 million. The increase in loss reserve estimates for prior policy years reflected claims development above expected levels during 2013, primarily from domestic lenders policies, commercial policies and the Company’s guaranteed valuation product offered in Canada. The reserve strengthening associated with domestic lenders policies was $67.4 million and was primarily attributable to increased claims frequency for policy years 2004 through 2008. The increased claims frequency was primarily due to mortgage lenders and servicers processing a large volume of foreclosures during 2013. As foreclosure processing increases, lenders claims generally increase, because lenders claims typically come from foreclosures in which the lender suffers a loss. At December 31, 2013, the Company expected the high level of foreclosure processing to continue in the near term as mortgage lenders and servicers worked through their foreclosure inventory. The reserve strengthening associated with domestic lenders policies reflected these expectations. The reserve strengthening associated with commercial policies was $38.8 million and was primarily attributable to several large commercial claims, mainly from mechanics liens, and primarily related to policy years 2007 and 2008. The reserve strengthening associated with the guaranteed valuation product offered in Canada was $21.7 million and was primarily attributable to claims frequency exceeding the Company’s expectations during 2013. The increase in frequency primarily related to policy years 2007 and 2010.
The current economic environment continues to show potential for volatility over the short term, which may affect title claims. Relevant contributing factors include continuing elevated foreclosure inventory and foreclosure processing and general economic uncertainty. Other factors, including factors not yet identified, may also influence claims development. While real estate and financial market conditions have improved to some extent as evidenced by increased real estate prices and a decline in mortgage defaults, significant uncertainty remains. In addition, while foreclosure inventory and foreclosure processing remain elevated compared to historic norms, the level of inventory and processing has declined from its peak. Nevertheless, the current environment continues to create an increased potential for actual claims experience to vary
4.60% senior unsecured notes due November 15, 2024, net of unamortized discount of $74 at December 31, 2014, effective interest rate of 4.60%
4.30% senior unsecured notes due February 1, 2023, net of unamortized discount of $760 and $837 at December 31, 2014 and 2013, respectively, effective interest rate of 4.35%
Trust deed notes with maturities through 2032, collateralized by land and buildings with a net book value of $52,414 and $55,206 at December 31, 2014 and 2013, respectively, weighted-average interest rate of 5.39% and 5.42%, at December 31, 2014 and 2013, respectively
Other notes and contracts payable with maturities through 2020, weighted-average interest rate of 5.30% and 2.96% at December 31, 2014 and 2013, respectively
At the Company’s election, borrowings of revolving loans under the credit agreement bear interest at (a) the Alternate Base Rate plus the applicable spread or (b) the Adjusted LIBOR rate plus the applicable spread (in each case as defined in the agreement). The Company may select interest periods of one, two, three or six months or (if agreed to by all lenders) such other number of months for Eurodollar borrowings of loans. The applicable spread varies depending upon the debt rating assigned by Moody’s Investor Service, Inc. and/or Standard & Poor’s Rating Services. The minimum applicable spread for Alternate Base Rate borrowings is 0.625% and the maximum is 1.00%. The minimum applicable spread for Adjusted LIBOR rate borrowings is 1.625% and the maximum is 2.00%. The rate of interest on Incremental Term Loans will be established at or about the time such loans are made and may differ from the rate of interest on revolving loans.
At December 31, 2014, the Company had available a foreign tax credit carryover of $2.2 million. The Company expects to utilize these credits within the carryover period.
At December 31, 2014, the Company had available net operating loss carryforwards for income tax purposes totaling $122.5 million, consisting of federal, state and foreign losses of $0.5 million, $38.5 million and $83.5 million, respectively. Of the aggregate net operating losses, $41.2 million have an indefinite expiration and the remaining $81.3 million expire at various times beginning in 2015. The Company carries a valuation allowance of $15.7 million against its deferred tax assets. Of this amount, $13.3 million relates to net operating losses; the remaining $2.4 million relates to other foreign deferred tax assets. The year-over-year decrease in the overall valuation allowance relates to the utilization of certain foreign losses and other foreign deferred tax assets against current year income.
As of December 31, 2014, 2013 and 2012, the liability for income taxes associated with uncertain tax positions was $24.1 million, $47.8 million and $47.9 million, respectively. The net decrease in the liability during 2014 was primarily attributable to an examination settlement reached with a taxing authority for issues related to the timing of deductibility, which, accordingly, did not impact the Company’s consolidated statement of income. The net decrease in the liability during 2013 was primarily attributable to the Company’s effective settlement of a prior year tax return position. The net increase in the liability during 2012 was primarily attributable to the Company’s claim for a timing deduction in a prior year tax return. As of December 31, 2014, 2013 and 2012, the liabilities could be reduced by $3.4 million, $32.6 million and $32.6 million, respectively, of offsetting tax benefits associated with the correlative effects of potential adjustments including timing adjustments and state income taxes. The net amounts of $20.7 million, $15.2 million and $15.3 million as of December 31, 2014, 2013 and 2012, respectively, if recognized, would favorably affect the Company’s effective tax rate.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various state jurisdictions, and various non-U.S. jurisdictions. The primary non-federal jurisdictions are California, Canada, India and the United Kingdom. The Company is no longer subject to U.S. federal, state and non-U.S. income tax examinations by taxing authorities for years prior to 2005.
The following table summarizes the Company’s benefit obligations, assets and funded status associated with its defined benefit pension and supplemental benefit plans:
Net actuarial loss and prior service credit for the defined benefit pension and supplemental benefit plans expected to be amortized from accumulated other comprehensive loss into net periodic cost over the next fiscal year include an expense of $34.0 million and a credit of $4.2 million, respectively.
The Company adopted updated mortality tables published by the Society of Actuaries in October 2014. The revised RP-2014 tables reflect substantial life expectancy improvements relative to the last tables published in 2000.
Assumptions for the expected long-term rate of return on assets of the defined benefit pension plans are based on future expectations for returns for each asset class based on the calculated market-related value of plan assets and the effect of periodic target asset allocation rebalancing, adjusted for the payment of reasonable expenses of the plan from plan assets. The expected long-term rate of return on assets was selected from within a reasonable range of rates determined by (1) historical real and expected returns for the asset classes covered by the investment policy and (2) projections of inflation over the long-term period during which benefits are payable to plan participants. The Company believes the assumptions are appropriate based on the investment mix and long-term nature of the plan’s investments. The use of expected long-term returns on plan assets may result in recognized pension income that is greater or less than the actual returns of those plan assets in any given year. Over time, however, the expected long-term returns are designed to approximate the actual long-term returns, and therefore result in a pattern of income and cost recognition that more closely matches the pattern of the services provided by the employees.
The investment manager tracks the estimated settlement funded status of the plan on a regular basis. When the funded status is equal to or greater than the next trigger point, the investment manager will rebalance to the allocation associated with that trigger point. The objective of liability tracking assets is to achieve performance related to changes in the value of the plan’s settlement liabilities, which is consistent with the objective of plan termination.
The following table presents the fair value of the Company’s defined benefit pension plan assets as of December 31, 2014 and 2013:
Level 2-Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets or liabilities at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.
The valuation techniques and inputs used by the Company to estimate the fair value of assets measured on a recurring basis, are summarized as follows:
The Company did not have any transfers in and out of Level 1, Level 2 and Level 3 measurements during the years ended December 31, 2014 and 2013. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.
The Company did not purchase or sell any non-agency mortgage-backed securities during the years ended December 31, 2014 and 2013.
The First American Financial Corporation 2010 Employee Stock Purchase Plan (the “ESPP”) allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each quarterly offering period. There were 354,000 and 350,000 shares issued in connection with this plan for the years ended December 31, 2014 and 2013, respectively. At December 31, 2014, there were 3.4 million shares reserved for future issuances.
The following table summarizes stock option activity for the year ended December 31, 2014:
Total rental expense for all operating leases and month-to-month rentals was $93.5 million, $94.6 million and $96.8 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Changes in the balances of each component of accumulated other comprehensive income (loss) for the years ended December 31, 2014, 2013 and 2012 are as follows:
The following table presents the effect of the reclassifications out of accumulated other comprehensive income (loss) on the respective line items in the consolidated statements of income:
These accumulated other comprehensive income components are included in the computation of net periodic cost. See Note 14 Employee Benefit Plans for additional details.
Raffone v. First American Title Insurance Company, filed on February 14, 2004 and pending in the Circuit Court, Nassau County, Florida, and
Slapikas v. First American Title Insurance Company, filed on December 19, 2005 and pending in the United States District Court for the Western District of Pennsylvania.
DeLaurentis v. Data Tree Information Services LLC, filed on January 16, 2015 and pending in the United States District Court for the Southern District of New York,
In re First American Home Buyers Protection Corporation, consolidated on October 9, 2014 and pending in the United States District Court for the Southern District of California.
The Company’s Canadian operations provide certain services to lenders which it believes to be exempt from excise tax under applicable Canadian tax laws. However, in October 2014, the Canadian taxing authority provided internal guidance that the services in question should be subject to the excise tax. While discussions with the taxing authority are ongoing, the Company believes that the guidance may result in an assessment. The amount, if any, of such assessment is not currently
known, and any such assessment would be subject to negotiation. In the event that the Company disagrees with the ultimate assessment, the Company intends to avail itself of avenues of appeal. While the Company believes it is reasonably likely that the Company would prevail on the merits, a loss associated with the matter is possible. In light of the foregoing, the Company is not currently able to reasonably estimate a loss or range of loss associated with the matter. While such a loss could be material to the Company’s operating results in any particular period if an unfavorable outcome results, the Company does not believe that this matter will have a material adverse effect on the Company’s overall financial condition or liquidity.
In March 2014, the Company completed the acquisition of a company that provides loan quality analytics, decision support tools and loan review services for the mortgage industry for a purchase price of $151.2 million. The Company completed additional acquisitions during 2014 for an aggregate purchase price of $11.3 million. The Company allocates the purchase price of each acquisition to the assets acquired and liabilities assumed using a variety of valuation techniques, including discounted cash flow analysis. These acquisitions have been included in the Company’s title insurance and services segment.
During the year ended December 31, 2013, the Company completed acquisitions for an aggregate purchase price of $5.3 million in cash and accrued contingent consideration of $1.2 million. The purchase price of each acquisition was allocated to the assets acquired and liabilities assumed using a variety of valuation techniques including discounted cash flow analysis. These four acquisitions have been included in the Company’s title insurance and services segment.
The corporate function consists primarily of certain financing facilities as well as the corporate services that support the Company’s business operations. Eliminations consist of inter-segment revenues and related expenses included in the results of the operating segments.
Selected financial information about the Company’s operations, by segment, for each of the past three years is as follows:
Long-lived assets allocated between domestic and foreign operations, and by segment, as of December 31, 2014, 2013 and 2012 are as follows:
Net income for the quarter ended December 31, 2013 includes a net reduction of $4.4 million related to certain items that should have been recorded in a prior period. These items decreased diluted net income per share attributable to the Company’s stockholders by $0.04 for the quarter.
Unrealized gain on securities for which credit losses have been recognized in earnings
The holding company received cash dividends from subsidiaries of $79.1 million, $125.1 million and $11.8 million for the years ended December 31, 2014, 2013 and 2012, respectively.