The Company owns an office building and adjacent real estate in Richmond, Virginia which it uses for its corporate headquarters. This property consists of approximately 128,000 square feet of office space and parking facilities. The Company's title insurance subsidiaries conduct their business operations primarily in leased office space. As of December 31, 2000, the Company had numerous leases for its branch offices and subsidiaries throughout the states in which it operates. In addition, it owns several other properties which in aggregate are not material to its business taken as a whole.
The Company's title plants constitute a principal asset. Such plants comprise copies of public records, maps, documents, previous reports and policies which are indexed to specific properties in an area. The plants are generally located at the office which serves a particular locality or in "service centers" serving multiple localities in major metropolitan areas. They enable title personnel to examine title matters relating to a specific parcel of real property as reflected in the title plant, and eliminate or reduce the need for a separate search of the public records. They contain material dating back a number of years and are kept current on a daily or other frequent basis by the addition of copies of documents filed of record which affect real property. The Company maintains title plants covering many of the areas in which it operates, although certain offices utilize jointly owned and maintained plants. The Company capitalizes only the initial cost of title plants. The cost of maintaining such plants is charged to expense as incurred.
The Company believes that its properties are maintained in good operating condition and are suitable and adequate for its purposes.
On February 27, 1998, the Company acquired all of the issued and outstanding shares of capital stock of Commonwealth and Transnation from Reliance Insurance Company, a subsidiary of Reliance Group Holdings, Inc. The assets and liabilities of Commonwealth and Transnation have been revalued to their respective fair market values as of that date. The financial statements of the Company reflect the combined operations of the Company, including Commonwealth and Transnation, from the closing date of the acquisition.
The Company's primary business is the insurance of titles to real property, which is greatly influenced by the real estate economy. During the three year period from 1998 to 2000, the Company's title operations benefited from the execution of three distinct aspects of its business strategy. Operations were expanded through the acquisition of title insurance agents and underwriters, including the acquisition of Commonwealth and Transnation in 1998, expenses were tightly monitored and controlled, and claims experience improved due to quality control efforts and an improved claims environment. During 1998, the Company benefited in particular from the acquisition of Commonwealth and Transnation, the strong national real estate economy, and a high level of residential refinancing activity.
The Company's operating revenues, consisting of premiums, title search, escrow and other fees, are dependent on overall levels of real estate and mortgage refinance activity, which are influenced by a number of factors including interest rates and the general state of the economy. In addition, the Company's revenues are affected by the Company's sales and marketing efforts and its strategic decisions based on the rate structure and claims environment in particular markets.
The Company's largest expense is commissions paid to independent agents. The Company regularly reviews the profitability of its agents, adjusting commission levels or cancelling certain agents where profitability objectives are not being met and expanding operations where acceptable levels of profitability are available. The Company continually monitors its expense ratio, which is the sum of salaries and employee benefits, agency commissions and other expenses (exclusive of interest, goodwill, exit and termination costs and write off of intangibles) expressed as a percentage of operating revenues.
Historically, residential real estate activity has been generally slower in the winter, when fewer families buy or sell homes, with increased volumes in the spring and summer. Residential refinancing activity is generally more uniform throughout the seasons but is highly subject to changes in interest rates. The Company typically reports its lowest revenues in the first quarter, with revenues increasing into the second quarter and through the third quarter. The fourth quarter customarily may be as strong as the third quarter, depending on the level of activity in the commercial real estate market.
In 1998 and 1999, the typical seasonality of the title insurance business was influenced by changes in the levels of refinancing activity. For additional information, see "Item 1 - Business - Cyclicality and Seasonality."
Comparison of Years Ended December 31, 2000, December 31, 1999 and December 31, 1998
The Company reported pre-tax investment income of $51.1 million, $48.0 million and $49.3 million in 2000, 1999 and 1998, respectively. Excluding capital gains and losses, investment income was $51.4 million, $49.6 million and $46.5 million in 2000, 1999 and 1998, respectively. The Company's investment portfolio consists of primarily fixed maturity securities whose income includes dividends and interest as well as realized gains and losses.
Exit and Termination Costs. Exit and termination costs on a pre-tax basis of approximately $3.1 million and $11.5 million were incurred in 2000 and 1998, respectively, in connection with the Primis acquisition and the formation of a title plant management joint venture in 2000 and the Commonwealth and Transnation acquisition in 1998. No such costs were incurred in 1999.
Agents' Commissions. Commissions paid to title insurance agents are the largest single expense incurred by the Company. The commission rate varies by geographic area in which the commission was earned. Commissions as a percentage of agency revenue were 78.3% in 2000, 77.8% in 1999 and 77.6% in 1998.
The Company pays U.S. federal and state income taxes based on laws in the jurisdictions in which it operates. The effective tax rates reflected in the income statement for 2000, 1999 and 1998 differ from the U.S. federal statutory rate principally due to non-taxable interest, dividend deductions, travel and entertainment and company-owned life insurance.
The Company reassesses the realization of deferred assets quarterly and, if necessary, adjusts its valuation allowance accordingly.
During February and March 2001, 2.0 million shares of the Company's preferred stock were converted to common stock. This conversion will decrease the amount of preferred dividends paid by $7.1 million on an annual basis. The new common shares will require dividends of the same rate paid on all other outstanding common shares.
In view of the historical ability of the Company to generate strong, positive cash flows, and the strong cash position and relatively conservative capitalization structure of the Company, management believes that the Company will have sufficient liquidity and adequate capital resources to meet both its short- and long-term capital needs. In addition, the Company has $42.0 million available under a credit facility which was unused at December 31, 2000.