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. 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 Company believes that its properties are maintained in good operating condition and are suitable and adequate for its purposes at current sales levels.
The Company reported improved operating earnings in 1997 and 1996. 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 1995 to 1997, the Company benefited from the execution of three distinct portions of its business strategy. Operations were expanded through the acquisition of title insurance agents and underwriters, expenses were tightly monitored and controlled, and claims experience improved due to quality control efforts and an improved claims environment.
The Company's profit margins are affected by several factors, including the volume of real estate activity, policy amount and the nature of real estate transactions. Volume is an important determinant of profitability because the Company, like any other title insurance company, has a significant level of fixed costs arising from personnel, occupancy costs and maintenance of title plants. Because premiums are based on the face amount of the policy, larger policies generate higher premiums although expenses of issuance do not necessarily increase in proportion to policy size. Profit margins are lower on refinancings than on sales due to premium discounts and higher cancellation rates generally experienced on refinancings. Cancellations affect profitability because costs incurred both in opening and in processing orders typically are not offset by fees.
In the fourth quarter of 1996, in connection with the performance of initial due diligence procedures related to the negotiation of the acquisition of Commonwealth and Transnation, the Company had the opportunity to see how the experience of these two major title underwriters compared to its own experience. The information gained from this experience along with extensive actuarial studies of the Company's book of business resulted in a determination that the projected ultimate losses for certain policy year business should be reduced to give greater weight to the favorable development on those years through December 31, 1996. The effect of the change in estimate was to decrease the provision for policy and contract claims by $78.0 million and increase net income by $50.7 million and net income per share by $5.70 and net income per share assuming dilution by $5.57.
Because the change in accounting principle to no longer discount policy and contract claims is inseparable from the change in estimate, both have been accounted for as a change in estimate. Accordingly, the net effect of the two changes, a decrease of $2.0 million in the provision for policy and contract claims, has been included in operations for the fourth quarter of 1996. The above changes were both made to conform with general industry practice. The changes are included in the provision for policy and contract claims, and no prior amounts have been restated.
See "Item 3 - Legal Proceedings" for a discussion of pending legal proceedings.
Comparison of Years Ended December 31, 1997, December 31, 1996 and December 31, 1995
Net income was $26.2 million in 1997, $36.5 million in 1996 and $17.1 million in 1995. The 1996 net income increase was attributable in part to capital gains resulting from a shift in the Company's investment portfolio from equities to fixed income securities, as discussed under "Investment Income" below. Net operating income (which excludes realized investment gains) was $26.3 million, $21.3 million, and $15.1 million in the fiscal years ended December 31, 1997, 1996 and 1995, respectively. The 1997 and 1996 increases reflected improved results from operations.
Operating revenues improved 11.7% to $622.8 million in 1997, compared to $557.8 million in 1996. This 1996 level was a 19.3% increase over the 1995 amount.
The 1997 and 1996 results benefited from a favorable economic environment. The monthly average mortgage rate was 7.6% and 7.8% in 1997 and 1996, respectively, and this favorable economic environment led to increased levels of housing starts and housing resales in 1997 and 1996 compared to 1995. Business volumes for direct and agency business improved approximately 18% from 670,000 transactions in 1995 to 790,000 in 1996 and improved approximately 8% from 790,000 to 855,000 in 1997.
Investment income decreased significantly to $16.3 million in 1997, compared to $36.4 million in 1996 after increasing from $15.5 million in 1995 to $36.4 million in 1996. The high level of investment income in 1996 was due primarily to capital gains of $23.4 million. Excluding these gains, the remaining components of investment income (dividends and interest) amounted to $17.1 million, $14.2 million and $14.0 million in 1997, 1996 and 1995, respectively.
Agents' Commissions. Commissions paid to title insurance agents are the largest single expense incurred by the Company. The commission rate varies by geographic area in which the commission was earned. Commissions as a percentage of agency revenue were 75.0%, 74.2% and 73.9% in 1997, 1996 and 1995, respectively.
Provision for Policy and Contract Claims. The Company's claims experience has shown improvement in recent years. The loss ratio was 5.4%, 5.2% and 5.2% in 1997, 1996 and 1995, respectively. As previously discussed, the Company changed its method of reporting policy and contract claims in the fourth quarter of 1996. Claims paid as a percentage of operating revenues were 4.4%, 4.8% and 6.5% in 1997, 1996 and 1995, respectively.
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 1997, 1996 and 1995 differ from the U.S. federal statutory rate principally due to non-taxable interest, dividend deductions, travel and entertainment and company-owned life insurance.
At December 31, 1997 the Company had recorded gross deferred tax assets of $32.1 million related primarily to policy and contract claims and employee benefit plans. Substantially all of this deferred tax asset balance could be realized in the future through the reversal of existing temporary taxable differences. Accordingly, it is more likely than not that the income tax benefits will be realized for all of the temporary deductible differences existing at December 31, 1997.
The Company has closely examined the Year 2000 issue and the potential costs and consequences to the Company in addressing this issue. As part of its business and growth strategy, the Company is currently investing in new information technology, including the replacement of multiple independent personal computer systems throughout its direct operations with an upgraded centralized system, that is "Year 2000" compliant. The software for such new centralized system is being developed by Elliptus Software Solutions, Inc., a Lawyers Title subsidiary that develops and markets title and escrow production software. As development of such software is nearly complete, management believes that the remaining software development costs will not be material. Management estimates that the Company's investment in hardware for the project will total approximately $12.5 million over the next eighteen months. The Company is also communicating with third parties with which it does business to coordinate further action with respect to the Year 2000 issue. As a result, management believes that, with the replacement of certain computer systems as described above, the Year 2000 issue is not expected to have a material impact on the Company's operations and that the cost of the Company's addressing the Year 2000 issue is not a material event or uncertainty that would cause its reported financial information not to be necessarily indicative of future operating results or financial condition.