- Management Analysis of Financial Position and Results of Operations ($ in Millions, Except Share Data)
This analysis pertains to the consolidated accounts of Old Republic International Corporation. The Company conducts its business through four major segments, namely its General (property and liability coverages), Title, Mortgage Guaranty, and Life insurance groups.
In 1993, the Company adopted several changes in accounting policies to comply with Financial Accounting Standards Board (FASB) pronouncements that have been mandated. The adoption of the asset and liability method for calculating deferred income taxes and the recognition of present value liabilities pertaining to post-retirement health benefits under retirement plans maintained by a few Old Republic subsidiaries increased net income by $8.6 or 15 cents per share (14 cents fully diluted) in the first quarter of 1993. Accounting for reinsurance ceded transactions affected the Company's balance sheet but not the consolidated income statement; assets and liabilities at December 31, 1993, were increased by corresponding amounts of approximately $1,524.2 due to the reclassification change for these transactions. Finally, the Company reexamined the classification of its invested assets which led to reporting such assets as either "held to maturity" or "available for sale"; the effect of these classification changes was to increase assets and the liability for deferred taxes by $25.2 and $8.7, respectively, and common shareholders' equity for the net unrealized appreciation of securities newly reclassified at fair value by $16.4 or 32 cents per common share as of December 31, 1993. See Note 1 of the Notes to Consolidated Financial Statements for further details relating to these changes. Prior years' financial statements have not been restated nor reclassified to reflect these changes as permitted by the pertinent FASB pronouncements.
Exclusive of the classification changes noted above, Old Republic's financial position at December 31, 1993 reflected increases in assets of 9.8%, liabilities of 8.6%, and common shareholders' equity of 13.5% when compared to the immediately preceding year-end. At December 31, 1993 and 1992, cash and invested assets represented 81.2% and 80.5% of consolidated assets, respectively. Relatively high short-term maturity investment positions were maintained as of the most recent year-ends to provide necessary liquidity for specific operating needs and to enhance flexibility in investment strategy. Changes in short-term investments reflect a large variety of seasonal and intermediate-term factors including seasonal operating cash needs, investment strategy, and expectations as to trends in interest yields. Accordingly, the future level of short-term investments will vary and respond to the dynamics of these factors and may, as a result, increase or decrease from current levels. During 1993 and 1992, the Corporation committed substantially all investable funds in short to intermediate-term fixed maturity securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities; the Corporation has not directed its investable funds to so-called "junk bonds". During 1993, however, Old Republic increased its commitment to common stock investments which reflected an increase of 50% vis-a-vis the related invested balance at year-end 1992. As of December 31, 1993, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in relation to consolidated assets or shareholders' equity.
Net premiums and fees earned increased by 12%, 16%, and 10% in 1993, 1992 and 1991, respectively. For each of the past three years, property and liability insurance premium increases were due to varying levels of growth in certain parts of the Company's business, but principally among liability coverages. During these years, the Corporation has cancelled periodically certain property and liability insurance business not meeting its underwriting expectations. Greater real estate financing activity during the three most recent calendar years led to higher revenues in the title segment. For the past three years, mortgage guaranty premiums also increased due to a rise in the amount of renewal and new business, and greater market penetration. Life and disability premium volume has generally trended down during the years 1992 and 1991 as the Corporation has continued to de-emphasize this business until greater returns are possible. An increase in 1993 of life and disability premium is attributed to the introduction of more favorably priced term life insurance products that received greater market acceptance.
While the Company's investment policies have not been designed to maximize capital gains, during 1992 such gains were much higher than those realized in 1993 and 1991. Dispositions of securities have been caused principally by: (1) calls prior to maturity by issuers, (2) a desire to reduce investments in tax exempt securities, (3) a desire to extend moderately the average life of the portfolio, and (4) the Company's ongoing process of continually monitoring its investments with a view toward maximizing the quality ratings and diversification of its portfolio. For the year 1993, approximately 58% of total dispositions represented maturities and early calls of existing holdings; for the year 1992 these amounted to approximately 37% of all securities sales and dispositions.
Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 56% in 1993, 58% in 1992 and 62% in 1991. This consolidated ratio was affected principally by a slightly improving claim ratio for property and liability insurance coverages. In the most recent three years, the Corporation's property and liability insurance subsidiaries, along with other companies in the industry, have also sustained higher loss assessments for residual market (assigned risk) business. Policyholders' dividends incurred in the Corporation's property and liability lines for each year reflect changes in the loss ratio for experience-rated policies. The title insurance loss ratio was affected by higher than normal claims provisions in both 1993 and 1992 which added approximately 3.0% and 3.8%, respectively, to this group's loss ratio. The loss ratio declined or remained relatively stable in the mortgage guaranty insurance line due to a reduction of frequency of claim occurrences.
The ratio of consolidated underwriting, acquisition, and insurance expenses to net premiums and fees earned was approximately 45% in 1993, 46% in 1992 and 43% in 1991. Variations in these ratios reflect a continually changing mix of coverages sold and attendant costs of producing business. In years during which title insurance premiums and fees grow significantly, as in 1993 and 1992, in particular, the consolidated expense ratio tends to rise as production costs for this line are higher than those for most other types of insurance.
Income before taxes decreased by 3% in 1993 and increased by 43% in 1992 and 32% in 1991. General insurance results have trended up slightly during the past five years and have continued as the major contributor to consolidated earnings, principally as a result of growing investment income. Title insurance operating results have improved over the past three years due to the previously discussed increase in revenues. The mortgage guaranty segment reflected significantly improved results due to increased revenues and favorable claims experience in each of the past three years, while life and disability operations have reflected a secular downward trend in the past three years. Consolidated pre-tax income for 1993 and 1992 in particular was affected positively by greater than normal realization of investment gains.
The effective consolidated income tax rates were 32% in 1993, 30% in 1992 and 26% in 1991. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from tax-exempt investment income, on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand. In August 1993, the corporate federal income tax rate was increased from 34% to 35% retroactive to January 1, 1993. In recent years the Corporation has emphasized purchases of taxable investment securities. Amortization of fresh start benefits stemming from the Tax Reform Act of 1986 (the "TRA") reduced income taxes by $1.9 in 1992 and $3.6 in 1991.
(d) Revenue Recognition-Pursuant to generally accepted accounting principles applicable to the insurance industry, benefits, claims, and expenses are associated with the related revenues by means of the provision for policy benefits, the deferral and subsequent amortization of acquisition costs, and the recognition of incurred benefits, claims and operating expenses.
(e) Deferred Policy Acquisition Costs-The Corporation's insurance subsidiaries, other than title companies, defer
(f) Future Policy Benefits/Unearned Premiums-See note 1(g) for discussion of FAS No. 113 "Accounting and Reporting for Reinsurance of Short Duration and Long-Duration Contracts". General insurance and level term credit life insurance policy liabilities represent unearned premium reserves developed by application of monthly pro-rata factors to premiums in force. Disability/accident & health and decreasing term credit life insurance policy liabilities are calculated primarily on a sum-of-the-years-digits method. Mortgage guaranty unearned premium reserves are calculated primarily on a pro-- rata basis. Ordinary life policy liabilities are determined on a level premium method and take into account mortality and withdrawal rates based principally on anticipated company experience; assumed interest rates range from 3.0% to 6.0%. With respect to annuity policies, the liabilities represent the surrender value of such policies during deferral periods, without adjustment for surrender charges; such values are deemed appropriate to provide for ultimate benefit reserves in the event policyholders exercise an annuity benefit option at a later date.
At December 31, 1992, future policy benefit liabilities and unearned premiums are included net of reinsurance ceded to other companies of $121.5. The Company issues, directly or as a reinsurer, certain insurance policies generally categorized as financial guarantees. The major types of guarantees pertain to (a) state, municipal and other general or special revenue bonds, (b) variable interest rate guarantees, and (c) insurance of the future residual value of fixed assets. The types of risks involved include failure by the bond issuer to make timely payment of principal and interest, changes in interest rates, and changes in the future value of fixed assets. The degree of risk pertaining to these insurance products is largely dependent on the effects of general economic cycles and changes in the credit worthiness of issuers whose obligations have been guaranteed. During the past three years, new commitments have been limited to those identified at (a) immediately above. Premiums received for financial guarantee policies are generally earned over the terms of the contract (which may range between 5 and 30 years) or on the basis of current exposure relative to maximum exposure in force; with respect to residual value insurance, that portion of the premium in excess of certain initial underwriting costs is deferred and taken into income when all events leading to the determination of exposure, if any, have occurred. Since losses on financial guarantee insurance products cannot be predicted reliably, the Company's unearned premium reserves serve as the primary income recognition and loss reserving mechanism. When losses become known and determinable, they are paid or placed in reserve and the remaining directly-related unearned premiums are taken into income.
With respect to mortgage guaranty insurance (net insurance in force of $24,026.1 and $16,647.0, at December 31, 1993 and 1992, respectively) the Company's reserving policies are set forth below in Note l(g).
(g) Losses, Claims and Settlement Expenses-Reserves are provided for the ultimate expected cost of settling unpaid losses and claims reported at each balance sheet date. Losses and claims incurred but not reported, as well as expenses required to settle losses and claims are established on the basis of various criteria, including historical cost experience and anticipated costs of servicing reinsured and other risks. Long-term disability-type workers' compen- sation reserves, however, are discounted to present value based on interest rates ranging from 3.5% to 4% as permitted by regulatory authorities. All reserves are necessarily based on estimates which are periodically reviewed and evaluated in the light of emerging claim experience and existing circumstances. The resulting changes in estimates are recorded in operations of the periods during which they are made. Consistent with industry practice, total loss and claim reserves are stated net of reinsurance ceded to other companies in the amount of $1,244.1 at December 31, 1992. Effective January 1, 1993 the Company adopted Financial Accounting Standard (FAS) No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" which eliminates the reporting of assets and liabilities relating to reinsured contracts net of reinsurance ceded balances. Accordingly, reinsured losses and unearned premiums are to be reported as assets. At December 31, 1993, assets and liabilities were, as a result, increased by corresponding amounts of approximately $1.5 billion. FAS No. 113 did not have any effect on the Company's results of operations.
Life Insurance companies domiciled in the United States and qualifying as life insurers for tax purposes are taxed under special provisions of the Internal Revenue Code. As a result of legislation, 1983 and prior years' tax deferred earnings (cumulatively $20.7 at December 31, 1993) credited to the former memorandum "policyholders' surplus account" will not be taxed unless they are subsequently distributed to shareholders. The Company does not presently anticipate any distribution or payment of taxes on such earnings in the future.
As a result of regular examinations of the tax returns for the Corporation and its subsidiaries, the Internal Revenue Service ("IRS") has proposed certain adjustments for additional taxes applicable to the years 1982 to 1990. The proposed adjustments pertain to the timing of certain deductions, the IRS's contention that contractually obligated premium refunds should be treated as dividends, deductions for certain loss and related reserves, a reinsurance transaction, and several other issues not involving material amounts. The Company and its tax counsel believe that substantially all of the proposed material adjustments are without merit, that the Company will be successful in vigorously defending its positions, and that the ultimate adjustments, if any, will not significantly affect its financial condition or results of operations. During 1993 and 1992, certain of the proposed adjustments were finally settled for immaterial amounts. In 1992, the Company's life insurance subsidiaries recorded previously unrecognized tax recoveries of $1.1 and related interest credits of approximately $12.4 stemming from resolution of various long-standing Internal Revenue Service disputes applicable to taxable years 1969 to 1981.
(l) Employee Benefit Plans- The Corporation has several pension plans covering approximately half of its employees. The plans are defined benefit plans in which the benefits are based primarily on years of service and employee com- pensation near retirement. It is the Corporation's policy to fund the plans' costs as they accrue. Plan assets are comprised principally of bonds, common stocks and short-term investments. The components of annual net periodic pension cost (credit) for the plans consisted of the following:
The projected benefit obligations for the plans were determined using the following at: December 31, 1993 1992 Settlement discount rates 7.5 - 8.0% 7.5 - 8.75% Rates of compensation increase 4.0 - 5.5% 5.0 - 6.0% Long-term rates of return on assets 8.0 - 9.0% 8.0 - 9.0%
(q) Statement Presentation-Amounts shown in the consolidated financial statements and applicable notes are stated (except as otherwise indicated and as to share data) in millions, which amounts may not add to totals shown due to rounding. Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to current presentation.
(b) Cash Dividend Restrictions-The payment of cash dividends by the Corporation is principally dependent upon the amount of its insurance subsidiaries' statutory policyholders' surplus available for dividend distribution. The insurance subsidiaries' ability to pay cash dividends to the Corporation is in turn generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. These authorities recognize only statutory accounting practices for determining financial position, results of operations, and the ability of an insurer to pay dividends to its shareholders. Based on 1993 data, the maximum amount of dividends payable to the Corporation by its insurance and other wholly-owned subsidiaries during 1994 without the prior approval of their respective regulatory authorities is approximately $192.4. However, management does not expect to distribute all such dividends since reinvested earnings are the Corporation's major source of capital to promote its growth and support its obligations to policyholders. (c) Debt Restrictions-Under the most restrictive covenants, the terms of Old Republic's guaranties relative to loan agreements described in Note 3(a) provide that while loans under such agreements are outstanding, Old Republic will maintain a minimum consolidated tangible net worth (excluding goodwill and net unrealized capital gains or losses, but including title plants and records) of at least $400.0. Such agreements also, among other things, restrict Old Republic from permitting "Debt" to exceed 25% of its consolidated tangible net worth (as adjusted for goodwill and net unrealized capital gains or losses on equity securities) without approval of the lenders.
Under the 1985 and 1992 plans, in the event the market price of Old Republic common stock reaches a preestablished value ("vesting acceleration price"), optionees may exercise their options to the extent of 10% of the number of shares covered by the option for each year that the optionee has been employed by the Corporation or its subsidiaries.
(e) Common Stock-There were 100,000,000 shares of common stock authorized at December 31, 1993. At the same date, there were 20,000,000 shares of Class "B" common stock authorized but none were issued or outstanding. Class "B" common shares have the same rights as common shares except for being entitled to 1/10th of a vote per share.
(f) Undistributed Earnings-The equity of the Corporation in the undistributed earnings, determined in accordance with generally accepted accounting principles, and in the net unrealized investment gains (losses) of its respective subsidiaries at December 31, 1993 amounted to $921.5 and $23.7, respectively. Common stock dividends declared during 1993, 1992 and 1991, to the Corporation by its subsidiaries amounted to $53.9, $50.6, and $38.6, respectively.
(h) Statutory Data-The shareholders' equity and net income, determined in accordance with statutory accounting practices, of the Corporation's insurance subsidiaries was as follows at the dates and for the periods shown:
(b) Leases-Some of the Corporation's subsidiaries maintain their offices in leased premises. Certain of these leases provide for the payment of real estate taxes, insurance, and other operating expenses. At December 31, 1993, aggregate minimum rental commitments (net of expected sub-lease receipts) under noncancellable operating leases of $106.2 are summarized as follows: 1994: $25.8; 1995: $20.2; 1996: $13.8: 1997: $9.5; 1998: $6.5; 1999 and after: $30.0.
(c) General-In the normal course of business, the Corporation and its subsidiaries are subject to various contingent liabilities, including possible income tax assessments resulting from tax law interpretations or issues raised by taxing authorities in their regular examinations. Management does not anticipate any significant losses or costs to result from any known or existing contingencies. (d) Legal Proceedings-There are no material legal proceedings other than those arising in the normal course of business and which generally pertain to claim matters related to insurance policies and contracts issued by the Corporation's insurance subsidiaries.
Note 6-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 1993 is presented below. In the opinion of management, all adjustments consisting of normal recurring adjustments necessary to a fair presentation of quarterly results have been reflected in the data which follows. It is also management's opinion, however, that quarterly operating data for insurance enterprises is not indicative of results to be achieved in succeeding quarters or years. The long-term nature of the insurance business, seasonal patterns in premium production and incidence of claims, and changes in yields on invested assets are some of the factors necessitating a review of operating results, changes in shareholders' equity, and cash flows for periods of several years to obtain a proper indicator of performance. The data below should be read in conjunction with the "Management Analysis of Financial Position and Results of Operations":
In computing the profit or loss before taxes for each segment, the following items have not been added or deducted: general corporate revenues and expenses, parent company interest expense, income taxes, and equity in operating results of, or dividends from, unconsolidated subsidiaries and affiliates. To reconcile the total assets shown for the General, Title, Mortgage Guaranty and Life Groups with total consolidated assets at December 31, 1993 and 1992, adjustments must be made for the parent company assets of $1,650.1 and $1,474.4, and consolidating eliminations of $2,022.9 and $1,578.8, respectively.
Note 8-Related Party Transactions - At December 31, 1993 and 1992, the Corporation owned 98.79% of the non-voting common shares, and 40% of the voting common and preferred shares of the American Business & Mercantile Insurance Group, Inc., ("AB&M Group" or "Group"), an affiliated insurance holding company engaged in the property and liability reinsurance business. As of the same dates, the American Business & Mercantile Insurance Mutual, Inc. ("Mutual"), a property & liability mutual insurer owned by its policyholders, held directly or through a subsidiary 0.10% of the non-voting common shares and 60% of the Group's voting common and preferred shares. At both dates, 1.11% of the Group's non-voting common shares were held by public shareholders.
At December 31, 1993, the Corporation owned 80.0% of the voting common stock of Employers General Insurance Group, Inc. ("EGI") an affiliated insurance holding company engaged in the property and liability insurance and reinsurance business, primarily in Texas. At such date, 20.0% of EGI's voting common stock was held by public shareholders.
Ceded to EGI 1993 1992 Premiums written $ 47.6 $ - Losses and loss expenses 30.4 - Loss and loss expense reserves 22.9 - Unearned premiums $ 13.1 $ -
We have audited the accompanying consolidated balance sheets of Old Republic International Corporation and subsidiaries (the "Company") as of December 31, 1993 and 1992, and the related consolidated statements of income, preferred stock and common shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Old Republic International Corporation and subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.