The distribution channel used to issue our policies affects our profitability margin. Our direct operations provide higher margins because we retain the entire premium from each transaction instead of paying a commission to an independent agent. We regularly review the profitability of our agents, adjust commission levels or cancel certain agents where profitability objectives are not being met and expand operations where acceptable levels of profitability are available.
We continually evaluate our cost structure in relation to anticipated changes in business levels discussed above. Our profit margin was 6.3 percent in 2006 compared to 9.2 percent in 2005 and 10.3 percent in 2004. During 2006, our profit margin was impacted by lower volume in residential business. During 2005, the profit margin was impacted by legal and settlement costs discussed below.
Generally, title insurance claims rates are lower than other types of insurance because title insurance policies insure against prior events affecting the quality of real estate titles rather than against unforeseen, and therefore less predictable, future events. Based on our review of the underlying claims data and trends therein, we have provided for title losses at 6.1 percent of operating revenue from the Title Operations segment for 2006 compared to 5.2 percent in 2005 and 4.3 percent in 2004. The increase in the claims provision ratio in 2006 was primarily due to increased claims in the 2003 and 2004 policy years. Since there is an extended time period for which we are liable, slight changes in frequency and severity of claims in more recent policy years can have a significant affect on the amount of liability required for Incurred But Not Reported (“IBNR”) claims. See “Critical Accounting Estimates - Policy and Contract Claims” below for further discussion.
As indicated above, portions of the Lender Services segment have cyclical trends similar to the Title Operations segment, particularly in the mortgage origination business. As a result of the downturn in the real estate market, operating revenue for the mortgage origination business decreased approximately 13.3 percent before the impact of the acquisitions.
This group includes businesses that are not significant enough in size to be reported as separate segments as well as the unallocated portion of the corporate expenses related to our corporate offices in Richmond, Virginia and unallocated interest expense. The businesses reported in this group provide residential property inspections, home warranties, commercial property valuations and assessments, and due diligence services.
We have pension and other retirement benefit plans covering a portion of our employees. These plans are valued annually by an actuary who employs significant assumptions that are particularly important when determining our projected liabilities for pension and other postretirement benefits. Payments related to these benefits will be made by us over a lengthy period and the projected liability will be impacted by assumptions which include inflation, investment returns and market interest rates, changes in the benefit obligations and laws and regulations covering the benefit obligations.
Operating revenue in the Lender Services segment increased $62.5 million, or 30.3 percent in 2005 compared to 2004. Acquisitions completed during 2004 contributed approximately $21.5 million to the increase in operating revenue for 2005. In 2005, real estate tax processing and flood certification services revenue was made up of gross receipts of $95.8 million, reduced by deferred recognition of revenue for $73.9 million of these receipts and increased by the recognition into revenue of approximately $68.3 million of our previously deferred service arrangements. The recognition of deferred revenue from terminated tax servicing contracts in our tax and flood business contributed approximately $33.8 million to the increase in operating revenue for 2005. The service life of our portfolio did not increase significantly compared to 2004. In addition, operating revenue for 2005 was negatively impacted by lower volume in the mortgage origination and loan servicing businesses as a result of the loss of certain customers partially offset by increased volume in the loan servicing business.
Changes in cash from financing activities primarily relate to the issuance and repayment of borrowings, dividends to our shareholders and other capital transactions. During 2006, uses of cash included stock repurchases of $40.1 million and dividend payments to our shareholders of $13.8 million. These uses of cash were more than offset by an issuance of $150.0 million in senior notes and the draw down of $100.0 million on a new credit facility in 2006 to fund the Capital Title merger and replace maturing senior notes. During 2005, our financing activities primarily related to an increase in funds held as deposits and proceeds from borrowings, partially offset by the cost of shares repurchased and repayments on borrowings. During 2004, our financing activities primarily related to our issuance of $125.0 million in Convertible Senior Debentures at 3.25 percent due in 2034, an increase in amounts held as deposits and the proceeds from the sale of stock warrants, offset by the cost of shares repurchased, the purchase of call options and payments on notes.
We have no required employer contributions to our Cash Balance Pension Plan at this time. We do not anticipate making any contributions to the Plan during 2007. See Note 12 in our financial statements under Part II, Item 8, “Financial Statements and Supplementary Data” for estimated future benefit payments related to unfunded postretirement benefit plans.
Loans receivable are carried at face value net of participations sold, unearned discounts and deferred loan fees and an allowance for losses. Unearned discounts and deferred loan fees are recognized using the interest method. Interest is accrued daily on a simple-interest basis.
While a loan is classified as non-accrual and future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest may be recognized on a cash basis.
In connection with the merger, we issued $100.0 million principal amount of Series E Senior Notes and drew down $100.0 million of our revolving credit facility to fund a portion of the merger. (See Note 10, “Credit Arrangements” for further information.)
Selected unaudited pro forma results of operations for the period ended December 31, 2006, assuming the merger had occurred as of January 1, 2005, is set forth below:
We have issued one preferred share purchase right (a “Right”) for each outstanding share of common stock. Each Right entitles the holder to purchase, upon certain triggering events, shares of our Series A Junior Participating Preferred Stock (“Junior Preferred Stock”) or common stock or other securities, as set forth in the Rights Agreement, as amended, between us and State Street Bank and Trust Company, the parent company of our transfer agent. Generally, the Rights will become exercisable if a person or group acquires or announces a tender offer for 20 percent or more of the outstanding shares of common stock. Under certain circumstances, the Board of Directors may reduce this threshold percentage to not less than 10 percent.
If a person or group acquires the threshold percentage of common stock described above, each Right will entitle the holder, other than such acquiring person or group, to purchase one one-hundredth of a share of Junior Preferred Stock at an exercise price of $85, subject to certain adjustments. As an alternative to purchasing shares of Junior Preferred Stock, if a person or group acquires the threshold percentage of common stock, each Right will entitle the holder, other than such acquiring person or group, to buy, at the then current exercise price of the Right, shares of common stock having a total market value of twice the exercise price. If we are acquired in a merger or other business combination, each Right will entitle the holder, other than such acquiring person or group, to purchase, at the then current exercise price of the Right, securities of the surviving company having a total market value equal to twice the exercise price of the Right. Following the acquisition by any person of more than the threshold percentage of the outstanding shares of our common stock but less than 50 percent of such shares, we may exchange one share of common stock for each Right (other than Rights held by such person).
During the first three quarters of 2004, we repurchased 1.25 million shares under a stock repurchase program authorized by the Board of Directors. In December 2004, the Board of Directors approved a program expiring February 2006 that authorized us to repurchase up to 1 million additional shares at a cost not to exceed $60.0 million. During the fourth quarter 2005, we fully executed the share repurchase program approved in December 2004. In October 2005, the Board of Directors approved a program expiring July 2007 that authorized us to repurchase an additional 1.25 million shares. For the year ended December 31, 2006, we have repurchased 618,000 shares for $40.1 million under the current repurchase program and there are approximately 569,000 shares remaining at December 31, 2006.
We have pension and other retirement benefit plans covering a portion of our employees. On December 31, 2004, we froze the accumulation of benefits available under our principal defined benefit pension plan. Effective December 31, 2004, we ceased future accruals to the retirement plan accounts of all plan participants (other than annual interest credits on account balances), caused the accrued benefits of participants to be fully vested as of December 31, 2004 and limited participation in the plan to those individuals who were participants in the Plan as of December 31, 2004. Participants prior to January 1, 1999, who met the requirements for early retirement on that date, may elect to receive their retirement benefits under the applicable prior plan or formula.
A reconciliation of our insurance subsidiaries’ net statutory surplus between NAIC SAP and practices prescribed and permitted by these states at December 31 is shown below:
We provide title services through direct operations and agents throughout the United States. We also offer title insurance in Mexico, Europe, Canada, the Caribbean, Latin America and Asia. At December 31, 2006 the international operations account for less than 1 percent of our income before income taxes. Tax related services are offered nationwide. Appraisal services are provided in 40 states.