Item 1 - Business
(a) General Development of Business. Old Republic International Corporation is a Chicago-based insurance holding company with subsidiaries engaged in the general (property & liability), mortgage guaranty, title, and life (life & disability) insurance businesses. In this report, "Old Republic", "the Corporation", or "the Company" refers to Old Republic International Corporation and its subsidiaries as the context requires. The aforementioned insurance segments are organized as the Old Republic General, Mortgage Guaranty, Title, and Life Groups, and references herein to such groups apply to the Company's subsidiaries engaged in the respective segments of business.
Financial Information Relating to Segments of Business (a)
The contributions to net revenues and income (loss) before taxes of each Old Republic segment are set forth below for the years shown, together with their respective assets at the end of each year. The information below should be read in conjunction with the consolidated financial statements, the notes thereto, and the "Management Analysis of Financial Position and Results of Operations" appearing elsewhere herein.
- ------------ (a) Reference is made to the table in Note 6 of the Notes to Consolidated Financial Statements, incorporated herein by reference, which shows the contribution of each subcategory to consolidated net revenues and income or loss before income taxes of Old Republic's insurance industry segments. (b) Revenues consist of net premiums, fees, net investment and other income earned; realized investment gains are shown in total for all groups combined. (c) In the first quarter of 1999, the Company sold its New York subsidiary and with it, its annuity book of business; this had no material effect on Old Republic's consolidated results or financial position.
General Insurance Group
Through its General Insurance Group subsidiaries, the Corporation assumes risks and performs related risk management and marketing services pertaining to a large variety of property and liability commercial insurance coverages. Old Republic does not have a meaningful participation in personal lines of insurance.
Liability Coverages: Commercial automobile full coverage protection, workers' compensation and general liability (including the general liability portion of commercial package policies) are the major classes of insurance underwritten for businesses and public entities such as municipalities. Within these classes of insurance, Old Republic specializes in a number of industries, most prominently the transportation, construction, forest product and coal and energy services industries. Such business is primarily produced through agency and brokerage channels.
The rates charged for all workers' compensation insurance are generally regulated by the various states. It is therefore possible that the rate increases necessary to cover any expansion of benefits under state laws or increases in claim frequency or severity may not always be granted soon enough to enable insurers to fully recover the amount of the benefits they must pay.
The Corporation has over the past several years diversified its General Insurance Group business. This diversification has been achieved through a combination of internal growth, the establishment of new subsidiaries, and through selective mergers with other companies. For 2000, production of commercial automobile (principally trucking) direct insurance premiums accounted for 41.9% of consolidated direct premiums written by the General Insurance Group. For the same year, workers' compensation and general liability direct insurance premiums amounted to 17.6% and 10.1%, respectively, of consolidated direct premiums written.
Specialty programs have been expanded or initiated to insure corporations' exposures to directors' and officers', as well as errors and omissions liability, to cover owners and operators of private aircraft for hull and liability exposures, and to insure grain elevators and liquid petroleum gas operations.
The Corporation assumes (primarily on a facultative basis) a moderate amount of reinsurance business produced by other insurance or reinsurance companies. Most of this business encompasses general and automobile liability lines, as well as a moderate amount of property exposures.
Property and Other Coverages: Old Republic's property insurance business primarily includes commercial physical damage insurance on trucking risks. A small volume of business is represented by fire and other physical perils for houses and commercial properties. All such insurance is produced through agents or financial intermediaries, such as finance companies, and on a reinsurance assumed basis.
Fidelity and surety coverages are underwritten through agents by the Old Republic Surety Group, Inc.
Old Republic Insured Credit Services, Inc. has marketed loan and retail installment sales credit guaranty insurance since 1955 through commercial banks and thrift institutions. This coverage provides lenders with a guaranty against defaults on home equity and home improvement loans and installment sales contracts.
Auto Warranty and Home Warranty are marketed directly by Old Republic through its own employees and selected independent agents.
Mortgage Guaranty Group
Real estate mortgage loan insurance protects lending institutions against certain losses, generally to the extent of 10% to 35% of the sum of the outstanding amount of each insured mortgage loan, and allowable costs incurred in the event of default by the borrower. The Corporation insures only first mortgage loans, primarily on residential properties having one-to-four family dwelling units.
Mortgage guaranty insurance premiums originate from savings and loan associations, mortgage bankers and other lending institutions. The Corporation's residential real estate loan insurance business is originated, approximately 15% by savings and loan associations, 65% by mortgage bankers and 20% by other lenders. The profitability of the Corporation's insurance products is not tied in any significant degree to the financial well-being of these institutions. While it is possible that the failure of a large number of such institutions could increase the competition for sales of certain insurance products to the surviving institutions, it is also likely that other institutions or providers of financial services would emerge to take their place.
Annual, monthly and single premium plans for residential real estate loan insurance are offered. Annual plans provide coverage on a year to year basis with first year premiums being dependent on the loan-to-value ratio and the coverage offered. Annual renewal premiums are charged on the basis of the outstanding loan balance on the anniversary date, or, if selected, on the original loan balance. Monthly plans provide coverage on a month-to-month basis with premiums being dependent on the loan-to-value ratio and the coverage offered. In the case of monthly premium plans, the first month and all renewal months are charged on the basis of the outstanding loan amount on the anniversary date or, if selected, on the original loan balance. Single premium plans provide coverage for a period of three to fifteen years, or the number of years required to amortize a standard mortgage to an 80% loan-to-value ratio, if selected. The premium charged similarly depends on the loan-to-value ratio, the coverage offered, the type of loan instrument (whether fixed rate/fixed payment or an adjustable mortgage loan) and whether the property is to be owner occupied. Approximately 11% and 87%, respectively, of the residential real estate loan insurance in force at December 31, 2000, has been written under annual and monthly premium plans. Monthly premium plans, a product that was introduced in 1993, accounted for approximately 98% of the new business written in 2000.
The Corporation limits its residential real estate insurance to lenders approved by it and supervised or regulated by federal or state authorities in order to obtain reasonable assurance as to the effectiveness of such institutions' lending practices. A master policy is issued to each approved lender, but the master policy does not obligate the Corporation to issue insurance on any particular loan. To obtain insurance on a specific mortgage loan, an approved lender generally submits an application, supported by a copy of the borrower's loan application, an appraisal report on the property by either the lender or an independent appraiser, a written credit report on the borrower, an affidavit of the borrower's equity and certain other information. The underwriting department reviews this material and approves or rejects the application, usually on the day it is received. The Corporation generally adheres to the underwriting guidelines published by the Federal Home Loan Mortgage Corporation. Upon approval of an application for insurance of a loan, the Corporation issues a commitment to insure the loan; this is followed by a certificate of insurance when the loan is consummated.
Title Insurance Group
The title insurance business consists primarily of the issuance of policies to real estate purchasers and investors based upon searches of the public records which contain information concerning interests in real property. The policy insures against losses arising out of defects, liens and encumbrances affecting the insured title and not excluded or excepted from the coverage of the policy.
There are two basic types of title insurance policies: lenders' policies and owners' policies. Both are issued for a onetime premium. Most mortgages made in the United States are extended by mortgage bankers, savings and commercial banks, state and federal agencies, and life insurance companies. The financial institutions secure title insurance policies to protect their mortgagees' interest in the real property. This protection remains in effect for as long as the mortgagee has an interest in the property. A separate title insurance policy is issued to the owner of the real estate. An owner's policy of title insurance protects an owner's interest in the title to the property.
The premiums charged for the issuance of title insurance policies vary with the policy amount and the type of policy issued. The premium is collected in full when the real estate transaction is closed, there being no recurring fee thereafter. In many areas, premiums charged on subsequent policies on the same property may be reduced, depending generally upon the time elapsed between issuance of the previous policies and the nature of the transactions for which the policies are issued. Most of the charge to the consumer relates to title services rendered in conjunction with the issuance of a policy rather than to the possibility of loss due to risks insured against. Accordingly, the cost of service performed by a title insurer relates for the most part to the prevention of loss rather than to the assumption of the risk of loss. Claim losses that do occur result primarily from title search and examination mistakes, fraud, forgery, incapacity, missing heirs and escrow processing errors.
In connection with its title insurance operations, Old Republic also provides escrow closing and construction disbursement services and real estate information products and services in connection with real estate transfers and loan transactions.
Life Insurance Group
Credit & Other Life and Disability: Old Republic markets and writes consumer credit life and disability insurance primarily through automobile dealers. Borrowers insured under consumer credit life insurance are also generally covered by consumer credit disability protection. Credit life insurance provides for the repayment of a loan, installment purchase, or other debt obligation in the event of the death of the borrower, while credit disability insurance provides for the payment of installments due on such debt while the borrower is disabled. Old Republic has also written various conventional life, disability/accident and health insurance coverages for many years, principally on a direct marketing basis through banks and other financial services institutions.
Ordinary term life insurance is sold through independent agents and brokers for relatively large face amounts, in both the United States and Canada. Marketing of term life insurance products is aimed principally toward self-employed individuals, professionals, owners of small businesses, and high net worth persons.
Consolidated Underwriting Statistics
The following table reflects underwriting statistics covering: 1) premiums together with loss, expense, and policyholders' dividend ratios for the major coverages underwritten solely in the General, Mortgage Guaranty and Title insurance groups; and 2) a summary of net retained life insurance in force at the end of the years shown:
- ------------ (a) Statutory net premiums earned and expense ratios may vary from amounts calculated pursuant to generally accepted accounting principles due to differences in the calculation of unearned premium reserves and acquisition cost under each accounting method. (b) Amounts and ratios reported are determined pursuant to generally accepted accounting principles. (c) Title loss, expense, and composite ratios are calculated on the basis of combined net premiums and fees earned.
Variations in the loss (including related claim settlement expense) ratios are caused by changes in the frequency and severity of claims incurred, changes in premium rates and the level of premium refunds, and periodic changes in claim and claim expense reserve estimates resulting from ongoing reevaluations of reported and unreported claims and claim expenses. Loss, expense, policyholders' dividends, and composite ratios have been rounded to the nearest percentage point. The loss ratios include loss adjustment expenses where appropriate. Policyholders' dividends are a reflection of changes in loss experience for individual or groups of policies, rather than overall results, and should be viewed in conjunction with loss ratio trends; policyholders' dividends apply principally to workers' compensation insurance.
General Insurance Group loss ratios for workers' compensation and liability insurance coverages in particular may reflect greater variability due to a number of factors. The variability of claims experience is due in part to chance events in any one year, changes in loss costs emanating from participation in involuntary markets (i.e. industry-wide insurance pools and associations in which participation is basically mandatory), and added provisions for loss costs not recoverable from assuming reinsurers which may experience financial difficulties from time to time. The Company generally underwrites concurrently workers' compensation, commercial automobile (liability and physical damage), and general liability insurance coverages for a large number of customers. Accordingly, an evaluation of trends in premiums, loss and dividend ratios for these individual coverages should be considered in the light of such a concurrent underwriting approach. The general insurance portion of the claims ratio improved in 2000 compared to 1999's; the latter was significantly higher when compared to that for 1998. Greater severity for the most recent loss occurrences was mainly responsible for the higher general insurance claim ratio in the last two calendar years. The higher ratios were largely attributable to commercial automobile (truck) liability insurance coverages, though smaller parts of Old Republic's risk transfer business also experienced increases in 1999 in particular, when compared to 2000 and 1998.
The loss ratio for mortgage guaranty insurance declined in each of the last three years; the improvement was mostly attributable to the strong employment and good general economic conditions which have led to lower loan default rates, and much higher cure rates for loans exhibiting payment difficulties. The title insurance loss ratio has been in the low single digits in each of the past three years due to a continuation of favorable trends in claims frequency and severity for business underwritten since 1992.
The decrease in net ordinary life insurance in force is attributed to a reduction in new business written during 2000.
General Insurance Claim Reserves
The Corporation's property and liability insurance subsidiaries establish claim reserves which consist of estimates to settle: a) reported claims; b) claims which have been incurred as of each balance sheet date but have not as yet been reported ("IBNR") to the insurance subsidiaries; and c) the direct costs, (fees and costs which are allocable to individual claims) and indirect costs (such as salaries and rent applicable to the overall administration of claim departments) to administer known and IBNR claims. Such claim reserves, except as to classification in the Consolidated Balance Sheets as to gross and reinsured portions, are reported for financial and regulatory reporting purposes at amounts that are substantially the same.
The establishment of claim reserves by the Corporation's insurance subsidiaries is a reasonably complex and dynamic process influenced by a large variety of factors. These include past experience applicable to the anticipated costs of various types of claims, continually evolving and changing legal theories emanating from the judicial system, recurring accounting and actuarial studies, the professional experience and expertise of the Company's claim departments' personnel or attorneys and independent adjusters retained to handle individual claims, the effect of inflationary trends on future claim settlement costs, and periodic changes in claim frequency patterns such as those caused by natural disasters, illnesses, accidents, or work-related injuries. Consequently, the reserve-setting process relies on the judgments and opinions of a large number of persons, on historical precedent and trends, and on expectations as to future developments. At any point in time, the Company and the industry are exposed to possibly higher than anticipated claim costs due to the aforementioned factors, and to the evolution, interpretation, and expansion of tort law, as well as to the effects of unexpected jury verdicts.
In establishing claim reserves, the possible increase in future loss settlement costs caused by inflation is considered implicitly, along with the many other factors cited above. Reserves are generally set to provide for the ultimate cost of all claims. With regard to workers' compensation reserves, however, the ultimate cost of long-term disability or pension-type claims is discounted to present value based on interest rates ranging from 3.5% to 4.0%. The Company, where applicable, uses only such discounted reserves in evaluating the results of its operations, in pricing its products and settling retrospective and reinsured accounts, in evaluating policy terms and experience, and for other general business purposes. Solely to comply with reporting rules mandated by the Securities and Exchange Commission, however, Old Republic has made statistical studies of applicable workers' compensation reserves to obtain estimates of the amounts by which claim and claim adjustment expense reserves, net of reinsurance, have been discounted. These studies have resulted in estimates of such amounts at approximately $151.7 million, $154.4 million and $169.5 million, as of December 31, 2000, 1999, and 1998, respectively. It should be noted, however, that these differences between discounted and non-discounted (terminal) reserves are, fundamentally, of an informational nature, and are not indicative of an effect on operating results for any one or series of years for the above-noted reasons.
The Company believes that its overall reserving practices have been consistently applied over many years, and that its aggregate net reserves have resulted in reasonable approximations of the ultimate net costs of claims incurred. However, no representation is made that ultimate net claim and related costs will not be greater or lower than previously established reserves.
The following table shows the indicated deficiencies or redundancies for the years 1990 to 2000. In reviewing this tabular data, it should be noted that prior periods' loss payment and development trends may not be repeated in the future due to the large variety of factors influencing the reserving process outlined herein above. The reserve redundancies or deficiencies shown for all years are not necessarily indicative of the effect on reported results of any one or series of years since retrospective premium and commission adjustments employed in various parts of the Company's business may offset, in whole or in part, such effects. (See "Consolidated Underwriting Statistics" above, and "Reserves, Reinsurance, and Retrospective Adjustments" elsewhere herein).
The subject of property and liability insurance claim reserves has been written about and analyzed extensively by a large number of professionals and regulators. Accordingly, the above discussion summary should, of necessity, be regarded as a basic outline of the subject and not as a definitive presentation.
(1) Amounts are reported net of reinsurance recoverable. (2) Excluding unallocated loss adjustment expense reserves. (3) Percent of most recent reestimated liability (line d). Decreases in paid loss percentages may at times reflect the reassumption by the Company of certain previously ceded loss reserves. (4) Percent of beginning liability (line b) for unpaid claims and claim adjustment expenses. (5) Most current liability reestimated (line d) as a percent of beginning liability (line b).
The following table shows an analysis of changes in aggregate reserves for the Company's property and liability insurance claims and claim adjustment expenses (1) for each of the years shown.
- ------------ (1) Excluding unallocated loss adjustment expense reserves. (2) Reserves for incurred but not reported losses amounted to approximately 24.8%, 24.9% and 29.9% of the totals shown as of December 31, 2000, 1999 and 1998, respectively.
The data in the two tables above, incorporates Old Republic's estimates for various asbestosis and environmental impairment ("A&E") claims or related costs that have been filed in the normal course of business against a number of its insurance subsidiaries. Such claims relate primarily to policies issued prior to 1985, many during a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. During all years and through the current date, the Corporation's insurance subsidiaries have typically issued general liability insurance policies with face amounts ranging between $1 million and $2 million and rarely exceeding $10 million. Such policies have, in turn, been subject to reinsurance cessions which have typically reduced the Corporation's retentions to $500,000 or less as to each claim.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to provide for normal claim occurrences as well as unusual exposures such as those pertaining to A&E claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves to cover certain claims such as those emanating from A&E exposures. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 2000, the Corporation's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to approximately $75.3 million gross, and $39.4 million, net of reinsurance. Based on average annual claims payments during the five most recent calendar years, such reserves represented 10.0 years (gross) and 15.5 years (net) of average annual claims payments.
Old Republic disagrees with the allegations of liability on virtually all A&E related claims of which it has knowledge on the grounds that exclusions in the policies preclude coverage for nearly all such claims, and that the Corporation never intended to assume such risks. Old Republic's exposure on such claims cannot therefore be calculated by conventional insurance reserving methods for this and a variety of reasons, including: a) the absence of statistically valid data inasmuch as such claims typically involve long reporting delays and very often uncertainty as to the number and identity of insureds against whom such claims have arisen or will arise; and b) the litigation history of such or similar claims for other insurance industry members that has produced court decisions that have been inconsistent with regard to such questions as when the alleged loss occurred, which policies provide coverage, how a loss is to be allocated among potentially responsible insureds and/or their insurance carriers, how policy coverage exclusions are to be interpreted, what types of environmental impairment or toxic tort claims are covered, when the insurer's duty to defend is triggered, how policy limits are to be calculated, and whether clean-up costs constitute property damage.
Individual insurance companies and others who have evaluated the potential costs of litigating and settling A&E claims have noted with serious concern the possibility that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, could likely undermine materially the financial condition of major participants in the property and liability insurance industry. In light of this substantial public policy issue, the Corporation is of the view that the courts will not resolve in the near future the litigation gridlock stemming from the non-resolution to date of environmental claims in particular. In recent times, the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting the determination of liability for environmental claims. As of December 31, 2000, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
Because of the above issues and uncertainties, estimation of reserves for losses and allocated loss adjustment expenses for the above noted types of claims is much more difficult or impossible. Accordingly, no representation can be made that the Corporation's reserves for such claims and related costs will not prove to be overstated or understated in the future.
(b) Investments. In common with other insurance organizations, Old Republic invests most funds provided by operations in income-producing investment securities.
All investments must comply with applicable insurance laws and regulations which prescribe the nature, form, quality, and relative amounts of investments which may be made by insurance companies. Generally, these laws and regulations permit insurance companies to invest within varying limitations in state, municipal and federal government obligations, corporate obligations, preferred and common stocks, certain types of real estate, and first mortgage loans. Old Republic's investment policies are also influenced by the terms of the insurance coverages written, by its expectations as to the timing of claim and benefit payments, and by income tax considerations. The following tables show invested assets at the end of the last three years, together with investment income for such years.
- ------------ (a) Investment expenses consist primarily of personnel costs, investment management and custody service fees and includes interest incurred on funds held of $1.5, $1.5 and $1.5 for the years ended December 31, 2000, 1999 and 1998, respectively.
For many years, Old Republic's investment policy has been to acquire and retain primarily investment grade, publicly traded, fixed maturity securities. Accordingly, the Corporation's exposure to so-called "junk bonds", private placements, real estate, mortgage loans, and derivatives is immaterial or non-existent. Management considers investment-grade securities to be those rated by Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors Service, Inc. ("Moody's") that fall within the top four rating categories, or securities which are not rated but have characteristics similar to securities so rated. The Company had bond and note investments in default as to principal and/or interest of $5.1 at December 31, 2000 and none at December 31, 1999.
The Company's investment policies have not been designed to maximize realized investment gains. Such gains in most recent years were mostly due to the sale of equity securities. Dispositions of securities were principally the result of scheduled maturities of bonds and notes and sales of equity securities. The Company's invested assets as of December 31, 2000 have been classified solely as "held to maturity" or "available for sale" pursuant to the existing investment policy.
The independent credit quality ratings and maturity distribution for Old Republic's consolidated fixed maturity investments, excluding short-term investments, at December 31, 2000 and 1999, are shown in the following tables. These investments, $4.3 billion and $4.2 billion at December 31, 2000 and 1999, respectively, represented approximately 59% and 61%, respectively, of consolidated assets as of such dates, and 89% and 90%, respectively, of consolidated liabilities as of such dates.
- ------------ (a) Ratings are assigned primarily by Moody's with remaining ratings assigned by Standard & Poor's and converted to the equivalent Moody's rating. (b) "All others" include securities which when purchased were investment grade, non-investment grade or non-rated convertible securities, and other non-rated securities such as small issues of tax exempt bonds.
(c) Marketing. Commercial automobile, workers' compensation and general liability insurance underwritten for larger commercial enterprises and public entities is marketed primarily through independent insurance agents and brokers with the assistance of Old Republic's trained sales, underwriting, actuarial, and loss control personnel. The remaining property and liability commercial insurance written by Old Republic is obtained through insurance agents or brokers who are independent contractors and generally represent other insurance companies, by direct sales, and through controlled marketing and underwriting joint ventures. No single source accounted for over 10% of Old Republic's premium volume in 2000.
Mortgage guaranty insurance is marketed primarily through a direct sales force which calls on savings and loan associations, other lending institutions, and mortgage bankers. No sales commissions or other forms of remuneration are paid to the lending institutions and others for the procurement or development of business.
The Mortgage Guaranty segment's ten largest customers were responsible for approximately 60.3%, 48.9% and 44.5% of direct insurance in force for the years ended December 31, 2000, 1999 and 1998, respectively. The largest single customer accounted for 11.7% of the direct insurance in force for the year ended December 31, 2000 compared to 9.5% in 1999 and 9.0% in 1998.
A substantial portion of the Company's title insurance business is referred to it by title insurance agents, builders, lending institutions, real estate developers, realtors, and lawyers. Title insurance is sold through 246 Company offices located in 32 states and through agencies and underwritten title companies in Guam, Puerto Rico, the District of Columbia and all states except Iowa and Oregon. The issuing agents are authorized to issue binders and title insurance policies based on their own search and examination, or on the basis of abstracts and opinions of approved attorneys. Policies are also issued through independent abstract companies (not themselves title insurers) pursuant to underwriting agreements. These agreements generally provide that the underwritten company may cause title policies of the Company to be issued, and the latter is responsible under such policies for any payments to the insured. Typically, the agency or underwritten title company deducts the major portion of the title insurance charge to the consumer as its commission for services. During 2000, approximately 54% of title insurance premiums and fees were accounted for by policies issued by agents and underwritten title companies.
Title insurance premium and fee revenue is closely related to the level of activity in the real estate market. The volume of real estate activity is affected by the availability and cost of financing, population growth, family movements and other factors. Also, the title insurance business is seasonal. During the winter months, new building activity is reduced and, accordingly, the Company does less title insurance business relative to new construction during such months than during the rest of the year. The most important factor, insofar as Old Republic's title business is concerned, however, is the rate of activity in the resale market for residential properties.
The personal contacts, relationships, and reputations of Old Republic's key executives are a vital element in obtaining and retaining much of its business. Many of the Company's customers produce large amounts of premiums and therefore warrant substantial levels of top executive attention and involvement. In this respect, Old Republic's mode of operation is similar to that of professional reinsurers and commercial insurance brokers, and relies on the marketing, underwriting, and management skills of relatively few key people for large parts of its business.
Several types of insurance coverages underwritten by Old Republic, such as credit life and disability, loan credit guaranty, title, and mortgage guaranty insurance, are affected in varying degrees by changes in national economic conditions. During periods of economic recession or rising interest rates, operating and/or claim costs pertaining to such coverages tend to rise disproportionately to revenues and generally result in reduced levels of profitability.
At least one Old Republic insurance subsidiary is licensed to do business in each of the 50 states, the District of Columbia, Puerto Rico, Virgin Islands, Guam, and each of the Canadian provinces; mortgage insurance subsidiaries are licensed in 50 states and the District of Columbia; title insurance operations are licensed to do business in 48 states, the District of Columbia, Puerto Rico and Guam. Consolidated direct premium volume distributed among the various geographical regions shown was as follows for the past three years:
(d) Reserves, Reinsurance, and Retrospective Adjustments. Old Republic's insurance subsidiaries establish reserves for future policy benefits, unearned premiums, reported claims, claims incurred but not reported, and claim adjustment expenses, as required in the circumstances. Such reserves are based on regulatory accounting requirements and generally accepted accounting principles. In accordance with insurance industry practices, claim reserves are based on estimates of the amounts that will be paid over a period of time and changes in such estimates are reflected in the financial statements when they occur. See "General Insurance Claim Reserves" herein.
To maintain premium production within its capacity and limit maximum losses and risks for which it might become liable under its policies, Old Republic, as is the practice in the insurance industry, may cede a portion or all of its premiums and liabilities on certain classes of insurance, individual policies, or blocks of business to other insurers and reinsurers. Although the ceding of insurance does not generally discharge an insurer from its direct liability to a policyholder, it is industry practice to establish the reinsured part of risks as the liability of the reinsurer. Old Republic also employs retrospective premium adjustments, contingent commissions, agency profit and risk-sharing arrangements, and joint underwriting ventures for parts of its business in order to minimize losses for which it might become liable under its insurance policies, and to afford its clients or producers a degree of participation in the risks and rewards associated with such business. Under retrospective arrangements, Old Republic collects additional premiums if losses are greater than originally anticipated and refunds a portion of original premiums if loss costs are lower. Pursuant to contingent commissions, agency profit and other risk-sharing arrangements, the Company adjusts commissions or premiums retroactively to likewise reflect deviations from originally expected loss costs. The amount of premium, commission, or other retroactive adjustments which may be made is either limited or unlimited depending on the Company's evaluation of risks and related contractual arrangements. To the extent that any reinsurance companies, retrospectively rated risks, or producers might be unable to meet their obligations under existing reinsurance or retrospective insurance and commission agreements, Old Republic would be liable for the defaulted amounts. In these regards, however, the Company generally protects itself by withholding funds, by securing indemnity agreements, surety bonds, or by otherwise collateralizing reinsurance obligations through irrevocable letters of credit, cash, or securities.
Old Republic's reinsurance practices with respect to portions of its business also result from its desire to bring its sponsoring organizations and customers into some degree of joint venture or risk sharing relationship. The Corporation may, in exchange for a ceding commission, reinsure up to 100% of the underwriting risk, and the premium applicable to such risk, to insurers owned by or affiliated with lending institutions, sponsors whose customers are insured by Old Republic, or individual customers who have formed "captive" insurance companies. The ceding commissions received compensate Old Republic for performing the direct insurer's functions of underwriting, actuarial, claim settlement, loss control, legal, reinsurance, and administrative services to comply with local and federal regulations, and for providing appropriate risk management services.
Remaining portions of Old Republic's business are reinsured with independent insurance or reinsurance companies under various quota share and excess of loss agreements.
Reinsurance protection on property and liability operations generally limits the net loss on any one risk to a maximum of (in whole dollars): workers' compensation-$1,000,000; auto liability-$600,000; general liability-$600,000; and property coverages-$300,000. Substantially all the mortgage guaranty insurance business is retained, with the exposure on any one risk currently averaging approximately $29,000. Title insurance risk assumptions, based on the title insurance subsidiaries' financial resources, are limited to a maximum of $25,000,000 as to any one policy. The maximum amount of ordinary life insurance retained on any one life by the Life Insurance Group is $300,000.
(e) Competition. The insurance business is highly competitive and Old Republic competes with many stock and mutual insurance companies. Many of these competitors offer more insurance coverages and have substantially greater financial resources than the Corporation. The rates charged for many of the insurance coverages in which the Corporation specializes, such as workers' compensation insurance, other property and liability insurance, title insurance, and credit life and disability insurance, are primarily regulated by the states and are also subject to extensive competition among major insurance organizations. The basic methods of competition available to Old Republic, aside from rates, are service to customers, expertise in tailoring insurance programs to the specific needs of its clients, efficiency and flexibility of operations, personal involvement by its key executives, and, as to title insurance, accuracy and timely delivery of evidences of title issued. For certain types of coverages, including loan credit guaranty and mortgage guaranty insurance, the Company also competes in varying degrees with the Federal Housing Administration ("FHA") and the Veterans Administration ("VA"). In these regards, the Corporation's insurance subsidiaries compete with the FHA and VA by offering different coverages and by establishing different requirements relative to such factors as interest rates, closing costs, and loan processing charges. The Corporation believes its experience and expertise have enabled it to develop a variety of specialized insurance programs for its customers and to secure state insurance departments' approval of these programs.
(f) Government Regulation. In common with all insurance companies, the Corporation's insurance subsidiaries are subject to the regulation and supervision of the jurisdictions in which they do business. The method of such regulation varies, but, generally, regulation has been delegated to state insurance commissioners who are granted broad administrative powers relating to: the licensing of insurers and their agents; the nature of and limitations on investments; approval of policy forms; reserve requirements; and trade practices. In addition to these types of regulation, many classes of insurance, including most of the Corporation's insurance coverages, are subject to rate regulations which require that rates be reasonable, adequate, and not unfairly discriminatory.
The Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC") have various qualifying requirements for private mortgage guaranty insurers which write mortgage insurance on loans acquired by the FNMA and FHLMC from mortgage lenders. These requirements include a basic standard calling for the maintenance of a ratio of aggregate insured risk to policyholders' surplus (defined as total statutory capital and surplus plus statutory contingency reserves) of not more than 25 to 1; maintaining the contingency reserve in accordance with state statutes and maintaining minimum policyholders' surplus of $5 million.
Most of the Company's savings and loan association customers for mortgage guaranty insurance are governed by the regulations of the Federal Home Loan Bank Board. A regulation of that Board prohibits savings and loan associations from insuring any loan with a mortgage insurance company if certain relationships exist between such mortgage insurance company and the savings and loan association. Generally, a savings and loan association may not obtain insurance from any mortgage insurance company if (1) any commission, fee or other compensation is paid to the savings and loan association or any of its officers, directors, employees or affiliates, (2) a savings account is maintained by the mortgage insurance company with such savings and loan association, (3) any officer or employee of the mortgage insurance company or its parent company is a director, officer or controlling person of the savings and loan association, or (4) either (a) the association or any director, officer, controlling person or affiliate holds equity securities of the mortgage insurance company or any parent company thereof having a cost in excess of $50,000 or representing more than one percent of any class of equity securities of the company, if its assets are less than $50 million, or one-half percent, if the assets equal or exceed $50 million, or (b) the association and all of its directors, officers, controlling persons or affiliates in the aggregate own equity securities of the mortgage insurance company having a cost in excess of $100,000, or two percent of a company the assets of which are less than $50 million, or one percent, if the assets equal or exceed $50 million.
There have been various proposals from time to time with respect to additional regulation of credit life and disability insurance which could have an adverse effect on the consumer credit insurance business. The financial institutions whose customers are insured by Old Republic are also regulated by federal and state authorities whose regulations have a direct effect on certain forms of credit life and disability insurance.
The majority of states have also enacted insurance holding company laws which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. Old Republic's insurance subsidiaries are subject to such legislation and are registered as controlled insurers in those jurisdictions in which such registration is required. Such legislation varies from state to state but typically requires periodic disclosure concerning the corporation which controls the registered insurers, or ultimate holding company, and all subsidiaries of the ultimate holding company, and prior approval of certain intercorporate transfers of assets (including payments of dividends in excess of specified amounts by the insurance subsidiary) within the holding company system. Each state has established minimum capital and surplus requirements to conduct an insurance business. All of the Company's subsidiaries meet or exceed these requirements, which vary from state to state.
(g) Employees. As of December 31, 2000, Old Republic employed approximately 5,815 persons on a full time basis. A majority of eligible full time employees participate in various pension plans which provide annuity benefits payable upon retirement. Eligible employees are also covered by hospitalization and major medical insurance, group life insurance, and various savings, profit sharing, and deferred compensation plans. The Company considers its employee relations to be good.
Item 2
Item 2 - Properties
The principal executive offices of the Company are located in the Old Republic Building in Chicago, Illinois. This Company owned building contains 151,000 square feet of floor space of which approximately 54% is occupied by Old Republic, and the remainder is leased to others. In addition to the Company-owned principal executive offices, a subsidiary of the Title Insurance Group partially occupies its headquarters building. This building contains 110,000 square feet of floor space of which approximately 65% is occupied by the Old Republic National Title Insurance Company. The remainder of the building is leased to others. Ten smaller buildings are owned by Old Republic and its subsidiaries in various parts of the country and are primarily used for its business. The carrying value of all buildings and related land at December 31, 2000 was approximately $19.1 million.
Certain other operations of the Company and its subsidiaries are directed from leased premises. See Note 4(b) of the Notes to Consolidated Financial Statements for a summary of all material lease obligations.
Item 3
Item 3 - Legal Proceedings
Legal proceedings against the Company arise in the normal course of business and generally pertain to claim matters related to insurance policies and contracts issued by the Corporation's insurance subsidiaries.
The Federal Department of Labor has revised the Federal Black Lung Program regulations effective January 19, 2001. These new regulations, which might require a re-evaluation of previously settled or denied workers' compensation claims, are being challenged in court by the insurance and coal mining industries. At this time, the outcome of this challenge is uncertain and the potential impact on gross and net of reinsurance reserves or retrospective rating policies due to the revised regulations is not measurable.
In December 1999, a class action lawsuit was filed against one of the Company's mortgage guaranty insurance subsidiaries in the Federal District Court for the Southern District of Georgia. The suit alleges that the subsidiary provided pool insurance and other services to mortgage lenders at preferential, below market prices in return for mortgage insurance business, and that such practices violated the Real Estate Settlement Procedures Act. The Court ruled in favor of a summary judgement motion filed by the Company's subsidiary and dismissed the law suit. The class plaintiffs have appealed and the appeal is currently before the U.S. Court of Appeals for the Eleventh Circuit. The ultimate outcome of this litigation is unknown at the present time. Accordingly, no provision for any liability, including the additional cost of defense, has been included in the Company's financial statements.
The City and County of San Francisco and certain escrow customers of an underwritten title agency subsidiary headquartered in the State of California have filed law suits alleging that the subsidiary: 1) failed to escheat unclaimed escrow funds; 2) charged for services not necessarily provided; and 3) collected illegal interest payments or fees from banks on the basis of funds held for escrow customers. The subsidiary has in turn conducted an internal review of its records and concluded that it had certain liabilities for part of the issues denoted at (1) and (2). Management believes that the alleged practices denoted at (3) are common within the industry, are not in conflict with various laws and regulations, and that it has meritorious defenses which will ultimately lead to a successful resolution of these practices. Through December 31, 2000, as the litigation has progressed on several fronts and additional information has come to its attention, the subsidiary has continually reevaluated its exposures and it has paid or otherwise provided cumulatively $39.8 million for its best estimate of litigation and related costs associated with all these issues.
In mid October, 2000, the California Department of Insurance (CDI) filed a complaint against the above referenced subsidiary. The complaint alleges violations of certain sections of the Insurance Code that prohibit any form of considerations to induce the referral of business to a title company. The CDI is seeking a maximum monetary penalty of $3.8 million. The Company believes it has meritorious defenses to the allegations and that its overall claim and other expense accruals are sufficient to cover these and other known exposures.
Item 4
Item 4 - Submission of Matters to a Vote of Security Holders
None
Item 4(a)-Executive Officers of the Registrant
Name Age Position - ------------------ --- ----------------------------------------------------- Paul D. Adams 55 Senior Vice President, Chief Financial Officer since 1990 and Treasurer since 1993.
Spencer LeRoy, III 54 Senior Vice President, General Counsel, and Secretary since 1992.
William A. Simpson 59 Senior Vice President/Mortgage Guaranty, and Director since 1980. President since 1972 of Republic Mortgage Insurance Company, a wholly-owned subsidiary.
A. C. Zucaro 61 Chief Executive Officer, President, Director and Chairman of the Board since 1990, 1981, 1976 and 1993, respectively.
The term of office of each officer of the Company expires on the date of the annual meeting of the board of directors, which is generally held in May of each year. There is no family relationship between any of the executive officers named above. Each of these named officers has been employed in executive capacities with the Company and/or its subsidiaries for the past five years.
PART II
Item 5
Item 5 - Market for the Registrant's Common Stock and Related Security Holder Matters
The Company's common stock is traded on the New York Stock Exchange under the symbol "ORI". The high and low closing prices as reported on the New York Stock Exchange, and cash dividends declared for each quarterly period during the past two years were as follows:
As of January 31, 2001, there were 3,276 registered holders of the Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial Statements for a description of certain regulatory restrictions on the payment of dividends by Old Republic's insurance subsidiaries. Closing prices have been restated, as necessary, to reflect all stock dividends and splits declared through December 31, 2000.
- -------------------------------------------------------------------------------- See Notes on Following Page
Notes to Item 6
Item 7 - Management Analysis of Financial Position and Results of Operations ($ in Millions, Except Share Data) - --------------------------------------------------------------------------------
OVERVIEW
This analysis pertains to the consolidated accounts of Old Republic International Corporation. The Company conducts its business through four separate segments, namely its General (property and liability coverages), Mortgage Guaranty, Title, and Life insurance groups.
FINANCIAL POSITION
Old Republic's financial position at December 31, 2000 reflected increases in assets, liabilities and common shareholders' equity of 4.9%, 2.2% and 10.9%, respectively, when compared to the immediately preceding year-end. Cash and invested assets represented 70.6% and 69.6% of consolidated assets as of December 31, 2000 and 1999, respectively. Consolidated operations produced positive cash flows for the latest three years. 2000 cash flow returned to a level slightly above the amount reported for 1998. 1999 cash flow was down compared to 2000 and 1998 due mainly to lower contributions from Old Republic's general insurance segment. In 2000, the invested asset base increased 6.3% principally as a result of greater operating cash flow and an increase in the value of bonds and stocks carried at market value; this was offset slightly by cash outflow to finance the Company's stock buy back program.
Relatively high short-term maturity investment positions are generally maintained 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 expected operating cash flows and investment strategy. Accordingly, the future level of short-term investments will vary and respond to the interplay of these factors and may, as a result, increase or decrease from current levels. During 2000 and 1999, the Corporation committed most 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; investable funds have not been directed to so-called "junk bonds" or types of securities categorized as derivatives. Old Republic's commitment to equity securities during 2000 increased vis-a-vis the related invested balance at year-end 1999 due to securities acquired and unrealized gains during the period. At December 31, 2000, the carrying value of bond and note investments in default as to principal and/or interest was immaterial in relation to consolidated assets or shareholders' equity.
The Company does not own or utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its debt obligations. Traditional investment management tools and techniques are employed to address the yield and valuation exposures of its invested assets base. The long term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through asset diversification and the purchase of investment grade securities. Reinvestment rate risk is controlled by concentrating on non-callable issues, and by taking asset-liability matching practices into account; purchases of mortgage and asset backed securities, which have variable principal prepayment options, are generally avoided. Market value risk is limited through the purchase of bonds of intermediate maturity. The combination of these investment management tenets is expected to produce a more stable long term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration. The market value of the Company's long term fixed maturity investment portfolio is sensitive, however, to fluctuations in the level of interest rates, but not materially affected by changes in anticipated cash flows caused by any prepayments. The impact of interest rate movements on the long term fixed maturity investment portfolio generally affects net realized gains or losses when securities are sold. With a market value of approximately $4,338.5, the long term fixed maturity investment portfolio has an average maturity of 4.4 years and an indicated duration of 3.8. This implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the market value of the long term fixed maturity investment portfolio of approximately 3.8%, or $162. With regard to its $292.9 common stock portfolio, the Company does not own nor engage in any type of option writing. A 10% decrease in the U.S. equity market prices could result in a decrease of $29.2 in the market value of the Company's common stock portfolio. These possible declines in values for Old Republic's bond and stock portfolios would affect negatively the level of the common shareholders' equity account at any point in time, but would not necessarily result in the recognition of realized investment losses as a likely combination of positive operating cash flow and the scheduled emergence of bond maturities should provide sufficient funds to meet obligations to policyholders and claimants, as well as debt service and cash dividend requirements at the holding company level.
The parent holding company generally meets its liquidity and capital needs through dividends paid by its subsidiaries and the issuance of short-term debt. The insurance subsidiaries' ability to pay cash dividends to the parent company, however, is generally restricted by law or subject to approval of the insurance regulatory authorities
of the states in which they are domiciled.
Old Republic's capitalization of $2,677.4 at December 31, 2000 consisted of long and short-term debt of $238.0, a minor amount of convertible preferred stock, and common shareholders' equity of $2,438.7. The changes in the common shareholders' equity account for the most recent three calendar years reflect primarily the retention of earnings in excess of dividends declared on outstanding preferred and common shares, an increase during 2000 and 1998 compared to a decrease during 1999 in the value of bonds and stocks carried at market value, and the acquisition of $66.4, $188.1 and $151.1 in 2000, 1999 and 1998, respectively, of the Company's common shares in open market transactions. In March 2000, the Company canceled 36.4 million common shares previously reported as treasury stock, restoring them to unissued status; this had no effect on total shareholders' equity or the financial condition of the Company. At its March 23, 2000 meeting, the Company's Board of Directors authorized the reacquisition of up to $200.0 of common shares as market conditions would warrant during the two year period from that date; as of December 31, 2000 a total of $177.3 of this authorization remained unutilized.
RESULTS OF OPERATIONS Revenues:
Consolidated net premiums and fees earned decreased by 2.5% and 1.6% in 2000 and 1999, respectively, and increased by 11.2% in 1998. Property and liability earned premiums increased 0.5% in 2000, and decreased 5.4% and 0.4% in 1999 and 1998, respectively. Premium production trends in this segment in the past three years were generally affected by a soft pricing environment that, until late 1999, made it difficult for the Company to obtain rate increases in a market place that's remained quite competitive. During the year 2000, Old Republic continued to shed some of the business for which it was unable to obtain necessary rate relief. Growth in mortgage guaranty premiums for the past three years was enhanced principally by relatively strong mortgage lending activity nationwide and by greater persistency of business in force in 1999 and 2000. Title Group premiums and fee revenues decreased 13.9% in 2000, and increased 2.8% in 1999 and 38.9% in 1998. Greater housing and mortgage finance activity were the main reasons for the rise in revenues in 1999 and 1998; the decrease in 2000 resulted mostly from a substantial decline in refinancings. Life and disability premiums in 2000 were approximately the same as in 1999; they decreased in 1999 due to reduced volume of Canadian travel accident insurance, and increased during 1998 as a result of greater term life and accident insurance production.
Net investment income grew by 4.1% and 0.9% in 2000 and 1998, respectively, and was down 3.6% in 1999. For each of the past three years, this revenue source was affected by positive consolidated operating cash flows, by a concentration of investable assets in interest-bearing fixed maturity securities, and by changes in market yields. As previously noted, the Company used mostly internal funds in the three latest calendar years for open market purchases of its common stock, thus reducing the size and earning power of its invested assets base. The average annual yield on investments was 5.6%, 5.5% and 5.7% for the years ended December 31, 2000, 1999 and 1998, respectively. This yield pattern reflects at once the relatively short maturity of Old Republic's fixed maturity securities portfolio, an uptrend in yields in 2000, and generally flat to declining yields during most of 1999 and 1998.
The Company's investment policies are not designed to maximize realized investment gains. Such gains were higher in 1998 than those registered in 2000 and 1999, mostly due to the discretionary sale of equity securities as market and other considerations warranted. Dispositions of securities were principally the result of scheduled maturities of bonds and notes and sales of equity securities. In 2000, 79.9% of total dispositions represented contractual maturities and early calls of existing holdings; for the years 1999 and 1998 these amounted to 71.0% and 58.3%, respectively.
Expenses:
Consolidated benefit, claim, and related settlement costs, as a percentage of net premiums and fees earned, were approximately 43.8% in 2000, 46.8% in 1999 and 43.2% in 1998. The general insurance portion of the claims ratio improved in 2000 compared to 1999's; the ratio for the latter was significantly higher when compared to that for 1998. Greater severity for the most recent loss occurrences was mainly responsible for the higher general insurance claim ratio in the last two calendar years. The higher ratios were largely attributable to commercial automobile (truck) liability insurance coverages, though smaller parts of Old Republic's risk transfer business also experienced increases in 1999 in particular, when compared to 2000 and 1998. The loss ratio for mortgage guaranty insurance declined in each of the last three years; the improvement was mostly attributable to the strong employment and good general economic conditions which have led to lower loan default rates, and much higher cure rates for loans exhibiting payment difficulties. The title insurance loss ratio has been in the low single digits in each of the past three years due to a continuation of favorable trends in claims frequency and severity for business underwritten since 1992.
The ratio of consolidated underwriting, acquisition, and insurance expenses to net premiums and fees earned was approximately 49.6% in 2000, 52.6% in 1999 and 50.2% in 1998. Variations in these ratios reflect a continually changing mix of coverages underwritten and attendant costs of producing business. The property and liability segment's
expense ratio remained approximately the same, averaging 28.3% during the latest three year period. The mortgage guaranty segment's expense ratio decreased in 2000 compared to 1999 and 1998 due to lower costs associated with an enhancement of information systems substantially completed in 1999, and a reduction in costs associated with contract underwriting services. The title insurance expense ratio was higher in 2000 and 1999 due in part to a decline or reduced growth in premium and fees relative to production and operating costs. Consumer and regulatory litigation and disputes in Old Republic's California title insurance subsidiary were responsible for expenses of $4.1, $16.2 and $19.5 charged to 2000, 1999 and 1998 operations, respectively. Consolidated interest and other corporate charges rose in 2000 due primarily to greater interest costs from a higher debt level.
Pre-Tax and Net Income:
Consolidated income before taxes increased by 34.5% in 2000, declined by 32.1% in 1999 and rose by 9.4% in 1998. General insurance results improved significantly in 2000 compared to 1999 due to better underwriting experience, which, nonetheless, was still lower than that achieved in 1998. The mortgage guaranty segment reflected rising earnings in each of the last three years due to increased premium revenues that generated higher income from underwriting operations, and higher investment income from a greater invested assets base. Title insurance earnings during the past three years were higher in 1998 compared to 2000 and 1999; this reflected the previously noted revenue and expense trends. Life and disability operations registered slightly increased earnings in 2000, whereas 1999 earnings benefited from the revision of certain actuarial factors used in calculating various life and health reserves and deferred acquisition costs. The net benefit of these revisions, the majority of which applied to 1999 premium revenues, amounted to approximately $4.8; this was partially offset by underwriting losses in Old Republic's Canadian travel accident coverages.
The effective consolidated income tax rates were 30.7% in 2000, 29.3% in 1999 and 31.2% in 1998. The rates for each year reflect primarily the varying proportions of pre-tax operating income derived from tax-sheltered investment income (principally tax-exempt interest) on the one hand, and the combination of fully taxable investment income, realized investment gains, and underwriting and service income, on the other hand. The lower rate in 1999 resulted from reduced income from underwriting and related services.
OTHER INFORMATION
Reference is here made to "Financial Information Relating to Segments of Business" appearing elsewhere herein.
Historical data pertaining to the operating performance, liquidity, and other financial matters applicable to an insurance enterprise such as Old Republic are not necessarily indicative of results to be achieved in succeeding years. In addition to the factors cited below, the long-term nature of the insurance business, seasonal and annual patterns in premium production and incidence of claims, changes in yields obtained on invested assets, changes in government policies and free markets affecting inflation rates and general economic conditions, and changes in legal precedents or the application of law affecting the settlement of disputed claims can have a bearing on period-to-period comparisons and future operating results.
Any forward-looking commentary or inferences contained in this report involve, of necessity, assumptions, uncertainties, and risks that may affect the Company's future performance. With regard to Old Republic's General Insurance segment, its results can be affected in particular by the level of market competition which is typically a function of available capital and expected returns on such capital among competitors, the levels of interest and inflation rates, as well as periodic changes in claim frequency and severity patterns caused by natural disasters, weather conditions, accidents, illnesses, work-related injuries, and unanticipated external events. Mortgage Guaranty and Title insurance results can be affected by such factors as changes in national and regional housing demand and values, the availability and cost of mortgage loans, employment trends, and default rates on mortgage loans; mortgage guaranty results may also be affected by various risk-sharing arrangements with business producers as well as the risk management and pricing policies of government sponsored enterprises. Life and disability insurance results can be impacted by the levels of employment and consumer spending, as well as mortality and health trends. At the holding company level, operating earnings or losses are generally affected by the amount of debt outstanding and its cost, as well as interest income on temporary holdings of short-term investments.
Any forward-looking commentaries speak only as of their dates. Old Republic undertakes no obligation to publicly update or revise such comments, whether as a result of new information, future events or otherwise, and accordingly they may not be unduly relied upon.
Item 8
Item 8 - Financial Statements
Listed below are the financial statements included herein: OLD REPUBLIC INTERNATIONAL CORPORATION AND SUBSIDIARIES Page No. --------
Consolidated Balance Sheets......................................... 23-24 Consolidated Statements of Income................................... 25 Consolidated Statements of Comprehensive Income..................... 26 Consolidated Statements of Preferred Stock and Common Shareholders' Equity...................................... 27 Consolidated Statements of Cash Flows............................... 28 Notes to Consolidated Financial Statements.......................... 29-50 Report of Independent Accountants................................... 51
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
- ------------ (*) At December 31, 2000 and 1999, there were 75,000,000 shares of $0.01 par value preferred stock authorized, of which 138,878 in 2000 and 153,183 in 1999 were convertible preferred shares issued and outstanding. As of the same dates, there were 500,000,000 shares of common stock, $1.00 par value, authorized, of which 121,444,862 in 2000 and 156,678,789 in 1999 were issued and outstanding. At December 31, 2000 and 1999 there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. Common shares classified as treasury stock were 3,191,362 and 34,479,299 as of December 31, 2000 and 1999, respectively.
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. - --------------------------------------------------------------------------------
Old Republic International Corporation and Subsidiaries Notes to Consolidated Financial Statements ($ in Millions, Except as Otherwise Indicated) - --------------------------------------------------------------------------------
Old Republic International Corporation is a Chicago-based insurance holding company with subsidiaries engaged in the general (property & liability), mortgage guaranty, title, and life (life & disability) insurance businesses. In this report, "Old Republic", "the Corporation", or "the Company" refers to Old Republic International Corporation and its subsidiaries as the context requires. The aforementioned insurance segments are organized as the Old Republic General Insurance, Mortgage Guaranty, Title Insurance, and Life Insurance Groups, and references herein to such groups apply to the Company's subsidiaries engaged in the respective segments of business. See Note 6 for a discussion of the Company's business segments.
Note 1-Summary of Significant Accounting Policies-The significant accounting policies employed by Old Republic International Corporation and its subsidiaries are set forth in the following summary.
(a) Consolidation Practices-The consolidated financial statements include the accounts of the Corporation and those of its major insurance underwriting and service subsidiaries. Non-consolidated insurance marketing and service sub sidiaries are insignificant and are reflected on the equity basis of accounting. All significant intercompany accounts and transactions have been eliminated in consolidation.
(b) Accounting Principles-The Corporation's insurance underwriting subsidiaries maintain their records in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities. In consolidating such subsidiaries, adjustments have been made to conform their accounts with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(c) Investments-The Company may classify its invested assets in terms of those assets relative to which it either (1) has the positive intent and ability to hold until maturity (generally carried at amortized costs for fixed maturity securities), (2) has available for sale (carried at fair value with adjustments to equity, net of deferred income taxes) or (3) has the intention of trading (carried at fair value with adjustments to income); as of December 31, 2000, the Company's invested assets were classified solely as "held to maturity" or "available for sale."
Fixed maturity securities and redeemable preferred stocks classified as "held to maturity" are generally carried at amortized costs while fixed maturity securities classified as "available for sale" in addition to other preferred and common stocks (equity securities) are included at fair value. Fair values for fixed maturity securities and equity securities are based on quoted market prices or estimates using values obtained from independent pricing services as applicable. Other long-term investments are carried at cost which approximates estimated realizable value.
The amortized cost and estimated fair values of fixed maturity securities are as follows:
The amortized cost and estimated fair value at December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Bonds and other investments carried at $161.3 as of December 31, 2000 were on deposit with governmental authorities by the Corporation's insurance subsidiaries to comply with insurance laws.
A summary of the Company's equity securities follows:
Investment income is reported net of allocated expenses and includes appropriate adjustments for amortization of premium and accretion of discount on fixed maturity securities acquired at other than par value. Dividends on equity securities are credited to income on the ex-dividend date. Realized investment gains and losses are reflected as revenues in the income statement and are determined on the basis of amortized value at date of sale for fixed maturity securities, and cost in regard to equity securities; such bases apply to the specific securities sold. Unrealized investment gains and losses, net of any deferred income taxes, are recorded directly as a component of accumulated other comprehensive income.
At December 31, 2000, the Corporation and its subsidiaries had no non-income producing fixed maturity securities.
The following table reflects the composition of net investment income, net realized gains or losses, and the net change in unrealized investment gains or losses for each of the years shown:
- ------------ (1) Investment expenses consist of personnel costs and investment management and custody service fees, and includes interest incurred on funds held of $1.5, $1.5 and $1.5 for the years ended December 31, 2000, 1999 and 1998, respectively. (2) Deferred income taxes do not apply since these securities are carried at amortized cost.
(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.
General insurance (property and liability) and level-term credit life insurance premiums are reflected in income on a pro-rata basis. Earned but unbilled premiums are generally taken into income on the billing date, and adjustments for retrospective premiums, commissions and similar charges are accrued on the basis of periodic evaluations of current underwriting experience and contractual obligations. First year and renewal mortgage guaranty premiums are recognized as income on a straight-line basis except that a portion of first year premiums received for certain high risk policies is deferred and reported as earned over the estimated policy life, including renewal periods. Single premiums for mortgage guaranty policies covering more than one year are earned on an accelerated basis over the policy term. Title insurance premiums are recognized as income upon the substantial completion of the policy issuance process. Title abstract, escrow, service, and other fees are taken into income at the time of closing of the related escrow. Ordinary life premiums are recognized as revenue when due. Decreasing term credit life and credit disability/accident & health insurance premiums are generally earned on a sum-of-the-years-digits or similar method.
(e) Deferred Policy Acquisition Costs-The Corporation's insurance subsidiaries, other than title companies, defer certain costs which vary with and are primarily related to the production of business. Deferred costs consist principally of commissions, premium taxes, marketing, and policy issuance expenses. With respect to most coverages, deferred acquisition costs are amortized on the same basis as the related premiums are earned or, alternatively, over the periods during which premiums will be paid or underwriting and claim services performed. The following table summarizes deferred policy acquisition costs and related data for the years shown:
(f) Future Policy Benefits/Unearned Premiums-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%.
At December 31, 2000 and 1999, the Life Insurance Group had $6,849.1 and $7,896.5, respectively, of net life insurance in force. Future policy benefits and unearned premiums, consisted of the following:
The Company has previously issued directly or assumed 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. Premium written is limited to renewal business written prior to 1998.
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.
No assurance can be given that unearned premiums will be greater or less than ultimate incurred losses on these policies.
The following table reflects certain data pertaining to net insurance in force for the Company's financial guarantee business at the dates shown:
With respect to mortgage guaranty insurance (net insurance in force of $85,461.1 and $76,953.8, at December 31, 2000 and 1999, respectively) the Company's reserving policies are set forth below in Note 1(g).
(g) Losses, Claims and Settlement Expenses-Reserves are estimates that provide 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' compensation reserves, however, are discounted to present value based on interest rates ranging from 3.5% to 4%.
The establishment of claim reserves by the Company's insurance subsidiaries is a reasonably complex and dynamic process influenced by a large variety of factors. These include past experience applicable to the anticipated costs of various types of claims, continually evolving and changing legal theories emanating from the judicial system, recurring accounting and actuarial studies, the professional experience and expertise of the Company's claim departments' personnel or attorneys and independent adjusters retained to handle individual claims, the effect of inflationary trends on future claim settlement costs, and periodic changes in claim frequency patterns such as those caused by natural disasters, illnesses, accidents, or work-related injuries. Consequently, the reserve-setting process relies on the judgments and opinions of a large number of persons, on historical precedent and trends, and on expectations as to future developments. At any point in time, the Company and the industry are exposed to possibly higher than anticipated claim costs due to the aforementioned factors, and to the evolution, interpretation, and expansion of tort law, as well as to the effects of unexpected jury verdicts.
The Company believes that its overall reserving practices have been consistently applied over many years, and that its aggregate net reserves have resulted in reasonable approximations of the ultimate net costs of claims incurred. However, no representation is made that ultimate net claim and related costs will not be greater or lower than previously established reserves.
The following table shows an analysis of changes in aggregate reserves for the Company's losses, claims and settlement expenses for each of the years shown.
All reserves are necessarily based on estimates which are periodically reviewed and evaluated in the light of emerging claim experience and changing circumstances. The resulting changes in estimates are recorded in operations of the periods during which they are made. Return and additional premiums and policyholders' dividends, all of which tend to be affected by development of claims in future years, may offset, in whole or in part, developed claim redundancies or deficiencies for certain coverages such as workers' compensation.
The data in the table above, incorporates Old Republic's estimates for various asbestosis and environmental impairment ("A&E") claims or related costs that have been filed in the normal course of business against a number of its insurance subsidiaries. Many such claims relate to policies issued prior to 1985, and during a short period between 1981 and 1982 pursuant to an agency agreement canceled in 1982. During all years and through the current date, the Corporation's insurance subsidiaries have typically issued general liability insurance policies with face amounts ranging between $1.0 and $2.0 and rarely exceeding $10.0. Such policies have, in turn, been subject to reinsurance cessions which have typically reduced the Corporation's retentions to $.5 or less as to each claim.
The Corporation's reserving methods, particularly as they apply to formula-based reserves, have been established to provide for normal claim occurrences as well as unusual exposures such as those pertaining to A&E claims and related costs. At times, however, the Corporation's insurance subsidiaries also establish specific formula and other reserves as part of their overall claim and claim expense reserves to cover claims such as those emanating from A&E exposures. These are intended to cover additional litigation and other costs that are likely to be incurred to protect the Company's interests in litigated cases in particular. At December 31, 2000, the Corporation's aggregate indemnity and loss adjustment expense reserves specifically identified with A&E exposures amounted to approximately $75.3 gross, and $39.4 net of reinsurance. Based on average annual claims payments during the five most recent calendar years, such reserves represented 10.0 years (gross) and 15.5 years (net) of average annual claims payments.
Old Republic disagrees with the allegations of liability on virtually all A&E related claims of which it has knowledge on the grounds that exclusions in the policies preclude coverage for nearly all such claims, and that the Corporation never intended to assume such risks. Old Republic's exposure on such claims cannot therefore be calculated by conventional insurance reserving methods for this and a variety of reasons, including: a) the absence of statistically valid data inasmuch as such claims typically involve long reporting delays and very often uncertainty as to the number and identity of insureds against whom such claims have arisen or will arise; and b) the litigation history of such or similar claims for other insurance industry members that has produced court decisions that have been inconsistent with regard to such questions as when the alleged loss occurred, which policies provide coverage, how a loss is to be allocated among potentially responsible insureds and/or their insurance carriers, how policy coverage exclusions are to be interpreted, what types of environmental impairment or toxic tort claims are covered, when the insurer's duty to defend is triggered, how policy limits are to be calculated, and whether clean-up costs constitute property damage.
Individual insurance companies and others who have evaluated the potential costs of litigating and settling A&E claims have noted with increasing concern the possibility that resolution of such claims, by applying liability retroactively in the context of the existing insurance system, could likely bankrupt or undermine seriously the financial condition of the property and liability insurance industry. In the light of this substantial public policy issue, the Corporation is of the view that the courts will not resolve in the near future the litigation gridlock stemming from the non-resolution to date of many environmental claims in particular. In recent times, the Executive Branch and/or the United States Congress have proposed changes in the legislation and rules affecting the determination of liability for environmental claims. As of December 31, 2000, however, there is no solid evidence to suggest that forthcoming changes might mitigate or reduce some or all of these claim exposures.
Because of the above issues and uncertainties, estimation of reserves for losses and allocated loss adjustment expenses for the above noted types of claims is much more difficult or impossible. Accordingly, no representation can be made that the Corporation's reserves for such claims and related costs will not prove to be overstated or understated in the future.
(h) Income Taxes-The Corporation and most of its subsidiaries file a consolidated tax return and provide for income taxes payable currently. Deferred income taxes included in the accompanying consolidated financial statements pursuant to generally accepted accounting principles will not necessarily become payable/recoverable in the future. The Company uses the asset and liability method of calculating deferred income taxes. This method calls for the establishment of a deferred tax, calculated at currently effective tax rates, for the cumulative temporary differences between financial statement and tax bases of assets and liabilities.
The provision for combined current and deferred income taxes reflected in the consolidated statements of income does not bear the usual relationship to operating income before taxes as the result of permanent and other differences between pre-tax income and taxable income determined under existing tax regulations. The more significant differences, their effect on the statutory income tax rate, and the resulting effective income tax rates are summarized below:
The tax effects of temporary differences that give rise to significant portions of the Company's net deferred tax recoverable (payable) are as follows at the dates shown:
Pursuant to special provisions of the Internal Revenue Code pertaining to mortgage guaranty insurers, a contingency reserve (established in accordance with insurance regulations designed to protect policyholders against extraordinary volumes of claims) is deductible from gross income. The tax benefits obtained from such deductions must, however, be invested in a special type of non-interest bearing U.S. Government Tax and Loss Bond. For Federal income tax purposes, the amounts deducted for the contingency reserve are taken into gross statutory taxable income (a) when the contingency reserve is permitted to be charged for losses under state law or regulation, (b) in the event operating losses are incurred, or (c) in any event upon the expiration of ten years.
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 $13.3 at December 31, 2000) credited to the former memorandum "policyholders' surplus account" will generally 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 1988 through 1995. The proposed adjustments pertain to the timing of certain deductions, the IRS' contention that certain salvage does not qualify for transition rule benefits, deductions for certain loss and unearned premium reserves, and several other issues not involving material amounts. The Company believes that substantially all of the proposed 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.
(i) Property and Equipment-Property and equipment is generally depreciated or amortized over the estimated useful lives of the assets, (2 to 27 years), substantially by the straight-line method. Expenditures for maintenance and repairs are charged to income as incurred, and expenditures for major renewals and additions are capitalized.
(j) Title Plants and Records-Title plants and records are carried at original cost or appraised value at date of purchase. Such values represent the cost of producing or acquiring interests in title records and indexes and the appraised value of purchased subsidiaries' title records and indexes at dates of acquisition. The cost of maintaining, updating, and operating title records is charged to income as incurred. Title records and indexes are ordinarily not amortized unless events or circumstances indicate that the carrying amount of the capitalized costs may not be recoverable.
(k) Goodwill-The costs of certain purchased subsidiaries in excess of related book values (goodwill) at date of acquisition are being amortized against operations principally over 40 years using the straight-line method. Amortization of goodwill amounted to $4.1 in 2000, $3.5 in 1999 and $3.6 in 1998.
(l) Employee Benefit Plans- The Corporation has several pension plans covering a portion of its work force. The plans are defined benefit plans pursuant to which pension payments are based primarily on years of service and employee compensation 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 changes in the projected benefit obligation are as follows:
The changes in the fair value of net assets available for plan benefits are as follows:
A reconciliation of the funded status of the plans is as follows:
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 weighted-average assumptions at the dates shown:
Included in the plans' assets are Common Shares of the Company valued at $7.0 and $6.7 as of December 31, 2000 and 1999, respectively.
The Corporation has a number of profit sharing and other incentive compensation programs for the benefit of a substantial number of its employees. The costs related to such programs are summarized below:
The Company sponsors a leveraged Employees Savings and Stock Ownership Plan (ESSOP) in which a majority of its employees participate. The ESSOP acquired all of its stock of the Company in 1987 and prior years. Accordingly, it is not required to adopt the American Institute of Certified Public Accountants' SOP No. 93-6, "Employers' Accounting for Employee Stock Ownership Plans." Shares of Company stock owned by the ESSOP are released to participants based on a formula prescribed by the Employee Retirement Income Security Act of 1974, and dividends on released shares are allocated to participants as earnings. The Company's contributions are based on a formula considering growth in net income per share over consecutive five year periods. As of December 31, 2000, there were 7,220,514 Common Shares owned by the ESSOP of which 27,088 were unreleased and unallocated. There are no repurchase obligations in existence. (See Note 2).
(m) Escrow Funds-Segregated cash deposit accounts and the offsetting liabilities for escrow deposits in connection with Title Insurance Group real estate transactions in the same amounts ($529.7 and $487.3 at December 31, 2000 and 1999, respectively) are not included as assets or liabilities in the accompanying consolidated balance sheets as the escrow funds are not available for regular operations.
(n) Earnings Per Share-Consolidated basic earnings per share excludes the dilutive effect of common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares actually outstanding for the year. Diluted earnings per share are similarly calculated with the inclusion of common stock equivalents. The following tables provide a reconciliation of net income and number of shares used in basic and diluted earnings per share calculations.
(o) Cash Flows-For purposes of the Consolidated Statements of Cash Flows, the Company considers short-term investments, consisting of money market funds, certificates of deposit, and commercial paper with original maturities of less than 90 days to be cash equivalents. These securities are carried at cost which approximates fair value.
Supplemental cash flow information:
(p) Concentration of Credit Risk-Excluding U.S. government fixed maturity securities, the Company is not exposed to any significant concentration of credit risk.
(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 the most current presentation.
Note 2-Debt-Consolidated debt of Old Republic and its subsidiaries is summarized below:
The carrying amount of the Company's commercial paper borrowings approximates its fair value. The fair value of publicly traded debt is based on its quoted market price.
Scheduled maturities of the above debt at December 31, 2000 are as follows: 2001: $113.9; 2002: $.4; 2003: $.6; 2004: $.4; 2005: $.6; 2006 and after: $121.8. During 2000, 1999 and 1998, $15.9, $10.3 and $10.0, respectively, of interest expense on debt was charged to consolidated operations.
Note 3-Shareholders' Equity - All common and preferred share data herein has been retroactively adjusted as applicable for stock dividends or splits declared through December 31, 2000.
(a) Preferred Stock-The following table shows certain information pertaining to the Corporation's preferred shares issued and outstanding:
Convertible ----------- Preferred Stock Series: G(1) -----------
Annual cumulative dividend rate per share........................ $ (1) Conversion ratio of preferred into common shares ................ 1 for .95 Conversion right begins.......................................... Anytime Redemption and liquidation value per share....................... (1) Redemption beginning in year...................................... (1) Total redemption value (millions).................................. (1) Vote per share..................................................... one Shares outstanding: December 31, 1999.................................................. 153,183 December 31, 2000.................................................. 138,878 =========== - ------------ (1) The Corporation has authorized up to 1,000,000 shares of Series G-2 Convertible Preferred Stock ("Series G") for issuance pursuant to the Corporation's Stock Option Plan. Each share of Series G pays a floating rate dividend based on the prime rate of interest. At December 31, 2000, the annual dividend rate for Series G was $.92 per share. Each share of Series G is convertible at any time, after being held six months, into 0.95 shares of Common Stock (See 3(c)). Unless previously converted, Series G shares may be redeemed at the Corporation's sole option five years after their issuance.
(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 2000 data, the maximum amount of dividends payable to the Corporation by its insurance and a small number of non-insurance company subsidiaries during 2001 without the prior approval of appropriate regulatory authorities is approximately $180.6.
(c) Stock Option Plan-The Corporation has a stock option plan for certain eligible key employees. Outstanding options at any one time may not exceed 5% of the Old Republic common stock then issued and outstanding. The exercise price of options is equal to the market price of the Corporation's stock on the date of grant; the term of each option is generally ten years from such date. Options may be exercised to the extent of 10% of the number of shares covered thereby on and after the date of grant, and cumulatively to the extent of an additional 10% on and after each of the first through ninth subsequent calendar years. In the event the market closing price of the Old Republic common stock reaches a pre-established value ("the vesting acceleration price"), however, optionees may exercise their options to the extent of 10% of the number of shares covered by the option for each year of employment by the optionee. The option plan enables optionees to, alternatively, exercise their options into Series "G" Convertible Preferred Stock. The exercise of options into such Preferred Stock reduces by 5% the number of equivalent common shares which would otherwise be obtained from the exercise of options into common shares.
For financial reporting purposes, Old Republic records the exercise of stock options directly in its capital accounts as permitted under existing accounting pronouncements. The following table shows a comparison of net income and related per share information as reported, and on a pro-forma basis on the assumption that the estimated value of stock options was treated as compensation cost. In estimating the compensation cost of options, the fair value of options at date of grant has been calculated using a Black-Scholes options pricing model that takes the assumptions shown below into account.
A summary of the status of the Corporation's stock options as of December 31, 2000, 1999 and 1998, and changes in outstanding options during the years then ended follows:
A summary of stock options outstanding and exercisable at December 31, 2000 follows:
(d) Common Stock-There were 500,000,000 shares of common stock authorized at December 31, 2000. At the same date, there were 100,000,000 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. In March 2000, the Company canceled 36,420,135 common shares previously reported as treasury stock, restoring them to unissued status; this had no effect on total shareholders' equity or the financial position of the Company.
The Corporation issued a total of 514,626 common shares valued at $4.6 in 1998 to effect acquisitions which were not material to Old Republic's financial position or operating results.
(e) 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, 2000 amounted to $1,722.7 and $46.0, respectively. Dividends declared during 2000, 1999 and 1998, to the Corporation by its subsidiaries amounted to $119.6, $178.9 and $158.2, respectively.
(f) Statutory Data-The policyholders' surplus and net income (loss), determined in accordance with statutory accounting practices, of the Corporation's insurance subsidiaries was as follows at the dates and for the periods shown:
In December, 1998, the National Association of Insurance Commissioners adopted a revised Accounting Practices and Procedures Manual ("Manual"). The Manual is a comprehensive compilation of statutory accounting practices and principles. The Manual is effective for accounting periods beginning January 1, 2001. Current estimates of the adoption of this Manual is not expected to have a material impact on the Company's statutory financial position or results of its statutory operations.
Note 4-Commitments and Contingent Liabilities: (a) Reinsurance-In order to maintain premium production within their capacity and to limit maximum losses for which they might become liable under policies underwritten, Old Republic's insurance subsidiaries, as is the common practice in the insurance industry, cede all or a portion of their premiums and liabilities on certain classes of business to other insurers and reinsurers. Although the ceding of insurance does not ordinarily discharge an insurer from liability to a policyholder, it is industry practice to establish the reinsured part of risks as the liability of the reinsurer. Old Republic also employs retrospective premium, contingent commission, and profit sharing arrangements for parts of its business in order to minimize losses for which it might become liable under insurance policies underwritten by it. To the extent that any reinsurance companies or retrospectively rated risks or producers might be unable to meet their obligations under existing reinsurance or retrospective insurance and agency agreements, Old Republic would be liable for the defaulted amounts. As deemed necessary, reinsurance ceded to other companies is secured by letters of credit, cash, and/or securities.
Reinsurance protection on property and liability operations generally limits the net loss on any one risk to a maximum of (in thousands): workers' compensation-$1,000; auto liability-$600; general liability-$600; and property coverages-$300. Substantially all the mortgage guaranty insurance business is retained, with the exposure on any one risk currently averaging approximately $29. Title insurance risk assumptions, based on the title insurance subsidiaries' financial resources, are limited to a maximum of $25,000 as to any one policy. The maximum amount of ordinary life insurance retained on any one life by the Life Insurance Group is $300.
Most of the reinsurance ceded by the Corporation's insurance subsidiaries in the ordinary course of business is placed on a quota share or excess of loss basis. Under quota share reinsurance, the companies remit an agreed upon percentage of their premiums written to assuming companies and are reimbursed for a pro-rata share of claims and commissions incurred and for a ceding commission to cover expenses and costs for underwriting and claim services performed. Under excess of loss reinsurance agreements, the companies are generally reimbursed for losses exceeding contractually agreed-upon levels.
The following information relates to reinsurance and related data for the General Insurance, Mortgage Guaranty and Life Insurance Groups for the three years ended December 31, 2000. For the years 1998 to 2000, reinsurance transactions of the Title Insurance Group have not been material.
(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, 2000, aggregate minimum rental commitments (net of expected sub-lease receipts) under noncancellable operating leases of $133.8 are summarized as follows: 2001: $32.5; 2002: $27.1; 2003: $21.1; 2004: $13.6; 2005: $8.4; 2006 and after: $30.8.
(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 or regulatory 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-Legal proceedings against the Company arise in the normal course of business and generally pertain to claim matters related to insurance policies and contracts issued by the Corporation's insurance subsidiaries.
The Federal Department of Labor has revised the Federal Black Lung Program regulations effective January 19, 2001. These new regulations, which might require a re-evaluation of previously settled or denied workers' compensation claims, are being challenged in court by the insurance and coal mining industries. At this time, the outcome of this challenge is uncertain and the potential impact on gross and net of reinsurance reserves or retrospective rating policies due to the revised regulations is not measurable.
In December 1999, a class action lawsuit was filed against one of the Company's mortgage guaranty insurance subsidiaries in the Federal District Court for the Southern District of Georgia. The suit alleges that the subsidiary provided pool insurance and other services to mortgage lenders at preferential, below market prices in return for mortgage insurance business, and that such practices violated the Real Estate Settlement Procedures Act. The Court ruled in favor of a summary judgement motion filed by the Company's subsidiary and dismissed the law suit. The class plaintiffs have appealed and the appeal is currently before the U.S. Court of Appeals for the Eleventh Circuit. The ultimate outcome of this litigation is unknown at the present time. Accordingly, no provision for any liability, including the additional cost of defense, has been included in the Company's financial statements.
The City and County of San Francisco and certain escrow customers of an underwritten title agency subsidiary headquartered in the State of California have filed law suits alleging that the subsidiary: 1) failed to escheat unclaimed escrow funds; 2) charged for services not necessarily provided; and 3) collected illegal interest payments or fees from banks on the basis of funds held for escrow customers. The subsidiary has in turn conducted an internal review of its records and concluded that it had certain liabilities for part of the issues denoted at (1) and (2). Management believes that the alleged practices denoted at (3) are common within the industry, are not in conflict with various laws and regulations, and that it has meritorious defenses which will ultimately lead to a successful resolution of these practices. As the litigation has progressed on several fronts and additional information has come to its attention, the subsidiary has continually re-evaluated its exposures and it has paid or otherwise provided for its best estimate of litigation and related costs associated with all these issues in the amounts of $4.1, $16.2 and $19.5 in 2000, 1999 and 1998, respectively.
In mid October, 2000, the California Department of Insurance (CDI) filed a complaint against the above referenced subsidiary. The complaint alleges violations of certain sections of the Insurance Code that prohibit any form of considerations to induce the referral of business to a title company. The CDI is seeking a maximum monetary penalty of $3.8. The Company believes it has meritorious defenses to the allegations and that its overall claim and other expense accruals are sufficient to cover these and other known exposures.
Note 5-Consolidated Quarterly Results-Unaudited - Old Republic's consolidated quarterly operating data for the two years ended December 31, 2000 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":
Note 6-Information About Segments of Business - The Corporation's business segments are organized as the General Insurance (property and liability insurance), Mortgage Guaranty, Title Insurance and Life Insurance Groups. The contributions of Old Republic's insurance industry segments to consolidated revenues and operating results, and certain balance sheet data pertaining thereto are shown in the following tables on the basis of generally accepted accounting principles ("GAAP"). Each of the Corporation's segments underwrites and services only those insurance coverages which may be written by it pursuant to state insurance regulations and corporate charter provisions.
The Corporation does not derive over 10% of its revenue from any one customer. Revenues and assets connected with foreign operations are not significant in relation to consolidated totals.
The General Insurance Group provides property and liability insurance primarily to commercial clients. Old Republic does not have a meaningful participation in personal lines of insurance. Commercial automobile (principally trucking) insurance is the largest type of coverage underwritten by the General Insurance Group accounting for approximately 41.9% of the Group's direct premiums written in 2000. The remaining premiums written by the General Insurance Group are derived largely from a wide variety of coverages, including workers' compensation, general liability, loan credit guaranty, and surety bonds. The General Insurance Group's operations have been expanded over the years to insure certain specialty lines such as directors' and officers' liability and errors and omissions liability insurance, to cover owners and operators of private aircraft for hull and liability exposures, and to provide automobile and home warranties.
Home mortgage loan insurance produced by the Mortgage Guaranty Group protects lending institutions against certain losses, generally to the extent of 10% to 35% of the sum of the outstanding amount of each insured mortgage loan, and allowable costs incurred in the event of default by the borrower. The Corporation insures only first mortgage loans, primarily on residential properties having one-to-four family dwelling units. Mortgage guaranty insurance premiums originate from savings and loan associations, mortgage bankers and other lending institutions. The Corporation's residential home loan insurance business is originated, approximately 15% by savings and loan associations, 65% by mortgage bankers and 20% by other lenders. The Mortgage Guaranty segment's ten largest customers were responsible for approximately 60.3%, 48.9% and 44.5% of direct insurance in force for the years ended December 31, 2000, 1999 and 1998, respectively. The largest single customer accounted for 11.7% of the direct insurance in force for the year ended December 31, 2000 compared to 9.5% in 1999 and 9.0% in 1998.
The title insurance business consists primarily of the issuance of policies to real estate purchasers and investors based upon searches of the public records which contain information concerning interests in real property. The policy insures against losses arising out of defects, loans and encumbrances affecting the insured title and not excluded or excepted from the coverage of the policy.
The Life Insurance Group markets and writes consumer credit life and disability insurance primarily through automobile dealers. Old Republic has also written various conventional life and disability/accident and health insurance coverages for many years, principally on a direct marketing basis through banks and other financial services institutions. Ordinary term life insurance is sold through independent agents and brokers for relatively large face amounts, in both the United States and Canada.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies pertinent thereto.
- --------- In the above tables, net premiums earned on a GAAP basis differ slightly from statutory amounts due to certain differences in calculations of unearned premium reserves under each accounting method. (a) Including unallocated investment income derived from invested capital and surplus funds./(b) Represents results of holding company parent, consolidation eliminating adjustments, and general corporate expenses, as applicable./(c) In the first quarter of 1999, the Company sold its New York subsidiary and with it, its annuity book of business; this had no material effect on Old Republic's consolidated results or financial position.
REPORT OF INDEPENDENT ACCOUNTANTS - --------------------------------------------------------------------------------
To the Board of Directors and Shareholders of Old Republic International Corporation Chicago, Illinois
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, preferred stock and common shareholders' equity and cash flows present fairly, in all material respects, the financial position of Old Republic International Corporation and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. 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. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois March 14, 2001
Item 9
Item 9 - Disagreements on Accounting and Financial Disclosure
None.
PART III
Item 10
Item 10 - Directors and Executive Officers of the Registrant
Omitted pursuant to General Instruction G(3). The Company will file with the Commission prior to April 1, 2001 a definitive proxy statement pursuant to Regulation 14A in connection with its Annual Meeting of shareholders to be held on May 25, 2001. See also Item 4(a) in Part I of this report. A list of Directors appears on the "Signature" page of this report.
Item 11
Item 11 - Executive Compensation
Omitted pursuant to General Instruction G(3). The Company will file with the Commission prior to April 1, 2001 a definitive proxy statement pursuant to Regulation 14A in connection with its Annual Meeting of shareholders to be held on May 25, 2001.
Item 12
Item 12 - Security Ownership of Certain Beneficial Owners and Management
Omitted pursuant to General Instruction G(3). The Company will file with the Commission prior to April 1, 2001 a definitive proxy statement pursuant to Regulation 14A in connection with its Annual Meeting of shareholders to be held on May 25, 2001.
Item 13
Item 13 - Certain Relationships and Related Transactions
Omitted pursuant to General Instruction G(3). The Company will file with the Commission prior to April 1, 2001 a definitive proxy statement pursuant to Regulation 14A in connection with its Annual Meeting of shareholders to be held on May 25, 2001.
PART IV
Item 14
Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as a part of this report: 1. Financial statements: See Item 8, Index to Financial Statements. 2. Financial statement schedules will be filed on or before April 30, 2001 under cover of Form 10-K/A. 3. See exhibit index on page 55 of this report.
(b) Reports on Form 8-K: 1. No reports on Form 8-K were filed during the fourth quarter of 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized (Name, Title or Principal Capacity, and Date).
(Registrant): Old Republic International Corporation
By : /s/ A. C. Zucaro 03/26/00 ----------------------------------------------- ------------ A. C. Zucaro, Chairman of the Board, Date Chief Executive Officer, President and Director
By : /s/ Paul D. Adams 03/26/00 ----------------------------------------------- ------------ Paul D. Adams, Senior Vice President, Date Chief Financial Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated (Name, Title or Principal Capacity, and Date).
/s/ Harrington Bischof /s/ John W. Popp - --------------------------------- --------------------------------- Harrington Bischof, Director* John W. Popp, Director*
/s/ Anthony F. Colao /s/ William A. Simpson - --------------------------------- --------------------------------- Anthony F. Colao, Director* William A. Simpson, Director* Chairman of Old Republic RE, Inc. President of Republic Mortgage Insurance Company
/s/ Jimmy A. Dew /s/ Arnold L. Steiner - --------------------------------- --------------------------------- Jimmy A. Dew, Director* Arnold L. Steiner, Director* Sales Group Manager of Republic Mortgage Insurance Company
/s/ Kurt W. Kreyling /s/ David Sursa - --------------------------------- --------------------------------- Kurt W. Kreyling, Director* David Sursa, Director*
/s/ Peter Lardner /s/ William G. White, Jr. - --------------------------------- --------------------------------- Peter Lardner, Director* William G. White, Jr., Director* Chairman of Bituminous Casualty Corporation
/s/ Wilbur S. Legg - --------------------------------- Wilbur S. Legg, Director*
* By/s/A. C. Zucaro Attorney-in-fact Date: March 22, 2001
EXHIBIT INDEX
An index of exhibits required by item 601 of Regulation S-K follows:
(3) Articles of incorporation and by-laws.
(A) * Restated Certificate of Incorporation, as amended. (Exhibit 3(A) to Registrant's Annual Report on Form 10-K for 1998).
(B) * By-laws, as amended. (Exhibit 3.2 to Form S-3 Registration Statement No. 333-43311).
(4) Instruments defining the rights of security holders, including indentures.
(A) * Certificate of Designation with respect to Series A Junior Participating Preferred Stock (Exhibit 4.1 to Form 8-K filed May 30, 1997).
(B) * Certificate of Designation with respect to Series G-2 Convertible Preferred Stock (Exhibit 4(A) to Registrant's Annual Report on Form 10-K for 1995).
(C) * Amended and Restated Rights Agreement dated as of May 15, 1997 between Old Republic International Corporation and First Chicago Trust Company of New York (Exhibit 4.1 to Registrant's Form 8-K filed May 30, 1997).
(D) * Agreement to furnish certain long term debt instruments to the Securities & Exchange Commission upon request (Exhibit 4(D) on Form 8 dated August 28, 1987).
(E) * Form of Indenture dated as of August 15, 1992 between Old Republic International Corporation and Wilmington Trust Company, as Trustee (Exhibit 4(G) to Registrant's Annual Report on Form 10-K for 1993).
(F) * Supplemental Indenture No. 1 dated as of June 16, 1997 supplementing the Indenture (Exhibit 4.3 to Registrant's Form 8-A filed June 16, 1997).
(G) * Supplemental Indenture No. 2 dated as of December 31, 1997 supplementing the Indenture. (Exhibit 4(G) to Registrant's Annual Report on Form 10-K for 1997).
(10) Material contracts.
** (A) * Copy of the Amended and Restated Old Republic International Corporation Key Employees Performance Recognition Plan. (Exhibit 10(A) to Registrant's Annual Report on Form 10-K for 1998).
** (B) * 1985 Old Republic International Corporation Non-qualified Stock Option Plan A (Exhibit 10.1 to Form S-3 Registration Statement No. 2-98166).
** (C) * Amendments to 1985 Old Republic International Corporation Non-qualified Stock Option Plan A (Exhibit 10(G) to Registrant's Annual Report on Form 10-K for 1991).
** (D) Amended and Restated 1992 Old Republic International Corporation Non-qualified Stock Option Plan.
** (E) * Amended and Restated Old Republic International Corporation Executives Excess Benefits Pension Plan. (Exhibit 10(E) to Registrant's Annual Report on Form 10-K for 1997)
** (F) * Form of Indemnity Agreement between Old Republic International Corporation and each of its directors and certain officers (Exhibit 10 to Form S-3 Registration Statement No. 33-16836).
** (G) * Copy of directors and officers liability and company reimbursement policy dated October 6, 1970 (Exhibit 12(A) to Form S-1 Registration Statement No. 2-41089).
** (H) * Copy of Bitco Key Employees Performance Recognition Plan. (Exhibit 10(H) to Registrant's Annual Report on Form 10-K 1997)
(Exhibit Index, Continued)
** (I) Copy of the RMIC Corporation/Republic Mortgage Insurance Company Amended and Restated Key Employees Performance Recognition Plan.
** (J) Copy of the RMIC Corporation/Republic Mortgage Insurance Company Executives Excess Benefits Pension Plan.
(21) Subsidiaries of the registrant.
(23) Consent of PricewaterhouseCoopers LLP
(24) Powers of attorney
(28) Consolidated Schedule P (To be filed by amendment.)
- --------------- * Exhibit incorporated herein by reference.
** Denotes a management or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K.