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| ORI > SEC Filings for ORI > Form 10-Q on 6-Nov-2009 | All Recent SEC Filings |
6-Nov-2009
Quarterly Report
OVERVIEW
This management analysis of financial position and results of operations pertains to the consolidated accounts of Old Republic International Corporation ("Old Republic" or "the Company"). The Company conducts its operations through three major regulatory segments, namely, its General (property and liability), Mortgage Guaranty, and Title insurance segments. A small life and health insurance business, accounting for 2.1% of consolidated operating revenues for the nine months ended September 30, 2009 and 1.8% of consolidated assets as of September 30, 2009, is included within the corporate and other caption of this report. The consolidated accounts are presented in conformity with the Accounting Standards Codification ("ASC"). This management analysis should be read in conjunction with the consolidated financial statements and the footnotes appended to them.
The insurance business is distinguished from most others in that the prices (premiums) charged for various insurance products are set without certainty of the ultimate benefit and claim costs that will emerge or be incurred, often many years after issuance and expiration of a policy. This basic fact casts Old Republic as a risk-taking enterprise managed for the long run. Management therefore conducts the business with a primary focus on achieving favorable underwriting results over cycles, and on the maintenance of financial soundness in support of the insurance subsidiaries' long-term obligations to insurance beneficiaries. To achieve these objectives, adherence to insurance risk management principles is stressed, and asset diversification and quality are emphasized. In addition to income arising from Old Republic's basic underwriting and related services functions, significant investment income is earned from invested funds generated by those functions and from shareholders' capital. Investment management aims for stability of income from interest and dividends, protection of capital, and sufficient liquidity to meet insurance underwriting and other obligations as they become payable in the future. Securities trading and the realization of capital gains are not objectives. The investment philosophy is therefore best characterized as emphasizing value, credit quality, and relatively long-term holding periods. The Company's ability to hold both fixed maturity and equity securities for long periods of time is in turn enabled by the scheduling of maturities in contemplation of an appropriate matching of assets and liabilities.
In light of the above factors, the Company's affairs are managed without regard to the arbitrary strictures of quarterly or even annual reporting periods that American industry must observe. In Old Republic's view, such short reporting time frames do not comport well with the long-term nature of much of its business. Management believes that the Company's operating results and financial condition can best be evaluated by observing underwriting and overall operating performance trends over succeeding five to ten year intervals. Such extended periods can encompass one or two economic and/or underwriting cycles, and thereby provide appropriate time frames for such cycles to run their course and for reserved claim costs to be quantified with greater finality and effect.
EXECUTIVE SUMMARY
Old Republic's year-over-year operating results, which exclude net realized investment gains or losses, worsened in this year's third quarter and first nine months. Results for 2009 reflected slightly higher loss costs in Old Republic's mortgage guaranty line but benefited from much greater market share-driven revenues and a lower expense ratio in the title insurance segment. General insurance operating results throughout 2009 were dampened by the combination of lower earned premiums and higher loss costs for certain insurance coverages.
The net loss for the latest quarter and this year's first nine months was reduced by deferred income tax credits of $20.5 ($0.08 per share) and $54.0 ($0.23 per share), respectively. The tax credits, which could not be recognized previously due to the requirements of accounting rules, stem from estimates of losses from other-than-temporary impairments of investments, most of which were originally recorded in the second quarter of 2008.
Consolidated Results - The major components of Old Republic's consolidated results and other data for the periods reported upon are shown below:
Quarters Ended September 30, Nine Months Ended September 30,
2009 2008 Change 2009 2008 Change
Operating revenues:
General insurance $ 514.4 $ 565.7 -9.1 % $ 1,545.2 $ 1,708.7 -9.6 %
Mortgage guaranty 164.6 172.8 -4.7 502.4 518.9 -3.2
Title insurance 259.7 174.7 48.7 639.0 521.2 22.6
Corporate and other 19.8 23.0 -13.9 62.6 75.6 -17.2
Total $ 958.6 $ 936.3 2.4 % $ 2,749.4 $ 2,824.5 -2.7 %
Pretax operating income
(loss):
General insurance $ 43.7 $ 77.0 -43.3 % $ 148.4 $ 223.2 -33.5 %
Mortgage guaranty (160.4) (152.8) -4.9 (443.0) (415.9) -6.5
Title insurance 4.0 (9.7) 142.0 0.6 (27.0) 102.4
Corporate and other 1.8 5.3 -65.7 4.3 11.4 -62.2
Sub-total (110.7) (80.1) -38.2 (289.6) (208.3) -39.0
Realized investment gains
(losses):
From sales 0.6 18.3 1.0 26.0
From impairments (1.5) (11.5) (1.5) (448.9)
Net realized investment
gains (losses) (0.9) 6.7 N/M (0.5) (422.8) N/M
Consolidated pretax income
(loss) (111.7) (73.4) -52.2 (290.2) (631.1) 54.0
Income taxes (credits) (65.4) (25.3) -158.0 (174.1) (199.3) 12.6
Net income (loss) $ (46.2) $ (48.0) 3.7 % $ (116.0) $ (431.8) 73.1 %
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Consolidated underwriting ratio:
Benefits and claims ratio 78.4 % 81.8 % 80.3 % 80.1 % Expense ratio 44.4 38.8 42.2 39.0 Composite ratio 122.8 % 120.6 % 122.5 % 119.1 % Components of diluted earnings per share: Net operating income (loss) $ (0.28) $ (0.20) -40.0 % $ (0.72) $ (0.50) -44.0 % Net realized investment gains (losses) 0.08 (0.01) N/M 0.23 (1.37) N/M Net income (loss) $ (0.20) $ (0.21) 4.8 % $ (0.49) $ (1.87) 73.8 % Cash dividends paid per share $ 0.17 $ 0.17 - % $ 0.51 $ 0.50 2.0 % |
N/M: Not meaningful
The above table shows both operating and net income (loss) to highlight the effects of realized investment gain or loss recognition and any non-recurring items on period-to-period comparisons. Operating income, however, does not replace net income computed in accordance with the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") as a measure of total profitability.
The recognition of realized investment gains or losses can be highly discretionary and arbitrary due to such factors as the timing of individual securities sales, recognition of estimated losses from write-downs for impaired securities, tax-planning considerations, and changes in investment management judgments relative to the direction of securities markets or the future prospects of individual investees or industry sectors. Likewise, non-recurring items which may emerge from time to time can distort the comparability of the Company's results from period to period. Accordingly, management uses net operating income, a non-ASC financial measure, to evaluate and better explain operating performance, and believes its use enhances an understanding of Old Republic's basic business results.
General Insurance Results - Pretax operating earnings for this year's quarterly
and year-to-date periods were affected mostly by reduced premium volume and
moderately higher claim and expense ratios. The following table shows these
effects:
General Insurance Group
Quarters Ended September 30, Nine Months Ended September 30,
2009 2008 Change 2009 2008 Change
Net premiums earned $ 446.7 $ 500.3 -10.7 % $ 1,344.9 $ 1,507.4 -10.8 %
Net investment income 64.7 61.9 4.5 191.8 189.1 1.4
Pretax operating income $ 43.7 $ 77.0 -43.3 % $ 148.4 $ 223.2 -33.5 %
(loss)
Claims ratio 77.5 % 72.5 % 76.1 % 72.8 %
Expense ratio 25.8 23.8 26.0 24.2
Composite ratio 103.3 % 96.3 % 102.1 % 97.0 %
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Earned premiums for the large majority of insurance coverages continued to trend lower throughout 2009. As in the recent past, premium growth has been constrained by the combination of a moderately declining rate environment during the past three years or so, and by recessionary economic conditions. These conditions affect such factors as sales and employment levels, both of which are important bases upon which premium rates are applied.
General insurance investment income trends benefited from a greater invested asset base.
Overall claim ratios continued to trend moderately higher in this year's third quarter and first nine months. 2009 claim experience for the consumer credit indemnity ("CCI") coverage, however, remained at high levels, adding approximately 7.2 percentage points to the above claim ratios. By contrast CCI claim experience in the third quarter and first nine months of 2008 was additive to general insurance claim ratios by 5.1 and 6.8 percentage points, respectively. Aggregate claim experience for other coverages did not show significantly adverse trends. Production and general operating expenses edged down slightly in 2009 but nonetheless resulted in a higher ratio as the expense reduction lagged a larger drop in earned premiums.
Mortgage Guaranty Results - Year-to-date mortgage guaranty operating results benefited from lower production and operating expenses, but were hindered by moderately higher claim costs during 2009. Key indicators of this segment's evolving performance are shown in the following table:
Mortgage Guaranty Group
Quarters Ended September 30, Nine Months Ended September 30,
2009 2008 Change 2009 2008 Change
Net premiums earned $ 138.9 $ 148.4 -6.4 % $ 425.8 $ 445.2 -4.3 %
Net investment income 23.8 22.0 8.4 68.4 65.0 5.4
Pretax operating income $ (160.4) $ (152.8) -4.9 % $ (443.0) $ (415.9) -6.5 %
(loss)
Claims ratio 214.0 % 203.1 % 203.8 % 192.3 %
Expense ratio 17.3 14.8 15.1 15.8
Composite ratio 231.3 % 217.9 % 218.9 % 208.1 %
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Mortgage guaranty earned premiums declined in each of this year's quarterly periods. The lower premium levels resulted mostly from the more selective underwriting criteria applied since late 2007, from an overall decline in the industry's business penetration, and from higher premium refunds related to claim rescissions. These factors were attenuated somewhat by rising persistency of business produced in prior years, and by a continuing decline in premiums ceded to lender-owned (captive) reinsurance companies. During this year's third quarter, the Mortgage Guaranty Group recaptured business previously ceded to several captives. In substance, the transactions are cut-off reinsurance arrangements whereby the captives have remitted to the Company the reserves on existing claim obligations and a risk premium for claims that will occur after the recapture date. Accordingly, the Company recorded proceeds of $148.9 and established a combination of claims reserves ($68.4) and premium reserves ($82.5) all of which resulted in little consequential effect on the pretax loss for the quarter or first nine months of 2009.
Mortgage guaranty investment income trends benefited from a greater invested asset base.
Claim ratios were up slightly year-over-year in both the third quarter and first nine months of 2009. Greater claim rescissions and a moderate decline in claim severity offset to some degree the impact on claim reserve provisions of a continuing uptrend in delinquent loans. The components of incurred mortgage guaranty claim ratios are shown in the following table. The recording of the above noted reinsurance recaptures had the effect of decreasing the paid claims ratios by 49.3 and 16.1 percentage points in this year's third quarter and first nine months, respectively, and increasing the claim reserve provisions ratios by identical amounts.
Mortgage Guaranty Group
Quarters Ended Nine Months Ended
September 30, September 30,
2009 2008 2009 2008
Incurred loss ratio from:
Paid losses 57.8 % 84.7 % 92.5 % 66.6 %
Reserve provisions 156.2 118.4 111.3 125.7
Total 214.0 % 203.1 % 203.8 % 192.3 %
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Title Insurance Results - Old Republic's title insurance business registered slightly better than break even results for the first nine months of 2009. Key operating performance indicators are shown in the following table:
Title Insurance Group
Quarters Ended September 30, Nine Months Ended September 30,
2009 2008 Change 2009 2008 Change
Net premiums and fees $ 253.3 $ 168.4 50.4 % $ 620.6 $ 502.1 23.6 %
earned
Net investment income 6.3 6.2 1.4 18.2 19.1 -4.3
Pretax operating income $ 4.0 $ (9.7) 142.0 % $ .6 $ (27.0) 102.4 %
(loss)
Claims ratio 8.3 % 7.0 % 7.6 % 7.0 %
Expense ratio 91.1 102.2 94.4 102.0
Composite ratio 99.4 % 109.2 % 102.0 % 109.0 %
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Growth in title premiums and fees for 2009 periods resulted from greater refinance transactions earlier this year and from the benefit of market share gains emerging from title industry dislocations and consolidations. Claim costs rose at a quicker pace, however, as the Company added moderately to reserve provisions to address recent claim emergence trends. Production and general operating expenses, while relatively lower as a percentage of premium and fees revenues, rose dollar-wise in reflection of greater personnel and other production costs related to the higher revenues attained and anticipated.
Corporate and Other Operations - The Company's small life and health insurance business and the net costs associated with the parent holding company and internal services subsidiaries produced a much lower gain in this year's first nine months. Period-to-period variations in the results of these relatively minor elements of Old Republic's operations usually stem from the volatility inherent to the small scale of its life and health business, fluctuations in the costs of external debt, and net interest on intra-system financing arrangements. A portion of the year-over-year decline in earnings was also due to foreign exchange adjustments for U.S. dollar conversions from the Canadian currency held by a life and health insurance subsidiary.
Cash, Invested Assets, and Shareholders' Equity - The following table reflects
Old Republic's consolidated cash and invested assets as well as shareholders'
equity at the dates shown:
% Change
September December September Sept '09/ Sept '09/
2009 2008 2008 Dec '08 Sept '08
Cash and invested assets: fair value basis $ 9,844.3 $ 8,855.1 $ 8,733.7 11.2 % 12.7 %
original cost basis $ 9,635.0 $ 9,210.0 $ 9,143.3 4.6 % 5.4 %
Shareholders' Total $ 3,901.3 $ 3,740.3 $ 3,914.3 4.3 % -0.3 %
equity:
Per common share $ 16.54 $ 15.91 $ 16.96 4.0 % -2.5 %
Composition of shareholders' equity per
share:
Equity before items below $ 15.09 $ 16.10 $ 16.96 -6.3 % -11.0 %
Unrealized investment gains (losses) and
other
accumulated comprehensive income (loss) 1.45 (0.19) -
Total $ 16.54 $ 15.91 $ 16.96 4.0 % -2.5 %
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Consolidated cash flow from operating activities amounted to $438.0 for the first nine months of 2009 versus $467.6 for the same period in 2008.
The investment portfolio reflects a current allocation of approximately 85% to fixed-maturity securities and 5% to equities. As has been the case for many years, Old Republic's invested assets are managed in consideration of enterprise-wide risk management objectives intended to assure solid funding of its subsidiaries' long-term obligations to insurance policyholders and other beneficiaries, and evaluations of their long-term effect on the stability of capital accounts. The portfolio contains little or no direct insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, junk bonds, hybrid securities, or illiquid private equity investments. In a similar vein, the Company does not engage in hedging or securities lending transactions, nor
does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes.
Substantially all changes in the shareholders' equity account reflect the
Company's net income or loss, dividend payments to shareholders, and impairments
or changes in market valuations of invested assets during the periods shown
below:
Shareholders' Equity Per Share
Quarter Nine Months
Ended Ended
September 30, September 30,
2009 2009 2008
Beginning balance $ 15.93 $ 15.91 $ 19.71
Changes in shareholders' equity for the
periods:
Net operating income (loss) (0.28) (0.72) (0.50)
Net realized investment gains (losses):
From sales - - 0.07
From impairments 0.08 0.23 (1.44)
Subtotal 0.08 0.23 (1.37)
Net unrealized investment gains (losses) 0.95 1.56 (0.37)
Total realized and unrealized investment 1.03 1.79 (1.74)
gains (losses)
Cash dividends (0.17) (0.51) (0.50)
Stock issuance, foreign exchange, and 0.03 0.07 (0.01)
other transactions
Net change 0.61 0.63 (2.75)
Ending balance $ 16.54 $ 16.54 $ 16.96
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Old Republic's significant investments in the stocks of two leading publicly held mortgage guaranty ("MI") businesses (MGIC Investment Corp. and The PMI Group) account for a substantial portion of the 2008 realized and unrealized investment losses shown in the above and following tables. Unrealized losses, including losses on securities categorized as other-than-temporarily impaired ("OTTI"), represent the net difference between the most recently established cost and the fair values of the investments at each point in time. The aggregate original and impaired costs, fair value, and latest reported underlying equity values of the aforementioned two mortgage guaranty investments are shown below.
September 30, December 31,
2009 2008 2007
Total value of the two MI Original cost $ 416.4 $ 416.4 $ 429.7
investments:
Impaired cost 106.8 106.8 N/A
Fair value 177.0 82.7 375.1
Underlying equity(*) $ 354.7 $ 515.9 $ 679.7
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(*) Underlying equity based on latest reports (which may lag by one quarter) issued by investees.
When making investment decisions, management considers the Company's ability to retain its holdings for a period sufficient to recover their cost and to obtain a competitive long-term total return. It also considers such factors as balance sheet effects of potential changes in market valuations, asset-liability matching objectives, long term ability to hold securities, tax planning considerations, and the investees' reported book values and ability to continue as going concerns. The above-noted mortgage guaranty holdings were acquired as passive long-term investment additions for a core segment of Old Republic's business in anticipation of a recovery for the MI industry in 2010. In management's judgment, the currently depressed market valuations of companies operating in the housing and mortgage-lending sectors of the American economy have been impacted significantly by the cyclical and macroeconomic conditions affecting these sectors, and by the recent dysfunctionality of the banking and mortgage lending industries.
For external financial reporting purposes, however, Old Republic uses relatively short time frames in recognizing OTTI adjustments in its income statement. In this context, absent issuer-specific circumstances that would result in a contrary conclusion, all unrealized investment losses pertaining to any equity security reflecting a 20 percent or greater decline for a six month period is considered OTTI. Unrealized losses that are deemed temporary and all unrealized gains are recorded directly as a separate component of the shareholders' equity account and in the consolidated statement of comprehensive income. As a result of accounting idiosyncrasies, however, OTTI losses recorded in the income statement of one period can not be offset in the income statement of a subsequent period by fair value gains on the previously impaired securities unless the gains are realized through actual sales. Such unrealized fair value gains can only be recognized through direct credits in the shareholders' equity account and in the consolidated statement of comprehensive income.
Recent Capital Raise - Early in this year's second quarter the Company obtained gross proceeds of $316.25 through a public offering of 8% Convertible Senior Notes due in 2012. The funds were used mostly to enhance the capital base of the general and title insurance segments, and to repay a portion of commercial paper debt previously incurred to strengthen the capital of the mortgage guaranty segment as of year end 2008. Along with the growth oriented capital additions to businesses with good prospects for the long term, the new funds enhance the stability and resiliency of Old Republic's consolidated capitalization.
DETAILED MANAGEMENT ANALYSIS
FINANCIAL ACCOUNTING AND REPORTING POLICIES
The Company's annual and interim financial statements incorporate a large number and types of estimates relative to matters which are highly uncertain at the time the estimates are made. The estimation process required of an insurance enterprise is by its very nature highly dynamic inasmuch as it necessitates a continuous evaluation, analysis, and quantification of factual data as it becomes known to the Company. As a result, actual experienced outcomes can differ from the estimates made at any point in time, and thus affect future periods' reported revenues, expenses, net income (loss), and financial condition.
Old Republic believes that its most critical accounting estimates relate to: a) the determination of other-than-temporary impairments in the value of fixed maturity and equity investments; b) the establishment of deferred acquisition costs which vary directly with the production of insurance premiums; c) the recoverability of reinsured paid and/or outstanding losses; and d) the establishment of reserves for losses and loss adjustment expenses. The major assumptions and methods used in setting these estimates are discussed in the Company's 2008 Annual Report on Form 10K.
In recent years, the Financial Accounting Standards Board ("FASB") has issued various releases requiring additional financial statement disclosures, and to provide guidance relative to the application of such releases. Of particular pertinence to the Company's financial statements are certain disclosures relating to uncertainties affecting income tax provisions, and methodologies for establishing the fair value and recording of other-than-temporary impairments of securities. The requisite disclosures and explanations of those matters have been included in the footnotes to the Company's financial statements.
FINANCIAL POSITION
The Company's financial position at September 30, 2009 reflected increases in assets, liabilities, and common shareholders' equity of 7.9%, 9.3% and 4.3%, respectively, when compared to the immediately preceding year-end. Cash and invested assets represented 68.8% and 66.8% of consolidated assets as of September 30, 2009 and December 31, 2008, respectively. As of September 30, 2009, cash and invested assets increased 11.2% to $9,844.3 as a result of positive operating cash flows, new funds from an April 2009 securities offering, and an increase in the fair value of fixed maturity investments.
Investments - During the first nine months of 2009 and 2008, the Company committed substantially all investable funds to short to intermediate-term fixed maturity securities. At both September 30, 2009 and 2008, approximately 99% of the Company's investments consisted of marketable securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities. The portfolio contains little or no insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, junk bonds, hybrid . . .
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