Old Republic International (ORI)

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Old Republic International (NYSE: ORI) is an insurance company offering mortgage, title, and general insurance. The company holds the 5th largest market share of the Title Insurance market.^[1] In 2007, the majority of company revenue and all of income came from Old Republic's General Insurance Group, which includes 15 diversified and uncorrelated types of insurance such as automobile, aviation, and home warranty. This diversification becomes particularly advantageous during times of economic and financial crisis.

Morningstar notes that historically, General Insurance had an operating profit of only 19%, whereas Title and Mortgage operations had operating profits of 38% and 63%, respectively.^[2] However, this changed in 2007 with the subprime lending that caused the title and mortgage segments to fall dramatically. Over 2007, both of these segments experienced losses and general insurance was the only segment to make a profit.^[3]

Unlike its main competitors, Old Republic has a diversified relationship between its different operating segments. Title Insurance competitors such as First American (FAF) and Fidelity National Financial (FNF) are more sensitive to changes in the volume of mortgage originations and refinances because it is their main source of revenues. Mortgage Insurance competitors such as MGIC Investment (MTG) and PMI Group (PMI) are more sensitive to changes in the amount of mortgage delinquencies, a particularly important fact in light of the Mortgage Market Meltdown. Old Republic is not wholly dependent on any of one source of insurance. Despite losses in 2007 in both Old Republic's Title Insurance and Mortgage Guaranty Segment, the company's earnings from its General Insurance Operations let the company turn an overall positive net income for 2007.^[3]

Old Republic reported a net loss of $48 million for Q3 of 2008.^[4] Management claims that this loss is due to mortgage related distress for both the company's Mortgage Guaranty and Title Insurance groups. Management expects this distress to continue into 2009, but said in a press release on October 23, 2008, that they are confident that earnings from their General Insurance Group will carry the company through the difficult economic times.^[5]

[edit] Company Overview

Old Republic Revenue and Income ^[6]

[edit] Business Financials

ORI 2007 Revenue by Segment ^[3]

Old Republic's income in 2007 declined by 41% compared to 2006. Management claimed this was due to operating losses from both the Mortgage Guaranty and Title Insurance Segments.^[7] This loss from Mortgage related business was offset by a gain from investments recognized during 2007.^[7] Operating Income from the General Insurance group remained unaffected by the Sub-Prime Mortgage Crisis, letting Old Republic post a $272.4 million net income for 2007.^[3]

[edit] Business Segments

General Insurance by Coverage Type ^[8]

• General Insurance (58% of revenue, 110% of pre-tax earnings^[3]) The General Insurance Segment offers a variety of different policies. These insurance products are related to commercial products rather than personal insurance policies. About 85% of the premiums earned from these policies are earned indirectly through independent agents.^[9] This means that the agency companies write the policy and then Old Republic assumes the risk in the policy in exchange for part of the premium. The following are the coverages offered in the General Insurance Segment:

Automobile Extended Warranty Insurance: this type of policy covers repairs on individual automobiles after the manufacturer's warranty on the automobile expires.

Aviation: this type of policy covers damages to aircraft equipment and liability of damages to people or property. This coverage does not include commercial airlines.

Commercial Automobile Insurance: this type of policy covers damages to people and property by commercial vehicle operations. Old Republic mostly covers trucking with these policies.

Commercial Multi-Peril: this type of policy covers liabilities from action by owners and employees of a business.

Consumer Credit Indemnity: this type of policy insures against individuals or customers being unable to pay their loans.

Errors & Omissions: this type of policy insures against liability and legal costs arising from acting below professional standards. These policies do not cover any type of medical worker.

Directors & Officers: this type of policy insures against legal claims made, usually by shareholders, against the directors and officers of a company.

Fidelity: this insurance covers against losses to a company due to dishonest actions of employees.

Guaranteed Asset Protection: this type of policy covers the difference between an insurance company's liability and the total remaining loan balance on a borrowed vehicle.

Surety: this type of policy ensures completion of projects, such as construction projects.

General Liability: this type of policy insures against general liabilities such as negligence.

Home Warranty Insurance: this type of policy covers repairs and maintenance on certain products within homes, such as heating systems.

Inland Marine: this type of policy covers damages and losses of property that is being transported over land.

Travel Accident: this type of policy covers losses due to trip delays and cancellations.

Workers' Compensation: this type of policy covers losses of a company due to compensation payments that they are contractually required to make when one of its employees becomes disabled, injured, or dies.

These policies perform, for the most part, independent of one another. For an insurance company, that means the losses from one type of policy are uncorrelated with losses from another type of policy. For example, increased claims in Aviation policies do not change our expectations of claims under the Surety policies. With the exception of Surety and Workers' Compensation, performance in the General Insurance segment is uncorrelated with performance in the Mortgage Guaranty and Title Insurance segments. As evidenced in the 2007 earnings by segment,^[3] declining performance occurred for both the Mortgage Guaranty and Title Insurance segment, while General Insurance performance was unaffected. Income before taxes for General Insurance grew from $401.6 million in 2006 to $418.0 million in 2007.^[3] Over the same time period, Income before taxes declined from $228.4 to $-110.4 for the Mortgage Guaranty segment, and from $31.0 million to $-14.7 million for the Title Insurance segment.^[3]

• Mortgage Guaranty (15% of revenue, -29% of pre-tax earnings^[3]) The Mortgage Guaranty Segment insurers mortgage lenders and investors from defaults on Mortgages. The policies issued by this segment only cover first mortgages taken on a property and often mortgages in which the down payment on the property is less than 20% of the property's purchase price.^[10]

• Title Insurance (21% of revenue, -14.7 of pre-tax earnings^[3]) Title Insurance protects purchasers of real property from defects in the title to the property and issues pertaining to what the purchaser can and cannot do with the property. Title policies are issued along with any purchase of real estate and are required for most mortgages and refinances. The Mortgage Market Meltdown has decreased the revenues of the Title Insurance Segment.

The remaining 22.6% of 2007 Pre-Tax income came from $15.1 million and $70.3 million Pre-Tax Earnings from Corporate operations and Realized Investment Gains, respectively.^[3]

The following are operating metrics that describe measurements of performance specific to Old Republic's industry:

• Consolidated Claims and Benefits Ratio is a ratio that measures expenses due to claims, benefits, and settlement costs versus the associated premiums earned. An increase in this ratio indicates higher expense for the company.
• General Insurance Premiums and Fees measures the amount of premiums and fees collected pertaining to policies in the General Insurance group. The steady growth in the General Insurance Premiums and Fees reflects a stable underwriting environment for the General Insurance policies.
• Mortgage Guaranty Premiums and Fees measures the amount of premiums and fees collected pertaining to policies in the Mortgage Guaranty group.
• Title Premiums and Fees measures the amount of premiums and fees collected pertaining to policies in the Title Insurance group. The decrease in Title Premiums and Fees reflects the decrease in mortgage originations and refinances.
• Gross Insurance Reserves at End of Year is the amount of money set aside to cover claims, expenses, and other losses related to previously issued insurance policies. This number depends on the claims rate during the year and on the company's policy for setting aside money as a reserve.

ORI 2007 Premiums by Location ^[14]

[edit] Key Trends and Forces

[edit] Changes in Regulations Affect Size and Frequency of Claims

Changes in Government regulations over the past ten years have shown how they can affect the performance of Old Republic's policies. In 2001, the Federal Department of Labor changed their policy regarding claims dealing with the Black Lung Disease, a condition that coal miners are at risk for.^[15] Old Republic insures coal mining and related businesses for Workers' Compensation against Black Lung claims. The change in regulation made the standards to file a Black Lung claim more lenient, increasing the number of Workers' Compensation claims against Old Republic. While these regulations hurt Old Republic's performance, the company is partially insulated against these adverse change in regulation by "loss-sensitive" policies that increase premium revenues for Old Republic as claims against individual policies grow.

Also in 2001, the Federal Government passed legislation that forced primary insurance companies to offer insurance against certified acts of terrorism.^[16] The government has agreed to subsidize these terrorism policies through 2014, but Old Republic's management notes that this regulation exposes the company to significantly more risk.^[16]

[edit] Interest Rates Affect Size of Payouts on Workers' Compensation Policies

Workers' Compensation insurance is subject to changes in interest rates. This coverage, which is second largest coverage offered by Old Republic,^[16] is payed out based on discounted future earnings of workers. Therefore, changes in interest rates affect the present value of claims that the company is liable to pay. Interest rate risk increases losses for both both Old Republic's Worker Compensation and Mortgage Guaranty coverages.

[edit] Increased Mortgage Delinquencies Negatively Affect Claims

The Subprime lending policies and their associated turmoil have increased the amount of Mortgage Delinquencies among home owners. This increase in delinquencies has increased the claims losses in the Mortgage Guaranty Segment. Claims for 2007 were 119% of their associated premiums earned.^[17] The increased level of claims caused the Mortgage Guaranty Segment to report a loss for the first time in 19 years.^[17] Over the past three years, the Claims Ratio for the Mortgage Guaranty Group has increased 37.2% in 2005 to 42.8% in 2006 and to 118.8% in 2007.^[17] Old Republic's Management comments that claims were both more frequent and greater in severity.^[17]

[edit] The declining U.S. Housing Market decreases Mortgage Originations

The US housing slump has negatively affected earnings from both Old Republic's Mortgage Guaranty and Title Insurance Segments. Over the past two years in particular, the declines in housing sales have decreased the number of Title Insurance policies available for the entire industry. While Mortgage Guaranty Policies did not face the same decrease, their claims rate increased dramatically as noted in the previous trend. Old Republic's management notes that the company's Title Operations in the Western United States faced the worst impact of the declining housing market.^[18]

[edit] Increasing Interest Rates decrease Refinances and Title Revenues

Low Interest Rates during the early 2000's encouraged refinancing of mortgages for both residential and commercial properties. As interest rates increased from 2005 to 2007,^[19] Title Insurance Premiums and Fees for Old Republic decreased from $1,081.8 million to $850.7 million.^[18]

[edit] Competition

Old Republic competes with insurers in each of the different segments in which it operates. The following are the largest insurers each of the segments.

• St. Paul Companies (TRV) is a holding company that deals with an array of different commercial, property, and casualty insurance. TRV competes with Old Republic's General Insurance Group. TRV, differs from Old Republic by offering more personal lines of insurance and a greater variety of business insurance. The companies compete in such areas as Workers Compensation Insurance, Commercial Automobile Insurance, General Liability, and Financial Indemnity Insurance. In 2007, TRV earned $26 billion in revenue.^[20] During this same time period, Old Republic earned $2.2 billion in premiums and fees from its General Insurance Operations.^[12] This is a rough comparison because it includes revenue from lines of insurance for TRV that Old Republic does not offer.

• First American (FAF) is a holding company and has earned at least 69% of its revenue from Title Insurance premiums over the past three years. First American has the largest market share in U.S. title insurance and competes directly with Old Republic for Title Insurance Premiums. First American also operates an Information Technology Segment, which provides Mortgage and Property Information.^[21] First American earned $5.5 billion in Title Insurance premiums in 2007.^[22] During the same year, Old Republic earned $1.1 billion from its Title Insurance Operations.^[12] Other top competitors for Title Insurance include Fidelity National Financial (FNF), Stewart Information Services (STC), and LandAmerica Financial Group (LFG).

• MGIC Investment (MTG) is a holding company that is the largest private mortgage insurer in the US.^[23] MTG competes with Old Republic's Mortgage Guaranty segment. MTG had premiums related to Mortgage Insurance of $1.3 billion in 2007.^[24] During this same period, Old Republic earned revenues from its Mortgage Guaranty Segment of $429.5 million.^[12] Nearly all of MTG's operations relate directly or indirectly to private mortgage insurance.

[edit] Market Share

Market Share data is not available for the General Insurance Group because of the many different varieties of General Insurance offered. Data for the Title Insurance market, however, indicates that Old Republic is the 5th largest Title Insurer by premiums earned.

The top four Title Insurers are all more narrowly focused on Title Insurance than Old Republic. Old Republic is the only of the the top five companies for which Title Insurance is not the main source of revenue for the company. All five companies also offer Escrow and Closing Fees for real estate transactions.

[edit] References

1. ↑ ^{1.0 1.1} 2007 Market Share by Family and State - DISTRIBUTION
2. ↑ Morningstar Analyst Report on ORI
3. ↑ ^{3.00 3.01 3.02 3.03 3.04 3.05 3.06 3.07 3.08 3.09 3.10} ORI 2007 10-K, Item 1: Business, Page 3
4. ↑ ORI 2008 10-Q, Page 4
5. ↑ ORI 2008 Q3 Results Press Release
6. ↑ ORI 2007 10-K, Item 6: Selected Financial Data, page 24
7. ↑ ^{7.0 7.1} ORI 2007 10-K, Item 7: Management Analysis of Financial Position and Results of Operations, Page 25
8. ↑ ORI 2007 10-K, Item 1: Business, Page 7
9. ↑ ORI 2007 10-K, Item 1: Business, Page 5
10. ↑ ORI 2007 10-K, Item 1: Business, Page 5
11. ↑ ^{11.0 11.1 11.2} ORI 2007 10-K, Item 7: Management Analysis of Financial Position and Results of Operations, Page 42
12. ↑ ^{12.00 12.01 12.02 12.03 12.04 12.05 12.06 12.07 12.08 12.09 12.10 12.11} ORI 2007 10-K, Item 7: Management Analysis of Financial Position and Results of Operations, Page 36
13. ↑ ^{13.0 13.1 13.2} ORI 2007 Notes to Consolidated Financial Statements, Page 59
14. ↑ ORI 2007 10-K, Item 1: Business, Page 14
15. ↑ ORI 2007 10-K, Item 1: Business, Page 9
16. ↑ ^{16.0 16.1 16.2} ORI 2007 10-K, Item 1: Business, Page 18
17. ↑ ^{17.0 17.1 17.2 17.3} ORI 2007 10-K, Item 7: Management Analysis of Financial Position and Results of Operations, Page 27
18. ↑ ^{18.0 18.1} ORI 2007 10-K, Item 7: Management Analysis of Financial Position and Results of Operations, Page 28
19. ↑ Historical Federal Funds Rates from moneycafe.com
20. ↑ TRV 2007 10-K, Item 6: Selected Financial Data, Page 67
21. ↑ FAF 2007 Annual Report, Item 1: Business, page 3
22. ↑ FAF 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 29
23. ↑ MTG 2007 Annual Report, Item 1: Business, page 4
24. ↑ MTG 2007 Annual Report, Item 6: Selected Financial Data, page 44