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Old Republic International 10-K 2009 Documents found in this filing:
Indicate by check
mark if the registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act.Yes: X/
No:>
Indicate by check
mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes: /
No:X>
Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports) and (2) has been subject to such filing requirements for the past
90 days. Yes: X/
No:>
Indicate by check
mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
¨
Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one).
Indicate by check
mark whether the registrant is a shell company (as defined in Exchange Act Rule
12b-2). Yes: /
No:X>
The aggregate
market value of the registrant's voting Common Stock held by non-affiliates of
the registrant (assuming, for purposes of this calculation only, that the
registrant’s directors and executive officers, the registrant’s various employee
benefit plans and American Business & Personal Insurance Mutual, Inc. and
its subsidiaries are all affiliates of the registrant), based on the closing
sale price of the registrant’s common stock on June 30, 2008, the last day of
the registrant’s most recently completed second fiscal quarter, was
$2,564,894,535.
The registrant had
235,036,335 shares of Common Stock outstanding as of January 30,
2009.
Documents incorporated by
reference:
The following
documents are incorporated by reference into that part of this Form 10-K
designated to the right of the document title.
There are 94 pages
in this report
PART
I
Item
1 - Business
(a) General Description of
Business.> Old Republic International Corporation is a Chicago based
holding company engaged in the single business of insurance underwriting. It
conducts its operations through a number of regulated insurance company
subsidiaries organized into three major segments, namely, it’s General (property
and liability insurance), Mortgage Guaranty, and Title Insurance Groups.
References herein to such groups apply to the Company's subsidiaries engaged in
these respective segments of business. The results of a small life and health
insurance business are included within the corporate and other caption of this
report. “Old Republic”, or “the Company” refers to Old Republic International
Corporation and its subsidiaries as the context requires.
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 the maintenance of financial soundness in support of its subsidiaries’ long
term obligations to insurance beneficiaries. To achieve these objectives,
adherence to certain basic insurance risk management principles is stressed, and
asset diversification and quality are emphasized. The underwriting principles
encompass:
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.
The contributions
to consolidated net revenues and income before taxes, and the assets and
shareholders’ equity of each Old Republic segment are set forth in the following
table. This information 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 in this
report.
2
3
Old Republic’s
General Insurance segment is best characterized as a commercial lines insurance
business with a strong focus on liability insurance coverages. Most of these
coverages are provided to businesses, government, and other institutions. The
Company does not have a meaningful exposure to personal lines insurance such as
homeowners and private automobile coverages, nor does it insure significant
amounts of commercial or other real property. In continuance of its commercial
lines orientation, Old Republic also focuses on specific sectors of the North
American economy, most prominently the transportation (trucking and general
aviation), commercial construction, forest products, energy, general
manufacturing, and financial services industries. In managing the insurance
risks it undertakes, the Company employs various underwriting and loss
mitigation techniques such as utilization of policy deductibles, captive
insurance risk-sharing arrangements, and retrospective rating and policyholder
dividend plans. These underwriting techniques are intended to better correlate
premium charges with the ultimate claims experience pertaining to individual or
groups of assureds.
Over the years, the
General Insurance Group’s operations have been developed steadily through a
combination of internal growth, the establishment of additional subsidiaries
focused on new types of coverages and/or industry sectors, and through several
mergers of smaller companies. As a result, this segment has become widely
diversified with a business base encompassing the following major
coverages:
Automobile Extended Warranty
Insurance (1992): Coverage is provided to the vehicle owner for certain
mechanical or electrical repair or replacement costs after the manufacturer’s
warranty has expired.
Aviation (1983): Insurance policies
protect the value of aircraft hulls and afford liability coverage for acts that
result in injury, loss of life, and property damage to passengers and others on
the ground or in the air. Old Republic’s aviation business does not extend to
commercial airlines.
Commercial Automobile Insurance
(1930’s): Covers vehicles (mostly
trucks) used principally in commercial pursuits. Policies cover damage to
insured vehicles and liabilities incurred by an assured for bodily injury and
property damage sustained by third parties.
Commercial Multi-Peril
(“CMP”)(1920’s): Policies afford
liability coverage for claims arising from the acts of owners or employees, and
protection for the physical assets of large businesses.
Financial Indemnity: Multiple
types of specialty coverages, including most prominently the following five, are
underwritten by Old Republic within this financial indemnity products
classification.
Consumer Credit Indemnity
(“CCI”)(1950’s): Policies provide limited
indemnity to lenders and other financial intermediaries against the risk of
non-payment of consumer loan balances by individual buyers and borrowers arising
from unemployment, bankruptcy, and other failures to pay.
Errors &
Omissions(“E&O”)/Directors & Officers (“D&O”)(1983):
E&O liability policies are
written for non-medical professional service providers such as lawyers,
architects and consultants, and provides coverage for legal expenses, and
indemnity settlements for claims alleging breaches of professional
standards. D&O coverage provides for the payment of legal expenses, and
indemnity settlements for claims made against the directors and officers of
corporations from a variety of sources, most typically
shareholders.
Fidelity (1981): Bonds cover
the exposures of financial institutions and commercial and other enterprises for
losses of monies or debt and equity securities due to acts of employee
dishonesty.
Guaranteed Asset Protection
(“GAP”)(2003): This insurance covers an
automobile loan borrower for the dollar value difference between a primary
insurance company’s liability for the total loss (remaining cash value) of an
insured vehicle and the amount still owed on an automobile loan.
Surety (1981): Bonds are
insurance company guarantees of performance by a corporate principal or
individual such as for the completion of a building or road project, or payment
on various types of contracts.
General Liability (1920’s):
Protects against liability of an assured which stems from carelessness,
negligence, or failure to act, and results in property damage or personal injury
to others.
Home Warranty Insurance
(1981): This
product provides repair and/or replacement coverage for home systems (e.g.
plumbing, heating, and electrical) and designated appliances.
Inland Marine (1920’s): Coverage pertains to the
insurance of property in transit over land and of property which is mobile by
nature.
Travel Accident (1970):
Coverages provided under these policies, some of which are also underwritten by
the Company’s Canadian life insurance affiliate, cover monetary losses arising
from trip delay and cancellation for individual insureds.
Workers’ Compensation
(1920’s): This coverage is purchased by employers to provide insurance
for employees’ lost wages and medical benefits in the event of work-related
injury, disability, or death.
4
Commercial
automobile, general liability and workers’ compensation insurance are typically
produced in tandem for many assureds. For 2008, production of commercial
automobile direct insurance premiums accounted for approximately 28.5% of
consolidated General Insurance Group direct premiums written, while workers’
compensation and general liability direct premium production amounted to
approximately 19.1% and 13.4%, respectively, of such consolidated
totals.
Approximately 83%
of general insurance premiums are produced through independent agency or
brokerage channels, while the remaining 17% is obtained through direct
production facilities.
Private mortgage
insurance protects mortgage lenders and investors from default related losses on
residential mortgage loans made primarily to homebuyers who make down payments
of less than 20% of the home’s purchase price. The Mortgage Guaranty Group
insures only first mortgage loans, primarily on residential properties
incorporating one-to-four family dwelling units.
There are two
principal types of private mortgage insurance coverage: “primary” and “pool”.
Primary mortgage insurance provides mortgage default protection on individual
loans and covers a stated percentage of the unpaid loan principal, delinquent
interest, and certain expenses associated with the default and subsequent
foreclosure. In lieu of paying the stated coverage percentage, the Company may
pay the entire claim amount, take title to the mortgaged property, and
subsequently sell the property to mitigate its loss. Pool insurance, which is
written on a group of loans in negotiated transactions, provides coverage that
ranges up to 100% of the net loss on each individual loan included in the pool,
subject to provisions regarding deductibles, caps on individual exposures, and
aggregate stop loss provisions which limit aggregate losses to a specified
percentage of the total original balances of all loans in the pool.
Traditional primary
insurance is issued on an individual loan basis to mortgage bankers, brokers,
commercial banks and savings institutions through a network of Company-managed
underwriting sites located throughout the country. Traditional primary loans are
individually reviewed (except for loans insured under delegated approval
programs) and priced according to filed premium rates. In underwriting
traditional primary business, the Company generally adheres to the underwriting
guidelines published by the Federal Home Loan Mortgage Corporation (“FHLMC” or
“Freddie Mac”) or the Federal National Mortgage Association (“FNMA” or “Fannie
Mae”), purchasers of many of the loans the Company insures. Delegated
underwriting programs allow approved lenders to commit the Company to insure
loans provided they adhere to predetermined underwriting guidelines. In 2008,
delegated underwriting approvals accounted for approximately 73% of the
Company’s new traditional primary risk written.
Bulk and other
insurance is issued on groups of loans to mortgage banking customers through a
centralized risk assessment and underwriting department. These groups of loans
are priced in the aggregate, on a bid or negotiated basis. Coverage for
insurance issued in this manner can be provided through primary insurance
policies (loan level coverage) or pool insurance policies (aggregate coverage).
The Company considers transactions designated as bulk insurance to be exposed to
higher risk (as determined by characteristics such as origination channel, loan
amount, credit quality, and loan documentation) than those designated as other
insurance.
Before insuring any
loans, the Company issues to each approved customer a master policy outlining
the terms and conditions under which coverage will be provided. Primary business
is then executed via the issuance of a commitment/certificate for each loan
submitted and approved for insurance. In the case of business providing pool
coverage, a separate pool insurance policy is issued covering the particular
loans applicable to each transaction.
As to all types of
mortgage insurance products, the amount of premium charge depends on various
underwriting criteria such as loan-to-value ratios, the level of coverage being
provided, the borrower’s credit history, the type of loan instrument (whether
fixed rate/fixed payment or an adjustable rate/adjustable payment),
documentation type, and whether or not the insured property is categorized as an
investment or owner occupied property. Coverage is non-cancelable by the Company
(except in the case of non-payment of premium or certain master policy
violations) and premiums are paid under single, annual, or monthly payment
plans. Single premiums are paid at the inception of coverage and provide
coverage for the entire coverage term. Annual and monthly premiums are renewable
on their anniversary dates with the premium charge determined on the basis of
the original or outstanding loan amount. The majority of the Company’s direct
premiums are written under monthly premium plans. Premiums may be paid by
borrowers as part of their monthly mortgage payment and passed through to the
Company by the servicer of the loan or they may be paid directly by the
originator of, or investor in the mortgage loan.
5
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. For
the year ended December 31, 2008, approximately 37% of the Company’s
consolidated title premium and related fee income stemmed from direct operations
(which include branch offices of its title insurers and wholly owned
subsidiaries of the Company), while the remaining 63% emanated from independent
title agents and underwritten title companies.
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 may be 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 customer 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, as well as real estate information products,
national default management services, and services pertaining to real estate
transfers and loan transactions.
Corporate and other
operations include the accounts of a small life and health insurance business as
well as those of the parent holding company and several minor corporate services
subsidiaries that perform investment management, payroll, administrative and
minor marketing services.
The Company’s small
life and health business registered 2008 and 2007 net premium revenues of $80.1
million and $77.0 million, respectively. This business is conducted in both the
United States and Canada and consists mostly of limited product offerings sold
through financial intermediaries such as automobile dealers, travel agents, and
marketing channels that are also utilized in some of Old Republic’s general
insurance operations. Production of term life insurance, accounting for net
premiums earned of $16.8 million in 2008 and $16.5 million in 2007, was
terminated and placed in run off as of year end 2004.
6
The following table
reflects underwriting statistics covering premiums and related loss, expense,
and policyholders' dividend ratios for the major coverages underwritten in the
Company’s insurance segments.
7
Variations in claim
ratios are typically 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 incurred but not reported claims and claim
expenses. The Company can therefore experience period-to-period volatility in
the underwriting results for individual coverages as demonstrated in the above
table. As a result of the Company’s basic underwriting focus in the management
of its business, it has attempted to dampen this volatility and thus ensure a
higher degree of overall underwriting stability by diversifying the coverages it
offers and industries it serves.
The claim ratios
include loss adjustment expenses where appropriate. Policyholders' dividends,
which apply principally to workers' compensation insurance, 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.
The general
insurance claims ratio reflects reasonably consistent trends for all reporting
periods. This major cost factor reflects largely pricing and risk selection
improvements that have been applied since 2001, together with elements of
reduced loss severity and frequency. General Insurance Group loss ratios for
workers' compensation and liability insurance coverages in particular may
reflect greater variability due to chance events in any one year, changes in
loss costs emanating from participation in involuntary markets (i.e. insurance
assigned risk 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, claims and dividend ratios for these individual coverages
should be considered in the light of such a concurrent underwriting approach.
With respect to commercial automobile coverages, higher claims ratios
experienced during the past three years are primarily due to greater claim
frequency. Better results in workers’ compensation in 2008 and 2007 have been
due to improved pricing in general as well as stronger growth of business
subject to captive reinsurance, retrospective premium, or self-insured
deductible programs that are intended to produce lower net loss ratios. The
claims ratio for a relatively small book of general liability coverages has
tended to be highly volatile, usually rising due to the impact of higher claims
emergence and greater than anticipated severity, mostly from legacy asbestos and
environmental claims exposures. The higher claim ratio for financial indemnity
coverages in 2008 and 2007 was driven principally by greater claim frequencies
experienced in Old Republic’s consumer credit indemnity (“CCI”) coverage. The
higher loss experience on Old Republic’s CCI product added 4.1 percentage points
to the 2008 general insurance overall composite ratio by comparison to an
insignificant effect for 2007.
The mortgage guaranty claims
ratios have continued to rise in recent periods, principally as a result of
higher reserve positions and paid losses. Reserve additions have been increasing
as a result of higher levels of reported delinquencies as well as increased
expectations as to claim frequencies and severities. Claim severity has trended
upward primarily due to loans with larger unpaid principal balances and
corresponding risk becoming delinquent along with a lower level of mitigation
potential due to housing depreciation trends. Expectations of greater claim
frequency are impacted by several factors, including the number of loans
entering into default, the outlook for the housing market, tightening lending
standards which affect borrowers’ ability to refinance troubled loans, the aging
of the bulk business, and the overall declining state of the
economy.
The title insurance
claim ratio has been in the mid single digits in each of the past several years
due to favorable trends in claims frequency and severity for business
underwritten in the past fifteen years or so. Though still reasonably contained,
the increases in claim ratios in 2008 and 2007 are reflective of the continuing
downturn in the housing and related mortgage industries.
The consolidated
claims, expense, and composite ratios reflect all the above factors and the
changing period-to-period contributions of each segment to consolidated
results.
General
Insurance Claim Reserves
The Company’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 management 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 Company's insurance subsidiaries is a reasonably
complex and dynamic process influenced by a large variety of factors. These
factors principally 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, statistical, and
actuarial studies, the professional experience and expertise of the Company's
claim departments' personnel or attorneys and independent claim adjusters,
ongoing changes in claim frequency or severity patterns such as those caused by
natural disasters, illnesses, accidents, work-related injuries, and changes in
general and industry-specific economic conditions. Consequently, the reserves
established are a reflection of the opinions of a large number of persons,
of the application and interpretation of historical precedent and trends, of
expectations as to future developments, and of management’s judgment in
interpreting all such factors. At any point in time, the Company is exposed to
possibly higher or lower than anticipated claim costs due to all of these
factors, and to the evolution, interpretation, and expansion of tort law, as
well as the effects of unexpected jury verdicts.
8
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 $156.8 million, $148.5 million and $151.0 million, as of
December 31, 2008, 2007 and 2006, 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.
Early in 2001, the
Federal Department of Labor revised the Federal Black Lung Program regulations.
The revisions basically require a reevaluation of previously settled, denied, or
new occupational disease claims in the context of newly devised, more lenient
standards when such claims are resubmitted. Following a number of challenges and
appeals by the insurance and coal mining industries, the revised regulations
were, for the most part, upheld in June, 2002 and are to be applied
prospectively. Since the final quarter of 2001, black lung claims filed or
refiled pursuant to these anticipated and now final regulations have increased,
though the volume of new claim reports has abated in recent years. The vast
majority of claims filed to date against Old Republic pertain to business
underwritten through loss sensitive programs that permit the charge of
additional or refund of return premiums to wholly or partially offset changes in
estimated claim costs, or to business underwritten as a service carrier on
behalf of various industry-wide involuntary market (i.e. assigned risk) pools. A
much smaller portion pertains to business produced on a traditional risk
transfer basis. The Company has established applicable reserves for claims as
they have been reported and for claims not as yet reported on the basis of its
historical experience as well as assumptions relative to the effect of the
revised regulations. Inasmuch as a variety of challenges are likely as the
revised regulations are implemented through the actual claim settlement process,
the potential impact on reserves, gross and net of reinsurance or retrospective
premium adjustments, resulting from such regulations cannot as yet be estimated
with reasonable certainty.
Old Republic's
reserve estimates also include provisions for indemnity and settlement costs for
various asbestosis and environmental impairment (“A&E”) claims 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,
including many issued during a short period between 1981 and 1982 pursuant to an
agency agreement canceled in 1982. Over the years, the Company's property and
liability insurance subsidiaries have typically issued general liability
insurance policies with face amounts ranging between $1.0 million and $2.0
million and rarely exceeding $10.0 million. Such policies have, in turn, been
subject to reinsurance cessions which have typically reduced the subsidiaries’
net retentions to $.5 million or less as to each claim. Old Republic's exposure
to A&E claims cannot, however, be calculated by conventional insurance
reserving methods for 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 insurance industry members
which has produced inconsistent court decisions with regard to such questions as
to when an 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. In recent times, the Executive Branch
and/or the Congress of the United States have proposed or considered changes in
the legislation and rules affecting the determination of liability for
environmental and asbestosis claims. As of December 31, 2008, however, there is
no solid evidence to suggest that possible future 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 A&E claims in particular is much more difficult or impossible
to quantify with a high degree of precision. Accordingly, no representation can
be made that the Company's reserves for such claims and related costs will not
prove to be overstated or understated in the future. At December 31, 2008, Old
Republic’s aggregate indemnity and loss adjustment expense reserves specifically
identified with A&E exposures amounted to approximately $172.4 million
gross, and $145.0 million net of reinsurance. Based on average annual claims
payments during the five most recent calendar years, such reserves represented
7.3 years (gross) and 9.9 years (net of reinsurance) of average annual claims
payments. Fluctuations in this ratio between years can be caused by the
inconsistent pay out patterns associated with these types of claims. For the
five years ended December 31, 2008, incurred A&E claim and related loss
settlement costs have averaged 2.4% of average annual General Insurance Group
claims and related settlement costs.
Over the years, 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.
The Company believes that its overall reserving practices have been consistently
applied over many years, and that its aggregate reserves have generally resulted
in reasonable approximations of the ultimate net costs of claims incurred.
However, no representation is made nor is any guaranty given that ultimate net
claim and related costs will not develop in future years to be greater or lower
than currently established reserve estimates.
9
The following table
shows the evolving redundancies or deficiencies for reserves established as of
December 31, of each of the years 1998 through 2008. 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 and settlement processes 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
cumulative retrospective premium and commission adjustments employed in various
parts of the Company's business may partially offset such effects. The
moderately deficient development of reserves at year-ends 1998 to 2002 pertain
mostly to claims incurred in prior accident years, generally for business
written in the 1980’s. (See “Consolidated Underwriting Statistics” above, and
“Reserves, Reinsurance, and Retrospective Adjustments” elsewhere
herein).
10
The following table
shows an analysis of changes in aggregate reserves for the Company's property
and liability insurance claims and allocated claim adjustment expenses for each
of the years shown:
(b) Investments.> In common
with other insurance organizations, Old Republic invests most capital and
operating funds in income producing securities. 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 debt, preferred and common stocks, certain types of real
estate, and first mortgage loans. For many years, Old Republic's investment
policy has therefore been to acquire and retain primarily investment grade,
publicly traded, fixed maturity securities. The investment policy is 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. As a consequence of all these factors, the Company’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, as well as
evaluations of their long-term effect on stability of capital accounts.
Accordingly, the Company's exposure to so called “junk bonds”, illiquid private
equity investments, real estate, mortgage loans, mortgage-backed securities,
asset-backed securities, collateralized debt obligations (“CDO’s”), guaranteed
investment contracts, and derivatives (including credit default swaps, interest
rate swaps, or structured investment vehicles, and auction rate variable
short-term investments) is either immaterial or non existent. In a similar vein, the Company does
not engage in hedging transactions or securities lending operations, nor does it
invest in securities whose values are predicated on non-regulated financial
instruments exhibiting amorphous counter-party risk attributes.
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 no bond or note investments in default as to principal and/or
interest at December 31, 2008 and 2007. The status and market value changes of
each investment is reviewed on at least a quarterly basis, and estimates of
other-than-temporary impairments in the portfolio’s value are evaluated and
established at each balance sheet date. Substantially all of the Company’s
invested assets as of December 31, 2008 have been classified as “available for
sale” pursuant to the existing investment policy.
The Company's
investment policies are not designed to maximize or emphasize the realization of
investment gains. The combination of gains and losses from sales or impairments
of securities are reflected as realized gains and losses in the income
statement. Dispositions of securities result principally from scheduled
maturities of bonds and notes and sales of fixed income and equity securities
available for sale. Dispositions of securities at a realized gain or loss
reflect such factors as ongoing assessments of issuers’ business prospects,
rotation among industry sectors, changes in credit quality, and tax planning
considerations.
11
The following
tables show invested assets at the end of the last two years, together with
investment income for each of the last three years:
The independent
credit quality ratings and maturity distribution for Old Republic's consolidated
fixed maturity investments, excluding short-term investments, at the end of the
last two years are shown in the following tables. These investments, $7.4
billion and $7.3 billion at December 31, 2008 and 2007, respectively,
represented approximately 56% of consolidated assets as of both such dates, and
78% and 84%, respectively, of consolidated liabilities as of such
dates.
12
(c) Marketing.> Commercial
automobile (trucking), workers' compensation and general liability insurance
underwritten for business 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, and by direct
sales. No single source accounted for over 10% of Old Republic's premium volume
in 2008.
Traditional primary
mortgage insurance is marketed primarily through a direct sales force which
calls on mortgage bankers, brokers, commercial banks, savings institutions and
other mortgage originators. No sales commissions or other forms of remuneration
are paid to the lending institutions or others for the procurement or
development of business. The Mortgage Guaranty segment’s ten largest customers
were responsible for 50.4%, 49.5%, and 39.7% of traditional primary new
insurance written in 2008, 2007, and 2006, respectively. The largest single
customer accounted for 15.6% of traditional primary new insurance written in
2008 compared to 9.8% and 8.8% in 2007 and 2006, respectively.
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 and related real estate settlement
products are sold through 227 Company offices and through agencies and
underwritten title companies in Puerto Rico, the District of Columbia and all 50
states. The issuing agents are authorized to issue commitments 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 title companies (not themselves title insurers) pursuant to
underwriting agreements. These agreements generally provide that the agency or
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 customer as its commission for services.
During 2008, approximately 63% 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 produces
less title insurance business relative to new construction during such months
than during the rest of the year. The most important factors, insofar as Old
Republic's title business is concerned, however, are the rates of activity in
the resale and refinance markets for residential properties.
The personal
contacts, relationships, reputations, and intellectual capital 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 consumer credit
indemnity, title, and mortgage guaranty insurance, are affected in varying
degrees by changes in national economic conditions. During periods when housing
activity or mortgage lending are constrained by any combination of rising
interest rates, tighter mortgage underwriting guidelines, falling home prices,
excess housing supply and/or economic recession operating and/or claim costs
pertaining to such coverages tend to rise disproportionately to revenues and can
result in underwriting losses and reduced levels of profitability.
At least one Old
Republic general 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 50 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:
13
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
and risk sharing arrangements for parts of its business in order to minimize
losses for which it might become liable under its insurance policies, and to
afford its customers 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 risk sharing arrangements, the Company adjusts production costs or
premiums retroactively to likewise reflect deviations from originally expected
loss costs. The amount of premium, production costs and other retrospective
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,
retrospective insurance and production 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, by
obtaining surety bonds, or by otherwise collateralizing such obligations through
irrevocable letters of credit, cash, or securities.
Reinsurance
recoverable asset balances represent amounts due from or credited by assuming
reinsurers for paid and unpaid claims and policy reserves. Such reinsurance
balances that are recoverable from non-admitted foreign and certain other
reinsurers such as captive insurance companies owned by assureds or business
producers, as well as similar balances or credits arising from policies that are
retrospectively rated or subject to assureds’ high deductible retentions are
substantially collateralized by letters of credit, securities, and other
financial instruments. Old Republic evaluates on a regular basis the financial
condition of its assuming reinsurers and assureds who purchase its
retrospectively rated or high deductible policies. Estimates of unrecoverable
amounts are included in the Company’s net claim and claim expense reserves since
reinsurance, retrospectively rated and self-insured deductible policies and
contracts do not relieve Old Republic from its direct obligations to assureds or
their beneficiaries.
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 Company 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, financial and other intermediaries 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 in most instances with independent
insurance or reinsurance companies pursuant to excess of loss agreements. Except
as noted in the following paragraph, reinsurance protection on property and
liability coverages generally limits the net loss on most individual claims to a
maximum of: $2.7 million for workers' compensation; $2.6 million for commercial
auto liability; $2.6 million for general liability; $8.0 million for executive
protection (directors & officers and errors & omissions); $1.1
million for aviation; and $2.6 million for property coverages.
Roughly 49% of the
14
mortgage guaranty
traditional primary insurance in force is subject to lender sponsored captive
reinsurance arrangements structured primarily on an excess of loss basis. All
bulk and other insurance risk in force is retained. Exclusive of reinsurance,
the average direct primary mortgage guaranty exposure is approximately (in whole
dollars) $40,200. Title insurance risk assumptions are currently limited to a
maximum of $500.0 million as to any one policy. The vast majority of title
policies issued, however, carry exposures of $1.0 million or
less.
Due to worldwide
reinsurance capacity and related cost constraints, effective January 1, 2002,
the Company began retaining exposures for all, but most predominantly workers’
compensation liability insurance coverages in excess of $40.0 million that were
previously assumed by unaffiliated reinsurers for up to $100.0 million.
Effective January 1, 2003, reinsurance ceded limits were raised once again to
the $100.0 million level, and as of January 1, 2005, they were further increased
to $200.0 million. Pursuant to regulatory requirements, however, all workers’
compensation primary insurers such as the Company remain liable for unlimited
amounts in excess of reinsured limits. Other than the substantial concentration
of workers’ compensation losses caused by the September 11, 2001 terrorist
attack on America, to the best of the Company’s knowledge there had not been a
similar accumulation of claims in a single location from a single occurrence
prior to that event. Nevertheless, the possibility continues to exist that
non-reinsured losses could, depending on a wide range of severity and frequency
assumptions, aggregate several hundred million dollars to an insurer such as the
Company in the event a catastrophe, such as caused by an earthquake, lead to the
death or injury of a large number of employees concentrated in a single facility
such as a high rise building.
As a result of the
September 11, 2001 terrorist attack on America, the reinsurance industry
eliminated coverage from substantially all contracts for claims arising from
acts of terrorism. Primary insurers such as the Company thereby became fully
exposed to such claims. Late in 2002, the Terrorism Risk Insurance Act of 2002
(the “TRIA”) was signed into law, immediately establishing a temporary federal
reinsurance program administered by the Secretary of the Treasury. The program
applied to insured commercial property and casualty losses resulting from an act
of terrorism, as defined in the TRIA. Congress extended and modified the program
in late 2005 through the Terrorism Risk Insurance Revision and Extension Act of
2005 (the “TRIREA”). TRIREA expired on December 31, 2007. Congress enacted a
revised program in December 2007 through the Terrorism Risk Insurance Program
Reauthorization Act of 2007 (the “TRIPRA”), a seven year extension through
December 31, 2014. The TRIA automatically voided all policy exclusions which
were in effect for terrorism related losses and obligated insurers to offer
terrorism coverage with most commercial property and casualty insurance lines.
The TRIREA revised the definition of “property and casualty insurance” to
exclude commercial automobile, burglary and theft, surety, professional
liability and farm owner's multi-peril insurance. TRIPRA did not make any
further changes to the definition of property and casualty insurance, however,
it does include domestic acts of terrorism within the scope of the program.
Although insurers are permitted to charge an additional premium for terrorism
coverage, insureds may reject the coverage. Under TRIPRA, the program’s
protection is not triggered for losses arising from an act of terrorism until
the industry first suffers losses of $100 billion in the aggregate during any
one year. Once the program trigger is met, the program will pay 85% of an
insurer’s terrorism losses that exceed that individual insurer’s deductible. The
insurer’s deductible is 20% of direct earned premium on property and casualty
insurance. Insurers may reinsure that portion of the risk they retain under the
program. Effective January 1, 2008, the Company reinsured limits of $198.0
million excess of $2.0 million for claims arising from certain acts of terrorism
for casualty clash coverage and catastrophe workers’ compensation liability
insurance coverage.
15
The FNMA and the
FHLMC sometimes also referred to as Government Sponsored Enterprises (“GSEs”)
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 call for compliance with the applicable
laws and regulations of the insurer’s domiciliary state and those states in
which it conducts business and maintenance of contingency reserves in accordance
with applicable state laws. The requirements also contain guidelines pertaining
to captive reinsurance transactions. The GSEs also place additional restrictions
on qualified insurers who fail to maintain the equivalent of a AA financial
strength rating from at least two nationally recognized statistical rating
agencies. During 2008, substantially all national mortgage guaranty insurance
companies, including Old Republic’s mortgage guaranty insurance subsidiaries,
experienced ratings downgrades below AA. All such companies have been required
to submit capital remediation plans to FNMA and FHLMC, and continue as approved
mortgage guaranty insurers for loans purchased by the GSEs.
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.
(h) Website access.> The
Company files various reports with the U.S. Securities and Exchange Commission
(“SEC”), including its annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, proxy statements, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act. The Company’s filings are available for viewing and/or copying at the SEC’s
Public Reference Room located at 450 Fifth Street, NW., Washington, DC 20549.
Information regarding the operation of the Public Reference Room can be obtained
by calling 1-800-SEC-0330. The Company’s reports are also available by visiting
the SEC’s internet website (http://www.sec.gov) and accessing its EDGAR database
to view or print copies of the electronic versions of the Company’s reports.
Additionally, the Company’s reports can be obtained, free of charge, by visiting
its internet website (http://www.oldrepublic.com), selecting Investors then SEC Filings to
view or print copies of the electronic versions of the Company’s reports. The
contents of the Company’s internet website are not intended to be, nor should
they be considered incorporated by reference in any of the reports the Company
files with the SEC.
Item
1A - Risk Factors
Risk factors are
uncertainties and events over which the Company has limited or no control, and
which can have a materially adverse effect on its business, results of
operations or financial condition. The Company and its business segments are
subject to a variety of risk factors and, within individual segments, each type
of insurance coverage may be exposed to varying risk factors. The following
sections set forth management’s evaluation of the most prevalent material risk
factors for the Company as a whole and for each business segment. There may be
risks which management does not presently consider to be material that may later
prove to be material risk factors as well.
Dividend Dependence and
Liquidity
The Company is an
insurance holding company with no operations of its own. Its principal assets
consist of the business conducted by its insurance subsidiaries. It relies upon
dividends from such subsidiaries in order to pay the interest and principal on
its debt obligations, dividends to its shareholders and corporate expenses. The
ability of the insurance subsidiaries to declare and pay dividends is subject to
regulations under state laws that limit dividends based on the amount of their
adjusted unassigned surplus, and require them to maintain minimum amounts of
capital, surplus and reserves. Dividends in excess of the ordinary limitations
can only be declared and paid with prior regulatory approval, of which there can
be no assurance. The inability of the insurance subsidiaries to pay dividends in
an amount sufficient to meet debt service and cash dividends on stock, as well
as other cash requirements of the Company could result in liquidity issues for
Old Republic.
Capitalization
The Company has
access to various capital resources including dividends from its subsidiaries,
holding company investments, undrawn capacity under its commercial paper
program, and access to debt and equity capital markets. At December 31, 2008 the
Company’s consolidated debt to equity ratio was 6.2%. This relatively low level
of financial leverage provides the Company with additional borrowing capacity to
meet its capital commitments.
16
Investment
Risks
The Company’s
invested assets and those of its subsidiaries are centrally managed through a
wholly owned asset management subsidiary. Most of the investments consist of
fixed maturity securities. Changes in interest rates directly affect the income
from, and the market value of fixed maturity investments and could reduce the
value of the Company’s investment portfolio and adversely affect the Company’s,
and its subsidiaries’, results of operations and financial condition. A smaller
percentage of total investments are in indexed funds and actively managed
equities. A change in general economic conditions, the stock market, or many
other external factors could adversely affect the value of those investments
and, in turn, the Company’s, or its subsidiaries’ results and financial
condition. Further, the Company manages its fixed maturity investments by taking
into account the maturities of such securities and the anticipated liquidity
needs of the Company and its subsidiaries. Should the Company suddenly
experience greater than anticipated liquidity needs for any reason, it could
face a liquidity risk that may adversely affect its financial condition or
operating results.
Excessive Losses and Loss
Expenses
Although the
Company’s three major business segments encompass different types of insurance,
the greatest risk factor common to all insurance coverages is excessive losses
due to unanticipated claims frequency, severity or a combination of both. Many
of the factors affecting the frequency and severity of claims depend upon the
type of insurance coverage, but others are shared in common. Severity and
frequency can be affected by changes in national economic conditions,
unexpectedly adverse outcomes in claims litigation, often as a result of
unanticipated jury verdicts, changes in court made law, adverse court
interpretations of insurance policy provisions resulting in increased liability
or new judicial theories of liability, together with unexpectedly high costs of
defending claims.
Inadequate
Reserves
Reserves are the
amounts that an insurance company sets aside for its anticipated policy
liabilities. Claim reserves are an estimate of liability for unpaid claims and
claims defense and adjustment expenses, and cover both reported as well as
incurred, but not yet reported claims. It is not possible to calculate precisely
what these liabilities will amount to in advance and, therefore, the reserves
represent a best estimate at any point in time. Such estimates are based upon
known historical loss data and expectations of future trends in claims
frequency, severity, interest rates and other considerations which in turn are
affected by a variety of factors over which insurers have little or no control
and which can be quite volatile. Reserve estimates are periodically reviewed in
light of known developments and, where necessary, adjusted and refined as
circumstances may warrant. Nevertheless, the reserve setting process is
inherently uncertain. If for any of these reasons reserve estimates prove to be
inadequate, the Company’s subsidiaries can be forced to increase their reported
liabilities; such an occurrence could result in a materially adverse impact on
their results of operations and financial condition.
Inadequate
Pricing
Premium rates are
generally determined on the basis of historical data for claims frequency and
severity as well as related production and other expense patterns. In the event
ultimate claims and expenses exceed historically projected levels, premium rates
are likely to prove insufficient. Premium rate inadequacy may not become evident
quickly and may require time to correct. Inadequate premiums, much like
excessive losses, if material, can adversely affect the Company’s business,
operating results and financial condition.
Liquidity
Risk
As indicated above,
the Company manages its fixed-maturity investments with a view toward matching
the maturities of those investments with the anticipated liquidity needs of its
subsidiaries for the payment of claims and expenses. If a subsidiary suddenly
experienced greater-than-anticipated liquidity needs for any reason, it could
require an injection of funds that might not necessarily be available to the
Company to meet its obligations at a point in time.
Regulatory
Environment
The Company’s
insurance businesses are subject to extensive governmental regulation in all of
the state and similar jurisdictions in which they operate. These regulations
relate to such matters as licensing requirements, types of insurance products
that may be sold, premium rates, marketing practices, capital and surplus
requirements, investment limitations, underwriting limitations, dividend payment
limitations, transactions with affiliates, accounting practices, taxation and
other matters. While most of the regulation is at the state level, the federal
government has increasingly expressed an interest in regulating the insurance
business and has injected itself through the Graham-Leach-Bliley Act, the
Patriot Act, financial services regulation, changes in the Internal Revenue Code
and other legislation. All of these regulations raise the costs of conducting an
insurance business through increased compliance expenses. Furthermore, as
existing regulations evolve through administrative and court interpretations,
and as new regulations are adopted, there can be no way of predicting what
impact these changes will have on the Company’s businesses in the future, and
the impact could adversely affect the Company’s profitability and limit its
growth.
17
Competition
Each of the
Company’s lines of insurance business is highly competitive and is likely to
remain so for the foreseeable future. Moreover, existing competitors and the
capital markets have from time to time brought an influx of capital and
newly-organized entrants into the industry, and changes in laws have allowed
financial institutions, like banks and savings and loans, to sell insurance
products. Increases in competition threaten to reduce demand for the Company’s
insurance products, reduce its market share, reduce its growth, reduce its
profitability and generally adversely affect its results of operations and
financial condition.
Rating
Downgrades
The competitive
positions of insurance companies, in general, have come to depend increasingly
on independent ratings of their financial strength and claims-paying ability.
The rating agencies base their ratings on criteria they establish regarding an
insurer’s financial strength, operating performance, strategic position and
ability to meet its obligations to policyholders. A significant downgrade in the
ratings of any of the Company’s major policy-issuing subsidiaries could
negatively impact their ability to compete for new business and retain existing
business and, as a result, adversely affect their results of operations and
financial condition.
Financial Institutions
Risk
The Company’s
subsidiaries have significant business relationships with financial
institutions, particularly national banks. The subsidiaries are the
beneficiaries of a considerable amount of security in the form of letters of
credit which they hold as collateral securing the obligations of insureds and
certain reinsurers. Some of the banks themselves have subsidiaries that reinsure
the Company’s business. Other banks are depositories holding large sums of money
in escrow accounts established by the Company’s title subsidiaries. There is
thus a risk of concentrated financial exposures in one or more such banking
institutions. If any of these institutions fail or are unable to honor their
credit obligations, or if escrowed funds become lost or tied up due to the
failure of a bank, the result could be adverse to the Company’s business,
results of operations and financial condition.
In addition to the
foregoing, the following are risk factors that are particular to each of the
Company’s three major business segments.
Catastrophic
Losses
While the Company
limits the property exposures it writes, the casualty or liability insurance it
underwrites creates an exposure to claims arising out of catastrophes. The two
principal catastrophe exposures are earthquakes and acts of terrorism in areas
where there are large concentrations of employees of an insured employer or
other individuals who could potentially be injured and assert claims against an
insured.
Following the
September 11, 2001 terrorist attack, the reinsurance industry eliminated
coverage from substantially all reinsurance contracts for claims arising from
acts of terrorism. As discussed elsewhere in this report, the U.S. Congress
subsequently passed TRIA, TRIREA, and TRIPRA legislation that required primary
insurers to offer coverage for certified acts of terrorism under most commercial
property and casualty insurance policies. Although these programs established a
temporary federal reinsurance program through December 31, 2014, primary
insurers like the Company’s general insurance subsidiaries retain significant
exposure for terrorist act-related losses.
Long-Tailed
Losses
Coverage for
general liability is considered long-tailed coverage. Written in most cases on
an “occurrence” basis, it often takes longer for the claims to be reported and
become known, adjusted and settled than it does for property claims, for
example, which are generally considered short-tailed. The extremely long-tailed
aspect of such claims as pollution, asbestos, silicosis, manganism (welding rod
fume exposure), black lung, lead paint and other toxic tort claims, coupled with
uncertain and sometimes variable judicial rulings on coverage and policy
allocation issues and the possibility of legislative actions, makes reserving
for these exposures highly uncertain. While the Company believes that it has
reasonably estimated its liabilities for such exposures to date, and that its
exposures are relatively modest, there is a risk of materially adverse
developments in both known and as-yet-unknown claims.
Workers’ Compensation
Coverage
Workers’
compensation coverage is the second largest line of insurance written within the
Company. The frequency and severity of claims under, and the adequacy of
reserves for workers’ compensation claims and expenses can all be significantly
influenced by such risk factors as future wage inflation in states that index
benefits, the speed with which injured employees are able to return to work in
some capacity, the cost and rate of inflation in medical treatments, the types
of medical procedures and treatments, the cost of prescription medications, the
frequency with which closed claims reopen for additional or related medical
issues, the mortality of injured workers with lifetime benefits and medical
treatments, the use of health insurance to cover some of the expenses, the
assumption of some of the expenses by states’ second injury funds, the use of
cost containment practices like preferred provider networks, and the
opportunities to recover against third parties through subrogation. Adverse
developments in any of these factors, if significant, could have a materially
adverse effect on the Company’s operating results and financial
condition.
18
Reinsurance
Reinsurance is a
contractual arrangement whereby one insurer (the reinsurer) assumes some or all
of the risk exposure written by another insurer (the reinsured). The Company
uses reinsurance to manage its risks both in terms of the amount of coverage it
is able to write, the amount it is able to retain for its own account, and the
price at which it is able to write it. The availability of reinsurance and its
price, however, are determined in the reinsurance market by conditions beyond
the Company’s control.
Reinsurance does
not relieve the reinsured company of its primary liability to its insureds in
the event of a loss. It merely reimburses the reinsured company. The ability and
willingness of reinsurers to honor their obligations represent credit risks
inherent in reinsurance transactions. The Company addresses these risks by
limiting its reinsurance to those reinsurers it considers the best credit risks.
In recent years, however, there has been an ever decreasing number of reinsurers
considered to be acceptable risks by the Company.
There can be no
assurance that the Company will be able to find the desired or even adequate
amounts of reinsurance at favorable rates from acceptable reinsurers in the
future. If unable to do so, the Company would be forced to reduce the volume of
business it writes or retain increased amounts of liability exposure. Because of
the declining number of reinsurers the Company finds acceptable, there is a risk
that too much reinsurance risk may become concentrated in too few reinsurers.
Each of these results could adversely affect the Company’s business, results of
operations and financial condition.
Insureds as Credit
Risks
A significant
amount of the Company’s liability and workers’ compensation business,
particularly for large commercial insureds, is written on the basis of risk
sharing underwriting methods utilizing large deductibles, captive insurance risk
retentions, or other arrangements whereby the insureds effectively retain and
fund varying and at times significant amounts of their losses. Their financial
strength and ability to pay are carefully evaluated as part of the underwriting
process and monitored periodically thereafter, and their retained exposures are
estimated and collateralized based on pertinent credit analysis and evaluation.
Because the Company is primarily liable for losses incurred under its policies,
the possible failure or inability of insureds to honor their retained liability
represents a credit risk. Any subsequently developing shortage in the amount of
collateral held would also be a risk, as would the failure or inability of a
bank to honor a letter of credit issued as collateral. These risk factors could
have a material adverse impact on the Company’s results of operations and
financial condition.
Guaranty Funds and Residual
Markets
In nearly all
states, licensed property and casualty insurers are required to participate in
guaranty funds through assessments covering a portion of insurance claims
against impaired or insolvent property and casualty insurers. Any increase in
the number or size of impaired companies would likely result in an increase in
the Company’s share of such assessments.
Many states have
established second injury funds that compensate injured employees for
aggravation of prior injuries or conditions. These second injury funds are
funded by assessments or premium surcharges.
Residual market or
pooling arrangements exist in many states to provide various types of insurance
coverage to those that are otherwise unable to find private insurers willing to
insure them. All licensed property and casualty insurers writing such coverage
voluntarily are required to participate in these residual market or pooling
mechanisms.
A material increase
in any of these assessments or charges could adversely affect the Company’s
results of operations and financial condition.
Prior Approval of
Rates
Most of the lines
of insurance underwritten by the Company are subject to prior regulatory
approval of premium rates in a majority of the states. The process of securing
regulatory approval can be time consuming and can impair the Company’s ability
to effect necessary rate increases in an expeditious manner. Furthermore, there
is a risk that the regulators will not approve a requested increase,
particularly in regard to workers’ compensation insurance with respect to which
rate increases often confront strong opposition from local business, organized
labor, and political interests.
Housing and Mortgage Lending
Markets
Any significant
development which adversely affects the housing and related mortgage lending
markets could be a risk factor for the Company’s mortgage insurance
subsidiaries. Falling home prices, excessive housing supplies, negative
employment trends, and unfavorable trends in the general health of
the national and regional economies, such as we are currently experiencing,
are all
19
factors which may
produce lower mortgage loan origination volumes that could result in a decline
of new business and/or an increase in mortgage defaults, all of which could in
turn lead to an increase in claims.
On the other hand,
low interest rates and rising home prices can also be risk factors inasmuch as
they can threaten persistency of coverage. Declining rates or rising home prices
can encourage mortgage refinance activity. When a mortgage loan insured by the
Company is refinanced, there is a risk the lender will replace the Company’s
coverage with coverage written by another mortgage insurer or, alternatively,
that coverage may no longer be necessary in the event that price appreciation of
the property has served to reduce the loan-to-value ratio below 80%. Each of
these factors, if significant enough, could have a materially adverse affect on
the business, results of operations and financial condition of the Company’s
mortgage guaranty subsidiaries.
Capitalization
Under state
insurance regulations, the Company’s mortgage guaranty insurance subsidiaries
are required to operate at a maximum risk to capital ratio of 25:1. If a
company’s risk to capital ratio exceeds the limit, it may be prohibited from
writing new business until its risk to capital ratio falls below the limit. At
December 31, 2008, the statutory risk to capital ratio was 19.8:1 on a combined
basis excluding the capital contribution noted below. All of the segment’s
mortgage guaranty insurance companies were within the 25:1 requirement. A
continuation of operating losses could further reduce statutory surplus thus
increasing the risk to capital ratio. Old Republic invested $150.0 million of
capital in its mortgage guaranty segment during the fourth quarter of 2008. The
Company evaluates the trends in this ratio on a quarterly basis to determine the
necessity of possible capital additions.
Competition
Competition is
always a risk factor and comes not only from the five other mortgage insurers
which comprise the industry, but also from the Federal Housing Administration
(“FHA”) as well as the GSEs, such as Fannie Mae and Freddie Mac, and the insured
mortgage lenders themselves. The market for private mortgage insurance exists
primarily as a result of restrictions within the federal charters of the GSEs
which require an acceptable form of credit enhancement on loans purchased by the
GSEs that have loan to value (LTV) ratios in excess of 80%. These institutions
establish the levels of required coverage, the underwriting standards for the
loans they will purchase and the loss mitigation efforts that must be followed
on insured loans. Changes in any of these respects could result in a reduction
of the Mortgage Guaranty Group’s business or an increase in its claim
costs.
In response to
their deteriorating financial condition, the GSEs were placed in conservatorship
under the Federal Housing Finance Agency (“FHFA”) in September 2008. As their
conservator, the FHFA could change the GSE’s business practices or new federal
legislation could alter the GSE’s charters in ways that could have a
dramatically adverse effect on our business and that of the other mortgage
insurers.
Lender
consolidation has resulted in fewer lenders originating a greater share of all
mortgage loans. In 2008, 40.9% of all mortgage loans were purchased or
originated by the top 3 nationwide lenders. Consequently, mortgage insurance
business is increasingly becoming controlled by a small number of nationwide
mortgage lenders, some of which have reduced the number of mortgage insurers
they do business with, thus increasing competition among the
insurers.
Many mortgage
lenders have organized their own captive reinsurers as a means of extending
their business to the underwriting of mortgage guaranty risks. Through such
captives they provide excess of loss, and in some cases, quota share reinsurance
protection to the mortgage guaranty insurers such as the Company’s subsidiaries
in this segment. This involvement is a competitive risk factor inasmuch as it
reduces the amount of business that the Company could otherwise retain. In
February 2008, Freddie Mac announced limitations on the percentage of risk that
can be ceded to captive reinsurers by its approved private mortgage insurers.
This limitation is effective for new risk written subsequent to May 31, 2008. In
September 2008, the Company announced that it was discontinuing excess of loss
reinsurance cessions to lenders’ captive insurance companies for new business
written subsequent to December 31, 2008. Consequently, over time the Company’s
Mortgage Guaranty Group will likely increase its net retention on the loans it
insures.
Other competitive
risk factors faced by the Company’s Mortgage Guaranty Group stem from certain
credit enhancement alternatives to private mortgage insurance. These
include:
Litigation and
Regulation
The possibly
adverse effect of litigation and regulation are ever present risk factors.
Captive reinsurance and other risk participating structures with mortgage
lenders have been challenged in recent years as potential violations of the Real
Estate Settlement Procedures Act (“RESPA”). From time to time, the U. S.
Department of Housing and Urban Development has considered adopting RESPA
regulations which would have adversely impacted mortgage insurance by requiring
that the premiums be combined with all other settlement service charges in a
single package fee. Adverse litigation or regulatory developments could have a
materially adverse effect on the Company’s mortgage guaranty business, results
of operations and financial condition.
20
Housing and Mortgage Lending
Markets
The fortunes of
title insurance are even more directly tied to the level of real estate activity
than are those of mortgage insurance. The principal risk factor for title
insurance is a decline in residential real estate activity. The major factors
that can adversely impact real estate activity include:
A significant
adverse development among any of these risk factors could have a materially
adverse effect on the Company’s title insurance business, results of operations
and financial condition.
Competition
Business comes to
title insurers primarily by referral from real estate agents, lenders,
developers and other settlement providers. The sources of business lead to a
great deal of competition among title insurers. Although the top four title
insurance companies during 2008 accounted for about 92% of industry-wide premium
volume, there are numerous smaller companies representing the remainder at the
regional and local levels. The smaller companies are an ever-present competitive
risk in the regional and local markets where their business connections can give
them a competitive edge. Moreover, there is almost always competition among the
major companies for key employees, especially those who are engaged in the
production side of the business.
Regulation and
Litigation
Regulation is also
a risk factor for title insurers. The title insurance industry has recently
been, and continues to be, under regulatory scrutiny in a number of states with
respect to pricing practices, and alleged RESPA violations and unlawful rebating
practices. The regulatory investigations could lead to industry-wide reductions
in premium rates and escrow fees, the inability to get rate increases when
necessary, as well as to changes that could adversely affect the Company’s
ability to compete for or retain business or raise the costs of additional
regulatory compliance.
As with the
Company’s other business segments, litigation poses a risk factor. Litigation is
currently pending in a number of states in actions against the title industry
alleging violations of rate applications in those states with respect to title
insurance issued in certain mortgage refinancing transactions and violations of
federal anti-trust laws in settling and filing premium rates.
Other
Risks
Inadequate title
searches are among the risk factors faced by the entire industry. If a title
search is conducted thoroughly and accurately, there should theoretically never
be a claim. When the search is less than thorough or complete, title defects can
go undetected and claims result.
To a lesser extent,
fraud is also a risk factor for all title companies -- sometimes in the form of
an agent’s or an employee’s defalcation of escrowed funds, sometimes in the form
of fraudulently issued title insurance policies.
Item
1B - Unresolved Staff Comments
None
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 53% is occupied by Old Republic, and the
remainder is leased to others. In addition to its Chicago building, a subsidiary
of the Title Insurance Group partially occupies its owned headquarters building
in Minneapolis, Minnesota. 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. Nine
smaller buildings are owned by Old Republic and its subsidiaries in various
parts of the nation and are primarily used for its business. The carrying value
of all owned buildings and related land at December 31, 2008 was $35.6
million.
21
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 - Legal Proceedings
Legal proceedings
against the Company arise in the normal course of business and usually pertain
to claim matters related to insurance policies and contracts issued by its
insurance subsidiaries. Other legal proceedings are discussed
below.
Purported class
action lawsuits are pending against the Company’s principal title insurance
subsidiary, Old Republic National Title Insurance Company (“ORNTIC”) in state
and federal courts in Connecticut, New Jersey, Ohio, Pennsylvania and Texas. The
plaintiffs allege that ORNTIC failed to give consumers reissue and/or refinance
credits on the premiums charged for title insurance covering mortgage
refinancing transactions, as required by rate schedules filed by ORNTIC or by
state rating bureaus with the state insurance regulatory authorities.
Substantially similar lawsuits are also pending against other unaffiliated title
insurance companies in these and other states as well, and additional lawsuits
based upon similar allegations could be filed against ORNTIC in the
future.
Since early
February 2008 approximately 80 purported consumer class action lawsuits have
been filed nationwide against the title industry’s principal title insurance
companies, their subsidiaries and affiliates, and title insurance rating bureaus
or associations in at least 10 states. The suits are substantially identical in
alleging that the defendant title insurers engaged in illegal price-fixing
agreements to set artificially high premium rates and conspired to create
premium rates which the state insurance regulatory authorities could not
evaluate and therefore, could not adequately regulate. A number of the suits
also allege violations of the Federal Real Estate Settlement Procedures Act
(“RESPA”). The Company and its principal title insurance subsidiary, Old
Republic National Title Insurance Company, are currently among the named
defendants in 36 of these actions in 6 states, and are likely to be included in
others. A second subsidiary, American Guaranty Title Insurance Company, was
originally named in some of the same suits but has been dismissed from all such
actions. No class has yet been certified in any of these suits.
Also pending
certification as a class action is a suit against ORNTIC and Old Republic Title,
Ltd. in the U.S. District Court for the Western District of Washington. Filed in
May, 2008, the suit alleges that ORNTIC and its affiliate deceptively charged
fees for reconveyancing services they did not perform and split the fees with
settlement service providers in violation of RESPA. The action seeks damages,
declaratory and injunctive relief. No class has yet been certified in the
action.
At their present
stage, the ultimate impact of these lawsuits, all of which seek unquantified
damages, attorneys’ fees and expenses, is uncertain and not reasonably
estimable. The Company and its subsidiaries intend to defend vigorously against
each of the aforementioned actions. Although the Company does not believe that
these lawsuits will have a material adverse effect on its consolidated financial
condition, results of operations or cash flows, there can be no assurance in
those regards.
Item
4 - Submission of Matters to a Vote of Security Holders
None.
22
PART
II
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