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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (FEE REQUIRED)
For the fiscal year ended: December 31, 2002
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OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____________________ to _______________________
Commission File Number: 0-4625
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OLD REPUBLIC INTERNATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware No. 36-2678171
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
307 North Michigan Avenue, Chicago, Illinois 60601
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 312-346-8100
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of each class on Which Registered
------------------- -----------------------
7% Subordinated Debentures Due June 15, 2007 New York Stock Exchange
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Common Stock/$1 par value New York Stock Exchange
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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. Yes: _X_/ No:___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes: _X_/ No:___
The aggregate market value of the Company'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, 2002, the
last day of the registrant's most recently completed second fiscal quarter, was
$3,460,881,154.
The Company had 120,618,769 shares of Common Stock outstanding as of February
28, 2003.
Documents incorporated by reference:
- -----------------------------------
The following documents are incorporated by reference into that part of this
Form 10-K designated to the right of the document title.
Title Part
Proxy statement for the 2003 Annual
Meeting of Shareholders III, Items 10, 11, 12 and 13
Exhibits as specified in exhibit index (page 55) IV, Items 14 and 15
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There are 56 pages in this report
PART I
Item 1-Business
(a) General Development of Business. Old Republic International Corporation is a
Chicago-based insurance holding company with subsidiaries engaged in the general
(property & liability), mortgage guaranty, title, and life (life & disability)
insurance businesses. In this report, "Old Republic", "the Corporation", or "the
Company" refers to Old Republic International Corporation and its subsidiaries
as the context requires. The aforementioned insurance segments are organized as
the Old Republic General, Mortgage Guaranty, Title, and Life Groups, and
references herein to such groups apply to the Company's subsidiaries engaged in
the respective segments of business.
Financial Information Relating to Segments of Business (a)
The contributions to net revenues and income (loss) before taxes of each
Old Republic segment are set forth below for the years shown, together with
their respective assets at the end of each year. The information below should be
read in conjunction with the consolidated financial statements, the notes
thereto, and the "Management Analysis of Financial Position and Results of
Operations" appearing elsewhere herein.
($ in Millions)
----------------------------------------------------------------------------------------
Years Ended December 31,
----------------------------------------------------------------------------------------
Net Revenues (b) Income (Loss) Before Taxes
------------------------------------------ ------------------------------------------
2002 2001 2000 2002 2001 2000
------------ ----------- ----------- ----------- ------------ -----------
General....................... $ 1,376.7 $ 1,195.0 $ 1,057.1 $ 182.1 $ 141.4 $ 116.9
Mortgage Guaranty............. 467.1 436.0 395.3 267.7 261.9 240.1
Title......................... 836.5 648.9 518.7 97.8 74.6 40.3
Life.......................... 57.0 58.4 62.0 6.4 4.9 5.3
Other Operations - Net........ 5.0 5.2 3.6 (7.1) (8.8) (10.0)
------------ ----------- ----------- ----------- ------------ -----------
Subtotal.................... 2,742.4 2,343.7 2,036.9 546.9 474.2 392.7
Realized Investment Gains..... 13.9 29.7 33.6 13.9 29.7 33.6
------------ ----------- ----------- ----------- ------------ -----------
Total....................... $ 2,756.4 $ 2,373.4 $ 2,070.6 $ 560.9 $ 503.9 $ 426.4
============ =========== =========== =========== ============ ===========
Assets at December 31,
------------------------------------------
2002 2001 2000
----------- ----------- -----------
General..................................................................... $ 5,876.5 $ 5,451.9 $ 5,111.4
Mortgage Guaranty........................................................... 1,921.2 1,731.6 1,483.3
Title....................................................................... 619.9 536.0 491.2
Life........................................................................ 233.3 236.3 244.5
Consolidated.............................................................. $ 8,715.4 $ 7,920.2 $ 7,281.4
=========== =========== ===========
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(a) Reference is made to the table in Note 6 of the Notes to Consolidated
Financial Statements, incorporated herein by reference, which shows the
contribution of each subcategory to consolidated net revenues and income or
loss before income taxes of Old Republic's insurance industry segments.
(b) Revenues consist of net premiums, fees, net investment and other income
earned; realized investment gains are shown in total for all groups
combined.
General Insurance Group
Through its General Insurance Group subsidiaries, the Corporation assumes
risks and performs related risk management and marketing services pertaining to
a large variety of property and liability commercial insurance coverages. Old
Republic does not have a meaningful exposure to personal lines of insurance.
Liability Coverages: Commercial automobile (mostly trucks) full coverage
protection, workers' compensation and general liability (including the general
liability portion of commercial package policies) are the major classes of
insurance underwritten for businesses and public entities such as
municipalities. Within these classes of insurance, Old Republic specializes in a
number of industries, most prominently the transportation (trucking and general
aviation), construction, forest products and energy industries. Most such
business is produced through independent agency and brokerage channels.
The basic rates charged for workers' compensation insurance are generally
regulated by the various states. It is therefore possible that the rate
increases necessary to cover any expansion of benefits under state laws or
increases in claim frequency or severity may not always be granted soon enough
to enable insurers to fully recover the amount of the benefits they must pay.
Over the years, the Corporation has diversified its General Insurance Group
business. This diversification has been achieved through a combination of
internal growth, the establishment of new subsidiaries, and through selective
2
mergers with other companies. For 2002, production of commercial automobile
(principally trucking) direct insurance premiums accounted for 35.2% of
consolidated direct premiums written by the General Insurance Group. For the
same year, workers' compensation and general liability direct insurance premiums
amounted to 20.4% and 13.7%, respectively, of consolidated direct premiums
written.
Over the years, specialty programs have been expanded or initiated to
insure corporations' exposures to directors and officers as well as errors and
omissions liability, and to insure owners and operators of private aircraft for
hull and liability exposures and airport facilities.
In the recent past, the Corporation has terminated its involvement with
certain smaller parts of its business including a reinsurance assumed line and
coverages for propane and petroleum distribution, natural gas utilities, and
grain elevators. The run off of these terminated portions of Old Republic's
business is not expected to affect meaningfully its future operating results or
financial condition.
Property and Other Coverages: Old Republic's property insurance business
incorporates mostly commercial physical damage insurance on trucking risks. A
small volume of business is represented by fire and other physical perils for
commercial properties. Such insurance is produced principally through
independent agencies or brokers. Fidelity and surety coverages are underwritten
through independent agents by the Old Republic Surety Group. Old Republic
Insured Credit Services, Inc. has marketed loan and retail installment sales
credit indemnity insurance since 1955 through commercial banks, thrifts and
other lending institutions. This coverage provides a limited indemnity to
lenders on home equity and home improvement loans as well as installment sales
contracts. Auto warranty and home warranty coverages are marketed by Old
Republic through its own employees and selected independent agents. Travel
insurance is produced through independent travel agents in the United States and
Canada. The coverages provided under these policies, some of which are also
underwritten by the Company's Life Insurance Group, include trip delay and trip
cancellation protection for insureds.
Mortgage Guaranty Group
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 Corporation insures only first mortgage loans, primarily on residential
properties having 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 Corporation may pay the entire claim amount and take title to the mortgaged
property. Pool insurance is generally used as an additional credit enhancement
for certain secondary market mortgage transactions and provides coverage ranging
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.
The Corporation's mortgage insurance business originates from mortgage
bankers (54.2%), commercial banks (16.2%), savings institutions (14.3%) and
other mortgage originators (15.3%). The profitability of the Corporation's
insurance products is not tied in any significant degree to the financial well
being of these institutions. While it is possible that the failure of a large
number of such institutions could increase the competition for sales of certain
insurance products to the surviving institutions, it is also likely that other
institutions or providers of financial services would emerge to take their
place.
Premiums charged depend on the loan-to-value ratio, the coverage offered,
the type of loan instrument (whether fixed rate/fixed payment or an adjustable
mortgage loan) and whether the property is to be investor or owner occupied. The
Corporation offers annual, monthly and single premium payment plans. Annual
plans provide coverage on a year-to-year basis and monthly plans provide
coverage on a month-to-month basis. Renewal premiums for annual and monthly
plans are charged on the basis of the original loan amount, or, if selected, on
the outstanding loan balance on the anniversary date of the loan. Single premium
plans provide coverage for the life of the loan, unless the plan uses a
specified term of a period of three to fifteen years. Approximately 94% of the
Corporation's direct mortgage insurance in force as of December 31, 2002, has
been written under monthly plans.
The Corporation limits its primary mortgage insurance to lenders approved
by it and supervised or regulated by federal or state authorities in order to
obtain reasonable assurance as to the effectiveness of such institutions'
lending practices. A master policy is issued to each approved lender and
provides that the lender must submit individual loans for insurance to the
Company. The loan is subject to certain underwriting criteria and must be
approved by the Corporation before the Corporation issues a commitment to insure
the loan (except in the case of delegated underwriting described herein). When
the loan is consummated, a certificate of insurance is provided to the lender.
The Corporation generally adheres to the underwriting guidelines published by
the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National
Mortgage Association ("FNMA"), purchasers of many of the loans the Corporation
insures.
3
Delegated underwriting is a program whereby approved lenders are allowed to
commit the Corporation to insure loans following preset underwriting guidelines.
Loans insured through delegated underwriting amount to 33.9% of total new
insurance written in 2002.
Title Insurance Group
The title insurance business consists primarily of the issuance of policies
to real estate purchasers and investors based upon searches of the public
records, which contain information concerning interests in real property. The
policy insures against losses arising out of defects, liens and encumbrances
affecting the insured title and not excluded or excepted from the coverage of
the policy.
There are two basic types of title insurance policies: lenders' policies
and owners' policies. Both are issued for a onetime premium. Most mortgages made
in the United States are extended by mortgage bankers, savings and commercial
banks, state and federal agencies, and life insurance companies. The financial
institutions secure title insurance policies to protect their mortgagees'
interest in the real property. This protection remains in effect for as long as
the mortgagee has an interest in the property. A separate title insurance policy
is issued to the owner of the real estate. An owner's policy of title insurance
protects an owner's interest in the title to the property.
The premiums charged for the issuance of title insurance policies vary with
the policy amount and the type of policy issued. The premium is collected in
full when the real estate transaction is closed, there being no recurring fee
thereafter. In many areas, premiums charged on subsequent policies on the same
property may be reduced, depending generally upon the time elapsed between
issuance of the previous policies and the nature of the transactions for which
the policies are issued. Most of the charge to the 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 and real estate
information products and services in connection with real estate transfers and
loan transactions.
Life Insurance Group
Old Republic markets and writes consumer credit life and disability
insurance primarily through automobile dealers. Borrowers insured under consumer
credit life insurance are also generally covered by consumer credit disability
protection. Credit life insurance provides for the repayment of a loan,
installment purchase, or other debt obligation in the event of the death of the
borrower, while credit disability insurance provides for the payment of
installments due on such debt while the borrower is disabled. Old Republic also
writes various conventional life, disability/accident and health insurance
coverages, principally through banks and other financial services institutions.
Ordinary term life insurance is sold through independent agents and brokers for
relatively large face amounts, in both the United States and Canada. Marketing
of term life insurance products is aimed principally toward self-employed
individuals, professionals, owners of small businesses, and high net worth
persons.
4
Consolidated Underwriting Statistics
The following table reflects underwriting statistics covering: 1) premiums
and related loss, expense, and policyholders' dividend ratios for the major
coverages underwritten in the General, Mortgage Guaranty, Title, and Life
insurance groups; and 2) the net retained life insurance in force at the end of
the years shown:
($ in Millions)
-------------------------------------------------
Years Ended December 31,
-------------------------------------------------
2002 2001 2000
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General Insurance Group:
Overall Experience:
Net Premiums Written............................................. $ 1,268.7 $ 1,078.5 $ 885.4
Net Premiums Earned ............................................. $ 1,182.3 $ 1,000.7 $ 859.8
Loss Ratio....................................................... 72.7% 75.4% 77.8%
Policyholders' Dividend Ratio.................................... (.1) (.1) .1
Expense Ratio ................................................... 25.8 26.7 28.1
------------- ------------- -------------
Composite Ratio.................................................. 98.4% 102.0% 106.0%
============= ============= =============
Experience By Major Coverages:
Commercial Automobile (Principally trucking):
Net Premiums Earned ............................................. $ 508.0 $ 457.7 $ 427.5
Loss Ratio....................................................... 78.4% 82.4% 91.4%
============= ============= =============
Workers' Compensation:
Net Premiums Earned ............................................. $ 226.2 $ 173.9 $ 142.4
Loss Ratio....................................................... 93.7% 90.0% 89.9%
Policyholders' Dividend Ratio.................................... (.5%) (1.0%) .4%
============= ============= =============
General Liability:
Net Premiums Earned ............................................. $ 55.3 $ 53.7 $ 44.1
Loss Ratio....................................................... 67.5% 70.8% 64.7%
============= ============= =============
Property:(a)
Net Premiums Earned ............................................. $ 151.9 $ 128.1 $ 118.0
Loss Ratio....................................................... 51.4% 59.1% 54.0%
============= ============= =============
Other Coverages:(b)
Net Premiums Earned ............................................. $ 240.8 $ 187.2 $ 127.5
Loss Ratio....................................................... 55.7% 57.0% 45.0%
============= ============= =============
Mortgage Guaranty Group:
Net Premiums Earned.............................................. $ 376.2 $ 353.1 $ 331.4
Loss Ratio....................................................... 14.1% 16.1% 15.0%
Expense Ratio.................................................... 32.3 27.5 29.6
------------- ------------- -------------
Composite Ratio.................................................. 46.4% 43.6% 44.6%
============= ============= =============
Title Insurance Group:(c)
Net Premiums Earned.............................................. $ 524.8 $ 382.7 $ 307.6
Combined Net Premiums & Fees Earned.............................. $ 813.4 $ 625.3 $ 494.0
Loss Ratio....................................................... 5.0% 4.0% 3.6%
Expense Ratio.................................................... 85.6 87.2 92.4
------------- ------------- -------------
Composite Ratio.................................................. 90.6% 91.2% 96.0%
============= ============= =============
Life Insurance Group:(d)
Net Premiums Earned.............................................. $ 50.1 $ 50.6 $ 53.4
Benefits & Claims Ratio.......................................... 58.0% 59.7% 55.3%
Expense Ratio.................................................... 42.5 45.4 50.6
------------- ------------- -------------
Composite Ratio.................................................. 100.5% 105.1% 105.9%
============= ============= =============
Net Retained Life Insurance in Force............................. $ 7,383.6 $ 7,500.4 $ 6,849.1
============= ============= =============
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Certain minor reclassifications of 2001 and 2000 data have been reflected in the
above table to conform to current presentation.
(a) Consists principally of fire, allied lines, commercial multi-peril and
inland marine coverages. (b) Consists principally of home and auto warranty,
fidelity, surety, aviation, credit indemnity, directors & officers and errors &
omissions coverages. (c) Title loss, expense, and composite ratios are
calculated on the basis of combined net premiums and fees earned. (d) Life Group
benefits and claims ratios take into account combined future benefit and claims
reserves.
5
Variations in the loss (including related claim settlement expense) ratios
are caused by changes in the frequency and severity of claims incurred, changes
in premium rates and the level of premium refunds, and periodic changes in claim
and claim expense reserve estimates resulting from ongoing reevaluations of
reported and incurred but not reported claims and claim expenses. The loss
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.
General Insurance Group loss ratios for workers' compensation and liability
insurance coverages in particular may reflect greater variability due to a
number of factors. Such variability is due in part to chance events in any one
year, changes in loss costs emanating from participation in involuntary markets
(i.e. industry-wide insurance pools and associations in which participation is
basically mandatory), and added provisions for loss costs not recoverable from
assuming reinsurers which may experience financial difficulties from time to
time. The Company generally underwrites concurrently workers' compensation,
commercial automobile (liability and physical damage), and general liability
insurance coverages for a large number of customers. Accordingly, an evaluation
of trends in premiums, loss and dividend ratios for these individual coverages
should be considered in the light of such a concurrent underwriting approach.
The general insurance portion of the claims ratio improved in 2002 compared to
2001 which also reflected an improvement over 2000. In addition to the effect of
a soft pricing environment for most property and liability coverages during the
1990's, greater severity for recent loss occurrences was mainly responsible for
the higher general insurance claim ratio in 2000. The higher ratios in 2000 were
largely driven by commercial automobile (truck) liability insurance coverages.
The general insurance claims ratios for 2002 continued to reflect, in most
cases, the pricing and risk selection improvements that began to emerge in 2000.
The lower 2002 mortgage guaranty claims ratio results from a decline in
claim provisions driven principally by a drop in expected claim severity. The
improvement in the 2000 ratio was mostly attributable to the strong employment,
housing markets, and good general economic conditions which led to reasonably
stable loan default rates and higher cure rates for loans exhibiting payment
difficulties. A small increase in 2001 was largely the result of a moderately
higher loan default rate factor.
The title insurance loss ratio has been in the low single digits in each of
the past three years due to a continuation of favorable trends in claims
frequency and severity for business underwritten since 1992 in particular. The
uptrend in the 2002 title insurance loss ratio stems from a rise in the net
provision for ultimate claim costs from the historically low levels achieved in
years 2001 and 2000.
General Insurance Claim Reserves
The Corporation's property and liability insurance subsidiaries establish
claim reserves which consist of estimates to settle: a) reported claims; b)
claims which have been incurred as of each balance sheet date but have not as
yet been reported ("IBNR") to the insurance subsidiaries; and c) the direct
costs, (fees and costs which are allocable to individual claims) and indirect
costs (such as salaries and rent applicable to the overall management of claim
departments) to administer known and IBNR claims. Such claim reserves, except as
to classification in the Consolidated Balance Sheets in terms of gross and
reinsured portions, are reported for financial and regulatory reporting purposes
at amounts that are substantially the same.
The establishment of claim reserves by the Corporation's insurance
subsidiaries is a reasonably complex and dynamic process influenced by a large
variety of factors. These factors 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
adjusters retained to handle individual claims, the effect of inflationary
trends on future claim settlement costs, and ongoing changes in claim frequency
patterns such as those caused by natural disasters, illnesses, accidents,
work-related injuries, or changes in economic conditions. Consequently, the
reserve-setting process relies on the judgments and opinions of a large number
of persons, on the application and interpretation of historical precedent and
trends, and on expectations as to future developments. At any point in time, the
Company and the industry are exposed to possibly higher than anticipated claim
costs due to the aforementioned factors, and to the evolution, interpretation,
and expansion of tort law, as well as the effects of unexpected jury verdicts.
In establishing claim reserves, the possible increase in future loss
settlement costs caused by inflation is considered implicitly, along with the
many other factors cited above. Reserves are generally set to provide for the
ultimate cost of all claims. With regard to workers' compensation reserves,
however, the ultimate cost of long-term disability or pension-type claims is
discounted to present value based on interest rates ranging from 3.5% to 4.0%.
The Company, where applicable, uses only such discounted reserves in evaluating
the results of its operations, in pricing its products and settling
retrospective and reinsured accounts, in evaluating policy terms and experience,
and for other general business purposes. Solely to comply with reporting rules
mandated by the Securities and Exchange Commission, however, Old Republic has
made statistical studies of applicable workers' compensation reserves to obtain
estimates of the amounts by which claim and claim adjustment expense reserves,
net of reinsurance, have been discounted. These studies have resulted in
estimates of such amounts at approximately $145.7 million, $151.3 million and
$151.7 million, as of December 31, 2002, 2001 and 2000, respectively. It should
6
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 re-evaluation 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. 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 and assumptions as to the effect of the
revised regulations. Inasmuch as a variety of challenges are likely as the
revised regulations are implemented in 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 Corporation'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
Corporation's retentions to $.5 million or less as to each claim. At December
31, 2002, the Corporation's aggregate indemnity and loss adjustment expense
reserves specifically identified with A&E exposures amounted to approximately
$104.5 million gross, and $56.9 million net of reinsurance. Based on average
annual claims payments during the five most recent calendar years, such reserves
represented 9.1 years (gross) and 14.9 years (net) of average annual claims
payments. 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
that has produced court decisions that have been inconsistent with regard to
such questions as 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, 2002, 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. Accordingly, no representation can be made that the
Corporation's reserves for such claims and related costs will not prove to be
overstated or understated in the future.
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 that ultimate net claim and related costs
will not be greater or lower than previously established reserves.
The following table shows the evolving redundancies or deficiencies for
reserves established as of December 31, of each of the years 1992 through 2002.
In reviewing this tabular data, it should be noted that prior periods' loss
payment and development trends may not be repeated in the future due to the
large variety of factors influencing the reserving process outlined herein
above. The reserve redundancies or deficiencies shown for all years are not
necessarily indicative of the effect on reported results of any one or series of
years since retrospective premium and commission adjustments employed in various
parts of the Company's business may partially offset such effects. (See
"Consolidated Underwriting Statistics" above, and "Reserves, Reinsurance, and
Retrospective Adjustments" elsewhere herein).
7
($ in Millions/Percentages to Nearest Whole Point)
- -----------------------------------------------------------------------------------------------------------------------------------
(a) As of December 31: 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(b) Liability(1) for unpaid
claims and claim adjustment
and claim adjustment
expenses(2): $1,573 $1,700 $1,768 $1,821 $1,829 $1,846 $1,742 $1,699 $1,661 $1,678 $1,802
================================================================================================
(c) Paid (cumulative) as of (3):
----------------------------
One year later 20% 20% 21% 22% 20% 23% 25% 25% 26% 25% -%
Two years later 32 33 35 34 35 39 39 41 41 - -
Three years later 41 42 42 43 45 48 50 51 - - -
Four years later 47 47 48 49 50 55 56 - - - -
Five years later 50 52 53 53 56 60 - - - - -
Six years later 54 55 56 58 60 - - - - - -
Seven years later 57 58 60 62 - - - - - - -
Eight years later 59 61 64 - - - - - - - -
Nine years later 63 65 - - - - - - - - -
Ten years later 66% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(d) Liability reestimated (i.e.,
cumulative payments plus
reestimated ending liability)
as of (4):
-----------------------------
One year later 97% 95% 95% 96% 94% 93% 96% 96% 97% 100% -%
Two years later 94 91 93 92 88 89 93 95 98 - -
Three years later 93 93 90 87 84 87 93 97 - - -
Four years later 96 91 87 83 82 87 95 - - - -
Five years later 95 89 84 82 83 89 - - - - -
Six years later 93 86 84 82 85 - - - - - -
Seven years later 92 86 85 85 - - - - - - -
Eight years later 92 88 88 - - - - - - - -
Nine years later 94 91 - - - - - - - - -
Ten years later 96% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(e) Redundancy (deficiency)(5)
for each year-end at (a): 4% 9% 12% 15% 15% 11% 5% 3% 2% -% -%
=================================================================================================
Average for all year-ends
at (a): 7.9%
====
- ----------
(1) Amounts are reported net of reinsurance. (2) Excluding unallocated loss
adjustment expense reserves. (3) Percent of most recent reestimated
liability (line d). Decreases in paid loss percentages may at times reflect
the reassumption by the Company of certain previously ceded loss reserves
from assuming reinsurers through commutations of then existing reserves.
(4) Percent of beginning liability (line b) for unpaid claims and claim
adjustment expenses. (5) Beginning liability less the most current
liability reestimated (line d) as a percent of beginning liability (line b).
The following table shows an analysis of changes in aggregate reserves for
the Company's property and liability insurance claims and allocated claim
adjustment expenses for each of the years shown:
($ in Millions)
-------------------------------------------
Years Ended December 31,
-------------------------------------------
2002 2001 2000
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the beginning of each year, net of reinsurance losses recoverable..... $ 1,678.9 $ 1,661.5 $ 1,699.2
----------- ------------ ------------
Incurred claims and claim adjustment expenses:
Provisions for insured events of the current year........................ 814.6 749.1 690.2
Change in provision for insured events of prior years.................... (7.1) (44.5) (66.6)
----------- ------------ ------------
Total incurred claims and claim adjustment expenses................. 807.5 704.6 623.6
----------- ------------ ------------
Payments:
Claims and claim adjustment expenses attributable to insured
events of the current year.......................................... 260.7 269.0 258.7
Claims and claim adjustment expenses attributable to insured
events of prior years................................................ 423.1 418.2 402.6
----------- ------------ ------------
Total payments...................................................... 683.8 687.2 661.3
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the end of each year (a), net of reinsurance losses recoverable....... 1,802.5 1,678.9 1,661.5
Reinsurance losses recoverable.............................................. 1,363.0 1,261.2 1,235.0
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses.......... $ 3,165.5 $ 2,940.1 $ 2,896.5
=========== ============ ============
- ----------
(a) Reserves for incurred but not reported losses amounted to approximately
25.3%, 24.3%, and 24.8% of the totals shown as of December 31, 2002, 2001
and 2000, respectively.
8
(b) Investments. In common with other insurance organizations, Old Republic
invests most funds provided by operations in income-producing investment
securities.
All investments must comply with applicable insurance laws and regulations
which prescribe the nature, form, quality, and relative amounts of investments
which may be made by insurance companies. Generally, these laws and regulations
permit insurance companies to invest within varying limitations in state,
municipal and federal government obligations, corporate obligations, preferred
and common stocks, certain types of real estate, and first mortgage loans. Old
Republic's investment policies are also influenced by the terms of the insurance
coverages written, by its expectations as to the timing of claim and benefit
payments, and by income tax considerations. The following tables show invested
assets at the end of the last three years, together with investment income for
such years:
Consolidated Investments
($ in Millions)
December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
----------- ------------ ------------
Held to Maturity
----------------
Fixed Maturity Securities:
Utilities.............................................................. $ 754.4 $ 777.6 $ 777.5
Tax-Exempt............................................................. 1,299.7 1,333.4 1,299.8
Redeemable Preferred Stocks............................................ - .7 .6
----------- ------------ ------------
2,054.1 2,111.8 2,078.0
----------- ------------ ------------
Other long-term investments............................................... 57.4 60.8 55.2
----------- ------------ ------------
Total held to maturity................................................. 2,111.6 2,172.7 2,133.3
----------- ------------ ------------
Available for Sale
------------------
Fixed Maturity Securities:
U.S. & Canadian Governments............................................ 976.2 869.0 709.2
Corporate.............................................................. 2,196.2 1,741.2 1,523.0
----------- ------------ ------------
3,172.4 2,610.2 2,232.2
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................. 2.2 1.7 2.6
Common Stocks.......................................................... 511.2 389.8 292.9
----------- ------------ ------------
513.5 391.6 295.5
----------- ------------ ------------
Short-term Investments.................................................... 253.8 298.5 378.0
----------- ------------ ------------
Total available for sale............................................... 3,939.9 3,300.4 2,905.8
----------- ------------ ------------
Total Investments......................................................... $ 6,051.5 $ 5,473.1 $ 5,039.1
=========== ============ ============
===============================================================================================================================
Sources of Consolidated Investment Income
($ in Millions)
Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
----------- ------------ ------------
Fixed Maturity Securities:
Taxable............................................................... $ 193.5 $ 189.5 $ 181.7
Tax-Exempt............................................................ 59.5 61.7 63.9
Redeemable Preferred Stocks........................................... - - -
----------- ------------ ------------
253.1 251.3 245.7
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................ .1 .1 .1
Common Stocks......................................................... 12.3 7.8 7.4
----------- ------------ ------------
12.4 7.9 7.6
----------- ------------ ------------
Other Investment Income:
Interest on Short-term Investments.................................... 6.0 15.8 18.3
Sundry................................................................ 5.2 6.1 8.6
----------- ------------ ------------
11.3 22.0 26.9
----------- ------------ ------------
Gross Investment Income.................................................. 276.9 281.3 280.2
Less: Investment Expenses (a)......................................... 4.2 6.5 6.2
----------- ------------ ------------
Net Investment Income.................................................... $ 272.6 $ 274.7 $ 273.9
=========== ============ ============
- ----------
(a) Investment expenses consist primarily of personnel costs, investment
management and custody service fees and includes interest incurred on funds
held of $ .3, $1.4 and $1.5 for the years ended December 31, 2002, 2001 and
2000, respectively.
9
For many years, Old Republic's investment policy has been to acquire and
retain primarily investment grade, publicly traded, fixed maturity securities.
Accordingly, the Corporation's exposure to so-called "junk bonds", private
placements, real estate, mortgage loans, and derivatives is immaterial or
non-existent. Management considers investment-grade securities to be those rated
by Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors
Service, Inc. ("Moody's") that fall within the top four rating categories, or
securities which are not rated but have characteristics similar to securities so
rated. The Company had bond or note investments in default as to principal
and/or interest with a carrying value of $1.6 million at December 31, 2002 and
no bond or note investments in default as to principal and/or interest as of
December 31, 2001.
The Company's investment policies have not been designed to maximize
realized investment gains. The Company reviews the status and market value
changes of its securities portfolio on at least a quarterly basis during the
year, and any provisions for other than temporary impairments in the portfolio's
value are evaluated and established at each quarterly balance sheet date. In
management's opinion, the Company's high quality and diversified portfolio,
which consists largely of publicly traded securities, has been a basic reason
for the absence of major impairment provisions in the periods reported upon. The
combination of gains and losses on sales of securities and such provisions or
write-downs 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. The Company's invested assets as of December 31, 2002 have
been classified solely as "held to maturity" or "available for sale" pursuant to
the existing investment policy.
The independent credit quality ratings and maturity distribution for Old
Republic's consolidated fixed maturity investments, excluding short-term
investments, at December 31, 2002 and 2001, are shown in the following tables.
These investments, $5.2 billion and $4.7 billion at December 31, 2002 and 2001,
respectively, represented approximately 60% of consolidated assets as of such
dates, and 94% and 92%, respectively, of consolidated liabilities as of such
dates.
- -------------------------------------------------------------------------------------------------------------------------------
Independent Ratings (a)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2002 2001
---------- ----------
(% of total portfolio)
Aaa.............................................................................. 30.9% 31.0%
Aa............................................................................... 24.3 28.2
A................................................................................ 31.4 29.5
Baa.............................................................................. 10.8 8.9
---------- ----------
Total investment grade....................................................... 97.4 97.6
All others (b)................................................................... 2.6 2.4
---------- ----------
Total........................................................................ 100.0% 100.0%
========== ==========
- ----------
(a) Ratings are assigned primarily by Moody's with remaining ratings assigned
by Standard & Poor's and converted to the equivalent Moody's rating.
(b) "All others" include securities which when purchased were investment grade,
non-investment grade or non-rated convertible securities, and other
non-rated securities such as small issues of tax exempt bonds.
- -------------------------------------------------------------------------------------------------------------------------------
Maturity Distribution
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2002 2001
---------- ----------
(% of total portfolio)
Due in one year or less.......................................................... 13.4% 11.4%
Due after one year through five years............................................ 55.9 50.7
Due after five years through ten years........................................... 29.9 36.7
Due after ten years through fifteen years........................................ .8 1.2
Due after fifteen years.......................................................... - -
---------- ----------
100.0% 100.0%
========== ==========
Average life, including short-term investments (years)........................... 3.7 4.1
========== ==========
(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 2002.
10
Mortgage guaranty insurance is marketed primarily through a direct sales
force which calls on mortgage bankers, 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
approximately 38.2%, 40.6% and 45.1% of direct new insurance written in 2002,
2001 and 2000, respectively. The largest single customer accounted for 11.2% of
direct new insurance written in 2002 compared to 8.8% and 12.6% in 2001 and
2000, 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 is sold through 249 Company
offices located in 32 states and through agencies and underwritten title
companies in Guam, Puerto Rico, the District of Columbia and all states except
Iowa. The issuing agents are authorized to issue binders and title insurance
policies based on their own search and examination, or on the basis of abstracts
and opinions of approved attorneys. Policies are also issued through independent
abstract companies (not themselves title insurers) pursuant to underwriting
agreements. These agreements generally provide that the underwritten company may
cause title policies of the Company to be issued, and the latter is responsible
under such policies for any payments to the insured. Typically, the agency or
underwritten title company deducts the major portion of the title insurance
charge to the customer as its commission for services. During 2002,
approximately 56% of title insurance premiums and fees were accounted for by
policies issued by agents and underwritten title companies.
Title insurance premium and fee revenue is closely related to the level of
activity in the real estate market. The volume of real estate activity is
affected by the availability and cost of financing, population growth, family
movements and other factors. Also, the title insurance business is seasonal.
During the winter months, new building activity is reduced and, accordingly, the
Company does less title insurance business relative to new construction during
such months than during the rest of the year. The most important factor, insofar
as Old Republic's title business is concerned, however, is the rate of activity
in the resale market for residential properties.
The personal contacts, relationships, and reputations of Old Republic's key
executives are a vital element in obtaining and retaining much of its business.
Many of the Company's customers produce large amounts of premiums and therefore
warrant substantial levels of top executive attention and involvement. In this
respect, Old Republic's mode of operation is similar to that of professional
reinsurers and commercial insurance brokers, and relies on the marketing,
underwriting, and management skills of relatively few key people for large parts
of its business.
Several types of insurance coverages underwritten by Old Republic, such as
credit life and disability, loan credit indemnity, title, and mortgage guaranty
insurance, are affected in varying degrees by changes in national economic
conditions. During periods of economic recession or rising interest rates,
operating and/or claim costs pertaining to such coverages tend to rise
disproportionately to revenues and generally result in reduced levels of
profitability.
At least one Old Republic insurance subsidiary is licensed to do business
in each of the 50 states, the District of Columbia, Puerto Rico, Virgin Islands,
Guam, Saipan, 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 49 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:
- -------------------------------------------------------------------------------------------------------------------------------
Geographical Distribution of Direct Premiums Written
- -------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
----------- ----------- -----------
United States:
Northeast................................................................ 8.4% 7.4% 7.0%
Mid-Atlantic............................................................. 8.3 7.9 7.8
Southeast................................................................ 17.7 17.9 17.9
Southwest................................................................ 12.8 13.7 12.4
East North Central....................................................... 14.8 14.6 15.5
West North Central....................................................... 13.0 13.8 14.8
Mountain................................................................. 7.9 8.5 8.6
Western.................................................................. 14.9 14.0 13.3
Foreign (Principally Canada)............................................... 2.2 2.2 2.7
----------- ----------- -----------
Total............................................................. 100.0% 100.0% 100.0%
=========== =========== ===========
(d) Reserves, Reinsurance, and Retrospective Adjustments. Old Republic's
insurance subsidiaries establish reserves for future policy benefits, unearned
premiums, reported claims, claims incurred but not reported, and claim
adjustment expenses, as required in the circumstances. Such reserves are based
on regulatory accounting requirements and generally accepted accounting
principles. In accordance with insurance industry practices, claim reserves are
based on estimates of the amounts that will be paid over a period of time and
changes in such estimates are reflected in the financial statements when they
occur. See "General Insurance Claim Reserves" herein.
To maintain premium production within its capacity and limit maximum losses
11
and risks for which it might become liable under its policies, Old Republic, as
is the practice in the insurance industry, may cede a portion or all of its
premiums and liabilities on certain classes of insurance, individual policies,
or blocks of business to other insurers and reinsurers. Although the ceding of
insurance does not generally discharge an insurer from its direct liability to a
policyholder, it is industry practice to establish the reinsured part of risks
as the liability of the reinsurer. Old Republic also employs retrospective
premium adjustments, contingent commissions, and agency profit 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
contingent commissions, agency profit and other risk-sharing arrangements, the
Company adjusts commissions or premiums retroactively to likewise reflect
deviations from originally expected loss costs. The amount of premium,
commission, or other 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 or retrospective insurance and commission
agreements, Old Republic would be liable for the defaulted amounts. In these
regards, however, the Company generally protects itself by withholding funds, by
securing indemnity agreements, 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 as are recoverable from non-admitted foreign and
certain other reinsurers, 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 claim and claim expense reserves since
reinsurance, retrospective rating, and high deductible policies and contracts do
not relieve Old Republic from its direct obligations to assureds or their
beneficiaries. Historically, the Company has not incurred material charges from
the non-recoverability of such balances and credits.
Old Republic's reinsurance practices with respect to portions of its
business also result from its desire to bring its sponsoring organizations and
customers into some degree of joint venture or risk sharing relationship. The
Corporation may, in exchange for a ceding commission, reinsure up to 100% of the
underwriting risk, and the premium applicable to such risk, to insurers owned by
or affiliated with lending institutions, sponsors whose customers are insured by
Old Republic, or individual customers who have formed "captive" insurance
companies. The ceding commissions received compensate Old Republic for
performing the direct insurer's functions of underwriting, actuarial, claim
settlement, loss control, legal, reinsurance, and administrative services to
comply with local and federal regulations, and for providing appropriate risk
management services.
Remaining portions of Old Republic's business are reinsured with
independent insurance or reinsurance companies under various quota share and
excess of loss agreements. Except as noted in the following paragraph,
reinsurance protection on property and liability operations generally limits the
net loss on most individual claims to a maximum of (in whole dollars):
$1,000,000 for workers' compensation; $1,000,000 for commercial auto liability;
$1,000,000 for general liability; $2,400,000 for executive protection (directors
& officers and errors & omissions); $1,000,000 for aviation; and $300,000 for
property coverages. Substantially all the mortgage guaranty insurance risk is
retained, with the exposure on any one risk currently averaging approximately
$27,300. Title insurance risk assumptions are limited to a maximum of $100.0
million as to any one policy beginning in 2003, and for amounts of up to $25.0
million in 2002 and prior years. The vast majority of title policies issued,
however, carry exposures of $500,000 or less. The maximum amount of ordinary
life insurance retained on any one life by the Life Insurance Group is $300,000.
Due to worldwide reinsurance capacity and related cost constraints,
effective January 1, 2002, the Corporation 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 once again raised to the $100.0 million level. 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 "Act") was signed into law, immediately establishing
a temporary federal reinsurance program administered by the Secretary of
Treasury. The Act defines what constitutes an "act of terrorism" and establishes
12
a formula based on primary insurers' premium volume to reimburse such insurers
for 93% of any terrorism losses suffered between November 26, 2002 and December
31, 2003, 90% of any losses suffered in 2004 and 85% of any losses suffered in
2005. Further, pursuant to the Act, losses are capped for each year at $100.0
billion. The Act will sunset on December 31, 2005 if not extended or replaced by
similar legislation. The Act automatically voided all policy exclusions which
were in effect for terrorism related losses. Under the Act, insurers must offer
terrorism coverage with most commercial property and casualty insurance lines
and are permitted to establish an additional premium charge for their share of
such risks, but insureds may elect to reject the coverage. Insurers are
permitted to reinsure that portion of the risk which they retain under the Act,
but the reinsurance market has not yet responded with a widespread willingness
to reinsure such risks. As of this date, coverage for acts of terrorism are
excluded from substantially all the Corporation's reinsurance treaties, and are
effectively retained by it subject to any recovery that would be collected under
the Act.
(e) Competition. The insurance business is highly competitive and Old Republic
competes with many stock and mutual insurance companies. Many of these
competitors offer more insurance coverages and have substantially greater
financial resources than the Corporation. The rates charged for many of the
insurance coverages in which the Corporation specializes, such as workers'
compensation insurance, other property and liability insurance, title insurance,
and credit life and disability insurance, are primarily regulated by the states
and are also subject to extensive competition among major insurance
organizations. The basic methods of competition available to Old Republic, aside
from rates, are service to customers, expertise in tailoring insurance programs
to the specific needs of its clients, efficiency and flexibility of operations,
personal involvement by its key executives, and, as to title insurance, accuracy
and timely delivery of evidences of title issued. Mortgage insurance companies
also compete by providing contract underwriting services to lenders enabling
lenders to improve the efficiency of their operations by outsourcing all or part
of their mortgage loan underwriting. For certain types of coverages, including
loan credit indemnity and mortgage guaranty insurance, the Company also competes
in varying degrees with the Federal Housing Administration ("FHA") and the
Veterans Administration ("VA"). In these regards, the Corporation's insurance
subsidiaries compete with the FHA and VA by offering different coverages and by
establishing different requirements relative to such factors as interest rates,
closing costs, and loan processing charges. The Corporation believes its
experience and expertise have enabled it to develop a variety of specialized
insurance programs for its customers and to secure state insurance departments'
approval of these programs.
(f) Government Regulation. In common with all insurance companies, the
Corporation's insurance subsidiaries are subject to the regulation and
supervision of the jurisdictions in which they do business. The method of such
regulation varies, but, generally, regulation has been delegated to state
insurance commissioners who are granted broad administrative powers relating to:
the licensing of insurers and their agents; the nature of and limitations on
investments; approval of policy forms; reserve requirements; and trade
practices. In addition to these types of regulation, many classes of insurance,
including most of the Corporation's insurance coverages, are subject to rate
regulations which require that rates be reasonable, adequate, and not unfairly
discriminatory.
The Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation 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, maintenance of minimum total
policyholders' surplus of $5.0 million, and maintenance of contingency reserves
in accordance with applicable state laws. The requirements also contain
guidelines pertaining to captive reinsurance transactions.
The financial institutions whose customers are insured by Old Republic are
also regulated by federal and state authorities whose regulations have a direct
effect on certain forms of credit life and disability insurance. There have been
various proposals from time to time with respect to additional regulation of
credit life and disability insurance which could have an adverse effect on the
Company's small consumer credit insurance business.
The majority of states have also enacted insurance holding company laws
which require registration and periodic reporting by insurance companies
controlled by other corporations licensed to transact business within their
respective jurisdictions. Old Republic's insurance subsidiaries are subject to
such legislation and are registered as controlled insurers in those
jurisdictions in which such registration is required. Such legislation varies
from state to state but typically requires periodic disclosure concerning the
corporation which controls the registered insurers, or ultimate holding company,
and all subsidiaries of the ultimate holding company, and prior approval of
certain intercorporate transfers of assets (including payments of dividends in
excess of specified amounts by the insurance subsidiary) within the holding
company system. Each state has established minimum capital and surplus
requirements to conduct an insurance business. All of the Company's subsidiaries
meet or exceed these requirements, which vary from state to state.
(g) Employees. As of December 31, 2002, Old Republic employed approximately
6,485 persons on a full time basis. A majority of eligible full time employees
participate in various pension plans which provide annuity benefits payable upon
retirement. Eligible employees are also covered by hospitalization and major
medical insurance, group life insurance, and various savings, profit sharing,
and deferred compensation plans. The Company considers its employee relations to
be good.
(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,
13
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 Financial Data and the EDGAR Filings
hyperlink to access the SEC's EDGAR database 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 shall they be considered
incorporated by reference into any of the reports the Company files with the
SEC.
Item 2-Properties
The principal executive offices of the Company are located in the Old
Republic Building in Chicago, Illinois. This Company owned building contains
151,000 square feet of floor space of which approximately 54% is occupied by Old
Republic, and the remainder is leased to others. In addition to the
Company-owned principal executive offices, a subsidiary of the Title Insurance
Group partially occupies its headquarters building. This building contains
110,000 square feet of floor space of which approximately 65% is occupied by the
Old Republic National Title Insurance Company. The remainder of the building is
leased to others. Nine smaller buildings are owned by Old Republic and its
subsidiaries in various parts of the country and are primarily used for its
business. The carrying value of all buildings and related land at December 31,
2002 was approximately $20.4 million.
Certain other operations of the Company and its subsidiaries are directed
from leased premises. See Note 4(b) of the Notes to Consolidated Financial
Statements for a summary of all material lease obligations.
Item 3-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 the Corporation's insurance subsidiaries. Other unusual
litigation is discussed below.
In December 1999, a class action lawsuit was filed against the Company in
the Federal District Court for the Southern District of Georgia. The suit
alleges that the Company provided pool insurance and other services to mortgage
lenders at preferential, below market prices in return for mortgage insurance
business, and that such practices violated the Real Estate Settlement Procedures
Act. The Court ruled in favor of a summary judgment motion filed by the Company
and dismissed the lawsuit. The class plaintiffs appealed, and the U.S. Court of
Appeals for the Eleventh Circuit vacated the judgment and remanded the case back
to the District Court. The Company filed a motion seeking a summary judgment on
grounds asserted in its earlier motion but not considered by the District Court.
On February 5, 2003, the District Court denied the plaintiffs' motions to
certify a class in both the lawsuit against the Company and a similar lawsuit
pending before the same Court against another mortgage guaranty insurer. While
the Court's decision is appealable, it is not known whether the plaintiffs will
seek an appeal, and accordingly, the ultimate outcome of this litigation cannot
be foreseen. Between 2000 and 2002, the Company has paid or otherwise provided
cumulatively $17.8 million, the majority of which was incurred in 2002, to cover
legal defenses and other costs associated with this litigation.
The City and County of San Francisco and certain escrow customers of an
underwritten title agency subsidiary headquartered in the State of California
have filed lawsuits alleging that the subsidiary: 1) failed to escheat unclaimed
escrow funds; 2) charged for services not necessarily provided; and 3) collected
illegal interest payments or fees from banks on the basis of funds held for
escrow customers. The subsidiary in turn conducted an internal review of its
records and concluded that it had certain liabilities for part of the issues
denoted at (1) and (2). The subsidiary defended against the alleged practice
denoted at (3) on the grounds that such practices are common within the
industry, are not in conflict with any laws or regulations, and other
meritorious defenses. The consolidated lawsuits have been tried and a judgment
rendered, affirming in part and denying in part the subsidiary's defenses. In
the aggregate, the judgment, excluding post-judgment interest, amounts to
approximately $33.0 million. The subsidiary has appealed the most significant
portions of the judgment, and management believes the judgment will be
substantially reduced on appeal. Through December 31, 2002, the subsidiary has
continually evaluated its exposures since the litigation began and has paid or
otherwise provided cumulatively $50.0 million including its best estimate of its
remaining liability and costs associated with all these issues.
Item 4-Submission of Matters to a Vote of Security Holders
None.
14
Executive Officers of the Registrant
The following table sets forth certain information as of December 31, 2002,
regarding the executive officers of the Company:
Name Age Position
- --------------------------- --- ----------------------------------------------------------------------
John S. Adams 45 Senior Vice President and Chief Financial Officer since August, 2001.
Charles S. Boone 49 Senior Vice President, Chief Investment Officer and Treasurer since
August, 2001.
James A. Kellogg 51 Senior Vice President/General Insurance and President of Old Republic
Insurance Company since October, 2002.
Spencer LeRoy, III 56 Senior Vice President, General Counsel and Secretary since 1992.
William A. Simpson 61 Senior Vice President/Mortgage Guaranty, and Director since 1980.
President since 1972 of Republic Mortgage Insurance Company, a
wholly-owned subsidiary.
A.C. Zucaro 63 Chief Executive Officer, President, Director and Chairman of the
Board since 1990, 1981, 1976 and 1993, respectively.
The term of office of each officer of the Company expires on the date of
the annual meeting of the board of directors, which is generally held in May of
each year. There is no family relationship between any of the executive officers
named above. Each of these named officers has been employed in executive
capacities with the Company and/or its subsidiaries for the past five years.
PART II
Item 5- Market for the Registrant's Common Stock and Related Security Holder
Matters
The Company's common stock is traded on the New York Stock Exchange under
the symbol "ORI". The high and low closing prices as reported on the New York
Stock Exchange, and cash dividends declared for each quarterly period during the
past two years were as follows:
Closing Price
----------------------------- Cash
High Low Dividends
----------- ----------- ---------
1st quarter 2001................................................... $ 32.00 $ 25.56 $ .14
2nd quarter 2001................................................... 29.37 27.40 .15
3rd quarter 2001................................................... 29.01 22.65 .15
4th quarter 2001................................................... $ 28.11 $ 23.74 $ .15
=========== =========== =========
1st quarter 2002................................................... $ 32.45 $ 27.15 $ .15
2nd quarter 2002................................................... 34.73 30.51 .16
3rd quarter 2002................................................... 32.64 25.28 .16
4th quarter 2002................................................... $ 32.20 $ 26.06 $ .16
=========== =========== =========
As of January 31, 2003, there were 3,043 registered holders of the
Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial
Statements for a description of certain regulatory restrictions on the payment
of dividends by Old Republic's insurance subsidiaries. Closing prices have been
restated, as necessary, to reflect all stock dividends and splits declared
through December 31, 2002.
15
Item 6-Selected Financial Data
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------- ------------ ------------
FINANCIAL POSITION ($ millions):
Cash and Invested Assets (a)........... $ 6,168.2 $ 5,586.7 $ 5,144.3 $ 4,828.5 $ 4,948.6
Other Assets........................... 2,547.1 2,333.4 2,137.1 2,109.8 2,071.1
Total Assets.................... 8,715.4 7,920.2 7,281.4 6,938.4 7,019.7
Liabilities, Other than Debt........... 5,417.9 4,977.1 4,604.0 4,530.8 4,569.1
Debt................................... 141.5 159.0 238.0 208.3 145.1
Total Liabilities............... 5,559.5 5,136.1 4,842.0 4,739.2 4,714.2
Preferred Stock........................ - .3 .7 .7 1.2
Common Shareholders' Equity............ 3,155.8 2,783.7 2,438.7 2,198.4 2,304.2
Total Capitalization (b)........ $ 3,297.4 $ 2,943.1 $ 2,677.4 $ 2,407.5 $ 2,450.6
============ ============ ============= ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS ($ millions):
Net Premiums and Fees Earned........... $ 2,423.9 $ 2,029.5 $ 1,736.8 $ 1,781.7 $ 1,810.6
Net Investment and Other Income........ 318.5 314.1 300.1 290.8 308.1
Realized Investment Gains.............. 13.9 29.7 33.6 29.5 53.0
Net Revenues................... 2,756.4 2,373.4 2,070.6 2,102.1 2,171.7
Benefits, Claims, Settlement
Expenses and Dividends............... 974.8 860.5 761.2 833.0 782.1
Underwriting and Other Expenses........ 1,220.6 1,008.9 882.9 952.0 922.8
Pretax Income..................... 560.9 503.9 426.4 317.0 466.7
Income Taxes.......................... 167.7 159.7 131.0 92.9 145.8
Net Income........................ $ 392.9 $ 346.9 $ 297.5 $ 226.8 $ 323.7
============ ============ ============ ============= ============
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA:(d)
Net Income:
Basic (c)............................. $ 3.26 $ 2.92 $ 2.49 $ 1.76 $ 2.35
============ ============ ============ ============ ============
Diluted .............................. $ 3.23 $ 2.88 $ 2.47 $ 1.75 $ 2.33
============ ============ ============ ============ ============
Dividends: Cash........................ $ .630 $ .590 $ .550 $ .490 $ .387
============ ============ ============ ============ ============
Stock....................... -% -% -% -% 50%
============ ============ ============ ============ ============
Book Value.............................. $ 26.17 $ 23.40 $ 20.62 $ 17.99 $ 17.27
============ ============ ============ ============ ============
Common Shares (thousands):
Outstanding........................... 120,598 118,977 118,253 122,199 133,402
============ ============ ============ ============ ============
Average and Equivalent Shares:
Basic.................. 120,575 118,957 119,318 128,958 137,347
============ ============ ============ ============ ============
Diluted................ 121,548 120,327 120,197 129,786 139,150
============ ============ ============ ============ ============
- ----------
(a) Consists of cash, investments and investment income due and accrued.
(b) Total capitalization consists of debt, preferred stock, and common
shareholders' equity.
(c) Calculated after deduction of minor amounts of preferred stock cash
dividends.
(d) All per share statistics herein have been restated to reflect all stock
dividends or splits declared through December 31, 2002.
16
Item 7-Management Analysis of Financial Position and Results of Operations
($ in Millions, Except Share Data)
- --------------------------------------------------------------------------------
OVERVIEW
This analysis pertains to the consolidated accounts of Old Republic
International Corporation which are presented on the basis of generally accepted
accounting principles ("GAAP"). The Company conducts its business through four
separate segments, namely its General (property and liability coverages),
Mortgage Guaranty, Title, and Life insurance groups. This information should be
read in conjunction with the consolidated financial statements and related
footnotes thereto included elsewhere in this document.
CHANGES IN ACCOUNTING POLICIES
During 2001, the Financial Accounting Standards Board issued two
pronouncements affecting accounting for business combinations occurring after
June 30, 2001, and the related treatment of goodwill and intangible assets
recorded pursuant to such or earlier combinations. In general terms, the first
pronouncement requires that business combinations initiated after June 30, 2001
be treated as purchases for financial accounting purposes, that the alternative
pooling of interests method of accounting be eliminated, and that identifiable
assets meeting certain criteria for intangibles be set apart from any purchased
goodwill. This pronouncement had no impact on the Company in 2001. Under the
second pronouncement, which took effect for fiscal years beginning after
December 15, 2001, all goodwill resulting from business combinations will no
longer be amortized against operations but must be tested periodically for
possible impairment of its carried value. Within six months of application of
this second pronouncement, a transitional goodwill impairment test needs to be
performed and any resulting charge is to be reported as a change in accounting
principle. As of December 31, 2001, the Company's consolidated unamortized
goodwill asset balance was $84.8, and the average annual charge from goodwill
amortization to operating results for the three calendar years ended 2001 was
approximately $4.0 (or 3 cents per average diluted share). The Company completed
the transitional goodwill impairment test required by FAS 142 in the first
quarter of 2002 and determined that there was no indication of goodwill or
intangible asset impairment.
FINANCIAL POSITION
The Company's financial position at December 31, 2002 reflected increases
in assets, liabilities and common shareholders' equity of 10.0%, 8.2% and 13.4%,
respectively, when compared to the immediately preceding year-end. Cash and
invested assets represented 70.8% and 70.5% of consolidated assets as of
December 31, 2002 and 2001, respectively. Consolidated results produced positive
operating cash flows for the latest three years. The increases in operating cash
flow for these years were mostly due to greater contributions by the Company's
three largest operating segments. In 2002, the invested asset base increased
10.4% to $6,168.2 principally as a result of such greater operating cash flow.
Relatively high short-term investment positions were maintained as of
December 31, 2002 and 2001. Such investment positions reflect a large variety of
seasonal and intermediate-term factors including current operating needs,
expected operating cash flows, and investment strategy considerations.
Accordingly, the future level of short-term investments will vary and respond to
the interplay of these factors and may, as a result, increase or decrease from
current levels. During 2002 and 2001, the Corporation committed most investable
funds in short to intermediate-term fixed maturity securities and equity
securities. Old Republic continues to adhere to its long-term policy of
investing primarily in investment grade, marketable securities; investable funds
have not been directed to so-called "junk bonds" or types of securities
categorized as derivatives. Old Republic's commitment to equity securities
during 2002 increased in relation to the related invested balance at year-end
2001 due to portfolio additions offset by net unrealized losses. At December 31,
2002, the carrying value of fixed maturity investments in default as to
principal and/or interest was immaterial in relation to consolidated assets or
shareholders' equity.
The Company does not own or utilize derivative financial instruments for
the purpose of hedging, enhancing the overall return of its investment
portfolio, or reducing the cost of its debt obligations. Traditional investment
management tools and techniques are employed to address the yield and valuation
exposures of its invested assets base. The long-term fixed maturity investment
portfolio is managed so as to limit various risks inherent in the bond market.
Credit risk is addressed through asset diversification and the purchase of
investment grade securities. Reinvestment rate risk is controlled by
concentrating on non-callable issues, and by taking asset-liability matching
practices into account; purchases of mortgage and asset backed securities, which
have variable principal prepayment options, are generally avoided. Market value
risk is limited through the purchase of bonds of intermediate maturity. The
combination of these investment management tenets is expected to produce a more
stable long-term fixed maturity investment portfolio that is not subject to
extreme interest rate sensitivity and principal deterioration. The market value
of the Company's long-term fixed maturity investment portfolio is sensitive,
however, to fluctuations in the level of interest rates, but not materially
affected by changes in anticipated cash flows caused by any prepayments. The
impact of interest rate movements on the long-term fixed maturity investment
portfolio generally affects net unrealized gains or losses as to securities
classified as available for sale. With a market value of approximately $5,344.2,
the long-term fixed maturity investment portfolio has an average maturity of 3.9
17
years and an indicated duration of 3.5. With regard to its $513.5 equity
portfolio, the Company does not own nor engage in any type of option writing.
Possible declines in values for Old Republic's bond and stock portfolios
could affect negatively the level of the common shareholders' equity account at
any point in time, but would not necessarily result in the recognition of
realized investment losses. In such circumstances, the likely combination of
positive operating cash flows and the scheduled emergence of maturities from the
Company's short duration bond portfolio should provide sufficient funds to meet
obligations to policyholders and claimants, as well as debt service and cash
dividend requirements at the holding company level. The Company reviews the
status and market value changes of its securities portfolio on at least a
quarterly basis during the year, and any provisions for other than temporary
impairments in the portfolio's value are evaluated and established at each
quarterly balance sheet date. In management's opinion, the Company's high
quality and diversified portfolio, which consists largely of publicly traded
securities, has been a basic reason for the absence of major impairment
provisions in the periods reported upon. The combination of gains and losses on
sales of securities and such provisions or write-downs of securities are
reflected as realized gains and losses in the income statement. In reviewing
investments for other than temporary impairment, the Company, in addition to a
security's market price history, considers the issuer's operating results,
financial condition and liquidity, its ability to access capital markets, credit
rating trends, most current audit opinion, industry and securities markets
conditions, and analyst expectations, in their totality to reach its
conclusions. The Company recognized other than temporary impairments of
investments in the amounts of $19.0 and $6.7 for the years ended December 31,
2002 and 2001, respectively; no such impairments were recognized during the year
ended December 31, 2000. Unrealized gains or losses on securities classified as
available for sale and carried at fair value are reflected directly in
shareholders' equity.
Among other major assets, substantially all of the Company's receivables
are not past due, and reinsurance recoverable balances on paid or estimated
unpaid losses are deemed to be fairly stated and recoverable from solvent
reinsurers. Deferred policy acquisition costs are estimated by taking into
account the variable costs of producing specific types of insurance policies,
and evaluating their recoverability on the basis of recent trends in claims
costs. The Company's deferred acquisition cost balances have not fluctuated
materially from period to period and do not represent significant percentages of
assets, shareholders' equity, or premium reserves.
The parent holding company meets its liquidity and capital needs
principally through dividends paid by its subsidiaries. The insurance
subsidiaries' ability to pay cash dividends to the parent company is generally
restricted by law or subject to approval of the insurance regulatory authorities
of the states in which they are domiciled. In contemplation of such restrictions
and approvals, the Company can receive up to $227.4 in dividends from its
subsidiaries in 2003. The liquidity achievable through such permitted dividend
payments is more than adequate to cover the parent holding company's cash
outflow represented mostly by interest on outstanding debt and quarterly cash
dividend payments to shareholders. In addition, Old Republic can access the
commercial paper market for up to $150.0 to meet unanticipated liquidity needs.
During 2002, the Company used a part of available cash flow to redeem a portion
of its commercial paper outstanding, thereby reducing consolidated debt by
approximately $15.0.
Old Republic's capitalization of $3,297.4 at December 31, 2002 consisted of
debt of $141.5, a minor amount of convertible preferred stock, and common
shareholders' equity of $3,155.8. Changes in the common shareholders' equity
account for the three most recent years reflect primarily the retention of
earnings in excess of dividends declared on outstanding preferred and common
shares, an increase in the value of investments carried at fair values, and the
repurchase of $66.4 in 2000 of the Company's common shares in open market
transactions. In March 2000, the Company canceled 36.4 million common shares
previously reported as treasury stock, restoring them to unissued status; this
had no effect on total shareholders' equity or the financial condition of the
Company. At its March, 2002 meeting, the Company's Board of Directors authorized
the reacquisition of up to $200.0 of common shares as market conditions warrant
during the two year period from that date; no stock had as yet been acquired
through December 31, 2002 pursuant to this authorization.
RESULTS OF OPERATIONS
Revenues:
Pursuant to generally accepted accounting principles applicable to the
insurance industry, benefits, claims, and expenses are associated with the
related revenues by means of the provision for policy benefits, the deferral and
subsequent amortization of acquisition costs, and the recognition of incurred
benefits, claims and operating expenses.
General insurance (property and liability) and level-term credit life
insurance premiums are reflected in income on a pro-rata basis. Earned but
unbilled premiums are generally taken into income on the billing date, and
adjustments for retrospective premiums, commissions and similar charges are
accrued on the basis of periodic evaluations of current underwriting experience
and contractual obligations. First year and renewal mortgage guaranty premiums
are recognized as income on a straight-line basis except that a portion of first
year premiums received for certain high risk policies is deferred and reported
as earned over the estimated policy life, including renewal periods. Single
premiums for mortgage guaranty policies covering more than one year are earned
on an accelerated basis over the policy term. Title insurance premiums are
recognized as income upon the substantial completion of the policy issuance
process. Title abstract, escrow, service, and other fees are taken into income
at the time of closing of the related escrow. Ordinary life premiums are
18
recognized as revenue when due. Decreasing term credit life and credit
disability/accident & health insurance premiums are generally earned on a
sum-of-the-years-digits or similar method.
The composition of Old Republic's earned premiums and fees for the periods
reported upon was as follows:
Years Ended December 31,
------------------------------------------------