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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, 2003
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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: 001-10607
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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
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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, 2003, the
last day of the registrant's most recently completed second fiscal quarter, was
$3,794,654,577.
The Company had 181,721,548 shares of Common Stock outstanding as of February
16, 2004.
Documents incorporated by reference:
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The following documents are incorporated by reference into that part of this
Form 10-K designated to the right of the document title.
Title Part
Proxy statement for the 2004 Annual
Meeting of Shareholders III, Items 10, 11, 12, 13 and 14
Exhibits as specified in
exhibit index (page 59) IV, Item 15
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There are 60 pages in this report
PART I
Item 1-Business
(a) General Description of Business. Old Republic International Corporation is a
Chicago-based insurance holding company with subsidiaries engaged in the general
(property and liability), mortgage guaranty, title, and life (life and
disability) insurance businesses. In this report, "Old Republic", "the
Corporation", or "the Company" refers to Old Republic International Corporation
and its subsidiaries as the context requires. The aforementioned insurance
segments are organized as the Old Republic General Insurance, Mortgage Guaranty,
Title Insurance, and Life Insurance Groups, and references herein to such groups
apply to the Company's subsidiaries engaged in the respective segments of
business.
Financial Information Relating to Segments of Business (a)
The contributions to net revenues and income (loss) before taxes of each
Old Republic segment are set forth below for the years shown, together with
their respective assets at the end of each year. The information below should be
read in conjunction with the consolidated financial statements, the notes
thereto, and the "Management Analysis of Financial Position and Results of
Operations" appearing elsewhere herein.
($ in Millions)
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Years Ended December 31,
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Net Revenues (b) Income (Loss) Before Taxes
------------------------------------------ ------------------------------------------
2003 2002 2001 2003 2002 2001
------------ ----------- ----------- ----------- ------------ -----------
General....................... $ 1,572.7 $ 1,376.7 $ 1,195.0 $ 259.0 $ 182.1 $ 141.4
Mortgage Guaranty............. 498.6 467.1 436.0 276.4 267.7 261.9
Title......................... 1,128.0 836.5 648.9 129.8 97.8 74.6
Life.......................... 58.4 57.0 58.4 4.3 6.4 4.9
Other Operations - Net........ 8.5 5.0 5.2 (8.8) (7.1) (8.8)
------------ ----------- ----------- ----------- ------------ -----------
Subtotal.................... 3,266.5 2,742.4 2,343.7 660.7 546.9 474.2
Consolidated Realized
Investment Gains............. 19.3 13.9 29.7 19.3 13.9 29.7
------------ ----------- ----------- ----------- ------------ -----------
Consolidated................ $ 3,285.8 $ 2,756.4 $ 2,373.4 $ 680.0 $ 560.9 $ 503.9
============ =========== =========== =========== ============ ===========
Assets at December 31,
------------------------------------------
2003 2002 2001
----------- ----------- -----------
General..................................................................... $ 6,603.5 $ 5,876.5 $ 5,451.9
Mortgage Guaranty........................................................... 2,080.1 1,921.2 1,731.6
Title....................................................................... 720.5 619.9 536.0
Life........................................................................ 244.6 233.3 236.3
Consolidated.............................................................. $ 9,712.3 $ 8,715.4 $ 7,920.2
=========== =========== ===========
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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 provides 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 such
as homeowners and private automobile coverages. Similarly, the Corporation does
not provide meaningful amounts of property insurance coverages for commercial
building and related contents.
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, or inflation-driven cost increases for
such exposures as medical costs related to bodily injuries may not always be
granted soon enough to enable insurers to fully recover the amount of the
benefits they must pay.
2
Over the years, Old Republic 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
mergers with other companies. For 2003, production of commercial automobile
direct insurance premiums accounted for approximately 33.7% of consolidated
direct premiums written by the General Insurance Group, while workers'
compensation and general liability direct insurance premiums amounted to 21.8%
and 16.5%, respectively, of such consolidated totals.
Among other liability coverages, Old Republic indemnifies corporations'
financial exposures to directors' and officers' liability as well as those
stemming from errors and omissions liability. In the past twenty years, the
Corporation has developed a presence in the general aviation insurance industry,
providing coverage for hull and liability exposures as well as such additional
areas as airport facilities and flying schools. All of these coverages are
produced through independent insurance agency and brokerage channels.
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. The Company believes it has made adequate provisions for
the ultimate claim costs pertaining to those businesses.
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 some 8,800
independent agents by the Old Republic Surety Group. Surety bonds, such as those
aimed at public officials, license and permit authorizations, and contract bonds
covering both public and private works, are typically written for exposures of
less than $500,000. Fidelity bonds are also extended to small to medium-sized
risks.
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.
Automobile extended 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.
Traditional primary insurance is issued on an individual loan basis to
mortgage bankers, brokers, commercial banks and savings institutions through a
network of underwriting sites located throughout the country. Traditional
primary loans are individually reviewed (except for loans insured under
delegated approval programs) and priced according to filed premium rates. In
underwriting traditional primary business, the Corporation generally adheres to
the underwriting guidelines published by the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA"),
purchasers of many of the loans the Corporation insures. Delegated underwriting
programs allow approved lenders to commit the Corporation to insure loans
provided they adhere to predetermined underwriting guidelines. In 2003,
delegated underwriting approvals accounted for 46.9% of the Corporation's new
traditional primary insurance written.
Bulk and other insurance is issued on groups of loans to mortgage banking
customers through a centralized risk assessment and underwriting process. These
groups of loans are priced in the aggregate, on a bid or negotiated basis.
3
Coverage for insurance issued in this manner can be issued under primary
insurance policies (loan level coverage) or pool insurance policies (aggregate
coverage). The Corporation considers transactions designated as bulk insurance
to be higher risk (as determined by characteristics such as loan amount, credit
quality, and loan documentation) than those designated as other insurance.
Before insuring any loans, the Corporation issues to each approved customer
a master policy outlining the terms and conditions under which coverage will be
provided. Primary business is then executed via the issuance of a
commitment/certificate for each loan submitted and approved for insurance. In
the case of business issued as pool coverage, a separate pool insurance policy
is issued covering the loans applicable to the transaction.
The amount of premium charge depends on loan-to-value ratios, the level of
coverage being provided, the type of loan instrument (whether fixed rate/fixed
payment or an adjustable rate/adjustable payment), documentation type, and
whether or not the insured property is to be an investment property or owner
occupied. Coverage is non-cancelable by the Company (except in the case of
non-payment of premium or certain master policy violations) and premiums are
paid under single, annual, or monthly payment plans. Single premiums are paid at
loan closing and provide coverage for the entire coverage term. Annual and
monthly premiums are renewable on their anniversary dates with the premium
charge determined on the basis of original or outstanding loan amount.
Substantially all of the Corporation's insurance in force as of December 31,
2003 has been written under monthly premium plans.
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. For the year ended December 31, 2003, approximately 40% of the
Company's consolidated title premium and related fee income stemmed from direct
operations through its marketing and underwriting staffs, while the remaining
60% emanated from independent title agents and service intermediaries such as
real estate attorneys and realtors.
There are two basic types of title insurance policies: lenders' policies
and owners' policies. Both are issued for a onetime premium. Most mortgages made
in the United States are extended by mortgage bankers, savings and commercial
banks, state and federal agencies, and life insurance companies. The financial
institutions secure title insurance policies to protect their mortgagees'
interest in the real property. This protection remains in effect for as long as
the mortgagee has an interest in the property. A separate title insurance policy
may be issued to the owner of the real estate. An owner's policy of title
insurance protects an owner's interest in the title to the property.
The premiums charged for the issuance of title insurance policies vary with
the policy amount and the type of policy issued. The premium is collected in
full when the real estate transaction is closed, there being no recurring fee
thereafter. In many areas, premiums charged on subsequent policies on the same
property may be reduced, depending generally upon the time elapsed between
issuance of the previous policies and the nature of the transactions for which
the policies are issued. Most of the charge to the customer relates to title
services rendered in conjunction with the issuance of a policy rather than to
the possibility of loss due to risks insured against. Accordingly, the cost of
service performed by a title insurer relates for the most part to the prevention
of loss rather than to the assumption of the risk of loss. Claim losses that do
occur result primarily from title search and examination mistakes, fraud,
forgery, incapacity, missing heirs and escrow processing errors.
In connection with its title insurance operations, Old Republic also
provides escrow closing and construction disbursement services, as well as real
estate information products and services pertaining to 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 in both the United States and Canada. Marketing of term life
insurance products is aimed principally toward self-employed individuals,
professionals, home owners and small business owners.
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)
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Years Ended December 31,
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2003 2002 2001
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General Insurance Group:
Overall Experience: Net Premiums Written............... $ 1,460.3 $ 1,268.7 $ 1,078.5
Net Premiums Earned ............... $ 1,382.7 $ 1,182.3 $ 1,000.7
Loss Ratio......................... 66.7% 72.7% 75.4%
Policyholders' Dividend Ratio...... 1.1 (.1) (.1)
Expense Ratio ..................... 25.5 25.8 26.7
------------- ------------- -------------
Composite Ratio.................... 93.3% 98.4% 102.0%
============= ============= =============
Experience By Major Coverages:
Commercial Automobile: Net Premiums Earned ............... $ 545.6 $ 508.0 $ 457.7
(Principally Trucking) Loss Ratio......................... 70.4% 78.4% 82.4%
============= ============= =============
Workers' Compensation: Net Premiums Earned ............... $ 277.2 $ 226.2 $ 173.9
Loss Ratio......................... 75.9% 93.7% 90.0%
Policyholders' Dividend Ratio...... 5.3% (.5%) (1.0%)
============= ============= =============
General Liability: Net Premiums Earned ............... $ 72.6 $ 55.3 $ 53.7
Loss Ratio......................... 89.3% 67.5% 70.8%
============= ============= =============
Financial Indemnity: (a) Net Premiums Earned ............... $ 161.8 $ 104.1 $ 72.3
Loss Ratio......................... 50.9% 40.9% 38.8%
============= ============= =============
Property: (b) Net Premiums Earned ............... $ 169.0 $ 151.9 $ 128.1
Loss Ratio......................... 58.9% 51.4% 59.1%
============= ============= =============
Other Coverages: (c) Net Premiums Earned ............... $ 156.4 $ 136.6 $ 114.8
Loss Ratio......................... 52.2% 66.9% 68.5%
============= ============= =============
Mortgage Guaranty Group: Net Premiums Earned................ $ 400.9 $ 376.2 $ 353.1
Loss Ratio......................... 22.7% 14.1% 16.1%
Expense Ratio...................... 24.8 32.3 27.5
------------- ------------- -------------
Composite Ratio.................... 47.5% 46.4% 43.6%
============= ============= =============
Title Insurance Group: (d) Net Premiums Earned................ $ 749.9 $ 524.8 $ 382.7
Combined Net Premiums
& Fees Earned.................... $ 1,103.8 $ 813.4 $ 625.3
Loss Ratio......................... 5.8% 5.0% 4.0%
Expense Ratio...................... 84.6 85.6 87.2
------------- ------------- -------------
Composite Ratio.................... 90.4% 90.6% 91.2%
============= ============= =============
Life Insurance Group: (e) Net Premiums Earned................ $ 51.6 $ 50.1 $ 50.6
Benefits & Claims Ratio............ 48.8% 58.0% 59.7%
Expense Ratio...................... 55.2 42.5 45.4
------------- ------------- -------------
Composite Ratio.................... 104.0% 100.5% 105.1%
============= ============= =============
Net Retained Life
Insurance in Force................ $ 7,431.2 $ 7,383.6 $ 7,500.4
============= ============= =============
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Certain minor reclassifications of prior year data have been reflected in the
above table to conform to current presentation.
(a) Consists principally of fidelity, surety, consumer credit indemnity, and
executive indemnity (directors & officers and errors & omissions) coverages.
(b) Consists principally of fire, allied lines, commercial multi-peril and
inland marine coverages.
(c) Consists principally of home and auto warranty, aviation and travel accident
coverages.
(d) Title loss, expense, and composite ratios are calculated on the basis of
combined net premiums and fees earned.
(e) Life Group benefits and claims ratios take into account combined actuarial
future benefit and claims reserves.
5
Variations in the loss (including related claim settlement expense) ratios
are typically caused by changes in the frequency and severity of claims
incurred, changes in premium rates and the level of premium refunds, and
periodic changes in claim and claim expense reserve estimates resulting from
ongoing reevaluations of reported and incurred but not reported claims and claim
expenses. The Company, therefore, can experience volatility in the underwriting
results of individual lines of coverage as demonstrated in the table on the
previous page. As a result of the Company's strong underwriting focus in the
management of its business, it has attempted to dampen this volatility and thus
ensure a higher degree of underwriting stability by diversifying the coverages
it offers and industries it serves. 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 2003 compared to
2002 which also reflected an improvement over 2001. The downtrend in this major
cost factor reflects largely the pricing and risk selection improvements
effected in the past thirty-six months or so. With respect to commercial
automobile coverages, the decline in the loss ratio in 2003 stems primarily from
the pricing and risk selection improvements made in recent years. In workers'
compensation, the decrease in the loss ratio in 2003 stems from improved pricing
in general as well as stronger growth of business subject to captive
reinsurance, retrospective premium, or high deductible programs that tend to
produce lower loss ratios. The 2003 dividend ratio rose primarily due to the
conversion of a large account to self-insured status which served to increase
policyholder dividend costs that were offset by a reduction in incurred losses.
The loss ratio for general liability coverages rose, exhibiting the impact of
higher claims emergence on a relatively small book of business. The increase in
the financial indemnity loss ratio for 2003 reflects higher loss costs for the
Company's consumer credit indemnity and executive indemnity coverages. The
decline in the 2003 loss ratios for other coverages reflects greater production
of aviation coverages and lower loss costs thereon, as well as improved home
warranty claims experience.
The lower 2002 mortgage guaranty claims ratio results from a decline in
claim provisions driven principally by a drop in expected claim severity, while
the increase in 2003 was driven mostly by higher claim frequencies. 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 2003 and 2002 title insurance loss ratios stems from a rise in
the net provision for ultimate claim costs from the historically low levels
achieved in 2001.
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 claims
adjusters, ongoing changes in claim frequency or severity patterns such as those
caused by natural disasters, illnesses, accidents, work-related injuries, and
changes in general and industry-specific economic conditions. Consequently, the
reserve-setting process relies on management's judgments and the 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 is 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%.
6
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 $142.9 million, $145.7 million and
$151.3 million, as of December 31, 2003, 2002 and 2001, respectively. It should
be noted, however, that these differences between discounted and non-discounted
(terminal) reserves are, fundamentally, of an informational nature, and are not
indicative of an effect on operating results for any one or series of years for
the above-noted reasons.
Early in 2001, the Federal Department of Labor revised the Federal Black
Lung Program regulations. The revisions basically require a reevaluation of
previously settled, denied, or new occupational disease claims in the context of
newly devised, more lenient standards when such claims are resubmitted.
Following a number of challenges and appeals by the insurance and coal mining
industries, the revised regulations were, for the most part, upheld in June,
2002 and are to be applied prospectively. Since the final quarter of 2001, black
lung claims filed or refiled pursuant to these anticipated and now final
regulations have increased, though the 2003 volume of new claim reports abated.
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, 2003, the Corporation's aggregate indemnity and loss adjustment expense
reserves specifically identified with A&E exposures amounted to approximately
$91.0 million gross, and $56.6 million net of reinsurance. Based on average
annual claims payments during the five most recent calendar years, such reserves
represented 6.3 years (gross) and 9.8 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, 2003, 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. For the five years ended December 31,
2003, incurred A&E claim and related loss settlement costs have averaged $9.4
million, net of reinsurance, per annum or 1.2% of such average annual General
Insurance Group costs.
The subject of property and liability insurance claim reserves has been
written about and analyzed extensively by a large number of professionals and
regulators. Accordingly, the above discussion summary should, of necessity, be
regarded as a basic outline of the subject and not as a definitive presentation.
The Company believes that its overall reserving practices have been consistently
applied over many years, and that its aggregate reserves have generally resulted
in reasonable approximations of the ultimate net costs of claims incurred.
However, no representation is made that ultimate net claim and related costs
will not develop in future years to be greater or lower than currently
established reserve estimates.
The following table shows the evolving redundancies or deficiencies for
reserves established as of December 31, of each of the years 1993 through 2003.
In reviewing this tabular data, it should be noted that prior periods' loss
payment and development trends may not be repeated in the future due to the
large variety of factors influencing the reserving process outlined herein
above. The reserve redundancies or deficiencies shown for all years are not
necessarily indicative of the effect on reported results of any one or series of
years since retrospective premium and commission adjustments employed in various
parts of the Company's business may partially offset such effects. (See
7
"Consolidated Underwriting Statistics" above, and "Reserves, Reinsurance, and
Retrospective Adjustments" elsewhere herein).
($ in Millions/Percentages to Nearest Whole Point)
- ------------ ----------------------------------------------------------------------------------------------------------------------
(a) As of December 31: 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(b) Liability(1) for unpaid
claims and claim adjustment
Expenses(2): $1,700 $1,768 $1,821 $1,829 $1,846 $1,742 $1,699 $1,661 $1,678 $1,802 $1,964
=================================================================================================
(c) Paid (cumulative) as of (3):
----------------------------
One year later 20% 21% 22% 20% 23% 25% 24% 25% 25% 24% -%
Two years later 33 35 33 34 38 39 40 40 40 - -
Three years later 42 42 42 44 47 49 50 50 - - -
Four years later 46 48 49 49 54 56 57 - - - -
Five years later 51 52 52 55 59 61 - - - - -
Six years later 55 55 57 59 63 - - - - - -
Seven years later 57 59 61 63 - - - - - - -
Eight years later 60 63 64 - - - - - - - -
Nine years later 64 66 - - - - - - - - -
Ten years later 67% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(d) Liability reestimated (i.e.,
cumulative payments plus
reestimated ending liability)
As of (4):
-----------------------------
One year later 95% 95% 96% 94% 93% 96% 96% 97% 100% 99% -%
Two years later 91 93 92 88 89 93 95 98 101 - -
Three years later 93 90 87 84 87 93 97 100 - - -
Four years later 91 87 83 82 87 95 98 - - - -
Five years later 89 84 82 83 89 97 - - - - -
Six years later 86 84 82 85 91 - - - - - -
Seven years later 86 85 85 86 - - - - - - -
Eight years later 88 88 86 - - - - - - - -
Nine years later 91 89 - - - - - - - - -
Ten years later 92% -% -% -% -% -% -% -% -% -% -%
=================================================================================================
(e) Redundancy (deficiency)(5)
for each year-end at (a): 8% 11% 14% 14% 9% 3% 2% -% -1% 1% -%
=================================================================================================
Average for all year-ends
at (a): 6.3%
====
- ----------
(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,
-------------------------------------------
2003 2002 2001
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the beginning of each year, net of reinsurance losses recoverable..... $ 1,802.5 $ 1,678.9 $ 1,661.5
----------- ------------ ------------
Incurred claims and claim adjustment expenses:
Provisions for insured events of the current year........................ 893.9 814.6 749.1
Change in provision for insured events of prior years.................... (25.8) (7.1) (44.5)
----------- ------------ ------------
Total incurred claims and claim adjustment expenses................. 868.1 807.5 704.6
----------- ------------ ------------
Payments:
Claims and claim adjustment expenses attributable to insured
events of the current year.......................................... 277.9 260.7 269.0
Claims and claim adjustment expenses attributable to insured
events of prior years................................................ 428.6 423.1 418.2
----------- ------------ ------------
Total payments...................................................... 706.6 683.8 687.2
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses
at the end of each year (a), net of reinsurance losses recoverable....... 1,964.1 1,802.5 1,678.9
Unallocated loss adjustment expense reserves................................ 83.6 78.5 76.6
Reinsurance losses recoverable.............................................. 1,515.0 1,363.0 1,261.2
----------- ------------ ------------
Amount of reserves for unpaid claims and claim adjustment expenses.......... $ 3,562.8 $ 3,244.1 $ 3,016.8
=========== ============ ============
- ----------
(a) Reserves for incurred but not reported losses amounted to approximately
30.3%, 25.3%, and 24.3% of the totals shown as of December 31, 2003, 2002
and 2001, 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,
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ------------ ------------
Available for Sale
Fixed Maturity Securities:
U.S. & Canadian Governments............................................ $ 993.4 $ 976.2 $ 869.0
Tax-Exempt............................................................. 1,277.2 - -
Utilities.............................................................. 828.5 - -
Corporate.............................................................. 2,641.8 2,196.2 1,741.2
----------- ------------ ------------
5,741.1 3,172.4 2,610.2
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................. 2.0 2.2 1.7
Common Stocks.......................................................... 511.4 511.2 389.8
----------- ------------ ------------
513.5 513.5 391.6
----------- ------------ ------------
Short-term Investments.................................................... 403.9 253.8 298.5
Miscellaneous Investments................................................. 53.2 - -
----------- ------------ ------------
Total available for sale............................................... 6,711.8 3,939.9 3,300.4
----------- ------------ ------------
Held to Maturity
Fixed Maturity Securities:
Utilities.............................................................. - 754.4 777.6
Tax-Exempt............................................................. - 1,299.7 1,333.4
Redeemable Preferred Stocks............................................ - - .7
----------- ----------- ------------
- 2,054.1 2,111.8
----------- ------------ ------------
Miscellaneous Investments................................................. 8.5 57.4 60.8
----------- ------------ ------------
Total held to maturity................................................. 8.5 2,111.6 2,172.7
----------- ------------ ------------
Total Investments......................................................... $ 6,720.4 $ 6,051.5 $ 5,473.1
=========== ============ ============
Sources of Consolidated Investment Income
($ in Millions)
Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ------------ ------------
Fixed Maturity Securities:
Taxable............................................................... $ 202.7 $ 193.5 $ 189.5
Tax-Exempt............................................................ 53.7 59.5 61.7
Redeemable Preferred Stocks........................................... - - -
----------- ------------ ------------
256.4 253.1 251.3
----------- ------------ ------------
Equity Securities:
Perpetual Preferred Stocks............................................ .1 .1 .1
Common Stocks......................................................... 14.4 12.3 7.8
----------- ------------ ------------
14.6 12.4 7.9
----------- ------------ ------------
Other Investment Income:
Interest on Short-term Investments.................................... 4.5 6.0 15.8
Sundry................................................................ 6.8 5.2 6.1
----------- ------------ ------------
11.4 11.3 22.0
----------- ------------ ------------
Gross Investment Income.................................................. 282.5 276.9 281.3
Less: Investment Expenses (a)......................................... 3.2 4.2 6.5
----------- ------------ ------------
Net Investment Income.................................................... $ 279.2 $ 272.6 $ 274.7
=========== ============ ============
- ----------
(a) Investment expenses consist primarily of personnel costs, investment
management and custody service fees and includes interest incurred on funds
held of $.1, $.3 and $1.4 for the years ended December 31, 2003, 2002 and
2001, 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 no bond or note investments in default as to principal
and/or interest at December 31, 2003, and $1.6 million of bond or note
investments in default as to principal and/or interest as of December 31, 2002.
The Company's investment policies have not been designed to maximize or
emphasize the realization of investment gains. The Company reviews the status
and market value changes of each of its investments on at least a quarterly
basis during the year, and estimates of 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, 2003 have been classified largely as "available for sale" pursuant
to the existing investment policy. (See Item 7 - "Management Analysis of
Financial Position and Results of Operations" for a more thorough discussion on
the transfer of fixed maturity securities from "held to maturity" to "available
for sale".)
The independent credit quality ratings and maturity distribution for Old
Republic's consolidated fixed maturity investments, excluding short-term
investments, at December 31, 2003 and 2002, are shown in the following tables.
These investments, $5.7 billion and $5.2 billion at December 31, 2003 and 2002,
respectively, represented approximately 59% and 60%, respectively, of
consolidated assets as of such dates, and 93% and 94%, respectively, of
consolidated liabilities as of such dates.
- -------------------------------------------------------------------------------------------------------------------------------
Credit Quality Ratings of Fixed Maturity Securities (a)
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
---------- ----------
(% of total portfolio)
Aaa.............................................................................. 29.7% 30.9%
Aa............................................................................... 19.1 24.3
A................................................................................ 32.0 31.4
Baa.............................................................................. 18.5 10.8
---------- ----------
Total investment grade....................................................... 99.3 97.4
All others (b)................................................................... .7 2.6
---------- ----------
Total........................................................................ 100.0% 100.0%
========== ==========
- ----------
(a) Credit quality ratings used are those assigned primarily by Moody's; other
ratings are assigned by Standard & Poor's and converted to equivalent
Moody's ratings classifications.
(b) "All others" includes non-investment grade or non-rated small issues of tax
exempt bonds.
- -------------------------------------------------------------------------------------------------------------------------------
Age Distribution of Fixed Maturity Securities
- -------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------
2003 2002
---------- ----------
(% of total portfolio)
Maturity Ranges:
Due in one year or less.......................................................... 11.0% 13.4%
Due after one year through five years............................................ 50.0 55.9
Due after five years through ten years........................................... 37.7 29.9
Due after ten years through fifteen years........................................ 1.3 .8
Due after fifteen years.......................................................... - -
---------- ----------
100.0% 100.0%
========== ==========
Average Maturity................................................................. 4.5 Yrs. 3.9 Yrs.
========== ==========
- -------------------------------------------------------------------------------------------------------------------------------
(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 2003.
10
Traditional primary mortgage insurance is marketed primarily through a
direct sales force which calls on mortgage bankers, brokers, commercial banks,
savings institutions and other mortgage originators. No sales commissions or
other forms of remuneration are paid to the lending institutions or others for
the procurement or development of business.
The Mortgage Guaranty segment's ten largest customers were responsible for
approximately 37.3%, 38.3% and 40.7% of traditional primary new insurance
written in 2003, 2002 and 2001, respectively. The largest single customer
accounted for 7.2% of traditional primary new insurance written in 2003 compared
to 10.6% and 8.2% in 2002 and 2001, 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 256 Company
offices located in 34 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 2003,
approximately 60% 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, consumer 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
- -------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
----------- ----------- -----------
United States:
Northeast................................................................ 9.3% 8.4% 7.4%
Mid-Atlantic............................................................. 9.7 8.3 7.9
Southeast................................................................ 17.6 17.7 17.9
Southwest................................................................ 12.1 12.8 13.7
East North Central....................................................... 14.9 14.8 14.6
West North Central....................................................... 12.2 13.0 13.8
Mountain................................................................. 7.5 7.9 8.5
Western.................................................................. 14.6 14.9 14.0
Foreign (Principally Canada)............................................... 2.1 2.2 2.2
----------- ----------- -----------
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 of the
periods when they occur. See "General Insurance Claim Reserves" herein.
11
To maintain premium production within its capacity and limit maximum losses
and risks for which it might become liable under its policies, Old Republic, as
is the practice in the insurance industry, may cede a portion or all of its
premiums and liabilities on certain classes of insurance, individual policies,
or blocks of business to other insurers and reinsurers. Although the ceding of
insurance does not generally discharge an insurer from its direct liability to a
policyholder, it is industry practice to establish the reinsured part of risks
as the liability of the reinsurer. Old Republic also employs retrospective
premium adjustments, contingent commissions, 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 commission, 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 such as captive insurance companies owned by assureds
or business producers, as well as similar balances or credits arising from
policies that are retrospectively rated or subject to assureds' high deductible
retentions are substantially collateralized by letters of credit, securities,
and other financial instruments. Old Republic evaluates on a regular basis the
financial condition of its assuming reinsurers and assureds who purchase its
retrospectively rated or high deductible policies. Estimates of unrecoverable
amounts are included in the Company's net claim and claim expense reserves since
reinsurance, 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, financial and other intermediaries
whose customers are insured by Old Republic, or individual customers who have
formed captive (self-owned) 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 mostly 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; $3,800,000 for executive protection (directors
& officers and errors & omissions); $1,000,000 for aviation; and $500,000 for
property coverages. Substantially all the mortgage guaranty insurance risk is
retained, with the exposure on any one risk currently averaging approximately
$22,200. 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 "TRIA") was signed into law, immediately establishing
12
a temporary federal reinsurance program administered by the Secretary of
Treasury. The TRIA defines what constitutes an "act of terrorism" and
establishes 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 TRIA, losses are capped for each year
at $100.0 billion. The TRIA will sunset on December 31, 2005 if not extended or
replaced by similar legislation. The TRIA automatically voided all policy
exclusions which were in effect for terrorism related losses. Under the TRIA,
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 TRIA, 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 TRIA.
(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
the latter to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting processes. 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 and related services 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 life and disability 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, 2003, Old Republic employed approximately
6,645 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.
13
(h) Website access. The Company files various reports with the U.S. Securities
and Exchange Commission ("SEC"), including its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements,
and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act. The Company's filings are available for viewing
and/or copying at the SEC's Public Reference Room located at 450 Fifth Street,
NW., Washington, DC 20549. Information regarding the operation of the Public
Reference Room can be obtained by calling 1-800-SEC-0330. The Company's reports
are also available by visiting the SEC's Internet website (http://www.sec.gov)
and accessing its EDGAR database to view or print copies of the electronic
versions of the Company's reports. Additionally, the Company's reports can be
obtained, free of charge, by visiting its Internet website
(http://www.oldrepublic.com), selecting 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 79% is occupied by the
Old Republic National Title Insurance Company. The remainder of the building is
leased to others. Ten smaller buildings are owned by Old Republic and its
subsidiaries in various parts of the country and are primarily used for its
business. The carrying value of all owned buildings and related land at December
31, 2003 was approximately $21.6 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 its insurance subsidiaries. Other legal proceedings are
discussed below.
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, 2003, the subsidiary has
continually evaluated its exposures since the litigation began and has paid or
otherwise provided cumulatively $52.4 million, including its best estimate of
its remaining liability, costs associated with all these issues, and
accumulating interest on the aforementioned judgment.
In December 1999, a class action lawsuit was filed against the Company's
principal mortgage guaranty insurance subsidiary in the Federal District Court
for the Southern District of Georgia. The suit alleged that the subsidiary
provided pool insurance and other services to mortgage lenders at preferential,
below market prices in return for mortgage insurance business, and that the
practices violated the Real Estate Settlement Procedures Act. Substantially
identical lawsuits were also filed against all of the other mortgage guaranty
insurers. The Company's subsidiary filed a summary judgment motion which the
Court ruled on favorably, dismissing 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 subsidiary again filed motions
seeking summary judgment on grounds it had asserted earlier but which were not
considered by the District Court and opposing certification of the class. On
February 5, 2003, the District Court denied class certification. The plaintiffs
petitioned the Court to reconsider its ruling or, alternatively, to certify
sub-classes. In order to bring the matter to a conclusion and avoid the
uncertainties and expenses of further litigation, the subsidiary entered into
settlement negotiations with the plaintiffs and reached a settlement agreement
calling for the payment of $10.0 million, including attorneys' fees. The
Agreement received final approval at a hearing set for that purpose on October
24, 2003. Between 2000 and 2003, the Company paid or otherwise provided
cumulatively $12.8 million, the majority of which was incurred in 2002 to cover
legal defenses and other costs associated with this litigation, including the
costs anticipated under the settlement. The full amount of the settlement was
paid on December 23, 2003.
14
Item 4-Submission of Matters to a Vote of Security Holders
None.
Executive Officers of the Registrant
The following table sets forth certain information as of December 31, 2003,
regarding the senior executive officers of the Company:
Name Age Position
- --------------------------- --- ------------------------------------------------------------------------------
John S. Adams 46 Senior Vice President and Chief Financial Officer since August, 2001.
Charles S. Boone 50 Senior Vice President, Chief Investment Officer and Treasurer since August,
2001.
James A. Kellogg 52 Senior Vice President/General Insurance and President of Old Republic
Insurance Company since October, 2002.
Spencer LeRoy, III 57 Senior Vice President, General Counsel and Secretary since 1992.
William A. Simpson 62 Senior Vice President/Mortgage Guaranty, and Director since 1980. President
since 1972 of Republic Mortgage Insurance Company, a wholly-owned subsidiary.
Rande K. Yeager 55 Senior Vice President/Title Insurance since March, 2003. President since
March, 2002 of Old Republic National Title Insurance Company.
A. C. Zucaro 64 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 2002......................................................... $ 21.63 $ 18.10 $ .100
2nd quarter 2002......................................................... 23.15 20.34 .107
3rd quarter 2002......................................................... 21.76 16.85 .107
4th quarter 2002......................................................... $ 21.47 $ 17.37 $ .107
=========== ========== ==========
1st quarter 2003......................................................... $ 20.18 $ 16.53 $ .107
2nd quarter 2003......................................................... 23.43 18.31 .113
3rd quarter 2003......................................................... 23.76 21.78 .113
4th quarter 2003......................................................... 25.79 22.83 .113
Special Dec. 2003......................................................... $ - $ - $ .667 (a)
=========== ========== ==========
- ----------
(a) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
As of January 30, 2004, there were 3,009 registered holders of the
Company's Common Stock. See Note 3(b) of the Notes to Consolidated Financial
Statements for a description of certain regulatory restrictions on the payment
of dividends by Old Republic's insurance subsidiaries. Closing prices have been
restated, as necessary, to reflect all stock dividends and splits declared
through December 31, 2003.
15
Item 6-Selected Financial Data
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
FINANCIAL POSITION ($ millions):
Cash and Invested Assets (a)........... $ 6,849.2 $ 6,168.2 $ 5,586.7 $ 5,144.3 $ 4,828.5
Other Assets........................... 2,863.0 2,547.1 2,333.4 2,137.1 2,109.8
Total Assets.................... 9,712.3 8,715.4 7,920.2 7,281.4 6,938.4
Liabilities, Other than Debt........... 6,020.9 5,417.9 4,977.1 4,604.0 4,530.8
Debt................................... 137.7 141.5 159.0 238.0 208.3
Total Liabilities............... 6,158.6 5,559.5 5,136.1 4,842.0 4,739.2
Preferred Stock........................ - - .3 .7 .7
Common Shareholders' Equity............ 3,553.6 3,155.8 2,783.7 2,438.7 2,198.4
Total Capitalization (b)........ $ 3,691.3 $ 3,297.4 $ 2,943.1 $ 2,677.4 $ 2,407.5
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS ($ millions):
Net Premiums and Fees Earned........... $ 2,936.0 $ 2,423.9 $ 2,029.5 $ 1,736.8 $ 1,781.7
Net Investment and Other Income........ 330.5 318.5 314.1 300.1 290.8
Realized Investment Gains.............. 19.3 13.9 29.7 33.6 29.5
Net Revenues................... 3,285.8 2,756.4 2,373.4 2,070.6 2,102.1
Benefits, Claims, Settlement
Expenses and Dividends............... 1,112.8 974.8 860.5 761.2 833.0
Underwriting and Other Expenses........ 1,492.9 1,220.6 1,008.9 882.9 952.0
Pretax Income..................... 680.0 560.9 503.9 426.4 317.0
Income Taxes.......................... 219.9 167.7 159.7 131.0 92.9
Net Income........................ $ 459.8 $ 392.9 $ 346.9 $ 297.5 $ 226.8
============ ============ ============ ============ ============
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA:(d)
Net Income:
Basic (c)............................. $ 2.53 $ 2.17 $ 1.94 $ 1.66 $ 1.17
============ ============ ============ ============ ============
Diluted .............................. $ 2.51 $ 2.16 $ 1.92 $ 1.65 $ 1.17
============ ============ ============ ============ ============
Dividends: Cash - Regular............... $ .446 $ .420 $ .393 $ .367 $ .327
- Special (e)........... .667 - - - -
------------ ------------ ------------ ------------ ------------
- Total................. $ 1.113 $ .420 $ .393 $ .367 $ .327
============ ============ ============ ============ ============
Stock........................ 50% -% -% -% -%
============ ============ ============ ============ ============
Book Value.............................. $ 19.57 $ 17.45 $ 15.60 $ 13.75 $ 11.99
============ ============ ============ ============ ============
Common Shares (thousands):
Outstanding........................... 181,606 180,898 178,465 177,380 183,299
============ ============ ============ ============ ============
Average: Basic...................... 181,549 180,863 178,436 178,977 193,438
============ ============ ============ ============ ============
Diluted.................... 183,302 182,323 180,491 180,295 194,680
============ ============ ============ ============ ============
- ----------
(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, 2003.
(e) In December, 2003 a special cash dividend of $.667 per share (adjusted for
a 50% stock dividend of the Company's common stock) was declared and paid.
16
Item 7-Management Analysis of Financial Position and Results of Operations
($ 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 the first quarter of 2002, the Company adopted Statement of
Financial Accounting Standards No. 142 ("FAS 142") "Goodwill and Other
Intangible Assets". Under FAS 142, goodwill and certain intangible assets will
no longer be amortized against operations but must be tested at least annually
for possible impairment of their carrying values. At December 31, 2003 and 2002,
the Company's consolidated unamortized goodwill asset balance was $87.5, and the
average annual charge from goodwill amortization to operating results for the
three calendar years ended 2001 was approximately $4.0 (or 2 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. During the first
quarter of 2003, the Company tested the carrying value of its goodwill and
intangible assets and determined that there was no indication of impairment of
such assets.
Effective January 1, 2003, the Company elected to reclassify its fixed
maturity securities categorized as held to maturity to the available for sale
classification. The securities involved are primarily utility and tax-exempt
bonds that accounted for approximately 34 percent of Old Republic's investment
portfolio. The decision was prompted by restrictive accounting rules affecting
held to maturity investment securities. The necessarily mechanical application
of these rules can inhibit the Corporation's ability to optimally manage its
investments from a practical business point of view. As of January 1, 2003, the
net impact of this reclassification on the Corporation's balance sheet was to
increase the carrying value of invested assets by $117.5, deferred tax
liabilities by $41.1, and shareholders' equity by $76.4, or approximately 42
cents per share. As of December 31, 2003, the net impact of this
reclassification on the Corporation's balance sheet is to increase the carrying
value of invested assets by $99.2, deferred tax liabilities by $34.7 and
shareholders' equity by $64.5, or approximately 36 cents per share. This change
has no income statement impact, no effect on Old Republic's ability to hold
individual securities to maturity as it may deem appropriate, and does not
affect the Company's necessary long-term orientation in the management of its
business. Going forward, Old Republic's shareholders' equity account could
reflect somewhat greater period-to-period volatility as the entire bond, note
and stock investment portfolio will now be marked to market on a quarterly
basis. Nevertheless, the Company believes that its ability to hold securities
until they mature or until such other time when they can be sold
opportunistically are much more significant and meaningful factors than the
balance sheet or income statement effect of changes in market values at any
point in time.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 148 ("FAS 148") "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS No. 123" for
periods starting after December 15, 2002. As of April 1, 2003, the Company
adopted the requirements of FAS 148 utilizing the prospective method. Under this
method, stock-based compensation expense is recognized for awards granted after
the beginning of the fiscal year of adoption. For all other stock option awards
outstanding, the Company continues to use the intrinsic value method permitted
under existing accounting pronouncements. In estimating the compensation cost of
options, the fair value of options has been calculated using the Black-Scholes
option pricing model. Expense recognition of stock options granted in 2003
reduced earnings per share by less than 1 cent per share.
FINANCIAL POSITION
The Company's financial position at December 31, 2003 reflected increases
in assets, liabilities and common shareholders' equity of 11.4%, 10.8% and
12.6%, respectively, when compared to the immediately preceding year-end. Cash
and invested assets represented 70.5% and 70.8% of consolidated assets as of
December 31, 2003 and 2002, respectively. Consolidated results produced positive
and growing consolidated operating cash flows for the latest three years, with
the Company's three largest operating segments providing substantially all such
funds from operations. In 2003, the invested asset base increased 11.0% to
$6,849.2 principally as a result of such higher operating cash flow and the
greater increase in fair value of investments resulting from the aforementioned
reclassification of fixed maturity securities.
During 2003 and 2002, the Corporation committed substantially all
investable funds to short to intermediate-term fixed maturity securities. At
both December 31, 2003 and 2002, approximately 99% of the Company's investments
consisted of marketable securities, including tax and loss bonds held by its
mortgage guaranty subsidiaries, which are redeemable by the U.S. Treasury for
tax purposes. 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 2003 remained stable in relation to the related invested balance at
17
year-end 2002; this resulted mostly from sales of equity securities, which were
essentially offset by purchases and net unrealized gains on the remaining
holdings. At December 31, 2003, the Company had no fixed maturity investments in
default as to principal and/or interest.
Relatively high short-term maturity investment positions were maintained as
of December 31, 2003 and 2002. 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.
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. With regard to its
equity portfolio, the Company does not own any options nor does it engage in any
type of option writing. Traditional investment management tools and techniques
are employed to address the yield and valuation exposures of the invested assets
base. The long-term fixed maturity investment portfolio is managed so as to
limit various risks inherent in the bond market. Cred