Old Republic International Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Old Republic is an insurance and related-services holding company, with General Insurance, Title Insurance, and RFIG mortgage-guaranty and consumer-credit run-off segments. Amounts below are in millions of dollars unless stated otherwise.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenues | $1,496.0 | $1,545.7 | $4,351.7 | $4,285.9 |
| Operating revenues | $1,488.7 | $1,504.2 | $4,293.6 | $4,208.9 |
| GAAP net income | $110.9 | $125.9 | $335.0 | $331.4 |
| GAAP diluted EPS | $0.39 | $0.44 | $1.17 | $1.16 |
| Pretax operating income (non-GAAP) | $156.7 | $143.3 | $437.0 | $413.3 |
| Net operating income (non-GAAP) | $106.2 | $99.0 | $297.2 | $281.4 |
| Diluted operating EPS (non-GAAP) | $0.37 | $0.35 | $1.04 | $0.99 |
Operating income excludes realized investment gains and losses; it is management’s non-GAAP measure and does not replace GAAP net income. Q3 pretax operating income rose 9.4%, while GAAP net income fell 11.9%, principally reflecting substantially lower realized investment gains. Nine-month GAAP net income increased 1.1%.
- Premiums and fees: $1,365.4 in Q3, down 0.5%; $3,925.1 for nine months, up 2.2%.
- Investment income: $95.7 in Q3, down 8.1%; $287.0 for nine months, down 0.6%. Realized investment gains were $7.2 in Q3 versus $41.4 a year earlier, and $58.1 year to date versus $77.0. 2016 included $4.9 of impairment losses.
- Underwriting ratios: Consolidated composite ratio was 94.4% in Q3 versus 96.2%, and 95.1% year to date versus 95.7%. General Insurance’s ratio worsened to 98.1% in Q3 from 96.5%; Title was 91.3% versus 91.5%. RFIG improved to 68.9% from 134.0%, with material favorable prior-year reserve development.
- Cash flow: Operating cash flow was $401.9 for nine months, down from $566.5. Investing activities used $849.5; financing provided $432.3, including $576.8 from debt issuance and $145.3 of common dividends. Cash ended at $144.6.
- Balance sheet at September 30: Total assets were $18,810.6, total investments $12,631.7, and common shareholders’ equity $4,446.1, up from $3,880.8 at year-end 2015. Book value was $17.13 per share, versus $15.02 at year-end.
- Debt and liquidity: Debt was $1,528.0, up from $952.8 at year-end, following the August issuance of $550.0 of 3.875% senior notes due 2026. Debt was 25.6% of total capitalization; the company also reported a 34.4% consolidated debt-to-equity ratio. Management said up to $493.8 of subsidiary dividends could be received in 2016 without prior regulatory approval and considered permitted dividends sufficient for expected parent-company needs.
Material changes and management commentary
- General Insurance pretax operating income fell 21.7% in Q3 and 8.0% year to date. Management attributed weaker results mainly to higher expenses, including start-up costs, second-quarter litigation provisions, and premium mix; Q3 earned premiums declined 1.7%.
- Title Insurance pretax operating income increased 6.3% in Q3 and 4.9% year to date. Management cited a favorable mortgage-rate and housing-market environment, while noting adverse effects from new mortgage disclosure rules.
- RFIG remains in run-off. Mortgage-guaranty claim costs declined amid fewer reported delinquencies and more cures or resolutions without payment. CCI continued to incur volatile claims and litigation costs. RMIC and its affiliate remain under North Carolina regulatory supervision; the filing says RMIC was statutorily solvent at quarter-end.
- Management expects recent General Insurance claim-ratio uptrends to abate and ratios to move gradually toward long-term annual targets in the high 60% to low 70% range, absent significant economic or industry dislocations. No specific companywide earnings or revenue guidance was provided.
Risks, contingencies, and other notable items
- Insurance reserves depend on estimates and may develop differently from current assumptions; changes could materially affect results in an individual reporting period. General Insurance includes long-tail commercial liabilities, and the company specifically identifies reserve estimation as a critical accounting estimate.
- Interest-rate and equity-price movements are the main market risks. The portfolio was approximately 78% fixed-maturity and short-term investments and 22% equities; a 100-basis-point parallel rate increase was estimated to reduce fixed-maturity portfolio fair value by approximately 4.2%.
- Material litigation includes the Countrywide/Bank of New York Mellon dispute, with a multi-phase trial scheduled to begin March 13, 2017, and an Ocwen action against RMIC. The company said it did not believe the disclosed proceedings were probable to have a material adverse consolidated effect, but noted outcomes are uncertain and additional costs could arise beyond reserves.
- Debt agreements identify potential default consequences if a significant subsidiary becomes insolvent. RMIC qualifies as a significant subsidiary; management said it was solvent and expected the regulatory order to prevent an event of default in the foreseeable future.
- The filing reported no material changes to previously disclosed risk factors, effective disclosure controls, and no materially affecting changes to internal control during the quarter.
Important facts for investors to verify
- Whether General Insurance expense growth and underwriting margins improve, particularly given the Q3 composite ratio increase.
- The sustainability of favorable RFIG reserve development and mortgage default-cure trends, alongside RMIC’s regulatory status and the CCI litigation exposure.
- Reserve adequacy and future development in long-tail claims, including workers’ compensation, general liability, and asbestos and environmental exposures.
- The impact of the higher debt balance and lower investment income on earnings, cash generation, and parent-company liquidity.
- Progress and potential exposure in the Countrywide and Ocwen proceedings, as well as the timing and outcomes of other disclosed litigation.