Business context and reporting period
Old Republic International Corporation filed this Form 10-Q for the quarter and six months ended June 30, 2016. The insurer operates through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit-indemnity run-off business.
Unless otherwise noted, financial amounts are in millions of dollars. Segment operating income and operating income per share are management measures that exclude realized investment gains or losses; they are not substitutes for GAAP net income.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenues | $1,435.5 | $1,393.3 | $2,804.9 | $2,704.6 |
| Net premiums and fees earned | $1,313.9 | $1,273.5 | $2,559.6 | $2,467.9 |
| Pretax operating income | $142.1 | $135.1 | $280.3 | $270.0 |
| Net income | $101.0 | $102.0 | $224.0 | $205.5 |
| Diluted GAAP EPS | $0.35 | $0.36 | $0.78 | $0.72 |
| Net realized investment gains | $6.6 | $16.6 | $50.8 | $35.5 |
- Operating revenues increased 3.0% in Q2 and 3.7% in the first half. Pretax operating income rose 5.1% and 3.8%, respectively; net income was down 1.0% in Q2 but up 9.0% year to date.
- Net operating income, excluding realized gains, was $96.7 in Q2 and $190.9 for the first half, up 6.0% and 4.7%. Q2 realized gains were lower year over year, while first-half gains were higher.
- Consolidated composite underwriting ratio was 95.4% in both the quarter and first half, unchanged from the first half of 2015 and 0.3 percentage point better than Q2 2015. General Insurance's ratio was 97.8% in Q2 and 97.4% year to date; Title's was 92.8% and 94.8%.
- General Insurance pretax operating income was $80.0 in Q2, down from $85.1, and $167.1 year to date, unchanged. Premium growth was supported by trucking, warranty, and a newer underwriting facility; competitive conditions and a declining construction account limited growth. Higher expenses, including start-up and litigation costs, weighed on results.
- Title Insurance pretax operating income was $44.6 in Q2 versus $47.7, and $66.0 year to date versus $63.6. Premiums and fees grew with housing and commercial-property activity, but operating costs rose faster than Q2 revenue.
- RFIG run-off pretax operating income improved to $14.3 in Q2 from a $0.1 loss and to $42.0 for the first half from $35.0. Mortgage-guaranty claims benefited from fewer reported delinquencies, more cures, and lower litigation-related costs; CCI remained loss-making and its claims were volatile.
Cash flow, balance sheet, debt, and liquidity
- First-half operating cash flow was $163.8, compared with $303.7 in 2015. Management noted that excluding MI and CCI run-off cash flows, the amounts were $218.7 and $387.7. The filing attributes much of the cash-flow movement to operating working-capital items, including receivables.
- At June 30, total assets were $17,991.2, shareholders’ equity $4,378.0, and debt $982.9. Equity increased 12.8% from year-end 2015, partly reflecting investment-market gains; book value was $16.89 per share versus $15.02 at year-end.
- Cash and invested assets totaled $12,138.7, including $168.7 of cash. The investment portfolio was approximately 80% fixed-maturity and short-term investments and 20% equities. The company reported no fixed-maturity investments in default and no impairment charges in the periods shown.
- Debt was primarily $546.9 of 3.75% convertible notes due 2018 and $395.4 of 4.875% senior notes due 2024. Carrying-value debt increased from $952.8 at year-end; the convertible notes’ reported fair value was $702.6. Consolidated debt to equity was 22.5%.
- Management stated that the parent could receive up to $493.8 in subsidiary dividends during 2016 without prior regulatory approval and considered available liquidity sufficient for expected parent-company outflows. Insurance-subsidiary dividends remain subject to legal limits or regulatory approval.
- Cash dividends were $0.1875 per share in Q2 and $0.3750 for the first half, slightly above the comparable 2015 rates.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance was provided. Management said it manages for long-term underwriting performance and financial strength, rather than short reporting periods. It expects General Insurance claim ratios to gradually return toward targeted annual averages in the high 60% to low 70% range.
- Management identified competition, claim frequency and severity, inflation and interest rates, weather and other external events, housing and mortgage conditions, employment, and mortgage defaults as factors that could affect results. It cautioned that historical performance is not necessarily indicative of future results.
- RMIC and its affiliate remain in run-off and under North Carolina insurance-department supervision. They were statutorily solvent at June 30, 2016; management expected solvency to continue. The regulator retains authority to amend the approved corrective plan. RMIC’s insolvency could, under specified circumstances, trigger a default under the company’s notes, although management believed this was not foreseeable.
- Material litigation includes a Countrywide/BNY Mellon dispute with a multi-phase trial scheduled to begin March 13, 2017; two unresolved RESPA class-action matters involving RMIC (no class certified); and patent disputes. A separate Ocwen complaint amendment filed July 5, 2016 alleges contract, bad-faith, and claims-handling violations against RMIC. Management said it would defend the matters and did not believe they were probable to have a material adverse effect, while acknowledging outcomes are uncertain and additional costs may arise.
- General Insurance net prior-year reserve development was favorable by $74.9 in the first half of 2016, compared with $162.7 of unfavorable development in the first half of 2015. RFIG reserve releases also materially supported current-period results. Insurance reserve estimates remain judgmental and may develop differently from current assumptions.
- Shareholders’ equity benefited from $349.9 of after-tax unrealized investment gains in the first half, primarily reflecting market-value changes; these gains are not equivalent to realized earnings. Fixed-maturity portfolio fair values are sensitive to interest-rate changes. The filing reported no material change in market-risk exposures from the 2015 Form 10-K and no material change in disclosed risk factors.
Important facts for investors to verify
- Whether General Insurance premium growth and underwriting profitability persist as expense ratios and claim trends evolve.
- How much current RFIG profitability depends on favorable reserve development, litigation costs, and declining mortgage defaults in a closed run-off portfolio.
- The adequacy and sensitivity of long-tail insurance reserves, including workers’ compensation, general liability, and mortgage-guaranty claims.
- Developments in the RMIC corrective plan, statutory solvency, Ocwen litigation, and other material legal proceedings.
- The sustainability of operating cash generation, access to regulated-subsidiary dividends, and the company’s ability to address the convertible notes due in 2018.
- Whether investment gains and higher book value reflect durable operating performance or primarily market-driven unrealized gains.