Old Republic International Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in millions of dollars unless stated otherwise. Old Republic is an insurance underwriter operating through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit-indemnity run-off businesses.
Financial performance and position
- Q2 revenue and earnings: Total revenues were $1,333.9, down from $1,461.5 a year earlier. Operating revenues were $1,283.9 versus $1,324.3. Pretax income was $99.6 versus $296.3, and net income was $66.1 versus $193.9. Diluted EPS was $0.24 versus $0.67.
- First-half performance: Total revenues were $2,764.5 versus $2,731.5; net income was $260.5 versus $250.2; diluted EPS was $0.91 versus $0.88. Pretax operating income, excluding realized investment gains, was $155.4 versus $239.1.
- Investment gains: Realized gains were $49.9 in Q2 versus $137.1, and $241.2 for the first half versus $141.7. No impairment losses were recorded in either comparative period. Management said 2014 gains largely reflected sales of non-income-producing or low-yielding securities, with proceeds generally reinvested in higher-yielding equities.
- Segments and underwriting: Q2 pretax operating income was $59.7 in General Insurance excluding CCI run-off, $26.0 in Title, and a $34.2 loss in RFIG run-off. General Insurance’s Q2 combined ratio was 100.2% excluding CCI, Title’s was 95.0%, and RFIG’s was 162.4%. The consolidated combined ratio was 102.1% for Q2 and 99.6% for the first half.
- Cash flow: Operating cash flow was $172.3 for the first half, down from $278.3; management attributed the change primarily to timing and amount of estimated tax payments. Cash was $146.3 at June 30. Cash dividends paid were $94.1 in the first half.
- Balance sheet and debt: Total assets were $17,183.9 and shareholders’ equity was $3,953.1. Debt was $566.2, including $550.0 of 3.75% convertible notes due 2018; debt-to-equity was 14.3%. Cash and investments totaled about $11.31 billion, excluding accrued investment income. The company reported up to $427.2 of subsidiary dividends available in 2014 without prior regulatory approval.
- Shareholder returns: Book value per share was $15.29 at June 30, versus $14.64 at year-end 2013. The Q2 dividend was $0.1825 per common share.
Material changes and management commentary
- Q2 GAAP earnings fell sharply year over year, principally alongside lower realized investment gains and substantially higher CCI run-off claims and litigation costs. First-half net income rose modestly, but pretax operating income was lower.
- General Insurance premiums earned increased 9.4% in both Q2 and the first half, supported by rate improvements and new business. Excluding CCI run-off, Q2 operating income was slightly lower; management cited elevated workers’ compensation and general-liability claim severity.
- Title premiums and fees declined 18.3% in Q2 and 16.5% in the first half, mainly due to fewer refinancing transactions, with winter weather and higher mortgage rates also cited. Market-share gains partly offset the decline.
- RFIG’s mortgage-guaranty run-off business remained profitable, supported by lower claim costs and favorable resolution of defaults. CCI results deteriorated: Q2 included increased reserves related to a litigated-case settlement and ongoing litigation with a major lender.
- Management emphasizes long-term underwriting and financial strength over quarterly results and evaluates operating trends over multi-year cycles. The filing provides no specific earnings or revenue guidance.
Outlook, risks, contingencies, and unusual items
- Mortgage-insurance regulatory plan: On July 1, 2014, after quarter-end, North Carolina regulators approved an amended corrective plan for RMIC and RMICNC. Old Republic had contributed $125.0 of cash and securities to RMIC in June. In mid-July, the subsidiaries processed approximately $657 of previously deferred claim payments; the amount was reflected at June 30 as loss reserves, with the required funds in short-term investments. The insurers remain under regulatory supervision and in run-off, and the regulator may amend the plan.
- Debt covenant/default exposure: RMIC is a significant subsidiary under the convertible notes. A future receivership following statutory impairment could potentially trigger an event of default. Management said RMIC was statutorily solvent at June 30 and did not consider regulatory takeover imminent, but noted there is no assurance of access to capital markets under stressed conditions.
- Legal matters: The company said it did not believe the disclosed lawsuits and arbitrations were probable to have a material adverse effect, while cautioning that outcomes are uncertain and additional costs beyond reserves may arise. A separate Bank of America suit against an Old Republic subsidiary was settled effective July 1, with dismissal filed July 29, 2014. Other title, credit-indemnity, and mortgage-insurance disputes remain pending.
- Investment and insurance risks: Interest-rate and equity-price changes are the principal market risks; fixed-income fair values may decline if rates rise. Claims estimates are inherently uncertain, especially for long-tail commercial liability, workers’ compensation, mortgage defaults, and litigation. Management cited continuing severity pressure in workers’ compensation and general liability. No material change to the risk factors in the 2013 Form 10-K was reported.
- Disclosure controls were reported effective, with no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the approximately $657 million post-quarter-end DPO payments were completed as described and how they affect RFIG reserves, liquidity, and run-off exposure.
- Developments in CCI litigation and related reserve adequacy, and whether further adverse claims provisions occur.
- Whether General Insurance claim severity, especially workers’ compensation and general liability, continues to pressure underwriting results and combined ratios.
- Whether Title Insurance volumes recover from the refinancing-related decline and how ongoing market conditions affect revenue and expense ratios.
- Future RMIC regulatory status and any implications for the $550 million convertible notes, including potential default or refinancing risks.
- How much reported earnings depend on realized investment gains, which management says can vary materially from period to period.