OLD REPUBLIC INTERNATIONAL CORP annual report, FY2010

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Old Republic International Corporation — 2010 Form 10-K

Business context and period. This annual report covers the fiscal year ended December 31, 2010. Old Republic is an insurance holding company operating in General, Mortgage Guaranty, and Title insurance, plus a small life and health business. Effective October 1, 2010, it acquired PMA Capital Corporation for $247.2 million, including 17.75 million Old Republic shares; 2010 results include PMA’s fourth quarter only.

Financial results and position

  • Revenue: Operating revenues were $3,993.5 million, up 5.2% from $3,797.2 million in 2009. Including realized investment gains, total revenues were $4,102.7 million. Premiums and fees earned rose 5.4% to $3,573.5 million.
  • Profit: Operating results remained loss-making: pretax operating loss was $81.5 million versus $279.9 million in 2009, and net operating loss was $0.16 per diluted share. GAAP net income was $30.1 million ($0.13 per diluted share), compared with a $99.1 million loss in 2009, helped by $109.1 million of realized investment gains. The 2010 income tax credit was $2.5 million.
  • Cash flow: Operating cash flow was negative $282.2 million, versus positive $532.9 million in 2009, primarily reflecting mortgage guaranty cash outflows. Investing activities provided $499.8 million; financing activities used $167.6 million.
  • Underwriting: The consolidated composite ratio improved to 111.4% from 118.5%, but remained above 100%. General Insurance’s ratio was 103.0%; Mortgage Guaranty’s 168.0%; Title’s 101.0%.
  • Liquidity and capital: Cash and invested assets totaled $10.49 billion; total assets were $15.88 billion. Debt was $475.0 million, shareholders’ equity $4.12 billion, and debt-to-equity 11.5%. The company reported up to $306.5 million of subsidiary dividends available in 2011 without prior regulatory approval and up to $150 million of commercial-paper access, subject to market availability. Annual dividends declared were $0.69 per share.
  • Investments: Net investment income was $379.0 million, slightly below $383.5 million. Fixed maturities were $8.53 billion, and 98.7% were investment grade.

Material changes versus 2009

  • Mortgage Guaranty pretax operating loss narrowed to $260.8 million from $486.4 million, while earned premiums fell 22.6% to $498.8 million. Captive reinsurance commutations and pool terminations improved reported 2010 pretax operating results by $65.4 million, but reduced operating cash flow by $173.2 million.
  • Title premiums and fees rose 36.3% to $1,211.0 million, reflecting market-share gains and real-estate refinance activity; pretax operating income was $9.4 million versus $2.1 million.
  • General Insurance pretax operating income declined 13.7% to $172.7 million. Its composite ratio worsened to 103.0% from 102.1%, amid soft pricing, recession-related pressure and elevated consumer credit indemnity claims.
  • Assets increased 11.9%, liabilities 14.2%, and equity 5.9%, with the PMA acquisition a major contributor. Book value per share declined to $16.16 from $16.49.

Outlook, risks and unusual items

  • Management emphasizes long-term underwriting performance and cautions that annual insurance results can be volatile; it provides no specific earnings or revenue guidance in the text provided. Management expected Mortgage Guaranty to continue incurring material losses, particularly on 2005–early 2008 business.
  • Mortgage insurer RMIC breached minimum capital requirements in the third quarter. The three mortgage subsidiaries’ combined statutory risk-to-capital ratio was 28.4:1 against a commonly applicable 25:1 limit. Regulatory waivers, including North Carolina’s, were subject to conditions and several were due to expire July 1, 2011; renewal was uncertain. Without waivers, new business could be restricted.
  • Mortgage claims remain sensitive to unemployment, home prices, delinquencies, foreclosure activity, and the outcome of coverage rescissions and denials. The filing reports $748.8 million of mortgage claims not paid due to rescissions and denials in 2010; related litigation could affect the practice and future results.
  • Reserving is inherently uncertain. General Insurance reserves include long-tail and asbestos/environmental exposures; A&E reserves were $195.7 million gross and $144.9 million net at year-end. The filing also notes renewed black-lung claims following 2010 regulatory changes.
  • Material litigation includes a Bank of America suit seeking more than $320 million, disputes with Countrywide and Chase over credit or mortgage insurance rescissions, and title/home-warranty class actions. Management said outcomes were not reasonably estimable and could not assure there would be no material adverse effect.
  • The acquisition added approximately $2.3 billion of year-end assets and $231 million of equity. PMA contributed a fourth-quarter pretax operating loss of about $10 million, including merger-related and corporate costs.

Important facts for investors to verify

  1. Whether RMIC’s regulatory waivers were extended and whether mortgage-insurance capital and new-business capacity improved.
  2. Mortgage delinquency, paid-claim, rescission/denial, and reserve trends, including whether reported improvement depends on commutations or other nonrecurring effects.
  3. Whether operating cash flow recovers from the 2010 deficit and whether subsidiary dividends and commercial-paper access remain adequate for parent-company obligations and shareholder dividends.
  4. Reserve development and claim exposures, especially PMA-related reserves, workers’ compensation, black lung, and asbestos/environmental claims.
  5. Developments and potential financial effects of the disclosed Bank of America, Countrywide, Chase, and title-insurance litigation.
  6. The sustainability of reported GAAP profitability after separating operating losses from realized investment gains and acquisition-related effects.