Old Republic International Corporation — Q3 2018 Form 10-Q
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2018. Old Republic is an insurance holding company operating primarily through General Insurance, Title Insurance, and its run-off Republic Financial Indemnity Group (RFIG) businesses.
Financial performance and condition
- Q3 revenue: Operating revenues were $1.644 billion, up 5.6% year over year. Total revenues were $1.780 billion, including $135.7 million of realized and unrealized investment gains.
- Q3 earnings: Net income was $275.2 million, or $0.92 per diluted share, versus $46.1 million, or $0.17, a year earlier. Excluding investment gains, net income was $167.9 million versus $22.8 million; pretax income excluding investment gains was $199.3 million versus $23.8 million.
- Nine-month results: Operating revenues were $4.668 billion, up 4.2%; net income was $477.0 million, or $1.59 per diluted share, versus $260.9 million, or $0.91. Excluding investment gains, net income was $419.6 million versus $223.5 million.
- Underwriting: The consolidated composite ratio was 93.1% in Q3 and 94.7% for the nine months, improving from 104.3% and 98.4%, respectively. General Insurance’s Q3 pretax operating income rose to $105.1 million from $59.7 million; Title Insurance income was essentially flat at $67.7 million; RFIG reported $13.3 million versus a $109.7 million loss.
- Cash flow and liquidity: Nine-month operating cash flow was $597.1 million, compared with $522.1 million. Cash was $115.2 million at quarter-end. Cash and invested assets totaled $13.420 billion, down 0.9% from year-end 2017. Management said permitted subsidiary dividends of up to $554.6 million in 2018, without prior regulatory approval, were sufficient for expected parent-company needs.
- Debt and equity: Debt declined to $981.1 million from $1.449 billion at year-end; debt was 15.6% of capitalization and 18.5% of shareholders’ equity. Shareholders’ equity was $5.311 billion, up 12.2% from year-end, while book value per share was $17.76 versus $17.72. The 3.75% convertible notes were converted into 32.2 million common shares in March.
- Dividends: Q3 cash dividends were $0.195 per common share. Nine-month dividends paid totaled $440.5 million, including a special dividend paid in January 2018.
Material changes versus the prior period
- Q3 reported earnings benefited substantially from a $128.4 million pretax unrealized gain on equity securities. A new accounting standard requires equity-security fair-value changes to be recorded in income; management cautioned this may increase earnings volatility. For the nine months, such gains were $17.7 million.
- Underlying operating performance improved, particularly in General Insurance. Its nine-month pretax operating income rose 29.1%, and its composite ratio improved to 96.8% from 98.9%.
- Comparisons with 2017 RFIG results are affected by $130 million of additional claim and related expense provisions recorded in 2017 for legacy Great Recession-era claims. General Insurance’s 2017 comparison also included $20 million of hurricane-related claim costs.
- The federal corporate tax rate fell from 35% to 21% effective in 2018. The nine-month effective tax rate was 17.1%, compared with 29.6% in 2017.
- Common shares outstanding increased following the convertible-note conversion. The company also recorded a $37.4 million ESSOP share purchase during Q2.
Outlook, commentary, and risks
- Management indicated General Insurance claim ratios may generally fall within a targeted high-60% to low-70% range, with an expense ratio of 23%–25%, absent significant economic or insurance-market disruption. No specific consolidated earnings guidance was provided.
- Management attributed General Insurance premium growth to rate increases and new business; it cited improving workers’ compensation and commercial trucking claims experience. Title premiums and fees grew, while nine-month Title pretax operating income declined 8.5% amid higher expenses and claim costs.
- RFIG is in run-off, with premiums declining as insured risk runs off. Results remain sensitive to mortgage defaults, claim severity, coverage rescissions and denials, and disputes over those decisions.
- Loss reserves are estimates subject to changes in claims experience, inflation, legal developments, and other assumptions. Gross claim reserves were $9.483 billion, including $3.018 billion of reinsurance recoverables. Management cautioned that future reserve development could materially affect results in an individual reporting period.
- Investment risks include interest-rate sensitivity and equity-price volatility. Available-for-sale fixed-maturity securities had a net unrealized loss of $116.8 million at September 30, versus a net unrealized gain of $120.0 million at year-end 2017; management said fixed-income losses primarily reflected interest-rate changes. The company reported no material change in market-risk exposures.
- The company reported no material unreserved non-claim litigation exposure and no material change to the risk factors in its 2017 annual report. It said disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring underwriting and investment income versus the Q3 equity-security fair-value gain and comparison with 2017 special charges.
- Whether General Insurance’s improved claim ratios and reserve trends persist, particularly in commercial auto and workers’ compensation.
- RFIG runoff exposure, remaining mortgage risk in force, and the assumptions supporting rescissions, denials, and claim reserves.
- Potential future reserve development and the recoverability and concentration of reinsurance balances.
- The effect of interest rates and equity markets on investment values, comprehensive income, and book value per share.
- Share dilution and capital returns following the convertible-note conversion, ESSOP share purchases, and special dividend.