Old Republic International Corporation — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also presents unaudited quarterly results; fourth-quarter 2016 net income was $131.9 million and diluted EPS was $0.46, versus $90.6 million and $0.32 in fourth-quarter 2015. Amounts below are U.S. dollars; financial amounts are in millions unless noted.
Business context and reporting period
Old Republic is an insurance holding company operating primarily through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit run-off businesses. Management emphasizes underwriting and financial strength over multi-year cycles, noting that short-period results can be volatile.
Financial performance and position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Operating revenues | $5,827.6 | $5,674.8 | +2.7% |
| Net premiums and fees earned | $5,333.2 | $5,179.4 | +3.0% |
| Net investment income | $387.0 | $388.6 | -0.4% |
| Realized investment gains | $72.8 | $91.3 | -20.2% |
| Pretax operating income | $613.1 | $540.4 | +13.4% |
| Pretax income, including realized gains | $686.0 | $631.8 | +8.6% |
| Net income | $466.9 | $422.1 | +10.6% |
| Diluted EPS | $1.62 | $1.48 | +$0.14 |
| Operating cash flow | $637.3 | $688.2 | -7.4% |
- Underwriting: Consolidated composite ratio improved to 94.6% from 96.0%; below 100% indicates underwriting profit under the company’s presentation. The benefit-and-claim ratio improved to 44.0% from 47.5%, while the expense ratio increased to 50.6% from 48.5%.
- Segments: General Insurance pretax operating income was $319.9 million, down 4.9%, with a 97.8% composite ratio. Title Insurance income rose 26.0% to $210.2 million; its composite ratio improved to 91.7%. RFIG run-off income increased to $69.8 million from $29.4 million, as claims declined.
- Balance sheet and liquidity: Total assets were $18,591.6 million, cash and invested assets $12,995.8 million, and shareholders’ equity $4,471.6 million at year-end. Book value per share rose to $17.20 from $15.02. Cash and invested assets represented 69.9% of assets.
- Investments: Total investments were $12,757.7 million; 92.0% of fixed-maturity securities were investment grade. Net investment income was nearly flat. Investment gains were lower than in 2015, and the company recorded $4.9 million of impairment losses.
- Debt and dividends: Debt increased to $1,528.7 million from $952.8 million, principally following a $550 million 3.875% senior-note issuance due 2026. Debt was 25.5% of total capitalization; management separately reported a 34.2% debt-to-equity ratio. The annual cash dividend was $0.75 per share, up from $0.74.
- Cash flow: Operating cash flow remained positive, but declined year over year. Excluding the inherently negative cash flows of the MI and CCI run-off businesses, management reported operating cash flow of $739.8 million in 2016 versus $812.8 million in 2015.
Material changes versus prior year
- Title Insurance delivered record pretax operating income, supported by higher premiums and fees and lower claims.
- General Insurance results were broadly stable operationally, but pretax operating income fell as expenses rose; prior-year reserve deterioration continued, concentrated in workers’ compensation and general liability.
- RFIG improved substantially as mortgage-insurance claims and reserve costs declined, although premiums and the insured portfolio continued to run off.
- Consolidated operating income increased, but realized investment gains fell, limiting the increase in total pretax income. Net investment income was slightly lower.
- Equity rose 15.2%, including a favorable change in unrealized investment gains. Debt rose with the 2026 note issuance; the 2018 convertible notes remain outstanding.
Outlook, risks, contingencies, and unusual items
- Management outlook: No formal consolidated earnings guidance is provided. Management expects general-insurance claim ratios, absent significant economic or industry disruption, to trend gradually toward long-term averages in the high-60% to low-70% range. RMIC’s long-term model indicates aggregate profitability for its run-off book through about 2022, but near-term mortgage-insurance losses remain possible.
- Mortgage-insurance regulatory position: RMIC and RMICNC stopped writing new business in 2011 and remain under North Carolina insurance-department supervision. At year-end 2016, RFIG mortgage subsidiaries were reported statutorily solvent, with $420.6 million in statutory capital including a $340.9 million contingency reserve; consolidated GAAP capitalization was $330.6 million. The regulator may amend the corrective plan.
- Reserving uncertainty: Consolidated gross claim and settlement reserves were $9,206.0 million, with $6,439.8 million net of reinsurance. General Insurance had unfavorable prior-year development of $9.9 million in 2016, concentrated in workers’ compensation and general liability; title and RFIG reported favorable development. Management’s reserve sensitivity analysis uses a potential range of approximately plus or minus 5%.
- Litigation: CCI results remained affected by a long-running dispute with Bank of America/Countrywide. Other disclosed matters include mortgage-insurance claims-handling litigation, a Countrywide-related insurance dispute with a trial scheduled to begin in September 2017, and patent litigation. The company did not consider material adverse outcomes probable, but noted uncertainty and possible additional costs.
- Other risks: Insurance pricing and claims severity, catastrophic events, long-tail and A&E claims, reinsurance recoverability, interest-rate and equity-market movements, housing and mortgage conditions, regulation, competition, and dependence of the parent on regulated subsidiary dividends. Up to $473.3 million of subsidiary dividends were available to the parent in 2017 without prior regulatory approval.
- Unusual financial items: The $550 million senior-note offering increased debt; 2016 also included $4.9 million in investment impairment losses. The company paid approximately $657 million of accumulated mortgage-insurance deferred payment obligations in 2014 under a regulatory corrective plan; this was a prior-period event, not a 2016 payment.
- Audit and controls: KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2016. Management reported disclosure controls and internal controls as effective.
Most important facts for investors to verify
- Whether General Insurance reserve development, particularly in workers’ compensation and general liability, stabilizes or worsens.
- Whether RMIC and RMICNC remain solvent and comply with the corrective plan, and how run-off claims and litigation affect capital and earnings.
- Whether Title Insurance growth and underwriting margins persist as mortgage rates, housing activity, and transaction volumes change.
- How higher debt, the 2018 convertible-note maturity, interest costs, and regulated subsidiary dividend capacity affect parent-company liquidity.
- Whether reported earnings and cash generation remain resilient if realized investment gains decline or investment yields stay low.