Business context and reporting period
Old Republic International Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The insurer operates principally through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit-indemnity run-off businesses. Unless stated otherwise, financial amounts are in millions of dollars.
Financial results and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Operating revenues | $1,492.1 | $1,435.5 | $2,922.1 | $2,804.9 |
| Net premiums and fees earned | $1,362.8 | $1,313.9 | $2,663.9 | $2,559.6 |
| Net investment income | $101.0 | $94.9 | $202.3 | $191.2 |
| Pretax operating income | $139.4 | $142.1 | $289.3 | $280.3 |
| Net operating income | $97.1 | $96.7 | $200.6 | $190.9 |
| Realized investment gains | $6.8 | $6.6 | $21.7 | $50.8 |
| GAAP net income | $101.6 | $101.0 | $214.7 | $224.0 |
| Diluted EPS | $0.35 | $0.35 | $0.74 | $0.78 |
Operating income is a company-defined non-GAAP measure; GAAP net income includes realized investment gains. Q2 consolidated composite underwriting ratio was 95.8% versus 95.4%; first-half ratio was 95.2% versus 95.4%.
- Segment performance: Q2 General Insurance pretax operating income fell to $62.7 from $80.0, with a 100.1% composite underwriting ratio. Title Insurance income rose to $65.0 from $44.6, with an 89.6% ratio. RFIG run-off income declined to $6.8 from $14.3.
- Cash flow: First-half operating cash flow was $259.0 versus $163.8. Investing activities used $118.0 and financing activities used $91.5. Cash ended the period at $195.1.
- Balance sheet: June 30 assets were $19,357.1; liabilities $14,695.3; and shareholders’ equity $4,661.8, or $17.85 per share. Cash and investments totaled $13,228.0.
- Debt and liquidity: Debt was $1,526.1, including $548.6 of 3.75% convertible notes due in 2018. Debt was 24.7% of total capitalization; debt-to-equity was 32.7%. The company reported up to $473.3 of subsidiary dividends available in 2017 without prior regulatory approval and said expected parent-company cash needs were covered by available liquidity.
- Dividends: Cash dividends were $0.19 per common share in Q2 and $0.38 for the first half.
Material changes versus prior periods
- First-half operating income increased 3.2% and net operating income increased 5.1%, while GAAP net income fell 4.2%, principally reflecting lower realized investment gains: $21.7 versus $50.8.
- Q2 net income was nearly unchanged; pretax operating income declined 1.9%. General Insurance results weakened as claims costs and prior-year reserve development rose, while Title Insurance earnings improved substantially.
- First-half premiums and fees grew 4.1%. General Insurance premiums increased 3.5% and Title Insurance premiums and fees increased 7.5%; RFIG run-off premiums declined 24.4% as expected in run-off.
- Investment income increased, but management noted continued low yields. Interest and other charges were higher year over year, partly reflecting debt issued in 2016.
- Book value per share increased to $17.85 from $17.20 at year-end 2016. Total debt was broadly stable versus year-end, but higher than a year earlier following the 2016 senior-note issuance.
Outlook, commentary, risks and contingencies
- No formal earnings guidance was provided. Management said General Insurance claim ratios, absent significant economic or industry disruption, could be expected to average in the high-60% to low-70% range over time; it described a long-term expense-ratio target range of 23% to 25%.
- Management attributed General Insurance pressure to unfavorable prior-year reserve development, concentrated in workers’ compensation, trucking-related commercial automobile, and general liability. The Q2 General Insurance claim ratio was 74.5%, and its composite underwriting ratio exceeded 100%.
- Title results benefited from continued housing and commercial property activity, lower claims, and favorable prior-year reserve development. Management cautioned that insurance results are affected by competition, interest and inflation rates, claim frequency and severity, and economic and legal conditions.
- RFIG mortgage insurers remain in run-off and under North Carolina regulatory supervision. RMIC was reported statutorily solvent at June 30, 2017. Management said the existing regulatory order precluded the related debt-default risk in the foreseeable future; insolvency of RMIC could otherwise potentially trigger acceleration provisions in the notes.
- Loss reserves are estimates subject to changes in claims experience, legal interpretations, inflation, and other factors. Gross loss and claim reserves were $9,386.6 at quarter-end; first-half General Insurance prior-year development was unfavorable by $28.8, partly offset by favorable Title and RFIG development.
- Investment risks include interest-rate and equity-price fluctuations. The portfolio was approximately 75% fixed-maturity and short-term investments and 25% equities; 93.1% of fixed maturities were investment grade. Management reported no other-than-temporary impairment charges in the periods shown.
- Material litigation includes the Countrywide credit-indemnity dispute, with a multi-phase trial scheduled to begin September 25, 2017, and an Ocwen dispute with RMIC that the company intends to defend. The filing says the identified proceedings were not considered probable to have a material adverse effect, but outcomes remain uncertain and additional costs could arise. Other disclosed patent and RESPA matters had favorable developments or settlements, with one RESPA matter awaiting a court decision.
- The company reported effective disclosure controls and no material changes in internal control during the quarter. It reported no material changes to the risk factors in its 2016 Form 10-K.
Important facts for investors to verify
- Whether adverse General Insurance reserve development continues, particularly in workers’ compensation, trucking, and general liability, and how it affects the combined underwriting ratio.
- Whether Title Insurance growth and low claim costs persist as housing, mortgage, and commercial-property conditions change.
- RFIG run-off claims, reserve assumptions, regulatory status of RMIC and RMICNC, and the remaining exposure to CCI litigation.
- The timing and terms of the 2018 convertible-note maturity or conversion, and the company’s ability to maintain liquidity and permitted subsidiary dividends.
- Developments in the Countrywide trial and Ocwen litigation, and any resulting changes to reserves or disclosures.
- Changes in investment yields, equity values, and unrealized losses, as well as the sensitivity of fixed-maturity portfolio values to interest rates.