Old Republic International Corporation — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014; comparisons are with Q1 2013 unless noted. Old Republic is an insurance underwriter operating through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit run-off businesses.
Financial results and position
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Operating revenues | $1,239.3 million | $1,265.4 million, down 2.1% |
| Total revenues, including realized investment gains | $1,430.6 million | $1,269.9 million |
| Net income | $194.4 million | $56.2 million |
| Diluted EPS | $0.67 | $0.21 |
| Operating income before tax, excluding realized investment gains | $105.7 million | $79.9 million |
| Net investment income | $82.8 million | $79.3 million |
| Operating cash flow | $135.4 million | $143.2 million |
| Cash at quarter-end | $130.2 million | $153.3 million at year-end 2013 |
Investment securities sales generated $191.2 million of pretax realized gains ($124.3 million after tax), versus $4.5 million pretax a year earlier. There were no impairment losses. Management said sales largely involved non-income-producing or low-yielding securities, with proceeds largely reinvested in higher-yielding U.S. equities. The substantial gain materially boosted reported earnings; management’s non-GAAP operating-income measure is intended to distinguish underlying results.
Segment performance: General Insurance operating revenue excluding CCI run-off was $745.3 million and pretax operating income was $81.8 million, up from $76.0 million. Its composite ratio improved slightly to 96.2% from 96.4%; earned premiums grew 9.4%. Title Insurance revenue was $401.8 million and pretax operating income was $4.7 million, down from $21.5 million; premiums and fees fell 14.5%, and its composite ratio rose to 100.1% from 96.4%. RFIG run-off pretax operating income improved to $19.5 million from a $20.2 million loss, mainly reflecting lower mortgage-guaranty claim provisions and favorable reserve development.
Balance sheet and liquidity: Total assets were $16.811 billion and common shareholders’ equity was $3.866 billion at March 31, 2014. Cash and invested assets plus accrued investment income totaled $11.286 billion. Debt was $566.2 million, including $550 million of 3.75% convertible notes due 2018; consolidated debt-to-equity was 14.6%. The company reported up to $427.2 million of subsidiary dividends could be received in 2014 without prior regulatory approval and considered parent liquidity adequate for expected needs. Cash dividends were $0.1825 per common share.
Material changes and management commentary
- Title results weakened amid fewer mortgage-refinance transactions, winter weather, higher mortgage rates, and uncertainty about credit availability. Management described the market downturn as transitory; continued market-share gains and lower title claim costs partly offset the revenue decline.
- General Insurance benefited from premium growth, rate improvements, and lower expenses, while loss costs increased. The segment’s claim ratio rose to 72.7% from 71.9% excluding CCI run-off; workers’ compensation and general-liability severity were identified as pressure points.
- RFIG mortgage-guaranty results improved as cure and resolution rates rose and housing and real-estate conditions improved. Its earned premiums continued to decline as the business remains in run-off.
- On March 20, 2014, Old Republic cancelled the previously announced recapitalization plan for its mortgage-guaranty subsidiary. The company intends to increase regulatory capital and RMIC and RMICNC are seeking regulatory approval to raise payouts on deferred obligations and valid new settlements, potentially to 100%. Those actions depend on NCDOI approval.
Risks, contingencies, and unusual items
- RMIC and RMICNC are under North Carolina regulatory supervision and run off existing business. Under the approved plan, settled claims are generally paid 60% in cash, with 40% recorded as deferred payment obligations; the accumulated DPO reserve was $604.2 million at March 31, 2014. The run-off plan is estimated to continue through 2021.
- RMIC is a significant subsidiary for purposes of the 2018 convertible notes. A qualifying insolvency-related court proceeding could trigger an event of default and make principal immediately payable. Management believes the NCDOI order precludes this in the foreseeable future and says it has sufficient liquidity to redeem a substantial portion of the notes, while acknowledging mitigation is not assured.
- The filing describes multiple title, credit-indemnity, and mortgage-insurance lawsuits and arbitrations, including class actions. Damages are generally unspecified; the company said it could not reasonably estimate potential liability and did not believe a material adverse effect was probable, but gave no assurance.
- Insurance loss reserves and investment impairment estimates require significant judgment. Net claim reserves were $6.642 billion; workers’ compensation and general liability severity, asbestos and environmental exposures, and mortgage-claim assumptions remain relevant uncertainties. Management noted reserve developments could materially affect results in an individual reporting period.
- Investment values are exposed primarily to interest-rate and equity-price risk. Fixed-maturity portfolio duration was 4.3 years; the filing estimated that a parallel 100-basis-point rate increase could reduce its fair value by approximately 4.3%. No material change in market-risk exposures was reported.
- No formal earnings guidance was provided. Management cautioned that historical results are not necessarily indicative of future results and cited competition, claims frequency and severity, interest and inflation rates, housing and mortgage conditions, employment, and legal developments as factors affecting results.
Investor facts to verify
- How much of the earnings increase is attributable to the unusually large realized investment gain, and whether reinvestment sustains investment income.
- Whether Title Insurance production and margins recover as refinance activity and housing-market conditions change.
- Whether General Insurance loss trends and reserve estimates, particularly workers’ compensation, general liability, and asbestos/environmental claims, remain within management’s assumptions.
- Whether NCDOI approves additional RMIC/RMICNC capital and higher claim payouts, and how the $604.2 million DPO reserve and run-off claims evolve.
- How mortgage-related litigation and the convertible-note default provisions affect potential liquidity needs.