Old Republic International Corporation — FY 2012 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2012; quarterly figures below include the fourth quarter. Old Republic is an insurance holding company operating through General Insurance, Title Insurance, and the RFIG mortgage guaranty and consumer credit indemnity run-off segment. A small life and accident business is included in Corporate & Other. Comparisons reflect the reclassification of CCI into RFIG.
Financial performance and position
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Operating revenues, excluding realized investment gains | $4,922.2 million | $4,529.9 million |
| Total revenues, including realized investment gains | $4,970.1 million | $4,645.5 million |
| Net premiums and fees earned | $4,471.0 million | $4,050.1 million |
| Net investment income | $336.5 million | $364.6 million |
| Pretax income (loss) | ($128.5) million | ($236.7) million |
| Net income (loss) | ($68.6) million; ($0.27) per diluted share | ($140.5) million; ($0.55) per diluted share |
| Operating cash flow | $532.0 million | ($94.9) million |
| Total assets | $16,226.8 million | $16,050.4 million |
| Shareholders’ equity | $3,596.2 million | $3,772.5 million |
| Debt | $572.9 million | $912.8 million |
Consolidated underwriting composite ratio was 110.4% versus 115.8%; excluding RFIG run-off, it was 98.1% versus 96.4%. Net investment income yield on original cost declined to 3.40% from 3.71%. Cash dividends were $0.71 per share, up from $0.70; book value per share fell to $14.03 from $14.76. Fourth-quarter 2012 net loss was $20.2 million, or $0.08 per share.
Cash and invested assets totaled $10,800.6 million. Fixed maturity securities were $8,566.2 million, with 99.3% of the portfolio rated investment grade. The consolidated debt-to-equity ratio was 15.9%. The company reported $9,303.3 million in gross loss, claim, and settlement expense reserves, including $6,456.2 million net of reinsurance.
Material changes versus prior year
- Operating revenues rose 8.7%, led by General Insurance growth of 8.5% and Title Insurance growth of 22.7%; RFIG run-off revenue declined 20.8% as its insured book continued to shrink.
- Title pretax operating income increased to $73.8 million from $36.2 million, with its composite ratio improving to 96.8% from 99.0%.
- General Insurance pretax operating income declined 26.3% to $261.0 million. Its claim ratio rose to 73.0% from 69.2%, particularly reflecting higher workers’ compensation, commercial auto, and liability claims. A $37.9 million pretax charge related to new deferred acquisition cost accounting guidance also affected 2012.
- RFIG’s pretax operating loss narrowed to $508.6 million from $727.8 million, but remained substantial. Its composite ratio was 232.2%.
- Net realized investment gains declined to $47.8 million from $115.5 million. The company redeemed $316.2 million of 8.0% convertible notes in May 2012, reducing debt and interest costs.
Outlook, risks, contingencies, and unusual items
- Mortgage insurance run-off: RMIC and RMICNC stopped writing new policies in 2011 and were placed under North Carolina regulatory supervision in 2012. Under the approved plan, 60% of settled claims is paid in cash and the remaining 40% is retained as a deferred payment obligation (DPO), payable only when approved by the regulator. Management’s model through 2022 indicated ultimate profitability, but management expected MI operating losses in 2013 and 2014. The model depends on uncertain assumptions, and the filing does not assure solvency or rule out future receivership.
- At December 31, 2012, RFIG mortgage subsidiaries had approximately $132.8 million of statutory capital, including $299.5 million in accumulated DPO reserve funds; RFIG’s consolidated GAAP capitalization was negative $56.6 million. Management expected the GAAP deficit to deepen as run-off losses continued.
- The 3.75% convertible notes due 2018 contain a potential event-of-default provision tied to a court-ordered insolvency proceeding involving RMIC, a significant subsidiary. Management said the regulatory orders reduced this near-term risk, while noting that mitigation plans are not assured. Parent-company liquidity depends substantially on regulated subsidiary dividends; approximately $350.6 million could be paid upstream in 2013 without prior regulatory approval.
- Material risks include uncertain claim-reserve estimates, mortgage and housing conditions, workers’ compensation severity and inflation, long-tail asbestos and environmental claims, catastrophe and terrorism losses, reinsurance recoverability, regulatory limits on dividends, and interest-rate and investment-value changes. Asbestos and environmental reserves were $119.4 million net of reinsurance.
- Pending matters include mortgage-insurance rescission disputes and related bank litigation, RESPA class actions, title-insurance cases, and other suits. Bank of America seeks more than $320 million in one credit-indemnity case; other claims generally seek unspecified damages. The company said it did not consider the matters probable to have a material consolidated effect, but stated that potential liabilities were generally not estimable.
- The company reported positive 2012 operating cash flow, but $299.5 million of DPO funds affected cash flows and claim payments. Interpret the cash-flow improvement in light of that deferred-claim arrangement and changing reserves.
Important facts for investors to verify
- Whether MI claims, cure rates, rescissions, and DPO releases support management’s long-term run-off assumptions and the expectation of losses in 2013–2014.
- How much of the $532.0 million operating cash flow reflects the DPO arrangement, and whether cash generation remains sustainable as claims are paid.
- Whether General Insurance claim trends and reserve development reverse the 2012 deterioration, especially in workers’ compensation.
- Whether Title Insurance growth and margins persist if refinancing and housing activity weaken.
- Developments in RMIC’s regulatory status, the 2018 convertible notes’ default provisions, subsidiary dividend capacity, and the identified litigation.
KPMG issued an unqualified opinion on the consolidated financial statements and concluded internal control over financial reporting was effective as of December 31, 2012.