Old Republic International Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise. Old Republic is an insurance underwriting group with General Insurance, Title Insurance, and RFIG mortgage-guaranty/consumer-credit run-off operations. RFIG and consumer credit indemnity results were combined for segment reporting; prior periods were reclassified.
Financial performance and position
- Revenue: Third-quarter operating revenue was $1,286.1, up 13.9% year over year; nine-month operating revenue was $3,643.2, up 8.7%. Growth outside RFIG run-off was 19.4% for the quarter and 12.8% year to date, led by Title Insurance. Net premiums earned were $1,061.4 for the quarter and $2,986.4 for nine months.
- Profit: GAAP net loss was $14.8 ($0.06 per share) for Q3 and $48.4 ($0.19 per share) for nine months, compared with losses of $116.5 and $195.7, respectively, in 2011. Net operating loss, a company-defined non-GAAP measure, was $26.9 for Q3 and $76.7 for nine months. Excluding RFIG run-off, net income was $71.6 for Q3 and $192.9 year to date; RFIG losses remained substantial.
- Segments and underwriting: General Insurance pretax operating income declined to $60.3 in Q3 and $200.5 year to date, from $77.2 and $248.1. Its composite ratio increased to 99.5% and 98.3%, respectively, as claim costs rose. Title Insurance pretax operating income improved to $21.7 and $53.6; its composite ratio improved to 96.2% and 96.8%. RFIG reported pretax operating losses of $132.9 for Q3 and $384.5 year to date. Consolidated composite ratios were 110.6% for Q3 and 110.5% year to date, versus 122.9% and 117.4% in 2011; excluding RFIG, they were 98.2% and 97.9%.
- Investment income and gains: Net investment income fell 9.7% to $82.0 in Q3 and 8.2% to $252.9 for nine months, reflecting lower yields and a smaller RFIG invested-asset base. Realized investment gains were $18.6 in Q3 and $43.6 year to date, compared with a year-earlier impairment-driven loss of $15.5 and $12.0. No impairment charges were recorded in 2012.
- Cash flow: Operating cash flow was positive $322.3 for the first nine months, versus negative $127.6 in 2011. Investing activities provided $185.7; financing activities used $475.7, including $339.7 of debt redemptions and $136.0 of dividends. Cash ended the period at $125.5.
- Balance sheet and liquidity: Total assets were $16,187.5 and shareholders’ equity $3,690.1 at September 30. Cash and invested assets totaled $10,665.9. Debt declined to $573.0 from $912.8 at year-end 2011; debt-to-equity was 15.5%. The company reported $550.0 of 3.75% convertible notes due 2018. Book value was $14.40 per share, down from $14.76 at year-end 2011. The quarterly dividend was $0.1775 per share.
- Reserves: Loss and loss-adjustment reserves were $9,158.6 gross, including $6,342.2 net of reinsurance, up from $8,786.6 gross and $5,878.5 net at year-end 2011. Nine-month net reserve increases included $305.9 in RFIG and $117.5 in General Insurance.
Material changes versus 2011
- GAAP losses narrowed materially, aided by improved RFIG results and the absence of 2011 impairment charges; underlying RFIG losses nevertheless continued to weigh on consolidated results.
- Title Insurance revenue and earnings strengthened amid higher refinancing activity, market-share gains, and improved expense ratios.
- General Insurance premiums grew, but higher claim costs in commercial automobile, general liability, and workers’ compensation reduced earnings and worsened the composite ratio. New acquisition-cost accounting guidance resulted in pretax charges of approximately $9 in Q3 and $31 for nine months.
- Debt decreased following redemption of $316.2 of 8.0% convertible notes in May and $20.0 of junior subordinated debt in June. The remaining 3.75% notes mature in 2018.
Outlook, risks, and unusual items
- RFIG regulatory and capital risk: RMIC stopped writing new mortgage-guaranty business in August 2011 and has operated under North Carolina Department of Insurance supervision since January 2012. The regulator required 50% cash payment on claims, with the balance deferred; the accumulated deferred payment obligation was $279.4. An October 16, 2012 hearing considered a corrective plan proposing 60% cash claim payments and continued supervision; an amended order was expected, but not yet issued as of the filing.
- RFIG’s three mortgage insurers had approximately $195.9 of statutory capital, including deferred claim reserves, and $22.8 of consolidated GAAP capitalization at September 30. Management said RFIG’s GAAP capital could become negative by year-end 2012 or shortly thereafter, while losses would continue to be recognized in Old Republic’s consolidated accounts. Management’s run-off model projected ultimate profitability, but expected 2012–2013 operating losses to exceed RMIC’s year-end 2011 statutory capital.
- RMIC is a “Significant Subsidiary” under the 2018 notes. A court-ordered receivership arising from statutory insolvency could trigger an event of default and accelerate repayment. Supervision itself was not an event of default. Management said it had sufficient liquid resources to redeem a substantial portion of the notes and was exploring alternatives, but gave no assurance these plans would resolve such an event.
- Management cited continued low investment yields, higher General Insurance claim costs, housing and mortgage-market conditions, loan defaults, claim-rescission assumptions, and legal developments as risks. The company stated it could not reasonably estimate potential liabilities from several disputed insurance and class-action matters, but did not believe those actions were probable to have a material adverse effect; no assurance was given.
- No company-wide quantitative earnings guidance was provided. Management emphasized evaluating insurance performance over longer cycles. The filing says market-risk exposures had not materially changed; interest rates and equity prices are the principal market risks.
- Accounting estimates with significant judgment include loss reserves, deferred tax assets, acquisition costs, reinsurance recoverability, and investment impairments. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Progress and final terms of the NCDOI corrective order, RMIC claim-payment deferrals, and RFIG’s statutory and GAAP capital position.
- Whether the mortgage-guaranty run-off assumptions—including claim frequency, cures, rescissions, recoveries, and housing conditions—remain consistent with actual experience.
- Development of General Insurance reserves and claim costs, particularly workers’ compensation, commercial automobile, general liability, and asbestos/environmental exposures.
- Title Insurance revenue sustainability if refinancing activity or housing-market conditions weaken, and whether improved expense and claim trends persist.
- Debt covenant/default exposure, parent-company liquidity and subsidiary dividend capacity, and the effect of investment yields and market valuations on income and equity.
- Status and potential exposure of the disclosed Countrywide, Bank of America, Chase, PNC, RESPA, and other legal proceedings; the filing does not provide a clear estimate of possible losses.