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ORI > SEC Filings for ORI > Form 10-Q on 9-Nov-2011All Recent SEC Filings




Quarterly Report

Nine Months Ended September 30, 2011 and 2010
($ in Millions, Except Share Data)


This management analysis of financial position and results of operations pertains to the consolidated accounts of Old Republic International Corporation ("Old Republic" or "the Company"). The Company conducts its operations through three major regulatory segments, namely, its General (property and liability), Mortgage Guaranty, and Title insurance segments. A small life and health insurance business, accounting for 1.9% of consolidated operating revenues for the nine months ended September 30, 2011 and 1.5% of consolidated assets as of that date, is included within the corporate and other caption of this report.

The consolidated accounts are presented in conformity with the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") of accounting principles generally accepted in the United States of America ("GAAP"). As a publicly held company, Old Republic utilizes GAAP largely to comply with the financial reporting requirements of the Securities and Exchange Commission ("SEC"). From time to time the FASB and the SEC issue various releases, most of which require additional financial statement disclosures and provide related application guidance. Of particular relevance to the Company's financial statements are recent disclosure requirements pertaining to uncertainties affecting income tax provisions, methodologies for establishing the fair value and recording of other-than-temporary impairments of securities, possible consolidation of variable interest entities, and composition of plan assets held by the Company's defined benefit plans. More recently, the FASB also issued new guidance relative to the calculation of deferred acquisition costs incurred by insurance entities and goodwill impairment. The requisite disclosures and explanations for these matters are covered in the pertinent sections of this Management Analysis and/or footnotes to the Company's consolidated financial statements regularly included in its quarterly and annual reports to the SEC on Forms 10-Q and/or 10-K, respectively.

As a state regulated financial institution vested with the public interest, however, business of the Company's insurance subsidiaries is managed pursuant to the laws, regulations, and accounting practices of the various states in the U.S. and the laws of a small number of other jurisdictions outside the U.S. in which they operate. In comparison with GAAP, the statutory accounting practices reflect greater conservatism and comparability among insurers, and are intended to address the primary financial security interests of policyholders and their beneficiaries. Additionally, these practices also affect a significant number of important factors such as product pricing, risk bearing capacity and capital adequacy, the determination of Federal income taxes payable currently, and the upstreaming of dividends by insurance subsidiaries to the parent holding company. The major differences between these statutory financial accounting practices and GAAP are summarized in Note 1(a) to the consolidated financial statements included in Old Republic's 2010 Annual Report on Form 10-K.

The insurance business is distinguished from most others in that the prices (premiums) charged for various insurance products are set without certainty of the ultimate benefit and claim costs that will emerge or be incurred, often many years after issuance and expiration of a policy. This basic fact casts Old Republic as a risk-taking enterprise. Management therefore conducts the business with a primary focus on achieving favorable underwriting results over cycles, and on the maintenance of financial soundness in support of the insurance subsidiaries' long-term obligations to insurance beneficiaries. To achieve these objectives, adherence to insurance risk management principles is stressed, and asset diversification and quality are emphasized.

In addition to income arising from Old Republic's basic underwriting and related services functions, significant investment income is earned from invested funds generated by those functions and from shareholders' capital. Investment management aims for stability of income from interest and dividends, protection of capital, and sufficient liquidity to meet insurance underwriting and other obligations as they become payable in the future. Securities trading and the realization of capital gains are not objectives. The investment philosophy is therefore best characterized as emphasizing value, credit quality, and relatively long-term holding periods. The Company's ability to hold both fixed maturity and equity securities for long periods of time is in turn enabled by the scheduling of maturities in contemplation of an appropriate matching of assets and liabilities.

In light of the above factors, the Company's affairs are necessarily managed for the long run and without significant regard to the arbitrary strictures of quarterly or even annual reporting periods that American industry must observe. In Old Republic's view, such short reporting time frames do not comport well with the long-term nature of much of its business. Management believes that the Company's operating results and financial condition can best be evaluated by observing underwriting and overall operating performance trends over succeeding five to ten year intervals. Such extended periods can encompass one or two economic and/or underwriting cycles, and thereby provide appropriate time frames for such cycles to run their course and for reserved claim costs to be quantified with greater finality and effect.

This management analysis should be read in conjunction with the consolidated financial statements and the footnotes appended to them.


Old Republic's 2011 consolidated operations remained unprofitable in the latest quarterly and year-to-date periods, whereas much lower consolidated operating losses were sustained in the same periods of 2010. From a business segment standpoint, year-to-date comparisons among these periods reflect more positive general and title insurance operating results in 2011. Mortgage guaranty performance, however, has continued to deteriorate as incurred claim costs have exacted a greater toll on Old Republic's overall bottom line.

Financial data for the third quarter and first nine months of 2011 includes the accounts of PMA Capital Corporation ("PMA") whose merger with Old Republic occurred on October 1, 2010. The addition of PMA-related accounts in this year's third quarter and first nine months had a positive effect on consolidated operating revenues of $144.2 and $423.7, and on net operating results of $3.8 and $15.0, for the respective periods.

Consolidated Results - The major components of Old Republic's consolidated results and other data for the periods reported upon are shown below.

                                Quarters Ended September 30,           Nine Months Ended September 30,
                                 2011          2010      Change        2011            2010        Change
Operating revenues:
General insurance            $      647.0    $  501.1     29.1 %   $    1,885.2    $    1,448.7     30.1 %
Mortgage guaranty                   125.9       142.4    -11.6            385.4           455.1    -15.3
Title insurance                     337.7       318.7      5.9          1,012.3           874.3     15.8
Corporate and other                  18.4        20.2     -9.2             67.0            69.4     -3.4
Total                        $    1,129.0    $  982.6     14.9 %   $    3,350.1    $    2,847.6     17.6 %
Pretax operating income
General insurance            $       64.7    $   25.8    149.9 %   $      204.2    $      124.5     64.1 %
Mortgage guaranty                 (237.8)      (94.0)   -152.9          (514.9)         (150.3)   -242.4
Title insurance                       9.6         5.7     67.6             17.8             1.1      N/M
Corporate and other                 (3.6)       (2.2)    -64.3           (11.1)           (3.6)   -207.6
Sub-total                         (167.1)      (64.6)   -158.6          (303.9)          (28.3)      N/M
Realized investment gains
From sales                           26.5         5.1                      38.1            80.9
From impairments                   (42.1)       (1.2)                    (50.2)           (1.2)
  Net realized investment          (15.5)         3.8      N/M           (12.0)            79.7   -115.1
gains (losses)
Consolidated pretax income        (182.7)      (60.7)   -200.7          (316.0)            51.3      N/M
Income taxes (credits)             (66.1)      (21.7)   -203.8          (120.2)             7.8      N/M
Net income (loss)            $    (116.5)    $ (38.9)   -198.9 %    $   (195.7)    $       43.5      N/M %

Consolidated underwriting ratio:

Benefits and claim ratio          72.8 %    68.3 %          69.0 %    62.9 %
Expense ratio                     50.1      48.3            48.4      48.2
Composite ratio                  122.9 %   116.6 %         117.4 %   111.1 %

Diluted earnings per share:
Net operating income (loss)            $ (0.43)   $ (0.17)           $ (0.75)   $ (0.04)
Net realized investment gains (losses)   (0.03)       0.01             (0.02)       0.22
Net income (loss)                      $ (0.46)   $ (0.16)           $ (0.77)   $   0.18

Cash dividends paid per share          $ 0.1750   $ 0.1725   1.4 %   $ 0.5250   $ 0.5175   1.4 %

Components of diluted
earnings per share:
Net operating income (loss):
General insurance                      $   0.18   $   0.07         $   0.56   $   0.37
Mortgage guaranty                        (0.62)     (0.26)           (1.32)     (0.40)
Title insurance                            0.02       0.02             0.05     -
Corporate and other                      (0.01)     -                (0.04)     (0.01)
Subtotal                                 (0.43)     (0.17)           (0.75)     (0.04)
Net realized investment gains (losses)   (0.03)       0.01           (0.02)       0.22
Net income (loss)                      $ (0.46)   $ (0.16)         $ (0.77)   $   0.18

N/M: Not meaningful

The recognition of realized investment gains or losses can be highly discretionary and arbitrary due to such factors as the timing of individual securities sales, recognition of estimated losses from write-downs of impaired securities, tax-planning considerations, and changes in investment management judgments relative to the direction of securities markets or the future prospects of individual investees or industry sectors. Likewise, non-recurring items which may

emerge from time to time can distort the comparability of the Company's results from period to period. Accordingly, management uses net operating income, a non-GAAP financial measure, to evaluate and better explain operating performance, and believes its use enhances an understanding of Old Republic's basic business results. Operating income, however, does not replace net income determined in accordance with GAAP as a measure of total profitability.

The preceding tables therefore show both operating and net income or loss to highlight the effects of realized investment gain or loss recognition on period-to-period comparisons. The composition of such realized gains or losses follows:

                                           Quarters Ended       Nine Months Ended
                                           September 30,          September 30,
                                           2011      2010        2011        2010
Realized gains (losses) from sales of
previously impaired securities:
Actual tax basis (loss) on sales         $      -   $     -   $        -   $ (44.0)
Accounting adjustment for impairment
charges taken in prior periods                  -         -           .4       71.9
Net amount included herein                      -         -           .4       27.9
Net realized gains from sales of all
other securities                             26.5       5.1         37.7       53.0
Net gain (loss) from actual sales            26.5       5.1         38.1       80.9
Net realized losses from impairments       (42.1)     (1.2)       (50.2)      (1.2)
Net realized investment gains (losses)
reported herein                          $ (15.5)   $   3.8   $   (12.0)   $   79.7

General Insurance Results - Operating earnings for 2011's third quarter and first nine months were affected positively by moderately lower claim costs and the above-noted inclusion of PMA's accounts. Key indicators of year-over-year performance follow:

                                                          General Insurance Group
                                  Quarters Ended September 30,           Nine Months Ended September 30,
                                  2011          2010       Change        2011             2010        Change
Net premiums earned             $   550.0     $   435.0     26.4 %    $    1,601.4     $    1,247.9    28.3 %
Net investment income                67.5          63.6      6.2             202.2            192.9     4.8
Benefits and claims costs           401.8         353.0     13.8           1,159.9            962.3    20.5
Pretax operating income (loss)  $    64.7     $    25.8    149.9 %    $      204.2     $      124.5    64.1 %

Claim ratio 73.1 % 81.2 % 72.4 % 77.1 % Expense ratio 25.9 26.1 25.9 26.9 Composite ratio 99.0 % 107.3 % 98.3 % 104.0 %

Third quarter, 2011 inclusion of the PMA-related accounts resulted in approximate increases of $112.5 in net premiums earned, $4.7 in net investment income, $82.7 in benefits and claims costs, and $5.8 in pretax operating income. For the first nine months of this year these amounts were $335.1, $13.6, $240.5, and $22.7, respectively. Excluding PMA's contribution, the remainder of general insurance net premiums earned posted basically flat quarterly and year-to-date comparisons. As reported for the past several years, the combination of ongoing recessionary conditions and a soft pricing environment in the commercial insurance arena has constrained premium growth. Lessened economic activity affects such factors as insureds' sales and employment levels, both of which are important elements upon which Old Republic's insurance premiums are based.

Overall general insurance underwriting performance was relatively stable in the first nine months of this year. The consumer credit indemnity ("CCI") coverage which is in temporary run-off and thus reflects only renewal premiums from 2008 and prior years' production, continued to produce adverse but moderately lower underwriting losses. CCI claims experience consequently burdened the overall general insurance claim ratio by 1.8 and 13.8 percentage points in the third quarter of 2011 and 2010, and by 2.5 and 9.6 for the first nine months of these years, respectively.

While PMA's merger produced a meaningful addition to general insurance consolidated invested assets, net investment income did not grow commensurably. The lower yields available for newly investable funds and the relatively short maturity configuration of the investment portfolio are impeding revenue growth from this source.

Mortgage Guaranty Results - Operating performance in this year's third quarter and first nine months was affected negatively by higher claim costs and much lower investment income emanating from a smaller invested asset base. Key indicators of this segment's interim results follow:

                                                          Mortgage Guaranty Group
                                  Quarters Ended September 30,           Nine Months Ended September 30,
                                   2011          2010      Change        2011            2010        Change
Net premiums earned             $     110.4    $  120.3     -8.2 %    $     336.1     $     385.7    -12.9 %
Net investment income                  15.0        20.7    -27.8             47.7            65.8    -27.6
Claims costs                          298.2       215.5     38.4            794.7           542.5     46.5
Pretax operating income (loss)  $   (237.8)    $ (94.0)   -152.9 %    $   (514.9)     $   (150.3)   -242.4 %

Claim ratio 270.0 % 179.1 % 236.4 % 140.6 % Expense ratio 47.3 14.8 26.0 14.0 Composite ratio 317.3 % 193.9 % 262.4 % 154.6 %

In the first nine months of 2010, Old Republic's mortgage guaranty subsidiaries had negotiated the terminations of various captive reinsurance and pool insurance contracts. From a financial accounting standpoint, premiums obtained upon terminations of captive reinsurance agreements are recognized as income when they are received rather than being deferred to future periods when the related claim costs are expected to arise. On the other hand terminations of pool insurance contracts cause a reduction of incurred claims due to the positive effect of reserves transferred, but negative cash flows ensue. As a result of these transactions, net premiums earned for the first nine months of 2010 were enhanced by $13.4, net losses incurred were reduced by $51.8, and net operating cash outflows of $173.6 were sustained. No similarly significant transactions have occurred during 2011.

Since the advent of the current economic crisis, new mortgage guaranty production has not added significantly to the Company's net risk in force base. Ongoing weakness from the downturn in overall mortgage originations, lower industry-wide penetration of the nation's current mortgage market, and the effects of more selective underwriting guidelines employed since late 2007 have been contributing factors. Together with premium refunds related to claim rescissions and the above-noted termination of pool insurance contracts which effectively ended subsequent periods' premium inflows, these factors led to a continued decline in earned premiums in the latest quarterly and year-to-date periods.

Net investment income dropped as a result of the lower invested asset base brought about by the aggregate effect of higher claim disbursements, lower premium volume, termination of insured mortgage pools, and a low yield environment for quality securities to which the investment portfolio is directed.

The above-noted impact of captive and pool transactions on 2010 premiums and claims notwithstanding, recurring mortgage guaranty claim costs rose by 38.4% and 33.7% in this year's third quarter and first nine months, respectively. While newly reported defaults have continued in a downtrend, other offsetting factors have led to these higher costs. The combination of higher claim payments, reduced levels of actual and estimated claim rescissions or denials on new and previously reported defaults, and moderately higher claim severity is most accountable for the upward pressure on 2011 incurred claim costs. The following table shows the major components of the resulting claim ratios inclusive of the above-noted effects of captive reinsurance and pool insurance contract terminations for the periods shown.

                                                     Mortgage Guaranty Group
                                              Quarters Ended       Nine Months Ended
                                              September 30,          September 30,
                                             2011       2010        2011        2010
Components of incurred claim ratio as a
percent of earned premiums:
Paid claims:
Excluding captive and pool transactions     252.4 %    247.6 %     253.5 %     164.9 %
Captive and pool transactions                   -     -102.4        -0.9        42.3
Paid claim ratio                            252.4      145.2       252.6       207.2
Claim reserve provisions:
Excluding captive and pool transactions      17.6      -64.5       -16.5        -5.3
Captive and pool transactions                   -       98.4         0.3       -61.3
Claim reserve provision ratio                17.6       33.9       -16.2       -66.6
Incurred claim ratio: As reported           270.0 %    179.1 %     236.4 %     140.6 %
                      Excluding captive

and pool transactions 270.0 % 183.1 % 237.0 % 159.6 %

Recurring production and other expenses declined slightly during 2011. From an expense ratio standpoint, however, the beneficial effect of this decline was largely negated by ongoing reductions in the earned premium base, from a third quarter 2011 accrual of employment severance and similar costs ($5.3), and from elimination ($29.1) of previously deferred acquisition costs no longer deemed recoverable in future run-off periods. The segment's expenses also include a third quarter 2011 write-off of the historical goodwill balance of $10.7.

As noted in prior periods' reports, the Company's flagship mortgage guaranty insurance carrier had been operating pursuant to a waiver of minimum state regulatory capital requirements since late 2009. This waiver expired on August

31, 2011. As a consequence, underwriting of new policies ceased and the existing book of business was voluntarily placed in run-off operating mode. In these circumstances the run-off will devolve within constraints of Old Republic's investment in the segment ($296.6), thereby limiting ORI's possible future economic loss to this amount. Should this capital investment become fully depleted, the loss would represent 7.7% of Old Republic's consolidated shareholders' equity or $1.16 per share outstanding at September 30, 2011.

The Company's standard model of projected results extending through 2020 continues to reflect ultimate profitability for the aggregate run-off book of business. While the establishment of a premium deficiency reserve is therefore unwarranted, the model nonetheless contemplates that this year's fourth quarter and years 2012-2013 will more likely than not reflect an operating loss. In this eventuality, capital committed to the flagship carrier (approximately $155.7, or $0.61 per ORI share outstanding at September 30, 2011), will continue on a path toward full depletion in relatively short order. In anticipation of this most likely turn of events, the Company is considering alternative run-off approaches to the achievement of its loss limiting objective. Implementation of any run-off plan will require approval by the North Carolina Department of Insurance as regulator of the flagship carrier.

The construction of any model of future quarterly and annual performance is predicated on a number of assumptions and is highly sensitive to a wide range of estimates. Many of the assumptions and estimates consider the conflicted interests of insured lending institutions, as well as general economic and industry-specific trends and occurrences over which the Company has no control. Importantly, the model cannot address with certainty the evolving or future social and economic policies of the U. S. Government vis-a-vis such critical sectors as the banking, mortgage lending, and housing industries, as well as its policies pertaining to financial intermediaries such as Fannie Mae and Freddie Mac.

Recent years' poor mortgage guaranty results notwithstanding, Old Republic maintains a long-term strategic interest in this line of insurance. With necessary enterprise risk management revisions to the existing business model, it anticipates re-activating this segment by directing new premium production to a separately held and capitalized subsidiary. Achievement of this objective will depend largely on the requisite approvals of the Company's state insurance regulator and its two major policyholders, Fannie Mae and Freddie Mac. At this juncture, however, there is no assurance whether or when this planned re-activation of the business will occur.

Title Insurance Results - Old Republic's title insurance business continued to portray the positive operating momentum that first emerged in the second quarter of 2009. Key performance indicators are shown below:

                                                           Title Insurance Group
                                   Quarters Ended September 30,           Nine Months Ended September 30,
                                  2011           2010       Change        2011            2010        Change
Net premiums and fees earned    $    330.4     $    311.8     6.0 %    $     990.3     $     853.6     16.0 %
Net investment income                  6.7            6.5     3.3             20.3            19.8      2.7
Claims costs                          25.6           26.0    -1.5             76.7            66.8     14.8
Pretax operating income (loss)  $      9.6     $      5.7    67.6 %    $      17.8     $       1.1      N/M %

Claim ratio 7.8 % 8.3 % 7.8 % 7.8 % Expense ratio 91.0 91.9 92.1 94.4 Composite ratio 98.8 % 100.2 % 99.9 % 102.2 %

Continued growth in premiums and fees benefitted mostly from market share gains emanating from title industry dislocations and consolidation during the past three years or so. The claim ratio for this year's first nine months was essentially unchanged from the prior year's level. While production and other expenses rose by 5.4% and 13.8% quarter-over-quarter and for the year-to-date period, respectively, the increase was lower than the 6.0% and 16.0% growth in premiums and fees revenues for these periods.

Corporate and Other Operations - The Company's small life and health business and the net costs associated with the parent holding company and its internal services subsidiaries produced losses for 2011 and 2010 interim periods. Variations in the results posted by these relatively minor elements of Old Republic's operations usually stem from volatility inherent to the small scale of its life and health business, fluctuations in the costs of external debt, and net interest expenses on intra-system financing arrangements.

                                                 Corporate and Other Operations
                             Quarters Ended September 30,          Nine Months Ended September 30,
                             2011          2010       Change        2011           2010        Change
Life & health premiums
earned                     $    16.2     $    18.1    -10.2 %    $      59.9     $     61.9     -3.2 %
Net investment income            1.4           1.7    -14.9              5.1            5.3     -2.7
Other income                      .6            .3     72.9              1.8            2.0    -10.3
Benefits and claims costs        7.6          10.2    -25.2             29.9           31.6     -5.3
Insurance expenses               8.7          10.1    -13.7             32.3           33.2     -2.8
Corporate and other
expenses-net                     5.6           2.0    171.7             15.8            8.1     96.1
Pretax operating income
(loss)                     $   (3.6)     $   (2.2)    -64.3 %    $    (11.1)     $    (3.6)   -207.6 %

Cash, Invested Assets, and Shareholders' Equity - The following table reflects Old Republic's consolidated cash and invested assets as well as shareholders' equity accounts at the dates shown:

. . .
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