EX-99.1 14 d355749dex991.htm EX-99.1 EX-99.1
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Exhibit 99.1

LOGO

A.C. Zucaro

Chairman &

Chief Executive Officer

To Old Republic’s Shareholders

Spin-Off of the Republic Financial Indemnity

Group’s Common Stock Through a

Distribution on the Old Republic Common Stock

In mid-March 2012 we announced the combination of our Consumer Credit Indemnity (“CCI”) Underwriting Division with our Mortgage Insurance (“MI”) Group. Concurrently we called attention to the necessity of recapitalizing the combined business which was re-named the Republic Financial Indemnity Group, Inc. (“RFIG”).

Recessionary conditions in U.S. housing finance which began in 2007 have led to substantial losses in the MI and CCI lines. As a result, capital funds identified with these lines at year-end 2006 have been fully depleted. Both of the lines are in a run-off operating mode, and cannot write new business due to the depleted capital accounts. While we still maintain a long-term strategic interest in these lines, we have stopped capital funding for them since they no longer meet our consolidated enterprise risk and capital management disciplines and objectives.

In consideration of all these factors, our management and board of directors concluded that the necessary future recapitalization and re-direction of the combined business could best be effected by separating these operations from the Old Republic International holding company. Combining the two lines, while maintaining their separateness within RFIG, provides the corporate structure to achieve these objectives. In late May of this year, we announced that RFIG would be established as an independent publicly held company. We will accomplish this through a spin-off of substantially all of our RFIG shares to Old Republic’s stockholders. The accompanying Information Statement describes the RFIG business and the interests of Old Republic's shareholders in the spin-off of RFIG’s stock.

If you own Old Republic common stock as of the close of business on June     , 2012, you will receive one share of RFIG common stock for each eight shares of Old Republic common stock that you own. The RFIG shares should be delivered to your account shortly after June     , 2012. As indicated in the accompanying Information Statement the value of the RFIG shares you receive will be treated as a taxable dividend. This value will be determined shortly after the spin-off occurs.

No Old Republic stockholder action is required, and you do not need to surrender your Old Republic shares to receive the RFIG common stock to which you are entitled. You will continue to hold the same number of Old Republic common shares after the spin-off. If a market develops for the RFIG common stock, it will trade in the over-the-counter markets under a trading symbol as yet unassigned.

The attached Information Statement contains detailed information about RFIG and the Spin-Off which we encourage you to read carefully.

Respectfully submitted on behalf

of the Old Republic Board of Directors,

A. C. Zucaro

Chairman & Chief Executive Officer

                    , 2012


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Information contained herein is subject to completion or amendment. A registration statement on Form 10 relating to these securities has been filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended.

 

Subject to Completion, dated May 23, 2012

INFORMATION STATEMENT

Republic Financial Indemnity Group, Inc.

Common Stock

(par value $0.01 per share)

Old Republic International Corporation (“Old Republic”) is furnishing this information statement to its shareholders in connection with the distribution by Old Republic of [        %] of the outstanding shares of common stock of Republic Financial Indemnity Group, Inc. (“RFIG”) that are owned by Old Republic to holders of Old Republic’s common stock. As of the date of this information statement, Old Republic owns [        %] of all of RFIG’s outstanding common stock.

On [                ], 2012, Old Republic’s board of directors granted final approval of the distribution of [        ]% of the shares of RFIG common stock owned by Old Republic to holders of Old Republic common stock. Holders of Old Republic common stock will be entitled to receive [                ] shares of RFIG common stock for every eight shares of Old Republic common stock held as of 5:00 p.m. New York time on the record date, [                ], 2012. No fractional shares will be issued. In the event a holder of Old Republic common stock would otherwise be entitled to a fractional share of RFIG common stock, the number of shares of RFIG common stock such holder will receive in the spin-off will be rounded up to the nearest whole number of shares of RFIG common stock. The distribution date for the spin-off will be [                ], 2012. Following the spin-off, Old Republic will retain approximately 371,000 shares of RFIG common stock, representing approximately 0.90% of RFIG’s issued and outstanding common stock. Old Republic also owns and will retain warrants to purchase 18,000,000 shares of RFIG common stock at $0.12 per share. If all such warrants were exercised in the future at the rate of one RFIG common share per warrant, Old Republic would own approximately 18,371,000 (31%) RFIG common shares out of approximately 59,288,000 resulting shares then outstanding inclusive of the 8,500,000 shares issued in May 2012.

You will not be required to pay any cash or other consideration for the shares of RFIG common stock that will be distributed to you or to surrender or exchange your shares of Old Republic common stock to receive shares of RFIG common stock in the spin-off. The distribution will not affect the number of shares of Old Republic common stock that you hold. No approval by Old Republic shareholders of the spin-off is required or being sought. You are not being asked for a proxy and you are requested not to send a proxy.

As discussed under “The Spin-Off—Trading of Old Republic Common Stock After the Record Date and Prior to the Distribution,” if you sell your shares of Old Republic common stock in the “regular way” market after the record date and prior to the spin-off, you also will be selling your right to receive RFIG common stock in connection with the spin-off. You are encouraged to consult with your financial advisor regarding the specific implications of selling your Old Republic common stock on or prior to the distribution date.

Currently, there is no public trading market for RFIG common stock. Following the spin-off, we will seek to have market prices for shares of RFIG common stock quoted in the over-the-counter markets (the OTC Bulletin Board and/or the OTC Markets Group, Inc. quotation services). There is no assurance that we will succeed in that attempt or that, if the shares are quoted in the over-the-counter markets, a market will ever develop for such securities.

In reviewing this information statement, you should carefully consider the matters described under the caption “Risk Factors” beginning on page 13.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities or determined if this information statement is truthful or complete. Any representation to the contrary is a criminal offense.

This information statement does not constitute an offer to sell or the solicitation of an offer to buy any securities.

Old Republic first mailed this information statement to its shareholders on or about [                ], 2012.

The date of this information statement is                 , 2012.


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TABLE OF CONTENTS

 

QUESTIONS AND ANSWERS ABOUT THE SPIN-OFF

     1   

SUMMARY

     6   

RFIG’S CORPORATE STRUCTURE

     12   

RISK FACTORS

     13   

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

     29   

THE SPIN-OFF

     29   

CAPITALIZATION

     36   

DIVIDEND POLICY

     37   

SELECTED HISTORICAL FINANCIAL DATA

     38   

UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

     42   

BUSINESS

     46   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS QUARTERS ENDED MARCH 31, 2012 and 2011

     66   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2011 and 2010

     86   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     108   

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     109   

RELATIONSHIP WITH OLD REPUBLIC AFTER THE SPIN-OFF

     110   

MANAGEMENT

     111   

EXECUTIVE COMPENSATION

     115   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     120   

DESCRIPTION OF CAPITAL STOCK

     122   

RIGHTS AGREEMENT

     123   

RECENT SALES OF UNREGISTERED SECURITIES

     124   

INDEMNIFICATION OF DIRECTORS AND OFFICERS

     126   

WHERE YOU CAN FIND MORE INFORMATION

     127   

INDEX TO FINANCIAL STATEMENTS

     F-1   

Unless we otherwise state or the context otherwise indicates, all references in this information statement to “us,” “we,” “our,” “ours,” “the Company,” or “RFIG” mean Republic Financial Indemnity Group, Inc. and its subsidiaries, and all references to “Old Republic” or “ORI” mean Old Republic International Corporation and its subsidiaries, other than, for all periods following the spin-off, RFIG.

The transaction in which RFIG will be separated from Old Republic International Corporation and become an independent, publicly traded company is referred to herein alternatively as the “distribution” or the “spin-off.”

This information statement is being furnished solely to provide information to Old Republic shareholders who will receive shares of RFIG common stock in connection with the spin-off. It is not provided as an inducement or encouragement to buy or sell any securities. You should not assume that the information contained in this information statement is accurate as of any date other than the date set forth on the cover. Changes to the information contained in this information statement may occur after that date, and we undertake no obligation to update the information contained in this information statement, unless we are required by applicable securities laws to do so.

 

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QUESTIONS AND ANSWERS ABOUT THE SPIN-OFF

 

 

Q: What is the spin-off?

 

A: The spin-off involves Old Republic’s distribution to its shareholders of approximately 99% of the shares of our common stock that it owns. Following the spin-off, we will be independent from ORI, and our shares will be registered under the 1934 Act and may be publicly traded if a trading market develops in the over-the-counter markets. You do not have to pay any consideration or give up any portion of your Old Republic common stock to receive shares of our common stock in the spin-off.

 

Q: Why is Old Republic separating RFIG from Old Republic’s business?

 

A: Recessionary conditions in U.S. housing finance which began in 2007 have led to substantial losses in Old Republic’s mortgage insurance and consumer credit indemnity lines. As a result, capital funds identified with these lines at year-end 2006 have been fully depleted. Both of the lines are in a run-off operating mode, and cannot write new business due to the depleted capital accounts. While Old Republic still maintains a long-term strategic interest in these lines, it has stopped capital funding for them since they no longer meet Old Republic’s enterprise risk and capital management disciplines and objectives. In consideration of all these factors, Old Republic’s management and board of directors concluded that the necessary future recapitalization and re-direction of the combined business could best be effected by separating these operations from the Old Republic International Corporation holding company. Combining the two lines, while maintaining their separateness within RFIG, provides the corporate structure to achieve these objectives. In late May of this year, Old Republic announced that RFIG would be established as an independent publicly held company. The spin-off of the RFIG shares to Old Republic’s shareholders will accomplish this objective.

 

Q: What is being distributed in the spin-off?

 

A: Old Republic will distribute as a dividend on a pro rata basis to its shareholders one share of RFIG common stock for each eight shares of Old Republic common stock outstanding as of the record date for the spin-off.

 

Q: What is the record date for the spin-off, and when will the spin-off occur?

 

A: The record date is [            ], 2012 and ownership is determined as of 5:00 p.m. New York time on that date. Shares of RFIG common stock will be distributed on [            ], 2012, which we refer to as the distribution date.

 

Q: As a holder of shares of Old Republic common stock as of the record date, what do I have to do to participate in the spin-off?

 

A: Nothing. However, you are urged to read this entire information statement carefully. No shareholder approval of the distribution is required. You are not being asked for a proxy. You do not need to pay any consideration, exchange or surrender your existing common shares of Old Republic or take any other action to receive your shares of RFIG common stock.

You will receive one share of RFIG common stock for each eight shares of Old Republic common stock held as of the record date and retained through the distribution date. You may also participate in the spin-off if you purchase Old Republic common stock in the “regular way” market after the record date and retain your Old Republic shares through the distribution date. See “The Spin-Off—Trading of Old Republic Common Stock After the Record Date and Prior to the Distribution.”

 

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Q: If I sell my shares of Old Republic common stock before or on the distribution date, will I still be entitled to receive RFIG shares in the spin-off?

 

A: If you sell your shares of Old Republic common stock prior to or on the distribution date, you may also be selling your right to receive shares of RFIG common stock. See “The Spin-Off—Trading of Old Republic Common Stock After the Record Date and Prior to the Distribution.” You are encouraged to consult with your financial advisor regarding the specific implications of selling your Old Republic common stock prior to or on the distribution date.

 

Q: How will fractional shares be treated in the spin-off?

 

A: No fractional shares will be issued. In the event a holder of Old Republic common stock would have otherwise been entitled to a fractional share of RFIG common stock, the number of shares of RFIG common stock such holder will receive in the spin-off will be rounded up to the nearest whole number of shares of RFIG common stock.

 

Q: Will the spin-off affect the number of shares of Old Republic I currently hold?

 

A: The number of shares of Old Republic common stock held by a shareholder will be unchanged.

 

Q: Why is the separation of the two companies structured as a spin-off?

 

A: We do not believe that a sale of RFIG to a third party is feasible in the near future. Therefore, we believe that a spin-off of shares in RFIG to Old Republic’s shareholders is the most viable way to separate the companies in the near term.

 

Q: What are the U.S. federal income tax consequences of the distribution of RFIG common stock?

 

A: We intend to take the position that the spin-off will be a taxable transaction for U.S. federal income tax purposes. Assuming this to be the case, an amount equal to the fair market value on the distribution date of the shares of our common stock received by you (after giving effect to rounding up to the nearest whole number of shares, if applicable) generally will be taxable as a dividend to the extent of your ratable share of Old Republic’s current or accumulated earnings and profits, if any, as determined for U.S. federal income tax purposes, with the excess treated first as a tax-free return of capital that reduces (but not below zero) your adjusted tax basis in your Old Republic common stock and then as capital gain from the sale or exchange of Old Republic common stock. For a more detailed discussion of the material U.S. federal income tax consequences of the spin-off, please see “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” below. Tax matters are complicated and the tax consequences of the spin-off to any particular Old Republic stockholder will depend on that stockholder’s particular situation. You should consult your own tax advisor to determine the tax consequences of the spin-off to you.

 

Q: When will I receive my RFIG shares? Will I receive a stock certificate for RFIG shares distributed as a result of the spin-off?

 

A: Registered holders of Old Republic common stock who are entitled to participate in the spin-off will receive a book-entry account statement reflecting their ownership of RFIG common stock. For additional information, registered shareholders in the United States or Canada should contact Old Republic’s transfer agent, Wells Fargo Shareowner Services, at (800) 468-9716 or through its website at www.wellsfargo.com/shareownerservices. See “Description of Capital Stock—Transfer Agent and Registar.”

 

Q: What if I hold my shares through a broker, bank or other nominee?

 

A: Old Republic shareholders who hold their shares through a broker, bank or other nominee will have their brokerage account credited with RFIG common stock. For additional information, those shareholders should contact their broker or bank directly.

 

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Q: What if I have stock certificates reflecting my shares of Old Republic common stock? Should I send them to the transfer agent or to Old Republic?

 

A: No, you should not send your stock certificates to the transfer agent or to Old Republic. You should retain your Old Republic stock certificates.

 

Q: If I was enrolled in an Old Republic dividend reinvestment plan, will I automatically be enrolled in an RFIG dividend reinvestment plan?

 

A: No. It is not contemplated at this time that RFIG will have a dividend reinvestment plan. As a result, any dividends declared and paid following the spin-off date will be made in cash to holders of these shares.

 

Q: What are the conditions of the spin-off?

 

A: The spin-off is subject to a number of conditions, including, among others, that the SEC has declared effective our registration statement on Form 10, of which this information statement is a part, under the Exchange Act.

We cannot assure you that any or all of these conditions will be met. To the extent waivable, Old Republic may waive one or more of these conditions in its sole and absolute discretion, and the determination by Old Republic regarding the satisfaction of these conditions will be conclusive. The fulfillment of these conditions will not create any obligation on Old Republic’s part to effect the distribution, and Old Republic has reserved the right to amend, modify or abandon any and all terms of the distribution and the related transactions at any time prior to the distribution date. See “The Spin-Off—Spin-Off Conditions and Termination.”

 

Q: Can Old Republic decide to cancel the distribution of RFIG common stock even if all the conditions have been met?

 

A: Yes. Until the distribution occurs, Old Republic has the right in its sole discretion to terminate the distribution, even if all conditions are satisfied.

 

Q: Will RFIG incur any debt prior to or at the time of the spin-off?

 

A: It is not expected that RFIG will incur any material indebtedness prior to the spin-off; however, pursuant to the terms of its outstanding Series A Variable Rate Senior Indenture No. 5 due December 31, 2038, RFIG currently has $180 million in outstanding indebtedness, all of which is owed to Old Republic.

 

Q: Are there risks to owning RFIG common stock?

 

A: Yes. RFIG’s business is subject to risks relating to the industry in which it operates, its ongoing contractual relationships with Old Republic and its status as a separate, publicly held company. RFIG’s business is also subject to risks relating to the separation. You are encouraged to read the section entitled “Risk Factors” in this information statement carefully.

 

Q: Does RFIG intend to pay cash dividends?

 

A: We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any future earnings to finance our operations. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, capital requirements, any contractual, regulatory or other restrictions on the payment of dividends by our subsidiaries to RFIG, and other factors that our board of directors deems relevant. See “Dividend Policy.”

 

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Q: Will RFIG common stock trade on a stock market?

 

A: Currently, there is no public market for RFIG common stock. We do not anticipate that RFIG common stock, immediately following the spin-off, will be listed on a national securities exchange. We anticipate, however, that subject to completion of the spin-off and acceptance by FINRA and/or the OTC Markets Group, Inc., price quotations for RFIG common stock will be made available in the over-the-counter markets (the OTC Bulletin Board and/or the OTC Markets Group, Inc. quotation services). We cannot predict with certainty the date on which a trading symbol for RFIG common stock will be received, or the date on which trading prices for RFIG common stock will begin to be quoted by any quotation service. We expect that those events will occur after the distribution date.

 

Q: Who will manage RFIG after the separation?

 

A: RFIG benefits from having in place a management team with an extensive background in the mortgage guaranty businesses. Led by Christopher S. Nard, who will be RFIG’s President and Chief Executive Officer after the separation, RFIG’s management team possesses deep knowledge of, and extensive experience in its industry. For more information regarding RFIG’s management, see “Management.”

 

Q: What will the relationship between Old Republic and RFIG be following the spin-off?

 

A: After the spin-off, Old Republic will own approximately 371,000 shares of RFIG common stock and warrants to acquire an additional 18,000,000 shares. Old Republic and RFIG will each be independent, publicly held companies with their own management teams and boards of directors. However, in connection with the spin-off, we are entering into or retaining a few agreements with Old Republic that will remain in effect for a while subsequent to the completion of the spin-off. See “Relationship with Old Republic After the Spin-Off.” We do not expect, however, that such agreements will be materially critical to RFIG’s operations. In any event, any subsequent renewal of the agreements would be approved by RFIG board members unaffiliated with Old Republic.

 

Q: Will I have appraisal rights in connection with the spin-off?

 

A: No. Holders of Old Republic common stock are not entitled to appraisal rights in connection with the spin-off.

 

Q: Who is the transfer agent for Old Republic and RFIG common stock?

 

A: Old Republic’s transfer agent is Wells Fargo Shareowner Services, whom we refer to as “Wells Fargo.” Upon consummation of the spin-off, we anticipate that Wells Fargo will also serve as the transfer agent for RFIG. Wells Fargo's address and telephone number is as follows:

Wells Fargo Shareowner Services

P.O. Box 64874

St. Paul, Minnesota 55164-0874

Telephone: (800) 468-9716

Website: www.wellsfargo.com/shareownerservices

 

Q: Who is the distribution agent for the spin-off?

 

A: Wells Fargo will also serve as the distribution agent for the spin-off.

 

Q: Whom can I contact for more information?

 

A: If you have questions relating to the mechanics of the distribution of Old Republic shares, you should contact the distribution agent at the address and telephone number provided above.

 

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Before the spin-off, if you have questions relating to the spin-off, you should contact Old Republic at:

Old Republic International Corporation

307 North Michigan Avenue

Chicago, Illinois 60601

Attention: Investor Relations

Telephone: (312) 346-8100

After the spin-off, questions should be addressed to:

Republic Financial Indemnity Group, Inc.

307 North Michigan Avenue

Chicago, Illinois 60601

Attention: Investor Relations

Telephone: (312) 346-8100.

 

 

 

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SUMMARY

 

The following is a summary of some of the information contained in this information statement. It does not contain all the details concerning us or the spin-off, including information that may be important to you. We urge you to read the entire document carefully, including the risk factors, our pro forma financial information and our historical consolidated financial statements and the notes to those financial statements.

Except as otherwise indicated or unless the context otherwise requires, the information included in this information statement assumes the completion of the separation of RFIG from Old Republic and the related distribution of our common stock.

Who We Are

Republic Financial Indemnity Group, Inc. (“RFIG”), is currently a majority-owned subsidiary of Old Republic. RFIG is a holding company which, through its wholly-owned operating subsidiaries, Republic Mortgage Insurance Company (“RMIC”), Republic Mortgage Insurance Company of North Carolina (“RMICNC”), and Republic Mortgage Insurance Company of Florida (“RMICFL”), is principally engaged as a nationwide private mortgage insurer.

In mid-March, 2012, Old Republic reorganized its operations to combine its Consumer Credit Indemnity (“CCI”) division with its mortgage guaranty operations. These two operations offer similar insurance coverages, share the same senior management leadership, and have been operating in run-off mode since 2008 and August, 2011, respectively. The term “run-off” means continuing to service existing insurance policies but not writing any new policies. Accordingly, the future results of RFIG will reflect the performance of the run-off of its mortgage guaranty business as well as its CCI business.

The spin-off will separate our mortgage guaranty and CCI business from the remainder of Old Republic’s operations and holdings. Recessionary conditions in U.S. housing finance which began in 2007 have erased the long-term profitability of Old Republic’s mortgage guaranty and CCI insurance lines and led to substantial losses. As a result, capital funds identified with these lines at year-end 2006 have been fully depleted. While Old Republic still maintains a long-term strategic interest in these lines, it has stopped capital funding for them since they no longer meet its enterprise risk and capital management disciplines and objectives. In consideration of all these factors, Old Republic’s management and board of directors have concluded that a necessary future recapitalization of the combined mortgage guaranty and CCI businesses can best be effected by separating these operations from Old Republic’s consolidated holdings.

RMIC, our flagship mortgage guaranty insurance carrier, had been operating pursuant to a waiver of minimum state regulatory capital requirement 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 placed in run-off operating mode. On January 19, 2012, the North Carolina Department of Insurance, or NCDOI, issued a Supervisory Order (“Order”), providing for its immediate administrative supervision of RMIC’ s run-off operations. The Order responds to the capital depletion at RMIC caused by an unprecedented level of losses experienced industry-wide.

In light of all the above factors our Mission as in independent company will be:

 

   

First and foremost to manage the MI and CCI run-off books of business in the most economical manner for the best interest of policyholders and their beneficiaries;

 

   

To operate as an administrative services company by offering our well-regarded policyholder and claim management services, and our information technology data base and processing facilities, to other unrelated parties that could gain economic benefits and efficiencies from such services; and

 

 

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To seek to recapitalize one or more of our MI and CCI insurance companies by accessing the capital markets for the new capital necessary for a re-entry into these insurance lines. Our re-entry will give important consideration to a redefined and legitimately robust business model that addresses currently, through reinsurance or similar means, the continued exposures of these lines to future economic catastrophe events such as those experienced since 2007.

Our Mortgage Guaranty Business — Historical Overview

Private mortgage insurance protects mortgage lenders and investors from default related losses on residential mortgage loans made primarily to homebuyers who make down payments of less than 20% of the home's purchase price. We insure only first mortgage loans, primarily on residential properties incorporating one-to-four family dwelling units. Our mortgage guaranty business was started in 1973.

There are two principal types of private mortgage insurance coverage: “primary” and “pool.” Primary mortgage insurance provides mortgage default protection on individual loans and covers a stated percentage of the unpaid loan principal, delinquent interest, and certain expenses associated with the default and subsequent foreclosure. In lieu of paying the stated coverage percentage, we may pay the entire claim amount, take title to the mortgaged property and subsequently sell the property to mitigate our loss. Our obligation to an insured lender with respect to a claim is determined by applying the policy’s coverage percentage to the claim amount. The traditional primary coverage percentage averaged 24.5% in 2011, although it ranges generally from 12% to 35%. Pool insurance, which is written on a group of loans in negotiated transactions, provides coverage that ranges up to 100% of the net loss on each individual loan included in the pool, subject to provisions regarding deductibles, caps on individual exposures, and aggregate stop loss provisions which limit aggregate losses to a specified percentage of the total original balances of all loans in the pool.

Traditional primary insurance is issued on an individual loan basis to mortgage bankers, brokers, commercial banks and savings institutions through a network of underwriting sites located throughout the country. Traditional primary loans are individually reviewed (except for loans insured under delegated approval programs) and priced according to filed premium rates. In underwriting traditional primary business, we generally adhere to the underwriting guidelines published by the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”), the Federal National Mortgage Association (“FNMA” or “Fannie Mae”), or other large mortgage purchasers on a negotiated basis. Delegated underwriting programs allow approved lenders to commit us to insure loans provided they adhere to a set of predetermined underwriting guidelines.

Bulk and other insurance is issued on groups of loans to mortgage banking customers through a centralized risk assessment and underwriting department. These groups of loans are priced in the aggregate, on a bid or negotiated basis. Coverage for insurance issued in this manner can be provided through primary insurance policies (loan level coverage) or pool insurance policies (aggregate coverage). We consider transactions designated as bulk insurance to be exposed to higher risk (as determined by characteristics such as origination channel, loan amount, credit quality, and loan documentation) than those designated as other insurance. The Company ceased writing business in the bulk channel in 2008.

Before insuring any loans, we issue to each approved customer a master policy outlining the terms and conditions under which coverage will be provided. Primary business is then executed via the issuance of a commitment/certificate for each loan submitted and approved for insurance. In the case of business providing pool coverage, a separate pool insurance policy is issued covering the particular loans applicable to each transaction.

As to all types of mortgage insurance products, the amount of premium charge depends on various underwriting criteria such as loan-to-value ratios, the level of coverage being provided, the borrower's credit history, the type of loan instrument (whether fixed rate/fixed payment or an adjustable rate/adjustable payment),

 

 

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documentation type, and whether or not the insured property is categorized as an investment or owner occupied property. Coverage is non-cancelable by the Company (except in the case of non-payment of premium or certain master policy violations) and premiums are paid under single, annual, or monthly payment plans. Single premiums are paid at the inception of coverage and provide coverage for the entire policy term. Annual and monthly premiums are renewable on their anniversary dates with the premium charge determined on the basis of the original or outstanding loan amount. The majority of our direct premiums are written under monthly premium plans. Premiums may be paid by borrowers as part of their monthly mortgage payment and passed through to us by the servicer of the loan or they may be paid directly by the originator of, or investor in the mortgage loan.

We have historically provided traditional primary and bulk mortgage guaranty insurance coverage on U.S. residential mortgage loans. Insurance in force is the total principal balance of our insured loans, and risk in force is the total amount of coverage for which we are at risk under our certificates of insurance. In run-off, we receive only the ongoing premiums of the remaining traditional primary and pool insurance in force, which we refer to as renewal premiums, net of any premium ceded to captive reinsurers and refunds resulting from policy cancellations or rescission of coverage. In most cases, renewal premium rates were determined at origination of coverage, based on perceived risk of the policy at that time, and cannot be subsequently changed.

Traditional primary insurance policies comprised 92.3%, 92.4% and 92.0% of our net risk in force at March 31, 2012, December 31, 2011, and December 31, 2010, respectively, while bulk insurance comprised substantially all of the remaining balance.

Run-off and Regulatory Supervision

RMIC, our flagship mortgage guaranty insurance carrier, had been operating pursuant to a waiver of minimum state regulatory capital requirement 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 placed in run-off operating mode. On January 19, 2012, the NCDOI, issued an Order, providing for its immediate administrative supervision of RMIC’s run-off operations. The Order responds to the capital depletion at RMIC caused by an unprecedented level of losses experienced industry-wide.

Supervision is an administrative proceeding under North Carolina law. It gives the NCDOI more oversight and control with the objective of allowing the insurer to develop a corrective plan subject to the NCDOI's approval. It is unlike receivership which involves rehabilitation or liquidation of a company pursuant to a formal, court-ordered proceeding. Receivership results in a company's assets and management passing to a receiver who is overseen by a court. Under the Order, RMIC continues to manage the business through the Company’s employees, and retains its status as a wholly-owned subsidiary of RFIG. The Order specifies that RMIC may not, without the prior written approval of the Commissioner, among other things, transfer any of its property, incur any debt, enter into any new reinsurance arrangement, make any material changes in management or increase salaries or benefits to management, and pay more than fifty percent of any claim allowed under any policy issued by RMIC. The remaining fifty percent of any claim is to be deferred and credited to a temporary statutory surplus account on the books of RMIC during an initial period not to exceed one year. Accordingly, all claim payments made on January 19, 2012 and thereafter are to be made at the rate of fifty percent.

In this run-off operating mode, RMIC collects renewal premiums, participates in industry modification activities, and services policies in force as of August 31, 2011. We have not written any new mortgage insurance business since August 31, 2011. Servicing in force policies during run-off includes, among things, billing and collecting premiums on policies that remain in force, cancelling coverage at the insured’s request, working to mitigate losses, reviewing policies for the existence of misrepresentation or fraud, and settling all legitimate filed claims per the provisions of the policies and the Order.

 

 

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The term “settled,” as used in this information statement in the context of the payment of a claim, refers to the satisfaction of RMIC’s obligations following the submission of valid claims by our policyholders. Prior to January 19, 2012, valid claims were settled solely by a cash payment. As required by the Order, effective on and after January 19, 2012, valid claims are settled by a combination of 50% in cash and 50% in the form of a deferred payment obligation, or DPO.

The DPO is a subordinated obligation of RMIC with no stated repayment terms. At March 31, 2012, the recorded DPO amounted to approximately $93 million or 7.7% of total invested assets and 4.9% of liabilities. The recording of a DPO does not impact reported settled losses as we continue to report the entire amount of a claim in our results of operations. The accounting treatment for the recording of DPOs on our balance sheet on a SAP basis is similar to a surplus note that is reported as a component of statutory surplus which serves to increase reported statutory surplus. However, in our financial statements prepared in accordance with GAAP included in this information statement, the DPOs are reported as liabilities. Any repayment of the DPO is dependent on the financial condition and future prospects of RMIC and is subject to the approval of the NCDOI.

Failure to comply with the provisions of the Order or any other violation of the North Carolina Insurance Code may result in the imposition of fines or penalties or subject RMIC to further legal proceedings, including the institution by the NCDOI of receivership proceedings for the conservation, rehabilitation or liquidation of RMIC. Any such actions could lead RFIG to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company.

In light of the regulatory supervision to which RMIC is subject as already discussed, absent substantial capital additions and future regulatory and other approvals, the ability of RFIG and its insurance subsidiaries to reemerge as an active underwriter of new business is currently unknown if not doubtful. The ultimate parent, Old Republic, has, based on its enterprise risk management objectives, communicated its unwillingness and inability to provide additional capital funds in an amount sufficient to restore and maintain minimum risk-to-capital ratios. Accordingly, recapitalization of RFIG will be dependent on the possible availability of funds from capital market sources.

All of these circumstances raise substantial doubt about RFIG’s and its insurance subsidiaries’ ability to continue as going concerns. However, the financial statements included in this information statement have been prepared on the assumption that RFIG will continue as a going concern. Under this assumption, RFIG contemplates the realization of assets, liquidation of liabilities, and settlement of deferred payment obligations in the ordinary course of running off the business over several years. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Recent Developments

In mid-March 2012, Old Republic combined its CCI division with its mortgage guaranty segment. The CCI and the mortgage guaranty operations offer similar insurance coverages, share the same senior management leadership, and have been operating in run-off mode since 2008 and August, 2011, respectively. CCI policies provide limited indemnity coverage to lenders and other financial intermediaries for the risk of non-payment of loan balances by individual buyers and borrowers. The coverage is for the risk of non-payment of loan balances. Claim costs are typically affected by unemployment, bankruptcy, and other wide-ranging economic circumstances leading to failures to pay.

The CCI run-off business is operated through Republic Credit Indemnity Companies, Inc., a wholly-owned subsidiary of RFIG, and its wholly-owned subsidiaries, Republic Insured Credit Services, Inc. (“RICS”), Republic Equity Credit Services, Inc. (“RECS”), and, effective April 1, 2012, by Republic Credit Indemnity Company with respect to run-off underwriting exposures.

 

 

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The CCI product is a property and casualty insurance coverage underwritten by Old Republic Insurance Company (“ORINSCO”) since 1955. From its inception, the coverage has been marketed, underwritten and claims administered for ORINSCO by ORI's wholly-owned managing underwriting agency, Republic Insured Credit Services, Inc. The original model for the coverage was the FHA Title I program, a program designed to assist consumers to obtain affordable home improvement loans by insuring loans made by private lenders to improve properties that meet certain requirements.

CCI coverage insures lenders against losses due to defaults on loans secured by liens against real property, generally single family residential property. From financial accounting and capital management standpoints the CCI product is categorized as a financial indemnity, long-tail insurance line. In varying applications and degrees, the underwriting principles applicable to CCI coverage take into account such factors as:

 

   

the credit worthiness and financial standing of the institution and assured(s);

 

   

the credit history and worthiness of the debtor or financial service provider;

 

   

the underwriting and servicing practices of the lending or financial intermediary and its performance in adherence to underwriting rules and standards;

 

   

the spread and diversification of risks; and,

 

   

similar loss mitigation opportunities.

CCI is underwritten on a policy year by policy year basis and covers portfolios of loans extended by such lenders or financial intermediaries as large and small banks, credit unions, savings & loans, and mortgage bankers. CCI coverage typically provides for a maximum loss payment equal to 10% of the original insured amounts.

ORINSCO prepares periodic analyses of its loss reserve estimates using reserving methodology that is akin to that used for other long-tail property and liability insurance lines. Loss estimates are established initially for the most recent accident years. Initial reserve levels are adjusted prospectively as actual claims emerge and greater permanence of longer term trends is established. A variety of external factors, including loan default and employment trends are considered in establishing our periodic loss reserve estimates. Expected loan loss recoveries are also taken into account on the basis of past experience and expectations about borrowers' future ability to repay defaulted debt balances.

Due to a general deterioration in the credit quality of such loans being made by lenders and the advent of the current recessionary conditions, ORINSCO voluntarily elected to discontinue writing new business in 2008 and to allow its earlier written business to run-off in the ordinary course.

Licensing and policy forms and rate filing efforts are underway to position Republic Credit Indemnity Company (“RCIC”) to replace ORINSCO as the CCI product underwriter. With the return of a favorable underwriting environment, RCIC would be free to resume writing new CCI business. It is not known when that might occur, and we have not established any timetable for a resumption of new business.

Notwithstanding the Quota Share Reinsurance Agreement and the Stop Loss Reinsurance Agreement discussed below, ORINSCO remains primarily liable under its CCI policies in the run-off business subject to this agreement.

In connection with the combination of the CCI and mortgage guaranty businesses, we have entered into two reinsurance arrangements with subsidiaries of Old Republic pertaining to the CCI business:

Quota Share Reinsurance Agreement. Effective April 1, 2012, ORINSCO reinsured its liabilities with Republic Credit Indemnity Company (“RCIC”) under a Quota Share Reinsurance Agreement covering 100% of

 

 

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the policy liabilities, except for the litigation expenses and exposures on certain existing lawsuits. Those liabilities are limited. RCIC is not responsible for those liabilities once its cumulative loss ratio under the Quota Share Reinsurance Agreement reaches 155% and any excess of such liabilities would remain with ORINSCO until RCIC’s cumulative loss ratio drops below 155% in subsequent years. ORINSCO pays RCIC a premium for the reinsurance coverage equal to 100% of the earned premiums less a ceding commission allowance for all production costs, premium taxes, board and bureau assessments, other external expenses, and a 1.25% annual processing fee adjustable by the year-over-year change in the consumer price index (“CPI”). The processing fee is subject to an annual minimum of $400,000, similarly adjustable by the annual change in the CPI.

Stop Loss Reinsurance Agreement. The liabilities assumed by RCIC under the Quota Share Reinsurance Agreement are in turn reinsured in part under a Stop Loss Reinsurance Agreement between RCIC and Old Republic General Insurance Corporation (“ORGENCO”), an Old Republic General Insurance Group subsidiary, under which ORGENCO reimburses RCIC for losses once RCIC's cumulative loss ratio reaches 85% for up to 70 additional loss ratio points. RCIC pays ORGENCO a reinsurance premium equal to 10% of the premium RCIC earns under the Quota Share Reinsurance Agreement. If cumulative losses during the stated term of the retrospective premium adjustment calculation are less than the total reinsurance premiums paid during that term, 50% of the excess reinsurance premium would be refunded to RCIC.

 

 

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RFIG’S CORPORATE STRUCTURE

 

Republic Financial Indemnity Group, Inc. is an insurance holding company that was incorporated in Delaware in 1979 as Old Republic Mortgage Guaranty Group, Inc. The name of the corporation was changed in March 2012. Our principal operating subsidiaries are reflected in the chart below. Our mortgage guaranty home office operations are located at 101 North Cherry Street, Winston-Salem, North Carolina 27101. Our telephone number at that location is (336) 661-0015. Our CCI operations and executive offices are located at 307 N. Michigan Avenue, Chicago, IL 60601, and our telephone number at that location is (312) 346-8100.

 

 

 

LOGO

 

(*) While the alignment and ownership structure of the mortgage guaranty insurance subsidiaries is subject to final determination, there are no plans to change their stand-alone status within RFIG.

 

 

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RISK FACTORS

Risks Relating to Our Business

 

Overview

RFIG, as now constituted, consists of Old Republic’s:

 

   

Mortgage Guaranty (“MI”) business which it entered into early in 1980 through its acquisition of RMIC Corporation and subsidiaries; and

 

   

Its CCI business which it started in 1955 as an underwriting division of Old Republic Insurance Company, the flagship carrier of the Old Republic General Insurance Group, Inc., (a property and liability group of insurance companies).

Old Republic announced the combination of the CCI division with its mortgage guaranty group of companies in mid-March 2012. The combination of these two businesses, separately held under the RFIG holding company, was effected since the two operations offer similar insurance coverages, share the same senior management leadership, and have been in run-off operating mode since 2008 (as to CCI) and August 2011 (as to MI). Both businesses have operated at a loss since 2007, are more likely than not to post losses in 2012 and 2013, if not longer, do not currently underwrite any new insurance policies, and need to be recapitalized in order to gain the opportunity of separately re-entering the MI and CCI markets.

Other than the “Order” discussed below and its impact on our mortgage guaranty business, the risk factors summarized hereinafter generally apply to both our MI and CCI lines. However, the issues and other matters pertaining to Fannie Mae and Freddie Mac, in particular, affect mostly our mortgage guaranty business.

We expect to experience continued material losses in our mortgage insurance and consumer credit indemnity lines, which will have a material adverse effect on our financial position and results of operations.

It is more likely than not that our MI and CCI lines will continue to incur material losses for years 2012 and 2013 in particular, though subsequent years may experience losses as well. Any decline in the rate and severity of losses will depend in part on improvements in general economic conditions, unemployment rates, and the housing, mortgage and credit markets. The timing of any such improvements cannot be accurately forecasted, and there is no assurance that improvements will be uniform across all sectors. Housing values and unemployment may be the last to recover in the current economic cycle. It is unclear to what extent, if at all, the loan modification programs of the FDIC, Fannie Mae, Freddie Mac, and loan servicers will reduce the rate of loan defaults and, in turn, mortgage insurance claims and losses.

Excessive losses and loss expenses due to unanticipated frequency and severity of claims have had a material adverse effect on our financial condition and results of operations

Excessive losses due to unanticipated claims frequency, severity or a combination of both is our most significant risk factor. Many of the factors affecting the frequency and severity of claims depend upon the type of insurance coverage, but others are shared in common. Severity and frequency can be affected by changes in national economic conditions, unexpectedly adverse outcomes in claims litigation, often as a result of unanticipated jury verdicts, changes in court made law, adverse court interpretations of insurance policy provisions resulting in increased liability or new judicial theories of liability, together with unexpectedly high costs of defending claims.

It is possible that RMIC, our flagship mortgage insurer, will become statutorily impaired and placed into receivership or liquidation by the North Carolina Department of Insurance

The material increases in mortgage guaranty insurance claims and loss payments that began in 2007 have substantially depleted RMIC’s statutory capital base and forced it to discontinue writing new business. Sixteen

 

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states have insurance laws or regulations which require a mortgage insurer to maintain a minimum amount of statutory capital relative to the level of risk in force, the most common measure being a risk to capital ratio of 25 to 1. The failure to maintain the prescribed minimum capital level in a particular state would generally require a mortgage insurer to immediately stop writing new business until it reestablishes the required level of capital or receives a waiver of the requirement from a state's insurance regulatory authority. RMIC breached the minimum capital requirement during the third quarter of 2010. RMIC had previously requested and, subsequently received waivers or forbearance of the minimum policyholder position requirements from the regulatory authorities in substantially all affected states. Following several brief extensions, the waiver from its domiciliary state of North Carolina expired on August 31, 2011, and RMIC and its sister company, Republic Mortgage Insurance Company of North Carolina, discontinued writing new business in all states and limited themselves to servicing the run-off of their existing business.

On January 19, 2012, the NCDOI issued an Order immediately placing RMIC under administrative supervision. Among other measures, RMIC was directed to reduce claim payments by 50% for up to one year’s time. The remaining 50% is to be recorded as a deferred payment obligation (“DPO”) and credited to a temporary statutory surplus account. The imposition of supervision and the restriction on claims payments will significantly reduce the rate at which RMIC's statutory capital is eroded by losses. As a result, management believes the Order makes RMIC’s statutory insolvency less likely. However, the Order could be amended or withdrawn by the NCDOI at any time or allowed to lapse after a year's time. There is therefore no assurance that the 50% payment limitation will remain in place for an extended period, nor that RMIC and its affiliated insurance companies will ultimately regain enough capital to re-enter the market and write new business, or that the Order will preclude the statutory impairment of RMIC at a later date. The NCDOI is currently reviewing the reasonableness of the level of our DPO through an independent actuarial firm retained by the NCDOI. We are unable to predict what the outcome of the NCDOI’s review will be; however, any reduction in the current level of our DPO would likely have a material adverse effect on our financial condition and results of operations.

In addition to restrictions on the payment of claims, the Order contains many other restrictions on the operation of RMIC’s business. Failure to comply with the provisions of the Order or any other violation of the North Carolina Insurance Code may result in the imposition of fines or penalties or subject RMIC to further legal proceedings, including the institution by the NCDOI of receivership proceedings for the conservation, rehabilitation or liquidation of RMIC. Any such actions could lead RFIG to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the company.

There is substantial doubt about our ability to continue as a going concern.

In light of the regulatory supervision to which RMIC is subject as already discussed, absent substantial capital additions and future regulatory and other approvals, the ability of RFIG and its insurance subsidiaries to reemerge as an active underwriter of new business is currently unknown if not doubtful. The ultimate parent, Old Republic, has, based on its enterprise risk management objectives, communicated its unwillingness and inability to provide additional capital funds in an amount sufficient to restore and maintain minimum risk-to-capital ratios. Accordingly, recapitalization of RFIG will be dependent on the possible availability of funds from capital market sources.

All of these circumstances raise substantial doubt about RFIG’s and its insurance subsidiaries' ability to continue as going concerns. However, the financial statements included in this information statement have been prepared on the assumption that RFIG will continue as a going concern. Under this assumption, RFIG contemplates the realization of assets, liquidation of liabilities, and settlement of deferred payment obligations in the ordinary course of running off the business over several years. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Either by notice or consent order, the following states have either suspended or provided notice of their intent to suspend RMIC’s license: AK, AR, GA, ID, IL, KY, LA, MO, NC, OK, TN, UT, VA, WV, and we

 

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expect other states will take similar action in the future. RMIC has confirmed with each state in which its license has been suspended that it should continue to service its existing in-force book of business. As such, while RMIC no longer issues coverage on new policies, it continues to process modifications on existing certificates of insurance, process premiums and settle claims in the normal course of business.

To actively write mortgage insurance we must be approved by Fannie Mae and Freddie Mac. RMIC and its affiliated MI insurance companies are no longer approved by Fannie Mae or Freddie Mac. There is no guarantee that we would be approved in the future to once again begin writing new insurance business.

We are indebted to Old Republic in the amount of $180 million and we do not have, nor is it likely that we will have in the future, the ability to service this debt, and as a result we may have difficulty raising additional capital in the future.

RFIG is a holding company that transacts business through its operating subsidiaries. Our primary assets are the capital stock of these operating subsidiaries. Thus, our ability to service the indebtedness owed to Old Republic under the $180 million face amount Series A Variable Rate Senior Debenture No. 5 due December 31, 2038 (the “Senior Debenture”) that we issued to Old Republic on March 14, 2012 in exchange for certain existing notes and the extension of an additional $5 million loan, depends upon the surplus and earnings of our subsidiaries and their ability to pay dividends to the holding company. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to make payment on RFIG’s debts or to make any funds available for that purpose. Given the restrictions in the Order on payments or other transfers of funds by RMIC, our flagship mortgage guaranty insurer, we do not expect that any funds will be available to RFIG from RMIC, nor do we expect any of our other subsidiaries to pay dividends to us in order to satisfy holding company obligations. Accordingly, we do not expect that we will be able to make interest payments when due under the Senior Debenture. While the Senior Debenture does not contain provisions giving the holder the right to accelerate the principal balance due in the event of a failure to make payments of interest or principal when due, our inability to make payments when due under the Senior Debenture could have a material adverse effect on our ability to raise capital through either the sale of debt or equity securities.

Our ability to finance our operations through the incurrence of additional indebtedness is constrained by the terms of our Senior Debenture and our lack of cash flow to service any such indebtedness.

Our Senior Debenture prohibits us from borrowing more than $5 million without the holder’s prior written approval. Further, given the constraints on our ability to receive dividends or other payments from RMIC under the Order, we do not expect that RFIG will have access to funds with which to service additional indebtedness that it may need to finance its operations. If RFIG is unable to raise the funds necessary to continue its operations, it may have to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company.

Our mortgage guaranty GAAP earnings may be materially adversely affected because our recognition of premium income under GAAP is not appropriately matched to our long-term claim exposures

Our mortgage insurance subsidiaries issue long duration, guaranteed renewable policies covering multi-year periods during which exposure to loss exists. Loss exposures typically manifest themselves as recurring losses usually concentrated between the second and fifth year following issuance of any one year's new policies. Additionally, the policies cover catastrophic aggregations of claims such as those that have occurred during the current recession engendered by substantial market dislocations in the housing and mortgage lending industries.

Our mortgage guaranty premiums stem principally from monthly installment policies. Substantially all such premiums are generally written and earned in the month coverage is effective. Recognition of claim costs, however, occurs only after an insured mortgage loan has missed two or more consecutive monthly payments. Accordingly, GAAP revenue recognition is not appropriately matched to the risk exposure and the consequent

 

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recognition of both normal and, most significantly, future catastrophic loss occurrences. As a result, mortgage guaranty GAAP earnings for any individual year or series of years may be materially adversely affected, particularly by cyclical catastrophic loss events such as the mortgage insurance industry has experienced since mid-year 2007. Reported GAAP earnings and financial condition form, in part, the basis for significant judgments and strategic evaluations made by management, analysts, investors, and other users of the financial statements issued by mortgage guaranty companies. The risk exists that such judgments and evaluations are at least partially based on GAAP financial information that does not match revenues and expenses and is not reflective of the long-term normal and catastrophic risk exposures assumed by mortgage guaranty insurers at any point in time.

Our loss reserves have proven to be inadequate to cover our losses on our mortgage insurance and CCI businesses

Our mortgage insurance subsidiaries establish reserves for losses and loss adjustment expenses based upon mortgage loans reported to be in default, as well as estimates of those in default but not yet reported. Of necessity, the reserves are at best estimates by management, taking into consideration its judgments and assumptions regarding the housing and mortgage markets, unemployment rates and economic trends in general. During the ongoing sustained economic downturn, loss reserve estimates become subject to even greater uncertainty and volatility. The rate and severity of actual losses have at times proven to be greater than expected and have required us to effect substantial increases in our loss reserves. Depending upon the magnitude, future claim reserve increases could have a materially adverse impact on our mortgage insurance business and our consolidated results of operations and financial condition. There can be no assurance that actual losses paid by the mortgage insurance subsidiaries, even with the benefit of the DPO provisions under the Order described above, will not be materially greater than previously established loss reserves.

We also establish reserves for CCI claim exposures based on reported loan defaults. These reserves are an estimate of liability for unpaid claims and claims defense and adjustment expenses, and cover both reported and incurred but not yet reported (“IBNR”) claims net of expected recoveries of incurred claims. It is not possible to calculate precisely what these liabilities will amount to in advance and, therefore, the reserves represent management's best estimate at any point in time. Such estimates are based upon known historical loss data, certain assumptions and expectations of future trends in claim frequency and severity, interest rates, claim salvage recoveries, and other economic considerations. The latter are affected by a variety of factors over which insurers have little or no control and which can be quite volatile.

Reserve estimates for our mortgage guaranty and CCI business are periodically reviewed in light of known developments and, where necessary, they are adjusted and refined as circumstances may warrant. Nevertheless, the reserve setting process is inherently uncertain. If, for any reason, reserve estimates prove to be inadequate, reported liabilities would need to be increased and our pretax income for the period in which our reserves are increased will decrease by a corresponding amount; such an occurrence could result in a materially adverse impact on our results of operations and financial condition.

We expect to experience fewer coverage rescissions in the future, and therefore the benefit we receive from rescissions will decline over time

Our mortgage insurance and CCI policy provisions permit us to rescind coverage whenever we find evidence that a loan did not qualify for insurance coverage in the first instance, or that a material misrepresentation had been made in the loan application by the borrower, the lender, and/or its agent. During the past several years, rescission rates rose dramatically. As a result, rescissions reduced materially the percentage of approved claims, and loss reserving estimates have reflected assumptions as to the levels and trends of rescission activity. Although we expect rescission activity to continue in future years, it is likely that the reserve reductions and lower claim settlements we will experience from future rescission activity will decline over time and will not be as significant as it has been in the past.

 

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A few policyholders who have experienced high rates of coverage rescission have instituted litigation or arbitration proceedings challenging our position on rescissions. Whether the current rescission rates continue or decrease, it is possible that further litigation or arbitral challenges to our rescissions of coverage could arise. If any of the challenges are successful, they could have a materially adverse effect on our consolidated operating results and financial position. Even if such challenges should prove unsuccessful, the legal defense costs of addressing them could be substantial.

A diminished role for Fannie Mae and Freddie Mac (“GSEs”) could materially adversely affect our ability to re-enter the mortgage insurance market

The market for private mortgage insurance exists almost entirely as a result of restrictions within the federal charters of the GSEs which require an acceptable form of credit enhancement on loans purchased by the GSEs that have loan- to-value (“LTV”) ratios in excess of 80%. These institutions establish the levels of required coverage, the underwriting standards for the loans they will purchase and the loss mitigation efforts that must be followed on insured loans. In response to their deteriorating financial conditions, the GSEs were placed in conservatorship under the Federal Housing Finance Agency (“FHFA”) in September 2008. As their conservator, the FHFA could change the GSEs’ business practices with respect to mortgage credit enhancement, or new federal legislation prompted by the increasing role of the federal government in the residential mortgage market could alter their charters or restructure the GSEs in ways that may reduce or eliminate their roles in the residential mortgage market. The current Federal administration has recommended winding down and gradually eliminating the GSEs’ role in housing finance. Any such changes could have a material adverse effect on the mortgage insurance industry and RMIC’s and its affiliates' ability to re-enter the market.

Competition in the mortgage insurance industry may adversely affect our ability to re-enter the mortgage insurance market

Competition is always a risk factor and arises not only from other private mortgage insurers, but also from the Federal Housing Administration (“FHA”), the Veterans Administration (“VA”), as well as the GSEs and the insured mortgage lenders themselves. Beginning in 2008, the volume of business underwritten by private mortgage insurers began to decline significantly, generally as a result of more restrictive underwriting guidelines, increased premium rates, and changes to the pricing policies of the GSE’s. These changes, coupled with certain changes to the FHA’s guidelines, resulted in a significant increase in the FHA’s insured volume and its share of the market for mortgage default protection.

Other competitive risk factors faced by the mortgage insurance industry stem from certain credit enhancement alternatives to private mortgage insurance. These include:

 

   

the retention of mortgage loans on an uninsured basis in the lender's portfolio of assets; and

 

   

capital markets alternative credit enhancements.

As previously noted, we ceased underwriting new mortgage guaranty business effective August 31, 2011. All of the above-noted competitive risk factors could adversely affect our mortgage insurance subsidiaries ability to re-enter the market in the future.

Historically, the CCI line has been a much smaller part of the financial indemnity field when compared to mortgage guaranty. Underwriting of new CCI policies ceased in early 2008 and the business has since been in run-off operating mode. Our ability to re-enter the CCI business through a newly established RFIG insurance subsidiary that is currently limited to assuming the CCI run-off will be predicated on a number of factors, including regulatory approval of revised policy forms, the obtaining of operating licenses in several additional states, and the availability of sufficient additional capital to gain market acceptance of the insurance coverage we plan to offer. There is no assurance that any or all of these requirements will be met in the near term.

 

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Adverse changes in the economy or the stock market could negatively affect the value of our invested assets, which could result in a material adverse effect on our financial condition and results of operations.

The invested assets of our insurance subsidiaries are managed by an asset management subsidiary of Old Republic pursuant to an agreement that has been in place for many years. Substantially all of the investments consist of fixed maturity securities.

Changes in interest rates directly affect the income from, and the fair value of, fixed maturity investments. Such changes could reduce the value of our investment portfolio and adversely affect our results of operations and financial condition. Further, we manage our fixed maturity investments by taking into account the maturities of such securities and our anticipated liquidity needs. Should we suddenly experience greater than anticipated liquidity needs for any reason, we could face a temporary cash shortfall that could have a materially adverse effect on our financial condition or operating results.

Our policies have not been priced adequately in the past, and our business, operating results and financial condition have been materially adversely affected

Premium rates are generally determined on the basis of historical data for claim frequency and severity as well as related production and other expense patterns. The housing crisis has resulted in ultimate claims and expenses exceeding historically projected levels, and premium rates have proved to be insufficient. Premium rate inadequacy will require time to correct, and, much like excessive losses, has adversely affected our business, operating results and financial condition.

The regulatory environment in which we operate imposes substantial restrictions on our ability to operate our business

Our insurance businesses are subject to extensive governmental regulation under U.S. laws and state regulations. These regulations relate to such matters as licensing requirements, types of insurance products that may be sold, premium rates, marketing practices, capital and surplus requirements, investment limitations, underwriting limitations, dividend payment limitations, transactions with affiliates, accounting practices, taxation and other matters. While most of the regulation is at the state level in the U.S., the federal government has increasingly expressed an interest in regulating the insurance business and has injected itself through the Graham-Leach-Bliley Act, the Patriot Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2009. Regulations bear directly on the costs of conducting an insurance business through increased compliance expenses. Apart from the rising costs of compliance, as existing regulations evolve through administrative and court interpretations, and as new regulations are adopted, there is no basis for predicting the impact that changes could have on our businesses in the future. The impact could have a material adverse effect on the manner in which we do business and our future ability to compete.

We are currently unrated by the major rating agencies. Ratings are not currently important to us because we are operating in run-off mode; however, our ability to re-enter the market or to raise capital in the future will be adversely affected by not having satisfactory ratings

The competitive positions of insurance companies in general have come to depend increasingly on independent ratings of their financial strength and claims-paying ability. The rating agencies base their ratings on criteria they establish regarding an insurer's financial strength, operating performance, strategic position and ability to meet its obligations to policyholders. The future inability to obtain sufficient ratings for any of our insurance subsidiaries could have a materially adverse effect on their future ability to compete for new business and, as a result, their operations and financial condition.

Our subsidiaries have significant relationships with financial institutions; the failure of any such institutions could have a material adverse effect on our business, results of operations and financial condition

Our MI subsidiaries have significant business relationships with financial institutions, particularly national banks. The subsidiaries are the beneficiaries of a considerable amount of security generally in the form of trust

 

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assets which they hold as collateral securing the obligations of insureds and certain reinsurers. Some of the banks themselves have subsidiaries that reinsure our business. There is thus a risk of concentrated financial exposures in one or more such banking institutions. If any of these institutions fail or are unable to honor their credit obligations, the result could have a materially adverse effect on our business, results of operations and financial condition.

Our risk management processes have proved inadequate in the past and could prove to be inadequate in the future

We have established processes and procedures designed to identify, measure, analyze, monitor and report the types of risk we and our subsidiaries are subject to, including operational risk, market risk, credit risk, liquidity risk, investment risk, interest rate risk, legal risk and reputational risk, among others. There are inherent limitations in such processes and procedures. In the past we have not adequately identified or anticipated risks relating to our business, and there is a risk that we may not adequately anticipate risks in the future. Such inadequacies have in the past resulted in, and could in the future lead to unexpected losses or expenses.

We are subject to legal risks relating to our business that could negatively affect us

We and certain of our subsidiaries are from time to time named defendants or otherwise involved in various legal proceedings, including class actions and other litigation or arbitration proceedings with third parties, as well as proceedings by regulatory agencies. Any of these actions could result in judgments, settlements, fines or penalties which could materially adversely affect our business, financial condition or results of operations.

Attracting and retaining qualified employees is critical to our continued operations

Our employees at all levels are employees at will and are depended on to successfully manage the run-off and any re-entry we make into the market place. Therefore, should we for any reason be unable to attract and retain qualified employees, our ability to effectively, efficiently and economically run off the book of business of the Company could be materially adversely affected. Further, under the Order entered by the NCDOI, we are prohibited from increasing the salaries or benefits of any member of RMIC’s management without the approval of the NCDOI. In the event that the NCDOI should not approve compensation increases that we believe are necessary to attract and retain qualified employees, our ability to successfully manage our run-off operations would be impaired, which could materially and adversely affect our financial condition and results of operations.

At March 31, 2012, we reported a common shareholder’s deficit under GAAP of $17.5 million. We believe that, absent significant positive changes in the economy and the residential real estate market, it is possible that the existing assets and future premiums of RMIC may not be sufficient to meet its current and future policyholder obligations, which could result in the institution of receivership proceedings for RMIC and consequently could lead us to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise seek to dissolve RFIG.

Since December 31, 2006, we have reported a cumulative net loss of $1.4 billion, which largely accounted for the GAAP common shareholder’s equity (deficit) of ($17.5) million at March 31, 2012. The item that has the most significant impact on the net income or loss that we report is incurred losses. Incurred losses are comprised of settled losses and the change in loss reserves. There have been large swings in incurred losses over the past five years, with most of the volatility coming from the level of newly reported defaults and related loss reserves and the loss development, including the change in loss reserves covering existing defaults.

As already noted, loss reserves are estimates of the ultimate costs of claim settlement on loans reported in default, and loans in default that are in the process of being reported to us as of the date of our financial statements. The actual amount of our claim settlements may be substantially different from our loss reserve estimates. Our estimates could be adversely affected by a variety of factors, including, but not limited to, further

 

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declines in home prices, specifically in certain geographic regions that have experienced only modest declines to date, a lack of improvement in the unemployment rate, and a decrease in the realized rescission rates compared to those utilized in our reserve methodology. Changes to our estimates of reserves could result in a significant impact to our results of operations and our accumulated deficit.

While a deficit in assets is a useful metric to measure the financial viability of a company at any point in time, it does not measure the future net profits, if any, on the existing book of business based upon the ongoing collection of premiums against the projected future claim payments on new defaults. Our standard model of the run-off of our remaining book of business indicates that it is more likely than not that years 2012 and 2013, at the least, will produce losses. Absent significant positive changes in the economy and the residential real estate market, it is possible that our existing assets and future premiums may not be sufficient to meet our current and future policyholder obligations.

Furthermore, because we are in run-off and no longer write new mortgage guaranty insurance, our primary source of revenue consists solely of renewal premiums, which we project will decline as our insurance in force declines.

We expect to receive reimbursement from RMIC for operating expenses incurred on behalf of the operating subsidiary under terms of a services agreement. Terms of the Order require the approval of the NCDOI for RMIC to reimburse these expenses. If we are unable to obtain the NCDOI’s approval for RMIC to reimburse certain operating costs of RFIG, then the limited assets of RFIG will dissipate at a much greater pace.

RFIG is a holding company and will be reliant on reimbursement from RMIC to pay for certain operating expenses, including expenses for directors’ fees, legal and accounting fees, and certain insurance premiums. RFIG together with a non-regulated service company had liquid assets of $9.2 million at March 31, 2012. Investment income is not a meaningful source of cash. If RFIG were unable to recoup the majority of its cash expenses from RMIC, RFIG’s assets would dissipate at a much greater pace, which could lead RFIG to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws or otherwise consider liquidation, and possibly eliminate all remaining shareholder value.

Since 2007, the United States housing market has experienced a significant amount of home price depreciation that has had and continues to have a negative impact on our results of operations and financial condition. If home prices do not appreciate or decline further, we may incur a higher level of losses from settled claims and increases to our loss reserves. Additionally, if home prices remain at depressed levels or decline further, additional borrowers that have the ability to pay may choose to default on their loan, which would further negatively impact our results of operations and financial condition.

In years prior to the onset of the current housing-related recession, one of the primary means of loss mitigation included the borrower selling a property prior to foreclosure. RMIC has, on occasion, purchased the property in lieu of paying the coverage percentage specified in the insurance policy. The ongoing decline in home prices has negatively affected both of these mitigation options as the fair value of many of the borrowers’ homes is actually less than the outstanding mortgage. If home values fail to appreciate or decline on a more significant and expanded geographic basis, the frequency of loans going into default and eventually resulting in a paid claim could increase and our ability to mitigate our losses on mortgages may be further reduced, which could have a material adverse effect on our business, financial condition and operating results.

We have a concentration of traditional primary risk in force in the distressed markets and these markets have a large amount of risk in default. Ongoing depressed home prices in these distressed markets could lead to further increases in reserves and paid claims, which could further negatively influence our financial performance.

At March 31, 2012, our traditional primary risk in force for the distressed markets in which we have written business—Florida, Arizona, California and Nevada—represented approximately 15.3% of our gross risk in force.

 

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These distressed markets have experienced greater home price depreciation since 2007 and higher foreclosure rates when compared to the rest of the country. Moreover, defaults in distressed markets represented 27.6% of our risk in default and 29.7% of our gross loss reserves at March 31, 2012. The default rate at March 31, 2012 in these distressed markets was 25.8% compared to 12.5% for the remainder of our portfolio. If the home values in the distressed markets remain at current depressed levels or drop further, we could experience additional adverse effects on our results of operations and financial condition due to the large concentration of our business in these distressed markets.

A large portion of our traditional primary risk in force consists of loans with high LTVs, which could result in a greater number of defaults and larger claims than loans with lower LTVs, especially during and following periods of declining home prices.

At March 31, 2012, 26.2% of our traditional primary mortgage insurance in force consisted of insurance on mortgage loans with LTVs at origination greater than 95%. During and following periods of rapidly declining home prices such as that which has occurred during the past few years, these loans have a greater propensity to default due to the decline in borrower’s equity. Loans with greater than 95% LTV at origination have historically experienced a significantly greater default rate than loans with lower LTVs. Many of the high LTV loans also contain other risk factors such as geographic location in distressed markets and were originated with reduced documentation requirements. If we experience an increased rate of default and paid claims on high LTV loans, our results of operations could be adversely affected.

Because we generally cannot cancel mortgage guaranty insurance policies or adjust renewal premiums due to changing economic conditions, unanticipated defaults and claims could cause our financial performance to suffer significantly.

We generally cannot cancel the mortgage guaranty insurance coverage that we provide or adjust renewal premium rates during the life of a mortgage guaranty insurance policy, even as economic conditions change. As a result, the impact of unanticipated changes, such as declining home prices and high levels of unemployment, cannot be offset by premium increases on policies in force or cancellation of insurance coverage other than those allowed by the master policies relating to fraud, misrepresentation or program violations at origination. The premiums we charge in many cases have not been adequate to compensate us for the risks and costs associated with the insurance coverage provided to our customers, especially in these distressed financial markets. An increase in the number or size of unanticipated defaults and claims could adversely affect our financial condition and operating results because we could not cancel existing policies or increase renewal premiums.

Our loss experience may increase as our policies continue to age.

Historically, we expected the majority of claims on insured loans in our portfolio to occur during the second through the fifth years after loan origination with only modest losses occurring thereafter. However, given the decline in home prices and high levels of unemployment that have occurred in recent years, we experienced an earlier default and claim pattern in the 2005, 2006 and 2007 policy years combined with an increase in new default activity in older policy years. Our loss experience may continue to increase as our policies age due to the significant decline in home prices and continued high unemployment rates.

If we failed to properly underwrite mortgage loans when we provided contract underwriting services, we may be required to provide monetary and other remedies to the customer.

Under the terms of our contract underwriting agreements, one of our subsidiaries agreed to indemnify the participating lender against losses incurred in the event that we failed to properly underwrite a loan in accordance with the lender’s underwriting guidelines, subject to contractual limitations on liability. The indemnification may be in the form of monetary or other remedies. As a result, we assumed risk in connection with our contract underwriting services. During 2011, we paid out $4.6 million on remedies and we have a reserve established of

 

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$11.9 million at December 31, 2011, which may not be sufficient to cover our future indemnification obligations. An increase in the number of previous contract underwritten loans for which we must provide an indemnity could adversely affect our financial condition.

Loan servicers have experienced a significant increase in their workload due to the rapid growth in defaults and foreclosures. If the loan servicer fails to act proactively with delinquent borrowers in an effort to avoid foreclosure, then the number of delinquent loans eventually resulting in a paid claim could increase.

The loan servicer maintains the primary contact with the borrowers throughout the life of the loan; however, we can become involved with any potential loss mitigation. It is important to us that the servicer is proactive in dealing with delinquent borrowers rather than simply allowing the loan to go to foreclosure. Historically, when a servicer became involved at an earlier stage of delinquency with workout programs and credit counseling, there was a greater likelihood that the loan would avoid foreclosure and would not result in a claim. It thus becomes extremely important that the servicer be properly staffed and trained to assist borrowers to avoid foreclosure and involve RMIC as part of the loss mitigation effort as early as possible. If loan servicers do not properly staff and train their personnel or enlist our assistance in loss mitigation efforts, then the number of loans going to foreclosure may increase. Increased foreclosures result in a greater number of claims that we are required to pay, which would have an adverse impact on our future operating results.

Risks Relating to the Spin-Off

 

We may not realize the potential benefits from the spin-off.

We may not realize the potential benefits that we expect from our spin-off from Old Republic. These potential benefits include: 1) allowing our executive management to concentrate on, and give their full attention to our businesses, 2) enhanced ability of each company to incentivize its key employees with equity-based compensation that is aligned with the performance of its own operations and the interests of RFIG’s shareholders, and 3) potentially allow RFIG to raise capital from private capital market sources to refinance the business.

In addition, we will incur costs, including those described below, which may exceed our estimates, and we will incur some negative effects from our separation from Old Republic, including loss of access to the financial, managerial and professional resources from which we have benefited in the past.

We will no longer enjoy the benefits of being included in Old Republic’s consolidated tax return

As a subsidiary of Old Republic, we have been included in Old Republic’s consolidated federal income tax returns, and have been a party to a tax sharing agreement with Old Republic. To the extent our tax losses have been used in Old Republic’s consolidated returns, we have received payment from Old Republic under the tax sharing agreement.

Following the spin-off, we will no longer be included in Old Republic’s consolidated returns, and will no longer be a party to the tax sharing agreement with Old Republic. We expect this will significantly limit our ability to obtain current and deferred tax benefits from our tax losses. This in turn will likely have a material adverse effect on our financial condition.

In 2010 and 2011, we received payments of $6.2 million and $4.4 million, respectively, under the tax sharing agreement with Old Republic. Those payments were attributable to the use of our tax losses in Old Republic’s consolidated tax returns. If we had filed a separate consolidated tax return with our subsidiaries for those years, we likely would not have received any current tax benefit from those tax losses. As of March 31, 2012, we have an outstanding current tax recoverable of $162.1 million due from Old Republic under the tax sharing agreement.

 

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Our historical consolidated and pro forma financial information are not necessarily indicative of our future financial results, nor do they reflect what our financial results would have been as an independent public company during the periods presented.

The historical consolidated financial information we have included in this information statement does not reflect what our financial condition, results of operations or cash flows would have been as an independent public company during the periods presented and is not necessarily indicative of our future financial condition, future results of operations or future cash flows. This is primarily a result of the following factors:

 

   

our historical consolidated financial results reflect expenses for services historically provided by Old Republic, and those amounts may be significantly lower than the comparable expenses we would have incurred as an independent company;

 

   

our capital requirements historically have been satisfied as part of Old Republic’s corporate-wide capital management programs, and our cost of debt and other capital may be significantly higher from that reflected in our historical consolidated financial statements;

 

   

the historical consolidated financial information may not fully reflect the increased costs associated with being an independent public company, including changes that will occur in our cost structure, management, financing arrangements and business operations as a result of our spin-off from Old Republic, including all the costs related to being an independent public company; and

 

   

our historical consolidated financial results reflect the benefits of being included in Old Republic’s consolidated federal income tax returns. See the discussion above under, “We will no longer enjoy the benefits of being included in Old Republic’s consolidated tax returns.”

The pro forma adjustments are based on available information and assumptions that we believe are reasonable; however, our assumptions may prove not to be accurate. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Unaudited Pro Forma Combined Financial Statements” and our historical consolidated financial statements and the notes to those statements included in this information statement.

We intend to take the position that the spin-off will be a taxable transaction for U.S. federal income tax purposes and your receipt of our common stock will likely be taxable to you.

We intend to take the position that the spin-off will be a taxable transaction for U.S. federal income tax purposes. Assuming this to be the case, an amount equal to the fair market value on the distribution date of the shares of our common stock received by you (after giving effect to rounding up to the nearest whole number of shares, if applicable) generally will be taxable as a dividend to the extent of your ratable share of Old Republic’s current or accumulated earnings and profits, if any, as determined for U.S. federal income tax purposes, with the excess treated first as a tax-free return of capital that reduces (but not below zero) your adjusted tax basis in your Old Republic common stock and then as capital gain from the sale or exchange of Old Republic common stock. This determination is made on a share-by-share basis.

In general, the public trading value of stock is strong evidence of its fair market value. Our common stock will not be listed on a national securities exchange. We currently anticipate that, following the spin-off, quotations for our common stock will be available on the OTC Bulletin Board and/or the OTC Markets Group, Inc. The value Old Republic reports to you as the amount of the distribution may be higher or lower than the trading price, if any, of our common stock as may be reported on the OTC Bulletin Board and/or the OTC Markets Group, Inc. quotation services on the distribution date. The value Old Republic reports to you will not be binding on the IRS or any other taxing authority and a taxing authority could ascribe a higher value to our shares. For a more detailed discussion of the material U.S. federal income tax consequences of the spin-off, please see “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” below.

 

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We will be subject to continuing contingent liabilities of Old Republic following the spin-off.

After the spin-off, there will be several significant areas where the liabilities of Old Republic may become our obligations. For example, under the Code and the related rules and regulations, each corporation that was a member of the Old Republic consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before the effective time of the spin-off is jointly and severally liable for the federal income tax liability of the entire Old Republic consolidated tax-reporting group for that taxable period. In connection with the spin-off, we will enter into a Tax Indemnity Agreement with Old Republic that will, among other things, allocate the responsibility for prior period taxes of the Old Republic consolidated tax reporting group between us and Old Republic. However, if Old Republic is unable to pay any prior period taxes for which it is responsible, we could be required to pay the entire amount of such taxes. Other provisions of federal law establish similar liability for other matters, including laws governing tax-qualified pension plans as well as other contingent liabilities.

We will not have complete control over matters relating to our taxation, which could adversely affect our liability for taxes.

We anticipate that we and our subsidiaries will be included in Old Republic’s consolidated group for U.S. federal income tax purposes for periods prior to the spin-off. In addition, we or one or more of our subsidiaries may be included in the combined, consolidated or unitary tax returns of Old Republic or one or more its subsidiaries for U.S. state or local income tax purposes. We expect that we will enter into a Tax Indemnity Agreement with Old Republic under which Old Republic will have effective control over U.S. tax decisions in connection with any consolidated, combined or unitary income tax returns in which we (or any of our subsidiaries) are included. That Agreement will require us to pay our allocable share of the tax due under any such returns. In addition, we expect to enter into a Services Agreement under which Old Republic will provide tax preparation and advisory services to us for a period following the spin-off. These arrangements may result in conflicts of interest between Old Republic and us. For example, under the Tax Indemnity Agreement, Old Republic may be able to choose to contest, compromise or settle an adjustment or deficiency proposed by the relevant taxing authority in a manner beneficial to Old Republic and detrimental to us.

Potential indemnification liabilities to Old Republic pursuant to the Separation and Distribution Agreement could materially and adversely affect our business, financial condition, results of operations and cash flows.

In connection with the spin-off, we will enter into a Separation and Distribution Agreement with Old Republic that provides for, among other things, the principal corporate transactions required to effect the spin-off, certain conditions to the spin-off and provisions governing the relationship between our company and Old Republic with respect to and resulting from the spin-off. Among other things, the Separation and Distribution Agreement will provide for indemnification obligations designed to make us financially responsible for substantially all liabilities that may exist relating to our mortgage guarantee business activities, whether incurred prior to or after the spin-off, as well as those obligations of Old Republic assumed by us pursuant to the Separation and Distribution Agreement. If we are required to indemnify Old Republic under the circumstances set forth in the Separation and Distribution Agreement, we may be subject to substantial liabilities. For a description of the Separation and Distribution Agreement, see “Relationship with Old Republic After the Spin-Off.”

In connection with our separation from Old Republic, the latter will indemnify us for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or that Old Republic’s ability to satisfy its indemnification obligation will not be impaired in the future.

Pursuant to the Separation and Distribution Agreement, Old Republic will agree to indemnify us for certain liabilities. However, third parties could seek to hold us responsible for any of the liabilities that Old Republic agrees to retain, and there can be no assurance that the indemnity from Old Republic will be sufficient to protect

 

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us against the full amount of such liabilities, or that Old Republic will be able to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Old Republic any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. If Old Republic is unable to satisfy its indemnification obligations, the underlying liabilities could have a material adverse effect on our business, financial condition, results of operations and cash flows.

After the spin-off, Old Republic’s insurers may deny coverage to us for liabilities associated with the occurrences prior to the spin-off. Even if we ultimately succeed in recovering from such insurance providers, we may be required to temporarily bear such loss of coverage.

Old Republic may fail to perform under various transaction agreements that will be executed as part of the separation or we may fail to have necessary systems and services in place when certain of the transaction agreements expire.

In connection with the separation, we and Old Republic will enter into a Separation and Distribution Agreement and will enter into various other agreements, including a Services Agreement, a Tax Indemnity Agreement, an Investment Counsel Services Agreement and certain reinsurance agreements. The Separation and Distribution Agreement, the Tax Indemnity Agreement and the Services Agreement will provide for the allocation of assets and liabilities between the companies following the separation for those respective areas and will include any necessary indemnifications related to liabilities and obligations. The Services Agreement will provide for the performance of certain services by each company for the benefit of the other for a period of time after the separation. We will rely on Old Republic to satisfy its performance obligations under these agreements. If Old Republic is unable to satisfy its obligations under these agreements, including its indemnification obligations, we could incur operational difficulties or losses. If we do not have in place our own systems and services, or if we do not have agreements with other providers of these services once certain transaction agreements expire, we may not be able to operate our business effectively and our profitability may decline.

We may have received better terms from unaffiliated third parties than the terms we will receive in our agreements with Old Republic.

The agreements we will enter into with Old Republic in connection with the spin-off, including the Separation and Distribution Agreement, Tax Indemnity Agreement, an Investment Counsel Services Agreement, a Services Agreement and the reinsurance agreements, were prepared in the context of the spin-off while we were still a wholly owned subsidiary of Old Republic. Accordingly, during the period in which the terms of those agreements were prepared, we did not have an independent board of directors or a management team that was independent of Old Republic. As a result, the terms of those agreements may not reflect terms that would have resulted from arm’s-length negotiations between unaffiliated third parties. Arm’s-length negotiations between Old Republic and an unaffiliated third party in another form of transaction, such as a buyer in a sale of a business transaction, may have resulted in more favorable terms to the unaffiliated third party. See “Relationship with Old Republic After the Spin-Off.”

Following the spin-off, we will have debt obligations that could restrict our business, financial condition, results of operations and cash flows.

Following the spin-off, we will need to finance our company’s capital needs on a stand-alone basis. Prior to and following the spin-off, we will have a total indebtedness for borrowed money of $180 million. RFIG has pledged surplus notes of RMIC and RMICNC totaling $155 million and the stock of our three mortgage insurance companies to Old Republic to secure this indebtedness. We may also incur a limited amount of additional indebtedness in the future. The terms of our existing indebtedness restricts us from incurring additional debt in excess of $5.0 million.

 

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Several members of our board of directors may have actual or potential conflicts of interest because of their ownership of shares of common stock of Old Republic.

Several members of our board of directors may have actual or potential conflicts of interest because of their ownership of shares of common stock or other relationships with Old Republic. See “Certain Relationships and Related Party Transactions.”

After the separation, certain of our directors may have actual or potential conflicts of interest because of their positions at Old Republic.

After the separation, one of our directors, Mr. Zucaro, will serve as Chairman of our Company and is expected to continue serving as CEO and Chairman of the board of directors of Old Republic. In addition, Mr. LeRoy, Old Republic's general counsel, will serve as the Vice Chairman of our board. The service of Messrs. Zucaro and LeRoy, as a director of RFIG, as well as a director or officer of Old Republic, could create, or appear to create, potential conflicts of interest when our or Old Republic’s management and directors pursue the same corporate opportunities or face decisions that could have different implications for us and Old Republic. For example, potential conflicts of interest could arise in connection with the resolution of any dispute between us and Old Republic regarding the terms of the agreements governing the separation and the relationship thereafter between us and Old Republic. Potential conflicts of interest could also arise if we and Old Republic enter into any commercial arrangements with each other in the future. In addition, conflicts of interest may arise with regard to the allocation of Mr. Zucaro’s and Mr. LeRoy’s and the other directors’ time between us and Old Republic. See “Certain Relationships and Related Party Transactions.” In all these regards, however, as a part of its corporate governance principles, RFIG will require Messrs. Zucaro and LeRoy to recuse themselves from any RFIG board approval of any contract or transaction with Old Republic.

Risks Relating to Ownership of Our Common Stock

 

Because there has not been any public market for our common stock, the market price and trading volume of our common stock may be volatile and you may not be able to resell your shares at or above the initial market price of our common stock following the spin-off.

Prior to the spin-off, there will have been no trading market for our common stock. We cannot assure you that an active trading market will develop or be sustained for our common stock after the spin-off, nor can we predict the prices at which our common stock will trade after the spin-off. The market price of our common stock could fluctuate significantly due to a number of factors, many of which are beyond our control, including:

 

   

fluctuations in our quarterly or annual earnings results or those of other companies in our industry;

 

   

failures of our operating results to meet the estimates of securities analysts or the expectations of our shareholders or changes by securities analysts in their estimates of our future earnings;

 

   

announcements by us or our competitors;

 

   

changes in laws or regulations which adversely affect our industry or us;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

general economic, industry and stock market conditions;

 

   

future sales of our common stock by our shareholders;

 

   

future issuances of our common stock by us; and

 

   

the other factors described in these “Risk Factors” and other parts of this information statement.

 

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There is not now, and there may not ever be, an active market for RFIG common stock, which limits your ability to sell or trade your shares and which may also adversely affect the price of such shares.

There currently is no market for RFIG common stock. Further, although RFIG common stock may be quoted in the future on a quotation service, trading of RFIG common stock may be extremely sporadic. For example, several days may pass before any shares may be traded. There can be no assurance that a more active market for the common stock will develop.

We cannot assure you that the common stock will become liquid or that it will be listed on a securities exchange or that price quotations will be provided by quotation services.

We cannot assure you that we will be able to meet the initial listing standards of any stock exchange, or that our stock will be quoted on a quotation service. We have no plans to list our common stock on a stock exchange. We expect that our common stock will be eligible to be quoted on the OTC Bulletin Board and/or the OTC Markets Group, Inc. quotations services following the spin-off. In those venues, however, an investor may find it difficult to obtain accurate quotations as to the market value of the common stock. In addition, if we failed to meet the criteria set forth in regulations promulgated by the SEC, various requirements would be imposed by law on broker-dealers who sell our securities to persons other than established customers and accredited investors. Consequently, such regulations may deter broker-dealers from recommending or selling the common stock, which may further affect its liquidity. This would also make it more difficult for us to raise additional capital.

Even if publicly traded in the future, RFIG common stock may be subject to “Penny Stock” restrictions.

If RFIG common stock becomes publicly traded and our stock price remains at less than $5, we will be subject to so-called penny stock rules which could decrease our stock’s market liquidity. The SEC has adopted regulations which define a “penny stock” to include any equity security that has a market price of less than $5 per share or an exercise price of less than $5 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require the delivery to and execution by the retail customer of a written disclosure statement of suitability relating to the penny stock, which must include disclosure of the commissions payable to both the broker/dealer and the registered representative and current quotations for the securities. Finally, the broker/dealer must send monthly statements disclosing recent price information for the penny stocks held in the account and information on the limited market in penny stocks. Those requirements could adversely affect the market liquidity of such stock. There can be no assurance that if RFIG common stock becomes publicly traded, the price will rise above $5 per share so as to avoid these regulations.

RFIG common stock may trade only in an illiquid trading market, which limits your ability to sell your shares.

When and if it occurs, trading of RFIG common stock will likely be conducted on the OTC Bulletin Board and/or the OTC Markets Group, Inc. quotation services. This will likely have an adverse effect on the liquidity of RFIG common stock, not only in terms of the number of shares that could be bought and sold at a given price, but also through delays in the timing of transactions and reduction in security analyst and media coverage of RFIG common stock. Each of these factors alone could generally have a depressive effect on the price of RFIG common stock.

A large number of our shares are or will be eligible for future sale, which may cause the market price for our common stock to decline.

Upon completion of the spin-off, we will have outstanding an aggregate of approximately 41.2 million shares of our common stock. A large number of those shares will be freely tradable without restriction or registration under the Securities Act of 1933. We are unable to predict whether large amounts of our common stock will be sold in the open market following the spin-off. We are also unable to predict whether a sufficient number of buyers would be in the market at that time. A portion of Old Republic’s outstanding common stock is

 

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held by index funds tied to the Standard & Poor’s 500 Index, the Dow Jones Industrial Average or other stock indices. Based on a review of publicly available information as of March 31, 2012, we believe that at least 85% of Old Republic’s outstanding common stock is held by institutional investors. It is possible that these or other Old Republic shareholders will sell the shares of our common stock they receive in the spin-off for various reasons. For example, such shareholders may not believe that our business profile or level of market capitalization as an independent company fits their investment objectives. The sale of significant amounts of our common stock or the perception in the market that this will occur may lower the market price of our common stock.

Provisions in our corporate documents could delay or prevent a change in control of our company, even if that change may be considered beneficial by some of our shareholders.

The existence of some provisions of our certificate of incorporation and by-laws, as well as its shareholders’ rights plan described below, could discourage potential proposals to acquire our company, discourage, delay or prevent a change in control of our company that a shareholder may consider favorable, or limit the price that investors may be willing to pay in the future for shares of our common stock. These include provisions:

 

   

permitting our board of directors to issue and set the terms of preferred stock without the approval of our shareholders;

 

   

permitting our board of directors to adopt, amend or repeal our by-laws;

 

   

providing for the division of our board of directors into three classes with staggered terms; and

 

   

restricting the rights of shareholders to submit proposals to be considered at shareholders’ meetings.

In connection with the spin-off, we expect to adopt a rights plan under which each outstanding share of our common stock will include a common share purchase right. The rights will be attached to and trade with the shares of common stock and will not be currently exercisable. The rights will become exercisable if a person or group acquires, or announces an intention to acquire, 5% or more of our outstanding common stock. The rights have some anti-takeover effects and generally will cause substantial dilution to a person or group that attempts to acquire control of us without conditioning the offer on either redemption of the rights or amendment of the rights to prevent this dilution, each of which requires our board’s approval. The rights could have the effect of delaying, deferring or preventing a change of control.

In addition, following the spin-off, we will be subject to Section 203 of the Delaware General Corporation Law, which may have an anti-takeover effect with respect to transactions not approved in advance by our board of directors, including discouraging takeover attempts that might result in a premium over the market price for shares of our common stock.

We believe these provisions protect our shareholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with our board of directors and by providing our board of directors with more time to assess any acquisition proposal, and are not intended to make our company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our board of directors determines is not in the best interests of our company and our shareholders. See “Description of Capital Stock.”

We may issue preferred stock with terms that could dilute the voting power or reduce the value of our common stock.

Our certificate of incorporation authorizes us to issue, without the approval of our shareholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over our common stock respecting dividends and distributions, as our board of directors generally may determine. The terms of one or more classes or series of

 

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preferred stock could dilute the voting power or reduce the value of our common stock. For example, we could grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we could assign to holders of preferred stock could affect the residual value of the common stock. See “Description of Capital Stock—Preferred Stock.”

We have issued warrants to Old Republic to purchase 18,000,000 shares of our common stock at $0.12 per share, the exercise of which would dilute the voting power and possibly reduce the value of our common stock.

In March 2012, we issued to Old Republic warrants to purchase 18,000,000 shares of RFIG common stock at $0.12 per share. If all such warrants were exercised in the future at the rate of one RFIG common share per warrant, the issuance of 18,000,000 shares at an exercise price of $0.12 per share would result in Old Republic’s percentage ownership of our common stock increasing from less than 1% (after giving effect to the distribution) to approximately 31%. Such issuance would be dilutive to the voting power of our outstanding common stock and could reduce the value of our common stock. See “Recent Sales of Unregistered Securities.”

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

 

This information statement contains certain forward-looking information about RFIG and Old Republic that is intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. These statements may be made directly in this information statement or may be incorporated into this information statement by reference to other documents and may include statements for the period after the completion of the spin-off. Forward-looking statements are statements that are not historical facts. Words such as “expect,” “believe,” “will,” “may,” “anticipate,” “plan,” “estimate,” “intend,” “should,” “can,” “likely,” “could” and similar expressions are intended to identify forward-looking statements. These statements include statements about the expected benefits of the spin-off, information about our objectives, plans, and expectations, the likelihood of satisfaction of certain conditions to the completion of the spin-off and whether and when the spin-off will be completed. Forward-looking statements are not guarantees of performance. These statements are based upon the current beliefs and expectations of our management and are subject to a number of risks, uncertainties and assumptions, most of which are difficult to predict and many of which are beyond our control. These include, but are not limited to, quarterly variations in operating results, adverse changes in economic conditions, estimates and assumptions in determining financial results, and the other risks described under “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in addition to the following other factors:

 

   

Any failure to realize expected benefits from the spin-off;

 

   

Risks associated with our substantial leverage following the spin-off; and

 

   

A change in our revenue and operating costs following the spin-off.

THE SPIN-OFF

 

General

The board of directors of Old Republic regularly reviews the various operations conducted by Old Republic to ensure that resources are deployed and activities are pursued in the best interest of its shareholders. On May [            ], 2012, Old Republic announced that its board of directors had granted initial approval of a plan to take various actions in contemplation of the distribution of our common stock to Old Republic’s shareholders in a spin-off transaction. This authorization is subject to final approval by the Old Republic board of directors, which approval is subject to, among other things, the conditions described below under “—Spin-Off Conditions and Termination.”

 

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We are currently a majority-owned subsidiary of Old Republic. We will be separated from Old Republic and will become an independent, publicly held company through a pro rata distribution of approximately 78.5% of our outstanding common stock to Old Republic’s shareholders, which we refer to as the distribution or the spin-off, on [            ], 2012, the distribution date. As a result of the spin-off, each holder of Old Republic common stock as of 5:00 p.m. New York time on [            ], 2012, the record date, will be entitled to (i) receive one share of our common stock for each of eight shares of Old Republic common stock owned by such holder and (ii) retain such holder’s shares in Old Republic.

Old Republic shareholders will not be required to pay for shares of our common stock received in the spin-off or to surrender or exchange shares of Old Republic common stock in order to receive our common stock or to take any other action in connection with the spin-off. No vote of Old Republic shareholders is required or sought in connection with the spin-off, and Old Republic shareholders have no appraisal rights in connection with the spin-off.

Reasons for the Spin-Off

Old Republic’s board and management believe that our separation from Old Republic will provide the following benefits:

 

   

potentially allow our executive management to concentrate on, and give their full attention to our business;

 

   

potentially enhance the ability of each company to incentivize its key employees with equity-based compensation that is aligned with the performance of its own operations and the interests of RFIG's shareholders; and

 

   

potentially allow RFIG to raise capital from private capital market sources to refinance the business.

Enhancing ability to attract, retain and appropriately reward key employees

The capital resources and the management skills required to run a successful mortgage guaranty and credit indemnity business are different from those required to run different insurance businesses. Old Republic’s board of directors and management concluded that separating the two businesses should improve both businesses’ ability to attract managers with the appropriate skill sets. In addition, they concluded that the proposed spin-off will allow each company to provide incentive compensation to key employees in the form of equity-based incentive compensation that is better aligned with the performance of each business. By separating the two companies while in run-off and, possibly, as re-entrants to the businesses, management of each should be in an improved position to attract and retain employees with the correct skill set, to motivate them appropriately, and to retain them for the long term.

Opportunity to achieve a recapitalization of our mortgage guaranty and consumer credit indemnity business

Recessionary conditions in U.S. housing finance which began in 2007 have led to substantial losses in Old Republic’s mortgage insurance and consumer credit indemnity lines. As a result, capital funds identified with these lines at year-end 2006 have been fully depleted. Both of the lines are in a run-off operating mode, and cannot write new business due to the depleted capital accounts. While Old Republic still maintains a long-term strategic interest in these lines, it has stopped capital funding for them since they no longer meet Old Republic’s enterprise risk and capital management disciplines and objectives. In consideration of all these factors, Old Republic’s management and board of directors concluded that the necessary future recapitalization and re-direction of the combined business could best be effected by separating these operations from the Old Republic International Corporation holding company. Combining the two lines, while maintaining their separateness within RFIG, provides the corporate structure to achieve these objectives. In late May of this year, Old Republic announced that RFIG would be established as an independent publicly held company. The spin-off of the RFIG shares to Old Republic’s shareholders will accomplish this objective.

 

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Results of the Spin-Off

After the spin-off, we will be an independent, publicly traded company. Immediately following the spin-off, we expect that approximately 41.2 million shares of our common stock will be issued and outstanding, based on (i) the distribution of one share of our common stock for each eight shares of Old Republic common stock anticipated to be outstanding on the record date, (ii) 8,500,000 shares issued in a private placement completed in May, 2012, and (iii) approximately 371,000 shares of our common stock retained by Old Republic. In addition, Old Republic owns warrants to purchase an additional 18,000,000 shares of our common stock at a future, indeterminate date at $0.12 per RFIG common share. See “Recent Sales of Unregistered Securities.” The actual number of shares of our common stock to be distributed will be determined based on the number of shares of Old Republic common stock outstanding as of the record date.

We and Old Republic will be parties to a number of agreements that govern the spin-off and our future relationship. For a more detailed description of these agreements, please see “Relationship with Old Republic After the Spin-Off.”

You will not be required to make any payment for the shares of RFIG common stock you receive, nor will you be required to surrender or exchange your shares of Old Republic common stock or take any other action in order to receive the shares of RFIG common stock to which you are entitled. The spin-off will not affect the number of outstanding shares of Old Republic common stock or any rights of Old Republic shareholders, although it could affect the market value of the outstanding Old Republic common stock.

Manner of Effecting the Spin-Off

The general terms and conditions relating to the spin-off are set forth in a Separation and Distribution Agreement that we will enter into with Old Republic. For a description of the terms of that agreement, see “Relationship with Old Republic After the Spin-Off.” Under the Separation and Distribution Agreement, the spin-off will be effective on the distribution date. As a result of the spin-off, each Old Republic shareholder will be entitled to receive one share of our common stock for each of eight shares of Old Republic common stock owned on the record date. As discussed below under “—Trading of Old Republic Common Stock After the Record Date and Prior to the Distribution,” if a holder of record of Old Republic common stock sells those shares in the “regular way” market after the record date and prior to the distribution, that shareholder also will be selling the right to receive shares of our common stock in the distribution. The distribution will be made in book-entry form. For registered Old Republic shareholders, our transfer agent will credit their shares of our common stock to book-entry accounts established to hold their shares of our common stock. Book-entry refers to a method of recording stock ownership in our records in which no physical certificates are issued. For shareholders who own Old Republic common stock through a bank or brokerage firm, their shares of our common stock will be credited to their accounts by the bank or broker. See “—When and How You Will Receive RFIG Shares” below. Each share of our common stock that is distributed will be validly issued, fully paid and nonassessable. As indicated under “Description of Capital Stock”, we expect that purchase rights for one one-hundredth of a share of Series A Junior Participating Preferred Stock will initially be attached to and trade with all shares of common stock pursuant to the terms of RFIG’s Rights Agreement. Holders of shares of our common stock will not be entitled to preemptive rights. See “Description of Capital Stock.” Following the spin-off, shareholders whose shares are held in book-entry form may request the transfer of their shares of our common stock to a brokerage or other account at any time, without charge.

When and How You Will Receive RFIG Shares

On the distribution date, Old Republic will release its shares of our common stock for distribution by Wells Fargo Shareowner Services, the distribution agent. The distribution agent will cause the shares of our common stock to which you are entitled to be registered in your name or in the “street name” of your bank or brokerage firm.

 

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“Street Name” Holders. Many Old Republic shareholders have Old Republic common stock held in an account with a bank or brokerage firm. If this applies to you, that bank or brokerage firm is the registered holder that holds the shares on your behalf. For shareholders who hold their Old Republic common stock in an account with a bank or brokerage firm, our common stock being distributed will be registered in the “street name” of your bank or broker, who in turn will electronically credit your account with the shares that you are entitled to receive in the distribution. We anticipate that banks and brokers will generally credit their customers’ accounts with our common stock on or shortly after the distribution date. We encourage you to contact your bank or broker if you have any questions regarding the mechanics of having your shares credited to your account.

Registered Holders. If you are the registered holder of Old Republic common stock and hold your Old Republic common stock either in physical form or in book-entry form, the shares of our common stock distributed to you will be registered in your name and you will become the holder of record of that number of shares of our common stock. Our distribution agent will send you a statement reflecting your ownership of our common stock.

Direct Registration System. As part of the spin-off, we will be adopting a direct registration system for book-entry share registration and transfer of our common stock. The shares of our common stock to be distributed in the spin-off will be distributed as uncertificated shares registered in book-entry form through the direct registration system. No certificates representing your shares will be mailed to you in connection with the spin-off. Under the direct registration system, instead of receiving stock certificates, you will receive a statement reflecting your ownership interest in our shares. The distribution agent will begin mailing book-entry account statements reflecting your ownership of shares promptly after the distribution date. You can obtain more information regarding the direct registration system by contacting our transfer agent and registrar.

Treatment of Fractional Shares

No fractional shares will be issued. In the event a holder of Old Republic common stock would otherwise be entitled to a fractional share of RFIG common stock, the number of shares of RFIG common stock such holder will receive in the spin-off will be rounded up to the nearest whole number of shares of RFIG common stock.

Transferability of Shares You Receive

The shares of our common stock distributed to Old Republic shareholders will be freely transferable, except for shares received by persons who may be deemed to be our “affiliates” under the Securities Act of 1933, as amended, or the Securities Act. Persons who may be deemed to be our affiliates after the spin-off generally include individuals or entities that control, are controlled by, or are under common control with us, and include our directors and certain of our officers. Our affiliates will be permitted to sell their shares of RFIG common stock only pursuant to an effective registration statement under the Securities Act or an exemption from the registration requirements of the Securities Act, such as the exemption afforded by Rule 144.

Under Rule 144, an affiliate may not sell within any three-month period shares of our common stock in excess of the greater of:

 

   

1% of the then outstanding number of shares of our common stock; and

 

   

the average weekly trading volume of our common stock in the over-the-counter markets during the four calendar weeks preceding the filing of a notice with the SEC on Form 144 with respect to such sale.

Sales under Rule 144 are also subject to certain provisions regarding holding periods, the manner of sale, notice requirements and availability of current public information about us.

Stock-Based Plans

Upon the completion of the spin-off, all unvested options of Old Republic held by our employees, including those being transferred to us from Old Republic through the CCI acquistion, will become immediately vested

 

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and, along with any options currently vested and not exercised, will be exercisable during the period running from the date of the completion of the spin-off until the earlier to occur of the expiration of the option or the fourth anniversary from the date of the completion of the spin-off.

Material U.S. Federal Income Tax Consequences of the Spin-Off

The following is a summary of certain U.S. federal income tax consequences to holders of Old Republic common stock. This summary does not discuss all tax considerations that may be relevant to stockholders in light of their particular circumstances, nor does it address the consequences to stockholders subject to special treatment under the U.S. federal income tax laws, such as tax-exempt entities, non-resident alien individuals, foreign entities, foreign trusts and estates and beneficiaries thereof, stockholders who acquire shares as compensation for services, insurance companies and dealers in securities. In addition, this summary does not address any state, local or foreign tax consequences.

All stockholders should consult their own tax advisors concerning the specific tax consequences of the distribution of our common stock to holders of Old Republic common stock in light of their particular circumstances. This summary is not intended to be, nor should it be construed to be, legal or tax advice to any particular investor.

U.S. Stockholders

We intend to take the position that the spin-off will be a taxable transaction for U.S. federal income tax purposes. Assuming this to be the case, a U.S. stockholder receiving shares of our common stock in the spin-off will be treated as receiving a distribution of property equal to the fair market value on the distribution date of the shares received. That distribution will be taxable as a dividend to the extent of the U.S. stockholder’s ratable share of Old Republic’s current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. Subject to certain limitations, the portion of the distribution treated as a dividend may be taxable to individuals at a reduced rate of 15%. Any amount of the distribution that exceeds a U.S. stockholder’s ratable share of Old Republic’s current and accumulated earnings and profits will be treated as a tax-free return of capital that reduces (but not below zero) the U.S. stockholder’s adjusted tax basis in its Old Republic common stock to the extent of such tax basis, with any remaining amount taxable as capital gain from the sale or exchange of Old Republic common stock. This determination is made on a share-by-share basis. Any capital gain will be long-term capital gain if the U.S. stockholder’s holding period for its shares of Old Republic common stock exceeds one year on the distribution date.

A U.S. stockholder’s tax basis in its shares of our common stock received in the spin-off generally will equal the fair market value of such shares on the distribution date, and a U.S. stockholder’s holding period for such shares will begin the day after the distribution date. As noted above, a U.S. stockholder’s tax basis in its shares of Old Republic common stock generally will be reduced (but not below zero) to the extent the spin-off represents a return of capital to such holder; the U.S. stockholder’s holding period for such Old Republic shares will not be affected by the spin-off.

We have not determined at this point the amount of the distribution or what portion, if any, of the distribution will be treated as a taxable dividend. This will be determined by us after the distribution and will be reported to our stockholders as described below under the caption, “Tax Reporting.”

Backup withholding may apply with respect to the amount of the distribution treated as a dividend paid to a U.S. stockholder, unless the U.S. stockholder provides a correct taxpayer identification number (which, in the case of an individual, is his or her social security number) and certifies whether such U.S. stockholder is subject to backup withholding by properly completing and executing IRS Form W-9 (or successor form) or otherwise establishes a basis for exemption from backup withholding. Certain U.S. stockholders (including, among others, corporations) are not subject to backup withholding. If backup withholding is required, shares of our common stock will be held back and sold on the market to the extent necessary to remit tax to the IRS and to pay brokerage and other costs.

 

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Non-U.S. Stockholders

For non-U.S. stockholders, the treatment of the spin-off by Old Republic of our common stock as a dividend, a return of capital or a capital gain will be determined in the manner described above under “U.S. Stockholders.”

In the case of a non-U.S. stockholder, the amount of the distribution constituting a dividend for U.S. federal income tax purposes will generally be subject to U.S. federal income tax at a rate of 30%, or a lower rate specified in any applicable income tax treaty. The amount of the distribution not constituting a dividend generally will not be subject to U.S. federal income tax.

The 30% income tax referenced above is generally collected by way of withholding. To the extent such withholding is required with respect to a non-U.S. stockholder, the withholding agent will sell a portion of the RFIG stock that has been allocated to such non-U.S. stockholder to satisfy the withholding tax liability and to pay brokerage and other costs. Non-U.S. stockholders who wish to claim the benefit of an applicable income tax treaty or other reduction in withholding for the spin-off must provide the withholding agent with a properly executed IRS Form W-8BEN, claiming such reduction.

Special rules will apply to a non-U.S. stockholder whose ownership of Old Republic common stock is treated as effectively connected with such non-U.S. stockholder’s trade or business conducted within the United States (or, if certain tax treaties apply, is attributable to a permanent establishment maintained in the United States).

Tax Reporting

The fair market value of the RFIG common stock received by each Old Republic stockholder will be determined by us after the distribution, based on a number of factors that will include, without limitation, the trading price of RFIG common stock at or near the distribution date. After this determination is made (and within the time limit required by the Internal Revenue Code), we will report to such stockholder and to the IRS the amount of the distribution (consisting of the fair market value of the RFIG common stock), together with the portion of the distribution treated as a taxable dividend. There is no assurance that the IRS or the courts will agree that the amount received in the distribution by an Old Republic stockholder is the amount determined by us, and it is possible that the IRS and the courts will ultimately determine that Old Republic stockholders, or some of them, received a larger distribution amount for Federal income tax purposes than the amounts reported to them by us. If the IRS were to challenge the amount of the distribution reportable by any Old Republic stockholder on such stockholder’s Federal income tax return, such stockholder would have to bear the expense and effort of defending against or otherwise resolving such challenge.

Consequences to Old Republic

If the fair market value of the RFIG common stock distributed in the spin-off exceeds Old Republic’s tax basis in such stock at the distribution date, the distribution will be treated as a taxable sale by Old Republic. Old Republic will recognize a gain on the distribution in an amount equal to the excess of the fair market value of the RFIG common stock on the distribution date over its tax basis in such common stock. If, however, Old Republic’s tax basis in the RFIG common stock exceeds the fair market value of such stock on the distribution date, then no gain or loss will be recognized by Old Republic on the distribution. Any such gain recognized may be offset, to the extent available, by capital loss carryovers and net operating loss carryovers.

The amount received in the distribution attributable to the RFIG common stock (i.e., the fair market value of the stock that is distributed) will be determined after the distribution, based on a number of factors that will include, without limitation, the trading price of RFIG common stock at or near the distribution date. Accordingly, the actual tax impact of the distribution on Old Republic cannot be determined until after the distribution.

 

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THE FOREGOING DISCUSSION DOES NOT PURPORT TO BE A COMPLETE DISCUSSION OF THE POTENTIAL TAX CONSEQUENCES OF THE SPIN-OFF. YOU SHOULD CONSULT YOUR OWN TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES TO YOU OF THE SPIN-OFF, INCLUDING THE APPLICABILITY AND EFFECT OF U.S. FEDERAL, STATE, LOCAL AND FOREIGN INCOME, ESTATE, GIFT AND OTHER TAX LAWS IN YOUR PARTICULAR CIRCUMSTANCES. NOTHING IN THIS DISCUSSION IS INTENDED TO BE, OR SHOULD BE CONSTRUED AS, TAX ADVICE.

Market for Our Common Stock

There is currently no public market for RFIG common stock. We have not applied to list RFIG common stock on any securities exchange but, subject to completion of the spin-off, we anticipate that RFIG common stock will trade in the over-the-counter market (OTCBB and/or OTC Markets Group, Inc. quotation services) after completion of applications by market makers with FINRA and/or the OTC Markets Group, Inc. Neither we nor Old Republic can give any assurances as to whether a trading market will develop or at what price our common stock may trade if a trading market develops following the spin-off. The trading price of RFIG common stock is likely to fluctuate significantly, particularly until an orderly market develops, if such a market develops. We cannot predict whether such a market will ever develop or the prices at which our shares may trade following the spin-off. See “Risk Factors—Risks Relating to Ownership of Our Common Stock.”

It is possible that trading of our common stock will commence on a when-issued basis shortly before the record date. When-issued trading refers to a sale or purchase made conditionally because the security has been authorized but not yet issued. On the first trading day following the distribution date, when-issued trading with respect to our common stock will end and “regular way” trading will begin. “Regular way” trading refers to trading after a security has been issued and typically involves a transaction that settles on the third full business day following the date of the transaction. We cannot predict what the trading prices for our common stock will be before or after the distribution date. See “Risk Factors—Risks Relating to Ownership of Our Common Stock.”

Trading of Old Republic Common Stock After the Record Date and Prior to the Distribution

Beginning on or shortly before the record date and through the distribution date, there will be two concurrent markets in which to trade Old Republic common stock: a “regular way” market and an ex-distribution market. Shares of Old Republic common stock that trade in the "regular way" market will trade with an entitlement to shares of our common stock distributed in connection with the spin-off. Shares that trade in the ex-distribution market will trade without an entitlement to shares of our common stock distributed in connection with the spin-off. Therefore, if you owned shares of Old Republic common stock at 5:00 p.m., New York time, on the record date and sell those shares in the “regular way” market after the record date and on or prior to the distribution date, you also will be selling your right to receive the shares of our common stock that would have been distributed to you in connection with the spin-off. If you sell those shares of Old Republic common stock in the ex-distribution market after the record date and on or prior to the distribution date, you will still receive the shares of our common stock that were to be distributed to you in connection with the spin-off as a result of your ownership of the shares of Old Republic common stock.

Spin-Off Conditions and Termination

We expect that the spin-off will be effective on [            ], 2012, provided that, among other things:

 

   

the completion of the distribution and the related transactions in accordance with the provisions set forth in the Separation and Distribution Agreement;

 

   

the SEC declaring effective our registration statement on Form 10, of which this information statement forms a part, no stop order suspending the effectiveness of the Form 10 shall be in effect, no proceedings for such purpose shall be pending before or threatened by the SEC and this information statement shall have been mailed to holders of Old Republic common stock as of the Record Date;

 

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all actions and filings necessary or appropriate under applicable federal, state or foreign securities or “blue sky” laws shall have been taken and, where applicable, become effective or been accepted by the applicable governmental authority;

 

   

the transaction agreements relating to the spin-off shall have been duly executed and delivered by the parties;

 

   

no order, injunction or decree issued by any court of competent jurisdiction or other legal restraint or prohibition preventing consummation of the distribution or any of the related transactions shall be in effect;

 

   

except for Messrs. Zucaro and Leroy as more fully described under “Management,” all of Old Republic’s representatives or designees shall have resigned or been removed as officers of RFIG or its subsidiaries and all of our representatives or designees shall have resigned or been removed as officers of Old Republic or its subsidiaries; and

 

   

no event or development shall have occurred or exist that, in the judgment of Old Republic’s board of directors, in its sole discretion, makes it inadvisable to effect the spin-off and other related transactions.

We cannot assure you that any or all of these conditions will be met. Old Republic may waive one or more of these conditions in its sole and absolute discretion, and the determination by Old Republic regarding the satisfaction of these conditions will be conclusive. The fulfillment of these conditions will not create any obligation on Old Republic’s part to effect the distribution, and Old Republic has reserved the right to amend, modify or abandon any and all terms of the distribution and the related transactions at any time prior to the distribution date.

Reason for Furnishing this Information Statement

This information statement is being furnished solely to provide information to Old Republic shareholders who will receive shares of RFIG common stock in the spin-off. It is not to be construed as an inducement or encouragement to buy or sell any of our securities. We believe that the information contained in this information statement is accurate as of the date set forth on the cover. Changes may occur after that date and neither Old Republic nor we undertake any obligation to update the information, except to the extent applicable securities laws require us to do so.

CAPITALIZATION

 

The following table presents our historical capitalization at March 31, 2012 on an actual basis and on a pro forma basis to give effect to (i) the issuance of 8,500,000 shares of common stock in a private placement completed in mid-May, 2012, and (ii) the spin-off and the related transactions as if the spin-off and the related transactions had occurred as of that date.

We are providing the capitalization table below for informational purposes only. You should not construe it as indicative of our capitalization or financial condition had the spin-off and the related transactions and events been completed on the date assumed. The capitalization table below also may not reflect the capitalization or financial condition that would have resulted had we been operated as an independent, public company at that date or our future capitalization or financial condition.

 

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You should read the table below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our “Consolidated Financial Statements” and related notes included elsewhere in this information statement.

 

As of March 31, 2012 ($ in Millions)

   Actual     Pro Forma  

Debt

   $ 177.8      $ 177.8   
  

 

 

   

 

 

 

Common Shareholder’s Equity:

    

Common stock(*)

     0.3        0.4   

Additional paid-in-capital

     227.2        228.2   

Retained earnings (accumulated deficit)(**)

     (256.9     (291.5

Accumulated other comprehensive income (loss)

     11.7        11.7   
  

 

 

   

 

 

 

Total Common Shareholder’s Equity

     (17.5     (51.1
  

 

 

   

 

 

 

Total Capitalization

   $ 160.3      $ 126.6   
  

 

 

   

 

 

 

 

(*) At March 31, 2012 (i) there were 100,000,000 shares of $.01 par value common stock authorized, of which 32,787,914 shares were outstanding, (ii) there were 50,000,000 Class B shares of $.01 par value common stock authorized, none of which were outstanding, and (iii) there were 25,000,000 shares of $0.01 par value preferred stock authorized, of which no shares were outstanding. The number of shares of common stock shown to be outstanding upon completion of the spin-off includes 8,500,000 shares of common stock issued in a private placement completed in mid-May, 2012. See “Recent Sales of Unregistered Securities.”

 

(**) Following the spin-off, RFIG will no longer be included in Old Republic's consolidated tax return. Consequently, it is more likely than not that full realization of RFIG's deferred tax assets of $34.6 million as of March  31, 2012 would not be achieved.

DIVIDEND POLICY

 

We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any future earnings to finance our operations. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operating results, capital requirements, any contractual, regulatory or other restrictions on the payment of dividends by our subsidiaries to RFIG, and other factors that our board of directors deems relevant.

RFIG is a holding company and has no direct operations. Our ability to pay dividends in the future will depend on the ability of our operating subsidiaries to pay dividends to us. Our insurance company subsidiaries are regulated insurance companies and therefore are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. RMIC and RMICNC are domiciled in North Carolina, RMICFL is domiciled in Florida, and RCIC is domiciled in Illinois. The insurance laws of these states generally limit the payments of dividends by an insurance company unless it has sufficient capital and surplus. Under the Order, RMIC is currently prohibited from transferring any of its property, which would include paying dividends to RFIG. Given RMIC’s current financial condition and operating outlook, we do not expect RMIC will ever pay dividends to RFIG.

For additional information regarding restrictions on the payment of dividends by us and our insurance company subsidiaries, see “Business—Regulation.”

 

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SELECTED HISTORICAL FINANCIAL DATA

 

The following tables present a summary of selected historical financial data for the periods indicated for Republic Financial Indemnity Group, Inc. and the Consumer Credit Indemnity Division.

Republic Financial Indemnity Group, Inc. —The selected historical statements of income and the selected balance sheet data as of and for the years ended December 31, 2009, 2008, and 2007 are derived from our unaudited consolidated financial statements, which are not included in this information statement. The selected historical statements of income and selected balance sheet data as of and for each of the years ended December 31, 2011 and 2010 are derived from our audited consolidated financial statements, which are included elsewhere in this information statement.

The selected historical financial data for the quarterly periods ended March 31, 2012 and 2011 are derived from our unaudited interim consolidated financial statements, which are included elsewhere in this information statement. We have prepared our unaudited consolidated financial statements on the same basis as our audited consolidated financial statements and have included all adjustments, consisting of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the audited periods. The selected historical financial data for the first quarters of 2012 and 2011 are not necessarily indicative of the results that may be obtained for a full year.

Consumer Credit Indemnity (“CCI”) Division—The CCI line has been a division of Old Republic Insurance Company (“ORINSCO”) since it was established in 1955. The selected historical statements of income for all periods indicated are derived from our unaudited internal divisional financial statements, which are not included in this information statement. As a division, the CCI business has not had a legally dedicated capital structure. Moreover, underwriting operations during all periods presented have generally been cash flow negative as paid claims have far exceeded premium income. Accordingly, little investment income has been attributed to the CCI line’s income statement. All other adjustments, consisting of normal and recurring adjustments, that we consider necessary for fair presentation of our operating results have been recorded in the preparation of the divisional financial statements.

The financial statements included in this information statement may not necessarily reflect our financial position, results of operations, and cash flows as if we had operated as a stand-alone public company during all periods presented. Accordingly, our historical results should not be relied upon as an indicator of our future performance.

The following selected historical financial data should be read in conjunction with “Capitalization”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our “Consolidated Financial Statements” and related notes included elsewhere in this information statement.

 

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Republic Financial Indemnity Group, Inc.

Selected Historical Financial Data

($ in Millions, Except Share Data)

 

 

    As of and For the
Quarters Ended
March 31,
    As of and For the Years Ended December 31,  
Statements of Income Data:   2012     2011     2011     2010     2009     2008     2007  

Revenues:

             

Net premiums earned

  $ 103.2      $ 113.9      $ 444.9      $ 498.8      $ 644.5      $ 592.5      $ 518.2   

Net investment income

    10.3        16.6        59.2        84.9        92.0        86.8        79.0   

Other income

    6.6        .5        1.9        4.6        9.5        10.6        11.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

    120.2        131.2        506.1        588.4        746.1        690.0        608.3   

Realized investment gains (losses)

    —          1.4        84.6        43.4        1.1        (9.9)        7.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    120.2        132.6        590.8        631.9        747.2        680.1        615.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Benefits, Claims and Expenses:

             

Claims and settlement expenses

    179.3        212.7        1,057.1        766.2        1,134.1        1,180.7        615.8   

Underwriting, acquisition and other expenses

    20.6        17.8        108.3        76.3        91.1        103.6        102.9   

Interest and other charges

    2.0        1.8        18.7        6.6        7.2        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    202.0        232.4        1,184.3        849.3        1,232.5        1,284.4        718.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes (credits)

    (81.8)        (99.7)        (593.5)        (217.3)        (485.2)        (604.3)        (102.9)   

Total Income Taxes (Credits)

    (28.6)        (35.1)        (204.6)        (79.4)        (175.1)        (217.1)        (41.4)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

  $ (53.2)      $ (64.5)      $ (388.8)      $ (137.8)      $ (310.1)      $ (387.2)      $ (61.5)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) Per Share:

             

Basic and diluted

  $ (2.75)      $ (3.97)      $ (23.91)      $ (8.48)      $ (19.07)      $ (23.81)      $ (3.78)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average Shares Outstanding:

             

Basic and diluted

    19,349,643        16,262,473        16,262,473        16,262,473        16,262,473        16,262,473        16,262,473   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet Data:

             

Total assets

  $ 2,025.2      $ 2,387.8      $ 2,027.6      $ 2,537.9      $ 3,233.4      $ 2,973.1      $ 2,523.8   

Total policy liabilities and accruals

    1,787.2        1,711.9        1,757.1        1,803.3        2,303.8        1,674.0        727.7   

Debt(2)

    177.8        175.0        175.0        150.0        150.0        150.0        —     

Common shareholder’s equity(1)

  $ (17.5)      $ 374.6      $ 16.2      $ 441.1      $ 581.7      $ 828.0      $ 1,237.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Book Value Per Share

  $ (0.54)      $ 23.04      $ 1.00      $ 27.13      $ 35.77      $ 50.92      $ 76.11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common Shares
Outstanding

    32,787,914        16,262,473        16,262,473        16,262,473        16,262,473        16,262,473        16,262,473   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

39


Table of Contents

Notes

 

(1) Acquisition of and Combination with Old Republic’s Credit Indemnity Division - In March, 2012, RFIG issued 16,525,441 common shares in exchange for all the stock of Republic Credit Indemnity Companies, Inc. (“RCICI”), an insurance holding company recently formed by ORI. RCICI was organized to encompass the Consumer Credit Indemnity (“CCI”) Division of ORI’s General Insurance Group (property and liability) subsidiary. On the date of exchange, RCICI’s balance sheet consisted of the following accounts ($ in millions):

 

Cash and short-term funds

   $  15.0   

Investment in three CCI agency and related services companies at ORI’s historical GAAP carrying value

     1.5   
  

 

 

 

Total assets

   $ 16.5   
  

 

 

 

Liabilities

   $ —     
  

 

 

 

Common shareholder's equity:

  

Capital stock

     .1   

Paid in capital

     16.0   

Retained earnings

     .3   
  

 

 

 

Total common shareholder's equity

     16.5   
  

 

 

 

Total liabilities and common shareholder's equity

   $ 16.5   
  

 

 

 

 

(2) In March, 2012 the Company’s $175.0 million notes payable to ORI were increased to $180.0 million after a cash receipt of $5.0 million from ORI. The notes were then consolidated into a single new note with detachable warrants to acquire RFIG common shares. The new note expires on December 31, 2038 and bears a variable interest rate indexed to the London Interbank Offered Rate ("LIBOR") plus 450 basis points, not to exceed a maximum rate of 8.5%. The new note is collateralized by the surplus notes previously issued by RMIC and RMICNC in the aggregate amount of $155.0 million and the stock of our three mortgage insurance companies.

Concurrent with the issuance of the new note, a total of 18,000,000 warrants were issued with the right to purchase one RFIG common share for $0.12 per share per warrant. The warrants may be exercised in whole or in part at any time after March 31, 2015 except that earlier exercise could occur in the event of certain exigent circumstances such as the acquisition of more than 15% of any RFIG voting securities by any one investor or group of investors acting in concert. A portion of the note principal amount was allocated to the warrants and accounted for as additional paid-in capital equal to their relative fair value of $2.1 million.

 

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Table of Contents

Consumer Credit Indemnity (CCI) Division

Selected Historical Financial Data

($ in Millions)

 

 

     Quarters Ended
March 31,
    Years Ended December 31,  
Statement of Income Data:    2012     2011     2011     2010     2009     2008     2007  

Revenues:

              

Net premiums earned

   $ 12.0      $ 20.8      $ 58.3      $ 87.9      $ 121.4      $ 204.3      $ 193.4   

Net investment income

     —          —          —          —          —          .3        .5   

Other income

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     12.0        20.8        58.4        88.0        121.5        204.6        194.0   

Realized investment gains (losses)

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     12.0        20.8        58.4        88.0        121.5        204.6        194.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Benefits, Claims and Expenses:

              

Claims and settlement expenses

     20.2        40.0        102.9        225.4        225.7        264.9        181.3   

Underwriting, acquisition and other expenses

     1.2        1.0        5.1        6.5        7.0        8.3        7.8   

Interest and other charges

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     21.5        41.1        108.0        232.0        232.8        273.3        189.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes (credits)

     (9.4     (20.2     (49.6     (143.9     (111.2     (68.6     4.8   

Total Income Taxes (Credits)

     (3.3     (7.0     (17.3     (50.3     (38.9     (24.0     1.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

   $ (6.1   $ (13.1   $ (32.2   $ (93.5   $ (72.3   $ (44.6   $ 3.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

41


Table of Contents

UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

 

The following unaudited pro forma combined financial statements (together with the related notes) should be read in conjunction with the sections entitled “Business”, “Selected Historical Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical annual and interim RFIG Consolidated Financial Statements and accompanying notes included elsewhere within this information statement.

The unaudited pro forma combined statements of income give effect to the spin-off as if it had occurred on January 1, 2011. The unaudited pro forma combined condensed balance sheet gives effect to the spin-off as it had occurred on March 31, 2012. In management’s opinion, the unaudited pro forma combined financial statements reflect adjustments that are both necessary to present fairly the unaudited pro forma combined statements of income and the unaudited pro forma combined condensed balance sheet of our business and for the periods indicated and are reasonable given the information currently available.

The unaudited pro forma combined financial statements are for illustrative and informational purposes only and are not intended to represent what our results from operations or financial position would have been had the transactions contemplated below occurred on the dates indicated. The unaudited pro forma combined financial statements should not be considered indicative of our future results of operations or financial position as an independent, public company.

The following unaudited pro forma combined financial statements give pro forma effect to the following:

 

   

Separation of the combined mortgage guaranty (“MI”) and consumer credit indemnity (“CCI”) insurance lines from Old Republic International Corporation’s consolidated business.

 

   

Acquisition for cash of $3.2 million all of the stock of the Republic Credit Indemnity Company (“RCIC”), an inactive property and liability insurer owned by an ORI subsidiary.

 

   

Assumption as reinsurance by RCIC of a 100% quota share portfolio as of April 1, 2012 of all CCI premium and loss reserves from Old Republic Insurance Company, the ORI insurance company subsidiary that underwrote this coverage.

 

   

RCIC’s entering into a stop loss reinsurance agreement with an ORI general insurance subsidiary. In substance, the stop loss agreement will cover RCIC’s quota share exposures in excess of 85% loss ratio retention (for up to 70 additional loss ratio points) during the term of the reinsurance contract.

 

   

Private placement of 8,500,000 newly issued shares of common stock at $0.12 per share (partial leveraged buyout).

 

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Table of Contents

Republic Financial Indemnity Group, Inc.

Unaudited Pro Forma Combined Statements of Income

($ in Millions, Except Share Data)

 

 

     Historical              
Quarter Ended March 31, 2012:    RFIG     CCI
Division
    Adjustments     Pro forma  

Revenues:

        

Net premiums earned

   $ 103.2      $ 12.0      $ (1.2 )(2)    $ 114.1   

Net investment income

     10.3        —          —          10.3   

Other income

     6.6        —          (6.2 )(3)      .3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     120.2        12.0        (7.4     124.8   

Realized investment gains (losses)

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     120.2        12.0        (7.4     124.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Claims and expenses:

        

Claims and settlement expenses

     179.3        20.2        (7.6 )(2)      191.9   

Underwriting, acquisition and other expenses

     20.6        1.2        (6.1 )(3)      15.8   

Interest and other charges

     2.0        —          —          2.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     202.0        21.5        (13.7     209.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes (credits)

     (81.8     (9.4     6.2        (85.0

Income taxes (credits)

     (28.6     (3.3     68.2 (1)      36.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (53.2   $ (6.1   $ (62.0   $ (121.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

   $ (2.75       $ (2.94
  

 

 

       

 

 

 

Average shares outstanding

     19,349,643            41,287,914   
  

 

 

       

 

 

 

Underwriting ratio:

        

Claim ratio

     173.6     167.6       168.2

Expense ratio

     13.6        10.5          13.5   
  

 

 

   

 

 

     

 

 

 

Composite ratio

     187.2     178.1       181.7
  

 

 

   

 

 

     

 

 

 

 

     Historical              
Quarter Ended March 31, 2011:    RFIG     CCI
Division
    Adjustments     Pro forma  

Revenues:

        

Net premiums earned

   $ 113.9      $ 20.8      $ (2.0 )(2)    $ 132.7   

Net investment income

     16.6        —          —          16.6   

Other income

     .5        —          —          .6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     131.2        20.8        (2.0     150.0   

Realized investment gains (losses)

     1.4        —          —          1.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     132.6        20.8        (2.0     151.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Claims and expenses:

        

Claims and settlement expenses

     212.7        40.0        (13.1 )(2)      239.7   

Underwriting, acquisition and other expenses

     17.8        1.0        .2        19.1   

Interest and other charges

     1.8        —          —          1.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     232.4        41.1        (12.8     260.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes (credits)

     (99.7     (20.2     10.7        (109.2

Income taxes (credits)

     (35.1     (7.0     3.7 (1)      (38.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (64.5   $ (13.1   $ 7.0      $ (70.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

   $ (3.97       $ (1.71
  

 

 

       

 

 

 

Average shares outstanding

     16,262,473            41,287,914   
  

 

 

       

 

 

 

Underwriting ratio:

        

Claim ratio

     186.7     192.1       180.5

Expense ratio

     15.1        5.1          14.0   
  

 

 

   

 

 

     

 

 

 

Composite ratio

     201.8     197.2       194.5
  

 

 

   

 

 

     

 

 

 

 

43


Table of Contents

Republic Financial Indemnity Group, Inc.

Unaudited Pro Forma Combined Statements of Income

($ in Millions, Except Share Data)

 

 

     Historical              

Year Ended December 31, 2011:

   RFIG     CCI
Division
    Adjustments     Pro forma  

Revenues:

        

Net premiums earned

   $ 444.9      $ 58.3      $ (5.8) (2)    $ 497.4   

Net investment income

     59.2        —          —          59.3   

Other income

     1.9        —          —          2.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     506.1        58.4        (5.8)        558.7   

Realized investment gains (losses)

     84.6        —          —          84.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     590.8        58.4        (5.8)        643.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Claims and expenses:

        

Claims and settlement expenses

     1,057.1        102.9        (36.7) (2)      1,123.3   

Underwriting, acquisition and other expenses

     108.3        5.1        1.0        114.5   

Interest and other charges

     18.7        —          —          18.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     1,184.3        108.0        (35.6)        1,256.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes (credits)

     (593.5)        (49.6)        29.8        (613.2)   

Income taxes (credits)

     (204.6)        (17.3)        173.2 (1)      (48.7)   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (388.8)      $ (32.2)      $ (143.4)      $ (564.5)   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

   $ (23.91)          $ (13.67)   
  

 

 

       

 

 

 

Average shares outstanding

     16,262,473            41,287,914   
  

 

 

       

 

 

 

Underwriting ratio:

        

Claim ratio

     237.6     176.5       225.8

Expense ratio

     23.9        8.7          22.6   
  

 

 

   

 

 

     

 

 

 

Composite ratio

     261.5     185.2       248.4
  

 

 

   

 

 

     

 

 

 

Notes

 

(1) Income Taxes — The allocation of current and deferred income taxes is based on RFIG’s relative contribution to ORI’s consolidated income tax expense or benefit with current credit for net losses to the extent recoveries are available through group income offsets or carry-back claims. RFIG’s financial statements reflect the application of this methodology to all periods presented. Under a separate return approach, taxes would be allocated to ORI’s subsidiaries as if they were separate taxpayers and stand-alone entities. Under this approach, it is more likely than not that full realization of RFIG’s deferred tax assets would not be achieved relative to the full year 2011 and first quarter 2012. The tables above demonstrate the impact on RFIG’s financial statements as if taxes were allocated to RFIG using a separate return approach.

 

(2) Stop Loss Agreement — Following the 100% quota share assumption of the CCI run-off business in 2012, RCIC expects to enter into a stop loss reinsurance agreement with an ORI general insurance subsidiary. In substance the stop loss agreement will cover the Company’s quota share exposures in excess of an 85% loss ratio retention (for up to 70 additional loss ratio points) during the term of the reinsurance contract.

 

(3) Represents consolidation elimination adjustments.

 

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Table of Contents

Republic Financial Indemnity Group, Inc.

Unaudited Pro Forma Condensed Combined Balance Sheet

($ in Millions, Except Share Data)

 

 

As of March 31, 2012:

   Historical
RFIG
    Adjustments     Pro forma  

Assets:

      

Cash and fixed maturity securities

   $ 1,642.3      $ 32.4 (2)    $ 1,675.8   
       1.0 (3)   

Equity securities

     —          —          —     

Other invested assets

     12.9        —          12.9   

Accounts and premiums receivable

     26.0        .9 (2)      26.9   

Federal income taxes recoverable: Current

     162.1        —          162.1   

Deferred

     34.6        (34.6 )(1)      —     

Reinsurance balances recoverable

     78.7        —          78.7   

Prepaid federal income taxes

     1.0        —          1.0   

Sundry assets

     67.3        —          67.3   
  

 

 

   

 

 

   

 

 

 

Total

   $ 2,025.2      $ (0.2   $ 2,025.0   
  

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity:

      

Policy liabilities

   $ 146.6      $ 7.9 (2)    $ 154.5   

Benefit and claim reserves

     1,640.6        25.4 (2)      1,666.0   

Debt

     177.8        —          177.8   

Sundry liabilities

     77.7        —          77.7   

Shareholders’ equity

     (17.5     (34.6 )(1)      (51.1
       1.0 (3)   
  

 

 

   

 

 

   

 

 

 

Total

   $ 2,025.2      $ (0.2   $ 2,025.0   
  

 

 

   

 

 

   

 

 

 

Book Value Per Share

   $ (0.54     $ (1.24
  

 

 

     

 

 

 

Common Shares Outstanding

     32,787,914          41,287,914   
  

 

 

     

 

 

 

Notes

 

(1) The allocation of current and deferred income taxes is based on RFIG’s relative contribution to ORI’s consolidated income tax expense or benefit with current credit for net losses to the extent recoveries are available through group income offsets or carry-back claims. RFIG’s financial statements reflect the application of this methodology to all periods presented. Under a separate return approach, taxes would be allocated to ORI’s subsidiaries as if they were separate taxpayers and stand-alone entities. Under this approach, it is more likely than not that full realization of RFIG’s deferred tax assets would not be achieved. The table above demonstrates the impact on RFIG’s March 31, 2012 balance sheet as if taxes were allocated to RFIG using a separate return approach.

 

(2) Represents the assumption as reinsurance by RCIC a 100% quota share portfolio of all CCI premium and loss reserves from the ORI insurance company subsidiary that underwrote this coverage.

 

(3) Private placement of 8,500,000 newly issued shares of common stock at $0.12 per share (partial leveraged buyout).

 

45


Table of Contents

BUSINESS

 

Who We Are

Republic Financial Indemnity Group, Inc. (“RFIG”) is currently a majority-owned subsidiary of Old Republic. RFIG is a holding company which, through its wholly-owned operating subsidiaries, Republic Mortgage Insurance Company (“RMIC”), Republic Mortgage Insurance Company of North Carolina (“RMICNC”), and Republic Mortgage Insurance Company of Florida (“RMICFL”), is principally engaged as a nationwide private mortgage insurer.

In mid-March , 2012, Old Republic reorganized its operations to combine its consumer credit indemnity (“CCI”) division with its mortgage guaranty operations. These two operations offer similar insurance coverages, share the same senior management leadership, and have been operating in run-off mode since 2008 and August, 2011, respectively. The term “run-off” means continuing to service existing insurance policies but not writing any new policies. Accordingly, the future results of RFIG will reflect the performance of the run-off of its mortgage guaranty business as well as its CCI business. See “—Recent Developments.”

The spin-off will separate our mortgage guaranty and CCI business from the remainder of Old Republic’s operations and holdings. Recessionary conditions in U.S. housing finance which began in 2007 have erased the long-term profitability of Old Republic’s mortgage guaranty and CCI insurance lines and led to substantial losses. As a result, capital funds identified with these lines at year-end 2006 have been fully depleted. While Old Republic still maintains a long-term strategic interest in these lines, it has stopped capital funding for them since they no longer meet its enterprise risk and capital management disciplines and objectives. In consideration of all these factors, Old Republic’s management and board of directors have concluded that a necessary future recapitalization of the combined mortgage guaranty and CCI businesses can best be effected by separating these operations from Old Republic’s consolidated holdings.

RMIC, our flagship mortgage guaranty insurance carrier, had been operating pursuant to a waiver of minimum state regulatory capital requirement 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 placed in run-off operating mode. On January 19, 2012, the NCDOI, issued an Order, providing for its immediate administrative supervision of RMIC’ s run-off operations. The Order responds to the capital depletion at RMIC caused by an unprecedented level of losses experienced industry-wide. See “ — Run-off and Regulatory Supervision.”

In light of all the above factors our Mission as in independent company will be:

 

   

First and foremost to manage the MI and CCI run-off books of business in the most economical manner for the best interest of policyholders and their beneficiaries;

 

   

To operate as an administrative services company by offering our well-regarded policyholder and claim management services, and our information technology data base and processing facilities, to other unrelated parties that could gain economic benefits and efficiency from such services; and

 

   

To seek to recapitalize one or more of our MI and CCI insurance companies by accessing the capital markets for the new capital necessary for a re-entry into these insurance lines. Our re-entry will give important consideration to a redefined and legitimately robust business model that addresses currently, through reinsurance or similar means, the continued exposures of these lines to future economic catastrophe events such as those experienced since 2007.

Our Mortgage Guaranty Business - Historical Overview

Private mortgage insurance protects mortgage lenders and investors from default related losses on residential mortgage loans made primarily to homebuyers who make down payments of less than 20% of the home's purchase price. We insure only first mortgage loans, primarily on residential properties incorporating one-to-four family dwelling units. Our mortgage guaranty business was started in 1973.

 

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There are two principal types of private mortgage insurance coverage: “primary” and “pool.” Primary mortgage insurance provides mortgage default protection on individual loans and covers a stated percentage of the unpaid loan principal, delinquent interest, and certain expenses associated with the default and subsequent foreclosure. In lieu of paying the stated coverage percentage, we may pay the entire claim amount, take title to the mortgaged property and subsequently sell the property to mitigate our loss. Our obligation to an insured lender with respect to a claim is determined by applying the policy’s coverage percentage to the claim amount. The traditional primary coverage percentage averaged 24.5% in 2011, although it ranges generally from 12% to 35%. Pool insurance, which is written on a group of loans in negotiated transactions, provides coverage that ranges up to 100% of the net loss on each individual loan included in the pool, subject to provisions regarding deductibles, caps on individual exposures, and aggregate stop loss provisions which limit aggregate losses to a specified percentage of the total original balances of all loans in the pool.

Traditional primary insurance is issued on an individual loan basis to mortgage bankers, brokers, commercial banks and savings institutions through a network of underwriting sites located throughout the country. Traditional primary loans are individually reviewed (except for loans insured under delegated approval programs) and priced according to filed premium rates. In underwriting traditional primary business, we generally adhere to the underwriting guidelines published by the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”), the Federal National Mortgage Association (“FNMA” or “Fannie Mae”), or other large mortgage purchasers on a negotiated basis. Delegated underwriting programs allow approved lenders to commit us to insure loans provided they adhere to a set of predetermined underwriting guidelines.

Bulk and other insurance is issued on groups of loans through a centralized risk assessment and underwriting department. These groups of loans are priced in the aggregate, on a bid or negotiated basis. Coverage for insurance issued in this manner can be provided through primary insurance policies (loan level coverage) or pool insurance policies (aggregate coverage). We consider transactions designated as bulk insurance to be exposed to higher risk (as determined by characteristics such as origination channel, loan amount, credit quality, and loan documentation) than those designated as other insurance. The Company ceased writing business in the bulk channel in 2008.

Before insuring any loans, we issue to each approved customer a master policy outlining the terms and conditions under which coverage will be provided. Primary business is then executed via the issuance of a commitment/certificate for each loan submitted and approved for insurance. In the case of business providing pool coverage, a separate pool insurance policy is issued covering the particular loans applicable to each transaction.

As to all types of mortgage insurance products, the amount of premium charge depends on various underwriting criteria such as loan-to-value ratios, the level of coverage being provided, the borrower's credit history, the type of loan instrument (whether fixed rate/fixed payment or an adjustable rate/adjustable payment), documentation type, and whether or not the insured property is categorized as an investment or owner occupied property. Coverage is non-cancelable by us (except in the case of non-payment of premium or certain master policy violations) and premiums are paid under single, annual, or monthly payment plans. Single premiums are paid at the inception of coverage and provide coverage for the entire policy term. Annual and monthly premiums are renewable on their anniversary dates with the premium charge determined on the basis of the original or outstanding loan amount. The majority of our direct premiums are written under monthly premium plans. Premiums may be paid by borrowers as part of their monthly mortgage payment and passed through to us by the servicer of the loan or they may be paid directly by the originator of, or investor in the mortgage loan.

We have historically provided traditional primary and bulk mortgage guaranty insurance coverage on U.S. residential mortgage loans. Insurance in force is the total principal balance of our insured loans, and risk in force is the total amount of coverage for which we are at risk under our certificates of insurance. In run-off, we receive only the ongoing premiums of the remaining traditional primary and pool insurance in force, which we refer to as renewal premiums, net of any premium ceded to captive reinsurers and refunds resulting from policy

 

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cancellations or rescission of coverage. In most cases, renewal premium rates were determined at origination of coverage, based on perceived risk of the policy at that time, and cannot be subsequently changed.

Traditional primary insurance policies comprised 92.3%, 92.4% and 92.0% of our net risk in force at March 31, 2012, December 31, 2011, and December 31, 2010, respectively, while bulk insurance comprised substantially all of the remaining balance. For more information on our obligations under traditional primary and bulk insurance, see “Defaults” and “Claims” below.

Republic Financial Indemnity Group, Inc. is an insurance holding company that was incorporated in Delaware in 1979 as Old Republic Mortgage Guaranty Group, Inc. The name of the corporation was changed in March 2012. Our mortgage guaranty home office operations are located at 101 North Cherry Street, Winston-Salem, North Carolina 27101. Our telephone number at that location is (336) 661-0015. Our CCI operations and executive offices are located at 307 N. Michigan Avenue, Chicago, IL 60601, and our telephone number at that location is (312) 346-8100.

Run-off and Regulatory Supervision

RMIC, our flagship mortgage guaranty insurance carrier, had been operating pursuant to a waiver of minimum state regulatory capital requirement 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 placed in run-off operating mode. On January 19, 2012, the NCDOI issued an Order, providing for its immediate administrative supervision of RMIC’ s run-off operations. The Order responds to the capital depletion at RMIC caused by an unprecedented level of losses experienced industry-wide.

Supervision is an administrative proceeding under North Carolina law. It gives the NCDOI more oversight and control with the objective of allowing the insurer to develop a corrective plan subject to the NCDOI's approval. It is unlike receivership which involves rehabilitation or liquidation of a company pursuant to a formal, court-ordered proceeding. Receivership results in a company's assets and management passing to a receiver who is overseen by a court. Under the Order, RMIC continues to manage the business through the Company's employees, and retains its status as a wholly-owned subsidiary of RFIG. The Order specifies that RMIC may not, without the prior written approval of the Commissioner, among other things:

 

   

dispose of or encumber any of its assets or its business in force;

 

   

lend, invest or transfer any of its funds or property;

 

   

incur any debt, obligation or liability, or merge or consolidate with another company;

 

   

enter into any new reinsurance arrangement or terminate any insurance policy, except for nonpayment of premiums due;

 

   

make any material change in management, or increase salaries or benefits to management;

 

   

pay more than fifty percent of any claim allowed under any policy issued by RMIC, with the remaining fifty percent to be deferred and credited to a temporary surplus account on the books of RMIC for an initial period not to exceed one year; and

 

   

make any other change in its operations that the Commission considers material.

The primary impact on policyholders and their beneficiaries is the Order’s requirement that RMIC may not pay more than fifty percent of any claims allowed under any policy of insurance it has issued. The remaining fifty percent of any claim is to be deferred and credited to a temporary statutory surplus account on the books of RMIC during an initial period not to exceed one year. Accordingly, all claim payments made on January 19, 2012 and thereafter are to be made at the rate of fifty percent.

 

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In this run-off operating mode, RMIC collects renewal premiums, participates in industry modification activities, and services policies in force as of August 31, 2011. We have not written any new mortgage insurance business since August 31, 2011. Servicing in force policies during run-off includes:

 

   

billing and collecting premiums on policies that remain in force;

 

   

cancelling coverage at the insured’s request;

 

   

working with borrowers in default to remedy the default and/or mitigate losses;

 

   

reviewing policies for the existence of misrepresentation, fraud or non-compliance with stated programs; and

 

   

settling all legitimately filed claims per the provisions of the policies and the Order.

The term "settled," as used in this information statement in the context of the payment of a claim, refers to the satisfaction of RMIC’s obligations following the submission of valid claims by our policyholders. Prior to January 19, 2012, valid claims were settled solely by a cash payment. As required by the Order, effective on and after January 19, 2012, valid claims are settled by a combination of 50% in cash and 50% in the form of a deferred payment obligation, or DPO.

The DPO is a subordinated obligation of RMIC with no stated repayment terms. At March 31, 2012, the recorded DPO amounted to approximately $93 million or 7.7% of total invested assets and 4.9% of liabilities. The recording of a DPO does not impact reported settled losses as we continue to report the entire amount of a claim in our results of operations. The accounting treatment for the recording of DPOs on our balance sheet on a statutory basis is similar to a surplus note that is reported as a component of statutory surplus which serves to increase reported statutory surplus. However, in our financial statements prepared in accordance with GAAP included in this information statement, the DPOs are reported as liabilities. Any repayment of the DPO is dependent on the financial condition and future prospects of RMIC and is subject to the approval of the NCDOI.

Failure to comply with the provisions of the Order or any other violation of the North Carolina Insurance Code may result in the imposition of fines or penalties or subject RMIC to further legal proceedings, including the institution by the NCDOI of receivership proceedings for the conservation, rehabilitation or liquidation of RMIC. Any such actions could lead RFIG to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company.

In light of the regulatory supervision to which RMIC is subject as already discussed, absent substantial capital additions and future regulatory and other approvals, the ability of RFIG and its insurance subsidiaries to reemerge as an active underwriter of new business is currently unknown if not doubtful. The ultimate parent, Old Republic, has, based on its enterprise risk management objectives, communicated its unwillingness and inability to provide additional capital funds in an amount sufficient to restore and maintain minimum risk-to-capital ratios. Accordingly, recapitalization of RFIG will be dependent on the possible availability of funds from capital market sources.

All of these circumstances raise substantial doubt about RFIG’s and its insurance subsidiaries' ability to continue as going concerns. However, the financial statements included in this information statement have been prepared on the assumption that RFIG will continue as a going concern. Under this assumption, RFIG contemplates the realization of assets, liquidation of liabilities, and settlement of deferred payment obligations in the ordinary course of running off the business over several years. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

RMIC is also subject to comprehensive regulation by the insurance departments of the various other states in which it is licensed to transact business.

 

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Underwriting Results

The following table reflects underwriting statistics covering premiums and related loss, expense, and composite ratios for the mortgage guaranty coverages underwritten by RFIG.

 

      ($ in Millions)  
      Quarters Ended
March 31,
    Years Ended
December 31,
 
     2012     2011     2011     2010  

Net Premiums Earned

   $     103.2          $ 113.9      $     444.9      $     498.8   

Claim Ratio

     173.6     186.7     237.6     153.6

Expense Ratio

     13.6        15.1        23.9        14.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Composite Ratio

     187.2     201.8     261.5     168.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Mortgage guaranty claim ratios for the periods presented were affected mostly by varying claim payment trends and reserve provisions as well as captive and pool transactions. Claim costs for this year's first quarter were 15.7% lower year-over-year as the continued downward trend in newly reported cases, relatively stable cure rates, and lower paid claims more than offset ongoing declines in claim rescission and denial activity. We negotiated the termination of various captive reinsurance and pool insurance contracts during 2010. Taken together all of these transactions reduced the incurred claim ratio by 15.0 percentage points for the year ended December 31, 2010. Reserve provisions have been impacted by the levels of reported delinquencies emanating from the downturn in the national economy, widespread stress in housing and mortgage finance markets, and increasing unemployment. Trends in expected and actual claim frequency and severity have been impacted to varying degrees by several factors including, but not limited to, significant declines in home prices which limit a troubled borrower's ability to sell the mortgaged property in an amount sufficient to satisfy the remaining debt obligation, more restrictive mortgage lending standards which limit a borrower's ability to refinance the loan, increases in housing supply relative to recent demand, historically high levels of coverage rescissions and claims denials as a result of material misrepresentation in key underwriting information or non-compliance with prescribed underwriting guidelines, and changes in claim settlement costs. The latter costs are influenced by the amount of unpaid principal outstanding on delinquent loans as well as the rising expenses of settling claims due to higher investigation costs, legal fees, and accumulated interest expenses.

Risk in Force

We had $13.8 billion of net traditional primary risk in force as of March 31, 2012 compared to $14.4 billion and $16.5 billion as of December 31, 2011, and 2010, respectively. Net traditional primary risk in force is stated net of risk ceded to captive insurers.

The following table reflects the percentage of traditional primary risk in force on our book of business by policy year as of the periods presented.

 

     Traditional Primary Risk in
Force
 
     March 31,
2012
    December 31,  
       2011     2010  

Policy Year

      

2003 & Prior

     9.6     9.9     11.8

2004

     6.9        7.0        7.3   

2005

     10.1        10.1        10.6   

2006

     11.1        11.0        11.2   

2007

     26.7        26.5        26.6   

2008

     18.7        18.6        18.8   

2009

     8.2        8.3        8.5   

2010

     5.4        5.4        5.2   

2011

     3.3        3.2        —     
  

 

 

   

 

 

   

 

 

 

Total

     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

 

 

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Net bulk risk in force was $.9 billion at March 31, 2012 compared to $1.0 billion and $1.1 billion as of December 31, 2011 and 2010, respectively.

The following table reflects the percentage of bulk risk in force on our book of business by policy year as of the periods presented.

 

     Bulk Risk in Force  
     March 31,     December 31,  
     2012     2011     2010  

Policy Year

      

2003 and Prior

     8.8     8.6     7.9

2004

     12.6        12.4        11.6   

2005

     25.9        26.2        28.0   

2006

     39.5        39.5        39.1   

2007

     13.2        13.3        13.4   
  

 

 

   

 

 

   

 

 

 

Total

     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

 

An analysis of the quality of our insured portfolio is provided in "Management’s Discussion and Analysis of Financial Condition and Results of Operations".

Investments

In common with other insurance organizations, RFIG invests most capital and operating funds in income producing securities. Investments must comply with applicable insurance laws and regulations which prescribe the nature, form, quality, and relative amounts of investments which may be made by insurance companies. Generally, these laws and regulations permit insurance companies to invest within varying limitations in state, municipal and federal government obligations, corporate debt, preferred and common stocks, certain types of real estate, and first mortgage loans. RFIG's investment policy is therefore to acquire and retain primarily investment grade, publicly traded, fixed maturity securities. The investment policy is also influenced by the terms of the insurance coverages written, by its expectations as to the timing of claim and benefit payments, and by income tax considerations. As a consequence of all these factors, the Company's invested assets are managed in consideration of enterprise-wide risk management objectives intended to assure solid funding of its subsidiaries’ long-term obligations to insurance policyholders and other beneficiaries, as well as evaluations of their long-term effect on stability of capital accounts. Accordingly, the investment portfolio contains no direct insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, junk bonds, hybrid securities, or illiquid private equity investments. In a similar vein, the Company does not engage in hedging transactions or securities lending operations, nor does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes. The Company does not have any exposure to European sovereign debt instruments.

Management considers investment grade securities to be those rated by Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors Service, Inc. ("Moody's") that fall within the top four rating categories, or securities which are not rated but have characteristics similar to securities so rated. The Company had no bond or note investments in default as to principal and/or interest at March 31, 2012 or December 31, 2011. The status and fair value changes of each investment is reviewed on at least a quarterly basis, and estimates of other-than-temporary impairments in the portfolio's value are evaluated and established at each balance sheet date. Substantially all of the Company's invested assets as of March 31, 2012 have been classified as "available for sale" pursuant to the existing investment policy.

The Company's investment policies are not designed to maximize or emphasize the realization of investment gains. The combination of gains and losses from sales or impairments of securities are reflected as realized gains and losses in the income statement. Dispositions of securities result principally from scheduled maturities of

 

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bonds and notes and sales of fixed income and equity securities available for sale. Dispositions of securities at a realized gain or loss reflect such factors as ongoing assessments of issuers' business prospects, rotation among industry sectors, changes in credit quality, and tax planning considerations.

Marketing

As previously noted, RMIC, our 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 placed in run-off operating mode. Prior to August 31, 2011, traditional primary mortgage insurance was marketed principally through a direct sales force which called on mortgage bankers, brokers, commercial banks, savings institutions and other mortgage originators. No sales commissions or other forms of remuneration were paid to the lending institutions or others for the procurement or development of business. Our ten largest mortgage guaranty customers were responsible for 36.0% and 34.4% of traditional primary new insurance written in 2011 and 2010, respectively. The largest single customer accounted for 14.4% of traditional primary new insurance written in 2011 compared to 10.6% in 2010. No new business has been written since August 31, 2011.

Loss Reserves

Our insurance subsidiaries establish reserves for reported claims, claims incurred but not reported, and claim adjustment expenses, as required in the circumstances. Such reserves are based on regulatory accounting requirements and generally accepted accounting principles. In accordance with insurance industry practices, claim reserves are based on estimates of the amounts that will be paid over a period of time and changes in such estimates are reflected in the financial statements of the periods during which they occur.

Reinsurance recoverable asset balances represent amounts due from or credited by assuming reinsurers for paid and unpaid claims and policy reserves. Such reinsurance balances that are recoverable from non-admitted foreign and certain other reinsurers such as captive insurance companies owned by assureds are substantially collateralized by securities. Estimates of unrecoverable amounts are included in our net claim and claim expense reserves since reinsurance does not relieve us from our direct obligations to assureds or their beneficiaries.

Our total claims exposure to our largest reinsurer, Bank of America Reinsurance Corporation, was $18.7 million, which represented 21.7% of total consolidated reinsured liabilities as of December 31, 2011. Prior to entering run-off, we entered into various captive reinsurance agreements. Under the typical captive reinsurance agreement, a captive reinsurer, generally an affiliate of the lender, assumed a portion of the risk associated with the lender’s book of business insured by RMIC in exchange for a percentage of the premiums collected. All of our captive reinsurance agreements include, among other things, minimum capital requirements and excess-of-loss provisions that provide for defined aggregate layers of coverage and a maximum exposure limit for the captive reinsurer. In accordance with the excess-of-loss provisions, we retain the first loss position on the first aggregate layer of risk and reinsure a second defined aggregate layer with the captive reinsurer. We generally retain the remaining risk above the defined aggregate layer reinsured with the captive reinsurer. Ceded premiums, net of ceded commissions, under these agreements generally ranged from 25% to 40% of premiums. Captive reinsurance agreements do not relieve RMIC from its obligations to policyholders. Failure of the captive reinsurer to honor its obligations under the captive reinsurance agreement could result in losses to RMIC; consequently, we limit our recoverables to the collateral held in the trust account for the benefit of the Company.

RMIC requires each captive reinsurer to establish a trust to support its obligations under the captive reinsurance agreement. If certain capitalization requirements of the trust are not maintained, RMIC retains the right to terminate the captive reinsurance agreement. The termination of the captive reinsurance agreement is referred to as a "commutation." Upon commutation, RMIC generally receives all remaining trust assets, reduces the reinsurance recoverable for amounts due from the captive reinsurer, and ceases ceding premium to the captive reinsurer.

 

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Commutations of captive reinsurance agreements generally result in an increase in our invested assets and a corresponding decrease in reinsurance recoverable during the period the agreements are commuted. The commutations have minimal impact on results of operations or financial condition, as the amount recorded as reinsurance recoverable under the captive reinsurance agreements is limited to the captive reinsurers’ accumulated trust balances. Captive reinsurance commutations contributed $13.6 million of additional premiums covering future losses during 2010. No similarly significant transactions occurred during 2011.

Roughly 15% of the mortgage guaranty traditional primary risk in force is subject to lender sponsored captive reinsurance arrangements structured primarily on an excess of loss basis. All bulk and other mortgage guaranty insurance risk in force is retained. Exclusive of reinsurance, the average direct primary mortgage guaranty exposure is approximately (in whole dollars) $38,400 per insured loan.

Competition

The insurance business is highly competitive and in the past we have competed with several other insurance companies. Many of these competitors had substantially greater financial resources than RFIG. The rates charged for our mortgage guaranty business are primarily regulated by the states and are also subject to extensive competition among major insurance organizations. The basic methods of competition available to RFIG, aside from rates, are service to customers, expertise in tailoring insurance programs to the specific needs of its clients, efficiency and flexibility of operations, and personal involvement by its key executives. Historically, we competed in varying degrees with the Federal Housing Administration (“FHA”) and the Veterans Administration (“VA”). In recent years, the FHA's market share of insured mortgages has increased significantly, mostly due to the more restrictive underwriting guidelines and premium rate increases imposed by private mortgage insurers. Through RMIC 's affiliate, RMIC Corporation, we also competed by providing contract underwriting services to lenders, enabling the lender to improve the efficiency of their operations by outsourcing all or part of their mortgage loan underwriting processes. As already noted, we ceased underwriting new mortgage guaranty insurance effective August 31, 2011.

Foreclosure Prevention Initiatives and Moratoriums

Several programs have been initiated by the federal government, the GSEs, and certain lenders that are, in general, designed to prevent foreclosures and provide relief to homeowners. These programs may involve modifications to the original terms of existing mortgages or their complete refinancing. These programs seek to provide borrowers a more affordable mortgage by modifying the interest rate, extending the term of the mortgage or, in limited cases, reducing the principal amount of the mortgage. We are active participants in many of these programs, including government-initiated programs such as the Home Affordable Modification Program (“HAMP”) and the Home Affordable Refinance Program (“HARP”).

HAMP provides incentives to borrowers, servicers, and lenders to modify loans that are currently in default. HAMP and other such programs have been responsible for a large percentage of our cures since 2009. The number of policies cured under these programs has declined in 2011 from levels experienced in 2010. In January 2012, the federal government announced that it was revising HAMP again by expanding eligibility requirements and increasing the incentive it pays servicers/lenders for principal forgiveness. For the first time beginning in the second quarter of 2012, the U.S. government will also pay Fannie Mae and Freddie Mac an incentive fee for principal forgiveness. HAMP was scheduled to expire at the end of 2012 but the government extended the program until December 2013. We cannot estimate the impact of these changes on the number of loans eligible for participation or the effect on our financial condition.

In determining the number of policies participating in HAMP as well as other foreclosure prevention programs, we rely on information provided to us primarily by the GSEs and servicers. However, we do not believe that we receive timely information on all participating loans or on the current status of the participating loans and we do not have the necessary information to determine the number of our policies in force that would be eligible for such modification programs. Furthermore, a number of the policies that have completed the trial

 

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modification period have subsequently re-defaulted and we believe the number of policies that re-default could increase in the future. This could be exacerbated by adverse conditions in the housing market or economy in general. The ultimate impact of HAMP and other modification programs is dependent on the number of policies that are successfully modified and do not re-default. Currently, we are unable to estimate with any degree of precision the number of policies that will ultimately cure and not re-default and are, therefore, unable to estimate the ultimate impact of these programs on our results of operations and financial condition. If HAMP or similar programs prove to be effective in preventing ultimate foreclosure, future settled claim activity could be reduced.

If a loan is modified or refinanced as part of one of these programs, the previously reported default would be cured, but we would maintain insurance on the loan and would be subject to the same ongoing risk if the policy were to re-default. Policies that re-default under these programs may ultimately result in losses that are greater than the loss that would have occurred if the policy were never modified. However, the Company feels that the program will overall have a positive impact on the portfolio. We do not provide loss reserves to account for the potential for re-default. These programs could also adversely affect us to the degree that borrowers who otherwise could make their mortgage payment choose to default in an attempt to become eligible for modification.

HARP was launched in 2009 but revised in the third quarter of 2011. This program is designed to provide a borrower who is current on all mortgage payments with the opportunity to take advantage of existing lower interest rates through a refinancing that would make the loan more affordable. Under the original HARP program, only fixed-rate loans with a maximum current loan-to-value ("LTV") ratio of 125% were eligible, although this restriction was later removed. The LTV limit for ARMs continues to be 105% of the current value.

Loan servicers and certain government entities have also implemented temporary foreclosure moratoriums in recent years for various reasons, some of which were in response to documentation problems and other issues with foreclosure proceedings. Because the completion of a valid foreclosure is a requirement for the filing of a claim for loss, these moratoriums serve to temporarily reduce our settled claims, but they may lead to greater ultimate claim costs due to the accrual of interest and other expenses. While some of these moratoriums have subsequently been terminated, unresolved legal matters remain for certain mortgages. These moratoriums have delayed our claims settled and increased the time a policy remains in our default inventory.

In February 2012, the federal government and state attorneys general reached a $25 billion agreement with five of the nation’s largest banks regarding claims that alleged, among other things, fraudulent foreclosure practices. The funds generally will be used for principal reductions, refinancing underwater borrowers, forbearance and short sales, and foreclosure prevention programs. The banks have three years to implement the plan and comply with terms. Only loans serviced by these five banks are eligible for participation in the settlement and loans owned or guaranteed by the GSEs, which comprise the majority of our insured risk, are ineligible. A great deal of uncertainty currently remains over how the program will be implemented as well as borrower eligibility, but currently we do not believe the agreement will have a meaningful impact on our future results of operations or financial condition.

Cancellation of Insurance

Generally, both primary and pool insurance remain effective until one of the following events occurs: the policy is cancelled at the insured’s request; we terminate the policy for non-payment of premium; the policy defaults and we satisfy our obligations under the insurance contract; or we rescind coverage or deny a claim (see "Loss Mitigation" below for more information on rescission activity and denials). While operating in run-off, the cancellation of a policy will reduce insurance in force and future premiums because we cannot replace the cancelled insurance with new mortgage insurance coverage. Upon policy cancellation, we may be required to refund any unearned premium depending on the type of policy or, in the case of rescinded coverage, we customarily refund some portion of the premium paid on the policy.

 

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When an individual borrower goes into default on an insured mortgage loan, the servicer may continue or discontinue remitting premium payments on that policy. In either case, as long as the policy was in force at the time the default occurred, we remain liable for the insured risk unless we rescind coverage. However, if the default subsequently cures and the servicer fails to remit the premium due through the current effective date, we may terminate the policy for non-payment of premium. Historically and as of December 31, 2011, many servicers have continued to remit premium payments for the majority of our policies in default. For more information on the default and claim process, see "Defaults" and "Claims" below.

Lenders may cancel mortgage insurance coverage when an insured loan is paid off, which generally occurs when a property is sold or a loan is refinanced. Any refinancing activity that takes place is most likely to occur with better performing loans or in areas experiencing comparatively better economic or home price conditions. If significant non-HARP refinancing activity were to occur, the percentage of our insurance in force covering poor performing loans, loans from economically distressed areas, or loans from areas experiencing unfavorable home price depreciation would increase. Because we are in run-off, we would be particularly adversely affected if this occurs because we are unable to write new insurance in areas experiencing home price appreciation or favorable economic conditions.

The following table provides information on premium and persistency trends for the periods shown:

 

     Earned
Premiums
($ in millions)
     Persistency  
     Direct      Net      Traditional
Primary
    Bulk  

Years Ended December 31:

          

2010

   $ 529.5       $ 498.8         82.1     88.0

2011

     468.1         444.9         83.2        85.3   

Quarters Ended March 31:

          

2011

     120.0         113.9         81.6        86.3   

2012

   $ 108.2       $ 103.2         82.8     86.1
  

 

 

    

 

 

    

 

 

   

 

 

 

Contract Underwriting

RMIC Corporation provided fee-based contract underwriting services to certain approved mortgage originators. Contract underwriting involved examining a prospective borrower’s information contained in a lender’s mortgage application file and making a determination as to whether the borrower should be approved for a mortgage loan subject to the lender’s underwriting guidelines. These services were provided for loans that required mortgage insurance, as well as for loans that did not require mortgage insurance.

If we failed to properly underwrite a loan subject to the lender’s underwriting guidelines or otherwise did not fulfill our obligations under the contract underwriting agreement with the lender, we could be required to provide monetary or other remedies to the lender customer. While we have ceased providing contract underwriting services, we generally remain exposed to potential liability for our previous underwriting activities. The length of exposure varies by agreement with the longest exposure being seven years from the date contract underwriting services were provided. Contract underwriting services provided after 2008 generally have shorter exposure periods. While expenses for contract underwriting remedies have historically been immaterial to our results of operations, in part due to the favorable conditions in the residential real estate market, these expenses have increased in recent years. During 2011 and 2010, net payments for contract underwriting remedies were $4.6 million and $4.5 million, respectively, and the reserve established for contract underwriting remedies was $11.9 million at December 31, 2011. There can be no assurance that expenses for contract underwriting remedies will continue to decrease in the future or that our reserve will be sufficient to cover our ultimate liability for these remedies.

 

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Defaults

The claim process on mortgage guaranty insurance begins with the lender’s notification to the insurer of a default on an insured loan. We define a default as an insured mortgage loan for which two or more consecutive monthly payments have been missed. The master policies require lenders to notify us of default on a mortgage payment within ten days of either (i) the date on which the borrower becomes four months in default or (ii) the date on which any legal proceeding affecting the loan commences, whichever occurs first. Notification is required within 45 days of default if it occurs when the first payment is due. We refer to the risk in force on loans that are in default as "risk in default." Risk in default does not account for accrued interest or other expenses that would be part of a claim for loss.

The incidence of default is affected by a variety of factors, including changes in borrower income, unemployment, divorce, illness, the level of interest rates, and the level of home price appreciation or depreciation. Home prices nationwide have been under immense pressure since 2007 and many areas have experienced significant declines. The mortgage insurance industry has little historical experience in projecting defaults in a market environment characterized by widespread declining home prices. We believe such price declines have helped precipitate a number of additional defaults. We have also experienced a large number of defaults where the certificate of insurance was not issued in compliance with our master policies due to fraud, misrepresentation or other underwriting violations that occurred during loan origination. When such activity is discovered, insurance coverage on the affected certificate is generally rescinded. While this has always been a portion of our claims settlement activity, rescission activity has been significantly higher since 2007 than in prior periods. See "Rescission and Denial Activity" below for more information.

Borrowers may cure defaults by making all delinquent loan payments or by selling the property and satisfying all amounts due under the mortgage. The probability a default is cured is affected by a variety of factors including: the borrower’s equity at the time of default; the borrower’s (or the lender’s) ability to sell the home for an amount sufficient to satisfy all amounts due under the mortgage; the effectiveness of loss mitigation efforts; general conditions in the housing market; and the borrower’s participation in loan modification programs such as HAMP.

See "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for a summary of our default statistics.

Claims

Defaults that are not cured usually result in the submission of a claim, although the submission of many claims has been delayed due to the foreclosure moratoriums and other legal challenges previously discussed. During the default period, we work with the insured in an effort to reduce losses through the loss mitigation efforts described below. The time frame from when we first receive a notice of default until the ultimate claim is settled is dependent on, among other factors, the foreclosure laws of the applicable state and historically has ranged from six to 18 months. Over the past two years, the time frame between the first notice of default to the ultimate claim payment has increased significantly for a variety of reasons including:

 

   

government and private industry efforts to prevent foreclosures through loan modification programs and other initiatives;

 

   

delays in submitting and processing claims by the servicers of the defaulted loans due to substantial volume increases in defaults;

 

   

legal challenges by homeowners and individual states over the foreclosure process; and

 

   

foreclosure moratoriums.

Historically, the settlement of claims is not evenly spread throughout the insurance coverage period. In general, relatively few claims were settled during the first year following loan origination. Loss exposures typically manifest themselves as recurring losses usually concentrated between the second and fifth year

 

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following issuance of any one year's new policies. A period of rising claim settlements historically followed that initial year of coverage. Thereafter, the number of claim settlements historically declined at a gradual rate, although the rate of decline could be affected by local economic conditions. Loans originated in 2006 through 2008 have performed significantly worse than previously originated loans. We believe this is primarily the result of: (1) deterioration in the housing and financial markets evidenced by a decline in home prices and reduced credit availability; (2) a larger percentage of loans originated with high LTVs during these years; (3) lax underwriting standards by certain mortgage loan originators; and (4) the onset of new high risk loan programs . It is difficult to project the future claim pattern of these books of business given the early accelerations, the risk composition of the underlying loans and the general conditions in the housing market which remain poor. Furthermore, default and claim activity on loans originated prior to 2006 have adversely deviated from historical patterns as weak economic conditions, home price declines, and reduced credit have affected even these more seasoned loans.

Under the terms of our master policies, the lender is required to file a claim with us no later than 60 days after it has acquired the borrower’s title to the underlying property through foreclosure, a negotiated short sale or a deed-in-lieu of foreclosure. A primary insurance claim amount includes (i) the amount of unpaid principal due under the loan; (ii) the amount of accumulated delinquent interest due on the loan (excluding late charges) to the date of claim filing; (iii) expenses advanced by the insured under the terms of the master policies, such as hazard insurance premiums, property maintenance expenses and property taxes prorated to the date of claim filing; and (iv) certain foreclosure and other expenses, including attorneys’ fees. Such claim amounts are subject to review and possible adjustment by us.

Generally, within 60 days after a valid claim has been filed, we have the option of either (i) settling the coverage percentage of the claim as specified on the certificate of insurance, with the insured retaining title to the underlying property and receiving all proceeds from the eventual sale of the property, or (ii) settling the full claim amount in exchange for the lender’s conveyance of good and marketable title to the property to us, and selling the property for our own account. During 2011 and 2010, due to the extent of the decline in home prices, we did not exercise the option to purchase properties in settlement of claims and we do not expect this will be a viable option going forward given the claims settlement provision of the Order. At December 31, 2011, we did not hold any properties as a result of electing to settle the full amount of the claim.

Our master policies also exclude any cost or expense related to the repair or remedy of any physical damage (other than "normal wear and tear") to the property collateralizing an insured mortgage loan. Such physical damage may be caused by accident, natural occurrence or other conditions.

Rescission and Denial Activity

Whenever we determine that an application contains a material misrepresentation, we either advise the insured in writing of our findings prior to rescinding coverage or exercise our unilateral right to rescind coverage for that loan, stating the reasons for that action in writing and returning the applicable premium. The rescission of coverage in instances of materially faulty representations or warranties provided in applications for insurance is a necessary and prevailing practice throughout the insurance industry. In the case of mortgage guaranty insurance, rescissions have occurred regularly over the years but have been generally immaterial. Since 2008, however, we have experienced a much greater incidence of rescissions due to increased levels of observed fraud and misrepresentations in insurance applications pertaining to business underwritten between 2004 and the first half of 2008. As a result, we have incorporated certain assumptions regarding the expected levels of coverage rescissions and claim denials in our reserving methodology since 2008. Such estimates, which are evaluated at

 

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each balance sheet date, take into account observed trends in rescission and denial rates. The table below shows the estimated effects of coverage rescissions and claim denials on loss reserves and paid and incurred losses.

 

     ($ in millions)  
     March 31,     December 31,  
     2012     2011     2011     2010  

Estimated reduction in beginning reserve

   $ 313.2      $ 710.3      $ 710.3      $ 1,712.2   

Total incurred claims and settlement expenses

        

(increased) by changes in estimated recissions:

        

Current year

     39.1        89.9        223.1        394.1   

Prior year

     (36.1     (77.6     (340.8     (215.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Sub-total

     3.0        12.3        (117.6     178.3   

Estimated rescission reduction in paid claims

     (50.9     (108.4     (279.5     (1,180.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Estimated reduction in ending reserve

   $ 265.3      $ 614.3      $ 313.2      $ 710.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

As above-noted, the estimated reduction in ending loss reserves reflects, in large measure, a variety of judgments relative to the level of expected coverage rescissions and claim denials on loans that are in default as of each balance sheet date. The provision for insured events of the current year resulted from actual and anticipated rescissions and claim denials attributable to newly reported delinquencies in each respective year. The provision for insured events of prior years resulted from actual rescission and claim denial activity or revisions in assumptions regarding expected rescission or claim denial rates on outstanding prior year delinquencies. The trends since 2010 reflect a continuing reduction in the level of actual and anticipated rescission and claim denial rates on total outstanding delinquencies. Claims not paid by virtue of rescission or denial represent our estimated contractual risk, before consideration of the impacts of any reinsurance and deductibles or aggregate loss limits, on cases that are settled by the issuance of a rescission or denial notification. 2010 rescissions include $431.4 million related to certain pool insurance contracts which were terminated during the year. Variances between the estimated rescission and actual claim denial rate are reflected in the periods during which they occur.

Although the insured has no right under the policy to appeal a Company claim decision, the insured may, at any time, contest in writing our findings or action with respect to a loan or a claim. In such cases, we consider any additional information supplied by the insured. This consideration may lead to further investigation, retraction or confirmation of the initial determination. If we conclude that we will reinstate coverage, we advise the insured in writing that we will do so immediately upon receipt of the premium previously returned. Reserves are not adjusted for potential reversals of rescissions or adverse rulings for loans under dispute since such reversals of claim rescissions and denials have historically been immaterial to the reserve estimation process.

There is currently a single instance in which we seek to recover from an insured for previously paid claims. In its counterclaim in the pending arbitration with Countrywide (Countrywide Fin'l Corp. v. Republic Mortg. Ins. Co., Case No. 72 195 Y 0011510 (AAA). The Countrywide parties are Countrywide Financial Corporation, Countrywide Home Loans, Inc., Bank of America, N.A., in its own capacity and as successor by merger of BAC Home Loan Servicing L.P.), RMIC is seeking to rescind a June 2006 amendment to a mortgage insurance policy that it contends was fraudulently induced by Countrywide. The amendment made coverage for a loan immediately incontestable for borrower misrepresentation. The Company seeks a declaration that the amendment is null and void and to recover the claim amounts totaling at least $26.6 million that it paid notwithstanding the existence of borrower misrepresentations that otherwise would have supported a rescission of coverage for those loans. We do not anticipate recoveries from previously paid claims in our reserving process until such time as a recovery is deemed probable and the amount can be reasonably estimated.

 

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Loss Mitigation

Once a default notice is received, we attempt to mitigate our loss. Loss mitigation techniques include pre-foreclosure sales, property sales after foreclosure, advances to assist distressed borrowers who have suffered a temporary economic setback, and the use of repayment schedules, refinances, loan modifications, forbearance agreements and deeds in lieu of foreclosure. When available, such mitigation efforts typically result in reduced losses from the coverage percentage stated in the certificate of insurance. Currently, our ability to employ these types of loss mitigation techniques is severely limited, primarily the result of depressed house prices and other adverse housing market conditions. As a result, we generally settle claims at or exceeding our risk in default depending on additional expenses included in the claim amount as described above.

With the approval of the servicers, we also employ third party vendors to contact borrowers in default in an attempt to assist them with modifications, including the complexities of HAMP. In addition to loss mitigation techniques that reduce or eliminate claims, when we settle a claim we also may obtain deficiency judgments against borrowers in those states that allow such actions so that we can recoup some of our losses. Deficiency judgments historically have not been a significant component of our loss mitigation activities and have been an immaterial amount of our paid claims in 2011 and 2010.

Recent Developments

In mid-March 2012, Old Republic combined its CCI division with its mortgage guaranty segment. The CCI and the mortgage guaranty operations offer similar insurance coverages, share the same senior management leadership, and have been operating in run-off mode since 2008 and August, 2011, respectively. CCI policies provide limited indemnity coverage to lenders and other financial intermediaries for the risk of non-payment of loan balances by individual buyers and borrowers. The coverage is for the risk of non-payment of loan balances. Claim costs are typically affected by unemployment, bankruptcy, and other wide-ranging economic circumstances leading to failures to pay.

The CCI run-off business is operated through Republic Credit Indemnity Companies, Inc., a wholly-owned subsidiary of RFIG, and its wholly-owned subsidiaries, Republic Insured Credit Services, Inc. ("RICS"), Republic Equity Credit Services, Inc. ("RECS"), and, effective April 1, 2012, by Republic Credit Indemnity Company with respect to run-off underwriting exposures.

The CCI product is a property and casualty insurance coverage underwritten by Old Republic Insurance Company ("ORINSCO") since 1955. From its inception, the coverage has been marketed, underwritten and claims administered for ORINSCO by ORI's wholly-owned managing underwriting agency, Republic Insured Credit Services, Inc. The original model for the coverage was the FHA Title I program, a program designed to assist consumers to obtain affordable home improvement loans by insuring loans made by private lenders to improve properties that meet certain requirements.

CCI coverage insures lenders against losses due to defaults on loans secured by liens against real property, generally single family residential property. From financial accounting and capital management standpoints the CCI product is categorized as a financial indemnity, long-tail insurance line. In varying applications and degrees, the underwriting principles applicable to CCI coverage take into account such factors as:

 

   

the credit worthiness and financial standing of the institution and assured(s);

 

   

the credit history and worthiness of the debtor or financial service provider;

 

   

the underwriting and servicing practices of the lending or financial intermediary and its performance in adherence to underwriting rules and standards;

 

   

the spread and diversification of risks; and,

 

   

similar loss mitigation opportunities.

 

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CCI is underwritten on a policy year by policy year basis and covers portfolios of loans extended by such lenders or financial intermediaries as large and small banks, credit unions, savings & loans, and mortgage bankers. CCI coverage typically provides for a maximum loss payment equal to 10% of the original insured amounts.

ORINSCO prepares periodic analyses of its loss reserve estimates using reserving methodology that is akin to that used for other long-tail property and liability insurance lines. Loss estimates are established initially for the most recent accident years. Initial reserve levels are adjusted prospectively as actual claims emerge and greater permanence of longer term trends is established. A variety of external factors, including loan default and employment trends are considered in establishing our periodic loss reserve estimates. Expected loan loss recoveries are also taken into account on the basis of past experience and expectations about borrowers' future ability to repay defaulted debt balances.

Due to a general deterioration in the credit quality of such loans being made by lenders and the advent of the current recessionary conditions, ORINSCO voluntarily elected to discontinue writing new business in 2008 and to allow its earlier written business to run-off in the ordinary course. Licensing and policy forms and rate filing efforts are underway to position Republic Credit Indemnity Company ("RCIC") to replace ORINSCO as the CCI product underwriter. With the return of a favorable underwriting environment, RCIC would be free to resume writing new CCI business. It is not known when that might occur, and we have not established any timetable for a resumption of new business.

Notwithstanding the Quota Share Reinsurance Agreement and the Stop Loss Reinsurance Agreement discussed below, ORINSCO remains primarily liable under its CCI policies in the run-off business subject to this agreement. In connection with the combination of the CCI and mortgage guaranty businesses, we have entered into two reinsurance arrangements with subsidiaries of Old Republic pertaining to the CCI business:

Quota Share Reinsurance Agreement. Effective April 1, 2012, ORINSCO reinsured its liabilities with Republic Credit Indemnity Company ("RCIC") under a Quota Share Reinsurance Agreement covering 100% of the policy liabilities, except for the litigation expenses and exposures on certain existing lawsuits. Those liabilities are limited. RCIC is not responsible for those liabilities once its cumulative loss ratio under the Quota Share Reinsurance Agreement reaches 155% and any excess of such liabilities would remain with ORINSCO until RCIC's cumulative loss ratio drops below 155% in subsequent years. ORINSCO pays RCIC a premium for the reinsurance coverage equal to 100% of the earned premiums less a ceding commission allowance for all production costs, premium taxes, board and bureau assessments, other external expenses, and a 1.25% annual processing fee adjustable by the year-over-year change in the consumer price index ("CPI"). The processing fee is subject to an annual minimum of $400,000, similarly adjustable by the annual change in the CPI.

Stop Loss Reinsurance Agreement. The liabilities assumed by RCIC under the Quota Share Reinsurance Agreement are in turn reinsured in part under a Stop Loss Reinsurance Agreement between RCIC and Old Republic General Insurance Corporation ("ORGENCO"), an Old Republic General Insurance Group subsidiary, under which ORGENCO reimburses RCIC for losses once RCIC's cumulative loss ratio reaches 85% for up to 70 additional loss ratio points. RCIC pays ORGENCO a reinsurance premium equal to 10% of the premium RCIC earns under the Quota Share Reinsurance Agreement. If cumulative losses during the stated term of the retrospective premium adjustment calculation are less than the total reinsurance premiums paid during that term, 50% of the excess reinsurance premium would be refunded to RCIC.

For a description of the pro forma financial effect of the combination of the CCI line with the mortgage guaranty line, see "Selected Historical Financial Data" and "Unaudited Pro Forma Combined Financial Statements."

 

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Regulation

In common with all insurance companies, RFIG’s insurance subsidiaries are subject to the regulation and supervision of the jurisdictions in which they do business. The method of such regulation varies, but, generally, regulation has been delegated to state insurance commissioners who are granted broad administrative powers relating to: the licensing of insurers and their agents; the nature of and limitations on investments; approval of policy forms; reserve requirements; and trade practices. In addition to these types of regulation, many classes of insurance, including most of RFIG’s insurance coverages, are subject to rate regulations which require that rates be reasonable, adequate, and not unfairly discriminatory.

The FNMA and the FHLMC sometimes also referred to as Government Sponsored Enterprises ("GSEs") have various qualifying requirements for private mortgage guaranty insurers which write mortgage insurance on loans acquired by the FNMA and FHLMC from mortgage lenders. These requirements call for compliance with the applicable laws and regulations of the insurer's domiciliary state and those states in which it conducts business and maintenance of contingency reserves in accordance with applicable state laws. The requirements also contain guidelines pertaining to captive reinsurance transactions. The GSEs also place additional restrictions on qualified insurers who fail to maintain the equivalent of a AA financial strength rating from at least two nationally recognized statistical rating agencies. Since 2008, substantially all national mortgage guaranty insurance companies, including RFIG’s mortgage insurance subsidiaries, have experienced ratings downgrades below AA. As a result, all of these companies were required to submit capital remediation plans to FNMA and FHLMC in order to continue as approved mortgage guaranty insurers for loans purchased by the GSEs. On January 19, 2012, the NCDOI issued a Summary Order providing for its immediate supervision of the Company's flagship mortgage guaranty insurance carrier as discussed elsewhere in this information statement.

RMIC and RMICNC are North Carolina-domiciled mortgage guaranty insurance companies. The NCDOI is the primary regulator of both RMIC and RMICNC. RMICFL is a Florida-domiciled mortgage guaranty insurance company and is regulated by the Florida Office of Insurance Regulation ("FOIR"). The North Carolina and Florida insurance laws grant broad powers to the NCDOI and FOIR commissioners to enforce rules or exercise discretion over almost all significant aspects of our insurance business. RMIC ceased issuing new commitments for mortgage guaranty insurance coverage in the second half of 2011 and is operating its business in run-off under the Order issued by the NCDOI, as discussed above.

Either by notice or consent order, the following states have either suspended or provided notice of their intent to suspend RMIC's license: AK, AR, GA, ID, IL, KY, LA, MO, NC, OK, TN, UT, VA, WV, and we expect other states will take similar action in the future. RMIC has confirmed with each state in which its license has been suspended that it should continue to service its existing in-force book of business. As such, while RMIC no longer issues coverage on new policies, it continues to process modifications on existing certificates of insurance, process premiums and settle claims in the normal course of business.

Because RFIG is an insurance holding company, the North Carolina and Florida insurance laws regulate, among other things, certain transactions in RFIG’s common stock and certain transactions between RFIG and its insurance subsidiaries. Specifically, no person may, directly or indirectly, offer to acquire or acquire beneficial ownership of more than 10% under North Carolina law and 5% under Florida law, of any class of outstanding securities of RFIG or its subsidiaries unless such person files a statement and other documents with the NCDOI or FOIR, respectively, and obtains their prior approval. These restrictions generally apply to all persons controlling or under common control with the insurance companies. "Control" is presumed to exist if such percentages or more of RFIG’s voting securities are owned or controlled, directly or indirectly, by a person, although the insurance regulatory authorities may find that "control", in fact, does or does not exist where a person owns or controls either a lesser or greater amount of securities. Other states in addition to North Carolina may regulate affiliated transactions and the acquisition of control of RFIG or its insurance subsidiaries.

The insurance laws of North Carolina and Florida generally limit the payments of dividends by an insurance company unless it has sufficient capital and surplus. Given RMIC’s current financial condition and operating

 

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outlook, it is prohibited from paying dividends to RFIG. The capital accounts of both RMIC and RMICNC consist, in part, of interest bearing surplus notes held by RFIG. In light of these companies' continuing losses, no interest payments are permitted on such notes.

Insurance regulations require appropriations to a statutory contingency reserve in annual amounts equal to 50% of mortgage guaranty premiums earned. Appropriated amounts may not be withdrawn for a period of ten years, except as may be permitted by the state based on the level of insured losses or by special approval of state insurance regulators. Given the significant level of our cumulative losses in 2007 through 2011, most of the contingency reserve has been released and we currently do not have a contingency reserve established in RMIC or RMICNC.

All of our insurance subsidiaries are subject to examination of their affairs by the insurance departments of every state in which they are licensed to transact business. The insurance regulatory authorities periodically conduct financial condition examinations of insurance companies and the results of the examinations are filed with all state insurance departments. The most recent examination of RMIC and RMICNC for the fiscal year ended December 31, 2007 was concluded on February 20, 2009, and no adjustments or material recommendations were made as a result of this examination.

The market for private mortgage insurance exists almost entirely as a result of restrictions within the federal charters of the GSEs which require an acceptable form of credit enhancement on loans purchased by the GSEs that have loan-to-value ("LTV") ratios in excess of 80%. These institutions establish the levels of required coverage, the underwriting standards for the loans they will purchase and the loss mitigation efforts that must be followed on insured loans. In response to their deteriorating financial conditions, the GSEs were placed in conservatorship under the Federal Housing Finance Agency ("FHFA") in September 2008. As their conservator, the FHFA could change the GSEs' business practices with respect to mortgage credit enhancement, or new federal legislation prompted by the increasing role of the deferral government in the residential mortgage market could alter their charters or restructure the GSEs in ways that may reduce or eliminate their roles in the residential mortgage market. The current Federal administration has recommended winding down and gradually eliminating the GSEs' role in housing finance. Any such changes could have a material adverse effect on the mortgage insurance industry and RMIC's and its affiliates' ability to re-enter the market.

Technology

RMIC's technical foundation is a low cost technology solution based around a full-featured servicing platform, completely integrated with common servicers and electronic data interchange standards that require no significant external service or license fees. Furthermore, the servicing systems are not tied into origination platforms or applications in a way that increases servicing costs and the different forms of servicing products can be added or subtracted from the mix resulting in best execution and lowest cost per policy servicing transaction.

Available Information

We expect to maintain our web site. Information contained on, or that can be accessed through, our web site does not constitute part of this information statement. We have included our web site address as a factual reference and do not intend it as an active link to our web site. Through our web site we plan to make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after this material is electronically filed with, or furnished to, the SEC. This material may be accessed by visiting the Investors/SEC Filings section of our web site at www.rmic.com. These filings are also accessible on the SEC’s website, www.sec.gov. You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (800) 732-0330. In addition, copies of our annual report on Form 10-K and our other SEC filings will be made available, free of charge, upon written request.

 

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Employees

As of March 31, 2012, we employed approximately 260 persons, the majority of whom are full-time employees. Employees are not covered by any collective bargaining agreement. We consider our employee relations to be good.

Properties

Our mortgage guaranty home office operations are located at 101 North Cherry Street, Winston-Salem, North Carolina 27101 and consist of approximately 70,000 square feet of leased office space. Our CCI operations and executive offices are located at 307 N. Michigan Avenue, Chicago, Illinois 60601 and consist of approximately 23,500 square feet of office space. We consider our facilities to be adequate for our current operations.

Legal Proceedings

Legal proceedings against RFIG and its subsidiaries routinely arise in the normal course of business and usually pertain to claim matters related to insurance policies and contracts issued by its insurance subsidiaries. Other, non-routine legal proceedings which may prove to be material to RFIG or a subsidiary are discussed below.

On December 19, 2008, Old Republic Insurance Company and Old Republic Insured Credit Services, Inc., ("Old Republic") filed suit against Countrywide Bank FSB, Countrywide Home Loans, Inc. ("Countrywide") and Bank of New York Mellon, BNY Mellon Trust of Delaware in the Circuit Court, Cook County, Illinois (Old Republic Insurance Company, et al. v. Countrywide Bank FSB, et al.). The suit seeks rescission of various credit indemnity policies issued to insure home equity loans and home equity lines of credit which Countrywide had securitized or held for its own account, and a declaratory judgment and money damages based upon material misrepresentations either by Countrywide as to the credit characteristics of the loans or by the borrowers in their loan applications. Countrywide filed a counterclaim alleging a breach of contract, bad faith and seeking a declaratory judgment challenging the factual and procedural bases that Old Republic had relied upon to deny or rescind coverage for individual defaulted loans under those policies, as well as unspecified compensatory and punitive damages.

On November 3, 2010, Bank of America, N.A. ("B of A") filed suit against Old Republic Insurance Company ("ORIC") in the U.S. District Court of the Western District of North Carolina (Bank of America, N.A. v. Old Republic Insurance Company) alleging breach of contract, breach of the duty of good faith and fair dealing, and bad faith with respect to ORIC's handling of certain claims under a policy of credit indemnity insurance issued to B of A. The policy is not related to those issued to Countrywide, which are the subject of the above-noted separate litigation. The B of A suit seeks a declaratory judgment with respect to the interpretation of certain policy terms, B of A's compliance with certain terms and conditions of the policy, and the propriety of certain positions and procedures taken by ORIC in response to claims filed by B of A. The suit also seeks money damages in excess of $320 million, pre-and post-judgment interest and unspecified punitive damages. On January 23, 2012, ORIC filed a counterclaim seeking damages based on B of A's alleged interference with ORIC's subrogation rights.

On December 31, 2009, two of the Company's mortgage insurance subsidiaries, Republic Mortgage Insurance Company and Republic Mortgage Insurance Company of North Carolina (together "RMIC") filed a Complaint for Declaratory Judgment in the Supreme Court of the State of New York, County of New York, against Countrywide Financial Corporation, Countrywide Home Loans, Inc., The Bank of New York Mellon Trust Company, N.A., BAC Home Loans Servicing, LP, and Bank of America N.A. as successor in interest to Countrywide Bank, N.A. (together "Countrywide") (Republic Mortgage Insurance Company, et al. v. Countrywide Financial Corporation, et al.). The suit relates to five mortgage insurance master policies (the "Policies") issued by RMIC to Countrywide or to the Bank of New York Mellon Trust Company as co-trustee for trusts containing securitized mortgage loans that were originated or purchased by Countrywide. RMIC has

 

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rescinded its mortgage insurance coverage on over 1,500 of the loans originally covered under the Policies based upon material misrepresentations of the borrowers in their loan applications or the negligence of Countrywide in its loan underwriting practices or procedures. Each of the coverage rescissions occurred after a borrower had defaulted and RMIC reviewed the claim and loan file submitted by Countrywide. The suit seeks the Court's review and interpretation of the Policies' incontestability provisions and its validation of RMIC's investigation procedures with respect to the claims and underlying loan files.

On January 29, 2010, in response to RMIC's suit, Countrywide served RMIC with a demand for arbitration under the arbitration clauses of the same Policies. The demand raises largely the same issues as those raised in RMIC's suit against Countrywide, but from Countrywide's perspective, as well as Countrywide's and RMIC's compliance with the terms, provisions and conditions of the Policies. The demand includes a prayer for punitive, compensatory and consequential damages. RMIC filed a motion to stay the arbitration, and Countrywide filed a motion to dismiss RMIC's lawsuit and to compel the arbitration. On July 26, 2010, the Court granted Countrywide's motion, ordering the matters be submitted to arbitration and dismissing the lawsuit. The arbitration is proceeding.

After its First Amended Complaint was dismissed on May 4, 2011, on July 19, 2011, J.P. Morgan Chase Bank, N.A. ("Chase") filed a Second Amended Complaint against RMIC in the U.S. District Court for the District of New Jersey arising out of RMIC's rescissions of coverage on approximately 377 mortgage loans. (J.P. Morgan Chase Bank, N.A. v. Republic Mortgage Insurance Company). The new lawsuit abandons the earlier claim, which the Court dismissed, that RMIC could not unilaterally rescind coverage. Instead, Chase alleges that RMIC's rescissions were improper either because the coverage had become incontestable; or the rescissions relied upon evidence that was either improperly obtained or insufficient, unreliable or immaterial; or the rescissions were not permitted by applicable law. Based on these allegations, Chase asserts claims for breach of contract, breach of good faith and fiduciary duties, negligence and violations of Colorado and Louisiana insurance laws and seeks declaratory relief and unspecified compensatory, treble and punitive damages. On September 26, 2011, RMIC filed a motion for entry of an order dismissing various claims in the Second Amended Complaint with prejudice and requiring Chase to provide a more definitive statement of any remaining claims. That motion is awaiting the Court's action.

On February 18, 2011, the Federal Deposit Insurance Corporation, as receiver of AmTrust Bank, filed a suit against Old Republic Insurance Company ("ORIC") in the U.S. District Court for the Northern District of Ohio arising out of ORIC's termination of a credit indemnity policy issued to insure home equity loans made or held by AmTrust. The suit (Federal Deposit Insurance Corporation v. Old Republic Insurance Company) alleges breach of contract and seeks a declaratory judgment that ORIC's attempted termination and/or cancellation of the policy did not terminate coverage of the insured loans and that ORIC remains obligated to provide coverage for such loans under the policy. The suit seeks damages in excess of $46 million, declaratory relief, pre-and post-judgment interest, attorneys' fees and costs. The suit was settled on April 27, 2012 in return for a complete termination of the policy in question. The company's obligations under this settlement were considered during its periodic loss reserving process.

Eight purported class action suits alleging RESPA violations have been filed in the Federal District Courts for the Central District of California, two in the Eastern District of Pennsylvania, two in the Western District of Pennsylvania, two in the Eastern District of California, and one in the Southern District of New York, respectively, between December 9, 2011 and April 19, 2012. The suits target J.P. Morgan Chase Bank, N.A., the PNC Financial Services Group, Inc. as successor to National City Bank, N.A., Citibank, N.A., Wachovia Bank, N.A., HSBC Bank USA, N.A., Bank of America, and Fifth Third Bank, each of their wholly-owned captive insurance subsidiaries and a number of the mortgage guaranty insurance companies, including RMIC. (Samp, Komarchuk, Whitaker v. J.P. Morgan Chase Bank, N.A., et al.; White, Hightower v. The PNC Financial Services Group, Inc., et al.; Menichino v. CitiBank, N.A., et al.; Ranjha v. Wachovia Bank, N.A., et al.; McCarn v. HSBC Bank USA, N.A., et al.; Riddle v. Bank of America, et al.; Manners v. Fifth Third Bank, et al.; and Rulison v. ABN AMRO/CitiBank, N.A., et al.) On March 14, 2012, the suit against Wachovia Bank and the mortgage insurers was voluntarily dismissed without prejudice by the plaintiffs. The lawsuits, filed by the same law firms

 

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in all but the most recent case, are substantially identical in alleging that the mortgage guaranty insurers had reinsurance arrangements with the defendant banks' captive insurance subsidiaries under which payments were made in violation of the anti-kickback and fee splitting prohibitions of Sections 8(a) and 8(b) of RESPA. Each of the suits seeks unspecified damages, costs, fees and the return of the allegedly improper payments. A class has not been certified in any of the suits.

On January 27, 2012, a purported national class action suit was filed in the Federal District Court, Northern District of California, Oakland Division. This suit names as defendants ORI and five of its subsidiaries, including RMIC. The suit alleges unfair, unlawful and fraudulent business practices in violation of California's Business & Professions Code and the payment of commissions and kickbacks in violation of the California Insurance Code and RESPA. The suit seeks declaratory injunctive relief, restitution and treble damages in unspecified amounts, and costs and fees.

Under GAAP, an estimated loss is accrued only if the loss is probable and reasonably estimable. The Company and its subsidiaries have defended and intend to continue defending vigorously against each of the aforementioned actions. The Company does not believe it probable that any of these actions will have a material adverse effect on its consolidated financial condition, results of operations, or cash flows, though there can be no assurance in those regards. Nor is the Company able to make a reasonable estimate or range of estimates of any potential liability under these lawsuits, the counterclaim, and the arbitration, all of which seek unquantified damages, attorneys' fees, and expenses. It is also unclear what effect, if any, the run-off operations of RMIC and depletion of its capital will have in the actions against it.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

QUARTERS ENDED MARCH 31, 2012 and 2011

($ in Millions, Except Share Data)

 

 

OVERVIEW

 

This management analysis of financial position and results of operations pertains to the consolidated accounts of the Republic Financial Indemnity Group, Inc. and its subsidiaries ("RFIG" or "the Company"). Prior to its mid-March, 2012 name change, the Company operated as the Old Republic Mortgage Guaranty Group, Inc., a wholly-owned subsidiary of Old Republic International Corporation ("Old Republic" or "ORI"). RFIG's insurance subsidiaries are: Republic Mortgage Insurance Company ("RMIC"), Republic Mortgage Insurance Company of North Carolina ("RMICNC"), and Republic Mortgage Company of Florida ("RMICFL").

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"). RFIG utilizes GAAP largely to comply with the financial reporting requirements of the FASB and the Securities and Exchange Commission ("SEC"). From time to time the FASB and the SEC issue various pronouncements 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, and methodologies for establishing the fair value of financial instruments and recording of other-than-temporary impairments of securities. 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 included in this information statement.

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 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, determination of Federal income taxes payable currently, and the upstreaming of dividends by insurance subsidiaries to their parent holding company. The major differences between these statutory financial accounting practices and GAAP are summarized in Note 1(a) to the Company's 2011 consolidated financial statements included elsewhere in this information statement.

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 of a policy. This basic fact casts RFIG as a risk-taking enterprise managed for the long run. 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 RFIG's basic underwriting and related services functions, investment income is earned from invested funds generated by those functions and from shareholder's 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 over time. 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.

 

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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. The recessionary conditions which have affected housing finance and related industries such as mortgage guaranty insurance since 2007 have shown this business to be exposed to long-developing catastrophic events. As further discussed in the "Basis of Presentation" footnote to the consolidated financial statements, these recessionary conditions have erased RFIG’s long-term profitability and produced substantial losses. As a result, the Company’s capital funds have been largely depleted. On August 31, 2011, RFIG’s insurance subsidiaries discontinued writing new business in all states and limited themselves to servicing the run-off of existing business. Additionally, RMIC is operating pursuant to a Summary Order issued by the North Carolina Department of Insurance placing it under supervision as of January 19, 2012. These circumstances raise substantial doubt about the Company and its insurance subsidiaries’ ability to continue as going concerns.

This management analysis should be read in conjunction with the consolidated financial statements and the footnotes appended to them included elsewhere in this information statement.

 

 

EXECUTIVE SUMMARY

 

Operating performance in this year's first quarter reflected lower claim cost ratios when compared with those registered in the same period of 2011 and all of last year. Key indicators of year-over-year performance follow:

 

Quarters Ended March 31,

   2012     2011     % Change  

Net premiums earned

   $ 103.2      $ 113.9        (9.4 )% 

Net investment income

     10.3        16.6        (37.9

Claim costs

     179.3        212.7        (15.7

Pretax operating income (loss)

     (81.8     (101.1     19.1   

Realized investment gains (losses)

     —          1.4        (99.9

Income taxes (credits)

     (28.6     (35.1     18.7   

Net income (loss)

   $ (53.2   $ (64.5     17.5
  

 

 

   

 

 

   

 

 

 

Claim ratio

     173.6     186.7     (7.0 )% 

Expense ratio

     13.6        15.1        (9.9
  

 

 

   

 

 

   

 

 

 

Composite ratio

     187.2     201.8     (7.2 )% 
  

 

 

   

 

 

   

 

 

 

Diluted earnings per share:

      

Net operating income (loss)

   $ (2.75   $ (4.03     31.8

Net realized investment gains (losses)

     —          .06        (100.0
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (2.75   $ (3.97     30.7
  

 

 

   

 

 

   

 

 

 

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 the Company's basic business results. Operating income (loss), however, does not replace net income determined in accordance with GAAP as a measure of total profitability.

Mortgage guaranty earned premiums for 2012 continued to decline. The 9.4 percent quarter-over-quarter reduction in the top line was mostly due to the gradual depletion of a book of business in run-off operating mode,

 

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and to premium refunds from claim rescission activity. Last year’s first quarter earned premiums reflected a decline of 16.4 percent even though the Company was still actively engaged in new business production, albeit at a much reduced level than existed during pre-recessionary years.

Net investment income declined due to a lower invested asset base driven by the aggregate effects of lower premium volume and claim disbursements, together with the low yield environment affecting the investment portfolio.

Claim costs for this year’s first quarter were 15.7 percent lower year-over-year as the continued downward trend in newly reported cases, relatively stable cure rates, and lower paid claims, more than offset on-going declines in claim rescission and denial activity. The claim ratio improved moderately to 173.6 percent in comparison to 186.7 percent posted in 2011’s initial quarter. The following table shows the composition of incurred claim costs:

 

Quarters Ended March 31,

   2012     2011  

Components of incurred claim ratio as a percent of earned premiums:

    

Paid claims:

    

Excluding captive and pool transactions

     222.5     253.0

Captive and pool transactions

     —          (0.3
  

 

 

   

 

 

 

Paid claim ratio

     222.5        252.7   
  

 

 

   

 

 

 

Claim reserve provisions:

    

Excluding captive and pool transactions

     (48.9     (66.1

Captive and pool transactions

     —          0.1   
  

 

 

   

 

 

 

Claim reserve provision ratio

     (48.9     (66.0
  

 

 

   

 

 

 

Incurred claim ratio: as reported

     173.6     186.7
  

 

 

   

 

 

 

As reported in earlier periods, the Company’s flagship mortgage guaranty insurance carrier, Republic Mortgage Insurance Company ("RMIC"), 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 placed in run-off operating mode. Afterwards, on January 19, 2012, RMIC received a Summary Order ("Order") from the North Carolina Department of Insurance placing the Company under supervision. Among other considerations, the Order instructed RMIC to reduce the cash payment on all claims by 50 percent during an initial period not to exceed one year. The remaining 50 percent deferred payment obligation ("DPO") is to be included in RMIC's statutory capital and will be paid at a future date if and when necessary funds are available.

The Company utilizes a proprietary standard model to forecast and evaluate the potential long-term performance of its book of business. Of necessity, the model takes into account actual premium and claim experience of prior periods, as well as a large number of assumptions and judgments about future outcomes that are highly sensitive to a wide range of estimates. Many of these relate to matters over which the Company has no control, including: 1) The conflicted interests, as well as the varying mortgage servicing and foreclosure practices of a large number of insured lending institutions; 2) General economic and industry-specific trends and events; and 3) The evolving or future social and economic policies of the U.S. Government vis-à-vis such critical sectors as the banking, mortgage lending, and housing industries, as well as its policies for resolving the insolvencies and future role of Fannie Mae and Freddie Mac.

These matters notwithstanding, the Company’s standard model of forecasted results extending through 2020 continues to reflect ultimate profitability for the book of business. While the establishment of a premium

deficiency reserve is therefore unwarranted, the model nonetheless contemplates that results for years 2012-2013

 

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will more likely than not reflect an operating loss far in excess of RMIC’s statutory capital balance. As long as the Order remains in place, the claim cost attenuation enabled by the DPO treatment should mitigate the adverse effect of accentuated claim costs on the statutory capital balance.

As already noted, in March of this year Old Republic announced that it was combining its CCI division with its Mortgage Guaranty ("MI") segment. The two operations offer similar insurance coverages, share the same senior management leadership, and have been operating in run-off mode since 2008 and August 2011, respectively. Concurrent with this action, the Old Republic Mortgage Guaranty Group ("ORMGG") was re-named as the Republic Financial Indemnity Group, Inc. ("RFIG"). RFIG will include a credit indemnity insurer, three existing mortgage insurers, and four related services entities, all of which will be separately held.

Despite recent years' poor results, RFIG maintains a long-term strategic interest in these lines. Any re-activation of the business, however, will require recapitalization of the Company, greater clarity about the future roles of Fannie Mae and Freddie Mac or any successor to them, and the necessary establishment of industry-wide risk management disciplines that address the long-term catastrophe exposures of these financial guaranties. At this juncture, there is no indication that these matters will be addressed by the industry or government institutions or that a recapitalization will occur; there is thus no assurance that an economically viable re-activation of RFIG's business will take place. Accordingly, the run-off will devolve within constraints of Old Republic's currently committed capital resources to RFIG. As of March 31, 2012, the total statutory capital, inclusive of accumulated DPO balances of $92.7, for the three mortgage insurance subsidiaries was approximately $165.5. As of the same date, RFIG's GAAP capitalization amounted to $160.3, and consisted of long-term debt of $177.8 due to the ORI parent company, and a common shareholder's equity (deficit) of ($17.5).

Cash, Invested Assets, and Shareholder's Equity - The following table reflects RFIG's cash and invested assets as well as shareholder's equity (deficit) at the dates shown:

 

                         % Change  
     March 31,
2012
    Dec. 31,
2011
     March 31,
2011
     March '12/
Dec '11
    March '12/
March '11
 

Cash and invested assets: Fair value basis

   $ 1,655.2      $ 1,682.5       $ 2,022.4         (1.6 )%      (18.2 )% 
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

                                                   Original cost basis

   $ 1,637.2      $ 1,666.1       $ 1,953.8         (1.7 )%      (16.2 )% 
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Shareholder's equity (deficit): Total

   $ (17.5   $ 16.2       $ 374.6         (208.0 )%      (104.7 )% 
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Consolidated cash flow from operating activities produced deficits of $72.8 and $128.3 for the quarters ended March 31, 2012 and 2011, respectively, as claims payments exceeded the declining premium base. The lower deficit in 2012 was primarily driven by the establishment of the DPO.

The consolidated investment portfolio reflects a current allocation of approximately 76 percent to fixed-maturity securities while the remaining 24 percent is dedicated to short-term investments. As has been the case for many years, Old Republic's invested assets are managed in consideration of enterprise-wide risk management objectives. These are intended to assure solid funding of its insurance subsidiaries' long-term obligations to policyholders and other beneficiaries, and the necessary long-term stability of capital accounts.

The investment portfolio contains no direct insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, junk bonds, hybrid securities, or illiquid private equity investments. In a similar vein, the Company does not engage in hedging or securities lending transactions, nor does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes.

With the exception of the Company's 2012 acquisition of the CCI servicing operations, substantially all changes in the shareholder's equity account reflect the Company's net loss or changes in market valuations of invested assets during the periods shown.

 

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DETAILED MANAGEMENT ANALYSIS

 

This section of the Management Analysis of Financial Position and Results of Operations is additive to and should be read in conjunction with the Executive Summary which precedes it.

FINANCIAL ACCOUNTING AND REPORTING POLICIES

 

The Company's annual and interim financial statements incorporate a large number and types of estimates relative to matters which are highly uncertain at the time the estimates are made. The estimation process required of an insurance enterprise is by its very nature highly dynamic inasmuch as it necessitates a continuous evaluation, analysis, and quantification of factual data as it becomes known to the Company. As a result, actual experienced outcomes can differ from the estimates made at any point in time and thus affect future periods' reported revenues, expenses, net income or loss, and financial condition.

RFIG believes that its most critical accounting estimates relate to: a) the determination of other-than-temporary impairments ("OTTI") in the value of fixed maturity and equity investments; b) the valuation of deferred income tax assets; c) the recoverability of reinsured paid and/or outstanding losses; and d) the establishment of reserves for losses and loss adjustment expenses. The major assumptions and methods used in setting these estimates are discussed in the Management Analysis of Financial Position and Results of Operations for the year ended December 31, 2011 included elsewhere in this information statement.

In recent years, the Financial Accounting Standards Board ("FASB") has issued various releases requiring additional financial statement disclosures, and to provide guidance relative to the application of such releases. Of particular relevance to the Company's financial statements are recent disclosure requirements pertaining to uncertainties affecting income tax provisions, and methodologies for establishing the fair value of financial instruments, and recording of other-than-temporary impairments of securities. The requisite disclosures and explanations of these matters have been included in the footnotes to the Company's consolidated financial statements included elsewhere in this information statement.

FINANCIAL POSITION

 

The Company's financial position at March 31, 2012 reflected decreases in assets, and common shareholder's equity of .1%, and 208.0%, respectively, and an increase in liabilities of 1.6% when compared to the immediately preceding year-end. Cash and invested assets represented 81.7% and 83.0% of consolidated assets as of March 31, 2012 and December 31, 2011, respectively. As of March 31, 2012, the cash and invested asset base declined by 1.6% to $1,655.2.

Investments - During the first quarter, the majority of investable funds was committed to short to intermediate-term fixed maturity securities. At both March 31, 2012 and 2011, all of the Company's investments consisted of marketable securities. RFIG continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities. The portfolio contains no direct insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations ("CDO's"), derivatives, junk bonds, hybrid securities, or illiquid private equity investments. In a similar vein, the Company does not engage in hedging transactions or securities lending operations, nor does it invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous or unfunded counter-party risk attributes. The Company does not have any exposure to European sovereign debt instruments. At March 31, 2012, RFIG had no fixed maturity investments in default as to principal and/or interest.

Relatively high short-term maturity investment positions continued to be maintained as of March 31, 2012. Such positions reflect a large variety of seasonal and intermediate-term factors including current operating needs,

 

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expected operating cash flows, quarter-end cash flow seasonality, and investment strategy considerations. Accordingly, the future level of short-term investments will vary and respond to the interplay of these factors and may, as a result, increase or decrease from current levels.

RFIG does not own or utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its debt obligations. With regard to its equity portfolio, the Company does not own any options nor does it engage in any type of option writing. Traditional investment management tools and techniques are employed to address the yield and valuation exposures of the invested assets base. The long-term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through asset diversification and the purchase of investment grade securities. Reinvestment rate risk is reduced by concentrating on non-callable issues, and by taking asset-liability matching considerations into account. Purchases of mortgage and asset backed securities, which have variable principal prepayment options, are generally avoided. Market value risk is limited through the purchase of bonds of intermediate maturity. The combination of these investment management practices is expected to produce a more stable long-term fixed maturity investment portfolio that is not subject to extreme interest rate sensitivity and principal deterioration.

The fair value of the long-term fixed maturity investment portfolio is sensitive to fluctuations in interest rates, but not materially affected by changes in anticipated cash flows caused by any prepayments. The impact of interest rate movements on the long-term fixed maturity investment portfolio generally affects net unrealized gains or losses. As a general rule, rising interest rates enhance currently available yields but typically lead to a reduction in the fair value of existing fixed maturity investments. By contrast, a decline in such rates reduces currently available yields but usually serves to increase the fair value of the existing fixed maturity investment portfolio. All such changes in fair value are reflected, net of deferred income taxes, directly in the shareholder's equity account, and as a separate component of the statement of comprehensive income. Given management's inability to forecast or control the movement of interest rates, the maturity spectrum of the fixed maturity securities portfolio is set within parameters of estimated liability payouts, and the overall portfolio is focused on high quality investments. By so doing, RFIG believes it is reasonably assured of its ability to hold securities to maturity as it may deem necessary in changing environments, and of ultimately recovering their aggregate cost. This conceptual framework of RFIG's investment policy therefore makes the GAAP balance sheet fair valuation of its fixed maturity investment portfolio less relevant to the long-term liquidity management of the Company.

Possible future declines in fair values for RFIG's bond and stock portfolios would negatively affect the common shareholder's equity account at any point in time, but would not necessarily result in the recognition of realized investment losses. The Company reviews the status and fair value changes of each of its investments on at least a quarterly basis during the year, and estimates of other-than-temporary impairments in the portfolio's value are evaluated and established at each quarterly balance sheet date. In reviewing investments for other-than-temporary impairment, the Company, in addition to a security's market price history, considers the totality of such factors as the issuer's operating results, financial condition and liquidity, its ability to access capital markets, credit rating trends, most current audit opinion, industry and securities markets conditions, and analyst expectations to reach its conclusions. Sudden fair value declines caused by such adverse developments as newly emerged or imminent bankruptcy filings, issuer default on significant obligations, or reports of financial accounting developments that bring into question the validity of previously reported earnings or financial condition, are recognized as realized losses as soon as credible publicly available information emerges to confirm such developments. Absent issuer-specific circumstances that would result in a contrary conclusion, any equity security with an unrealized investment loss amounting to a 20% or greater decline for a six month period is considered other-than-temporarily-impaired. In the event the Company's estimate of other-than-temporary impairments is insufficient at any point in time, future periods' net income (loss) would be affected adversely by the recognition of additional realized or impairment losses, but its financial condition would not necessarily be affected adversely inasmuch as such losses, or a portion of them, could have been recognized previously as unrealized losses.

 

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The following tables show certain information relating to the Company's fixed maturity portfolios as of the dates shown:

 

 

Credit Quality Ratings of Fixed Maturity Securities (a)

 

 

     March 31,
2012
    December 31,
2011
 

Aaa

     16.4     17.7

Aa

     8.8        8.9   

A

     42.7        42.6   

Baa

     31.9        30.5   
  

 

 

   

 

 

 

Total investment grade

     99.8        99.7   

All other (b)

     .2        .3   
  

 

 

   

 

 

 

Total

     100.0     100.0
  

 

 

   

 

 

 

 

(a) Credit quality ratings used are those assigned primarily by Moody's for U.S. Governments, Agencies and Corporate issuers and by Standard & Poor's ("S&P") for U.S. and Canadian Municipal issuers, which are converted to equivalent Moody's ratings classifications.
(b) "All other" includes non-investment grade or non-rated issuers.

 

 

Gross Unrealized Losses Stratified by Industry Concentration for Non-Investment Grade Fixed Maturity Securities

 

 

     March 31, 2012  
     Amortized
Cost
    Gross Unrealized
Losses
 

Fixed Maturity Securities by Industry Concentration:

    

Industrial

   $ 1.1      $ —     
  

 

 

   

 

 

 

Total

   $ 1.1  (c)    $ —     
  

 

 

   

 

 

 

 

(c) Represents .1% of the total fixed maturity securities portfolio.

 

 

Gross Unrealized Losses Stratified by Industry Concentration for Investment Grade Fixed Maturity Securities

 

 

     March 31, 2012  
     Amortized
Cost
    Gross Unrealized
Losses
 

Fixed Maturity Securities by Industry Concentration:

    

Utilities

   $ 55.8      $ .6   

Technology

     22.5        .3   

Consumer Non-durables

     30.2        .2   

Retail

     9.8        .2   

Other (includes 10 industry groups)

     105.2        .8   
  

 

 

   

 

 

 

Total

   $ 223.7 (d)    $ 2.2   
  

 

 

   

 

 

 

 

(d) Represents 18.2% of the total fixed maturity securities portfolio.

 

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Gross Unrealized Losses Stratified by Maturity Ranges for All Fixed Maturity Securities

 

 

     March 31, 2012  
     Amortized Cost
of Fixed Maturity Securities
     Gross Unrealized Losses  
     All      Non-
Investment
Grade
Only
     All      Non-
Investment
Grade
Only
 

Maturity Ranges:

           

Due in one year or less

   $ —         $ —         $ —         $ —     

Due after one year through five years

     19.5         1.1         .1         —     

Due after five years through ten years

     195.3         —           1.9         —     

Due after ten years

     9.9         —           .1         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 224.9       $ 1.1       $ 2.2       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

Gross Unrealized Losses Stratified by Duration and Amount of Unrealized Losses

 

 

     March 31, 2012  
     Amount of Gross Unrealized Losses  
     Less than
20% of
Cost
     20% to
50%
of Cost
     More than
50% of
Cost
     Total
Gross
Unrealized
Loss
 

Number of Months in Loss Position:

           

Fixed Maturity Securities:

           

One to six months

   $ 2.2       $ —         $ —         $ 2.2   

Seven to twelve months

     —           —           —           —     

More than twelve months

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2.2       $ —         $ —         $ 2.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Number of Issues in Loss Position:

           

Fixed Maturity Securities:

           

One to six months

     69         —           —           69   

Seven to twelve months

     1         —           —           1   

More than twelve months

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     70         —           —           70  (e) 
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(e) At March 31, 2012 the number of fixed maturity securities issues in an unrealized loss position represent 14.9% as to the total number of such issues held.

The aging of issues with unrealized losses employs balance sheet date fair value comparisons with an issue's original cost net of other-than-temporary impairment adjustments. The percentage reduction from such adjusted cost reflects the decline as of a specific point in time (March 31, 2012 in the above table) and, accordingly, is not indicative of a security's value having been consistently below its cost at the percentages shown nor throughout the periods shown.

 

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Age Distribution of Fixed Maturity Securities

 

 

     March 31,
2012
    December 31,
2011
 

Maturity Ranges:

    

Due in one year or less

     17.6     20.4

Due after one year through five years

     33.5        31.2   

Due after five years through ten years

     47.5        46.1   

Due after ten years through fifteen years

     1.2        2.1   

Due after fifteen years

     .2        .2   
  

 

 

   

 

 

 

Total

     100.0     100.0
  

 

 

   

 

 

 

Average Maturity in Years

     5.2        5.2   
  

 

 

   

 

 

 

Duration (f)

     4.5        4.5   
  

 

 

   

 

 

 

 

(f) Duration is used as a measure of bond price sensitivity to interest rate changes. A duration of 4.5 as of March 31, 2012 implies that a 100 basis point parallel increase in interest rates from current levels would result in a possible decline in the fair value of the long-term fixed maturity investment portfolio of approximately 4.5%.

 

 

Composition of Unrealized Gains (Losses)

 

 

     March 31,
2012
    December 31,
2011
 

Fixed Maturity Securities:

    

Amortized cost

   $ 1,231.6      $ 1,297.9   

Estimated fair value

     1,249.7        1,314.3   
  

 

 

   

 

 

 

Gross unrealized gains

     20.2        19.4   

Gross unrealized losses

     (2.2     (3.0
  

 

 

   

 

 

 

Net unrealized gains (losses)

   $ 18.0      $ 16.4   
  

 

 

   

 

 

 

Other Assets - Among other major assets, substantially all of the Company's receivables are not past due. Reinsurance recoverable balances on paid or estimated unpaid losses are deemed recoverable from solvent reinsurers, or are collateralized by equivalently valued cash and investments, or have otherwise been reduced by allowances for estimated amounts unrecoverable.

Liquidity - The RFIG parent holding company meets its liquidity needs principally through dividends paid by its subsidiaries and the limited cash resources accumulated and retained over time. The insurance subsidiaries' ability to pay cash dividends to the parent company is generally restricted by law or subject to approval of the insurance regulatory authorities of the states in which they are domiciled. In light of the subsidiaries' net losses and gradually depleting capital resources during the past five years, no dividends have been paid to the parent company. At March 31, 2012, RFIG, together with a non-regulated service subsidiary, had $9.2 in readily available liquidity. Given its limited liquidity resources, it is unlikely that RFIG will be able to meet its contractual debt obligations for the forseeable future, if ever.

Capitalization - RFIG's total capitalization of $160.3 at March 31, 2012 consisted of common shareholder's equity (deficit) of $(17.5), and long-term debt of $177.8 due to ORI. With the exception of the Company's 2012 acquisition of the CCI servicing operations, changes in the common shareholder's equity account reflect primarily net losses incurred and net unrealized securities gains or losses for the periods reported upon.

 

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Under state insurance regulations, the Company's three insurance subsidiaries are required to operate at a maximum risk to capital ratio of 25:1 or otherwise hold minimum amounts of capital based on specified formulas. RFIG's flagship 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 result, the Company's insurance subsidiaries discontinued writing new business in all states and limited themselves to servicing the run-off of their existing businesses.

RESULTS OF OPERATIONS

 

Revenues: Premiums & Fees

 

Premium revenues stem primarily from monthly installments paid on long-duration, guaranteed renewable insurance policies. Substantially all such premiums are written and earned in the month coverage is effective. With respect to relatively few annual or single premium policies, earned premiums are largely recognized on a pro-rata basis over the terms of the policies. Revenue recognition for insured loans, however, is not appropriately or necessarily matched to the risk exposure and the consequent recognition of both normal and catastrophic loss occurrences.

The following tables provide information on production and related risk exposure trends:

 

Mortgage Guaranty Production by Type  

New Insurance Written:

   Traditional
Primary
     Bulk      Other     Total  

Years Ended December 31:

          

2010

   $ 3,990.2       $ —         $ —        $ 3,990.2   

2011

     2,099.8         —           —          2,099.8   

Quarters Ended March 31:

          

2011

     688.2         —           —          688.2   

2012

   $ 1.6       $ —         $ —        $ 1.6   
  

 

 

    

 

 

    

 

 

   

 

 

 

New Risk Written by Type:

   Traditional
Primary
     Bulk      Other     Total  

Years Ended December 31:

          

2010

   $ 930.0       $ —         $ —        $ 930.0   

2011

     511.0         —           —          511.0   

Quarters Ended March 31:

          

2011

     160.2         —           —          160.2   

2012

   $ .4       $ —         $ —        $ .4   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Earned Premiums      Persistency  

Premium and Persistency Trends by Type:

   Direct      Net      Traditional
Primary
    Bulk  

Years Ended December 31:

          

2010

   $ 529.5       $ 498.8         82.1     88.0

2011

     468.1         444.9         83.2        85.3   

Quarters Ended March 31:

          

2011

     120.0         113.9         81.6        86.3   

2012

   $ 108.2       $ 103.2         82.8     86.1
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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While there is no consensus in the marketplace as to the precise definition of "sub-prime", RFIG generally views loans with credit (FICO) scores less than 620, loans underwritten with reduced levels of documentation and loans with loan to value ratios in excess of 95% as having a higher risk of default. Risk in force concentrations by these attributes are disclosed in the following tables for both traditional primary and bulk production. Premium rates for loans exhibiting greater risk attributes are typically higher in anticipation of potentially greater defaults and claim costs. Additionally, bulk insurance policies, which represent 6.5% of total net risk in force as of March 31, 2012, are frequently subject to deductibles and aggregate stop losses which serve to limit the overall risk on a pool of insured loans. As the decline in the housing markets has accelerated and mortgage lending standards have tightened, rising defaults and the attendant increases in reserves and paid claims on higher risk loans have become more significant drivers of increased claim costs.

 

Net Risk in Force  

Net Risk in Force By Type:

   Traditional
Primary
     Bulk      Other      Total  

As of December 31:

           

2010

   $ 16,557.4       $ 1,187.0       $ 256.1       $ 18,000.6   

2011

     14,476.9         1,017.7         176.3         15,671.0   

As of March 31:

           

2011

     16,058.7         1,149.5         248.6         17,457.0   

2012

   $ 13,862.0       $ 976.9       $ 172.6       $ 15,011.6   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Analysis of Risk in Force  

Risk in Force Distribution By FICO Scores:

   FICO less
than 620
    FICO 620
to 680
    FICO Greater
than 680
    Unscored/
Unavailable
 

Traditional Primary:

        

As of December 31:

        

2010

     6.4     27.5     64.7     1.4

2011

     6.2        26.8        65.7        1.3   

As of March 31:

        

2011

     6.3        27.3        65.0        1.4   

2012

     6.3     26.9     65.6     1.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Bulk(a):

        

As of December 31:

        

2010

     23.2     32.1     44.6     .1

2011

     24.0        32.2        43.7        .1   

As of March 31:

        

2011

     23.5        32.1        44.3        .1   

2012

     24.1     32.3     43.5     .1
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Risk in Force Distribution By Loan to Value ("LTV") Ratio:

   LTV
85.0
and below
    LTV
85.01
to 90.0
    LTV
90.01
to 95.0
    LTV
Greater
than 95.0
 

Traditional Primary(b):

        

As of December 31:

        

2010

     5.3     37.0     31.9     25.8

2011

     5.1        36.2        32.9        25.8   

As of March 31:

        

2011

     5.2        36.9        32.1        25.8   

2012

     5.0     35.9     32.9     26.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Bulk(a):

        

As of December 31:

        

2010

     57.7     22.8     9.6     9.9

2011

     57.1        22.9        9.8        10.2   

As of March 31:

        

2011

     57.4        22.9        9.8        9.9   

2012

     57.2     22.9     9.9     10.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Bulk pool risk in-force, which represented 30.9% of total bulk risk in-force at March 31, 2012, has been allocated pro-rata based on insurance in-force.
(b) The LTV distribution reflects base LTV ratios which are determined prior to the impact of single premiums financed and paid at the time of loan origination.

Risk in Force Distribution By Top Ten States:

 

     Traditional Primary  
     TX     FL     GA     IL     CA     NC     PA     NJ     OH     VA  

As of December 31:

                    

2010

     8.7     7.5     5.2     5.0     5.1     4.7     4.2     3.1     3.3     2.9

2011

     8.8        7.5        5.2        5.0        5.0        4.8        4.3        3.3        3.3        3.0   

As of March 31:

                    

2011

     8.7        7.5        5.2        4.9        5.1        4.7        4.2        3.1        3.3        3.0   

2012

     8.8     7.5