10-Q 1 form10q063011.htm OLD REPUBLIC INTERNATIONAL CORPORATION FORM 10Q FOR THE PERIOD ENDED JUNE 30, 2011 form10q063011.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q

[x]
Quarterly report pursuant to section 13 or 15(d) of the Security Exchange Act of 1934
 
for the quarterly period ended: June 30, 2011 or
   
[  ]
Transition report pursuant to section 13 or 15(d) of the Security Exchange Act of 1934

Commission File Number:
001-10607
 

 
OLD REPUBLIC INTERNATIONAL CORPORATION
 
 
(Exact name of registrant as specified in its charter)
 



Delaware
 
No. 36-2678171
(State or other jurisdiction of
 
(IRS Employer Identification No.)
incorporation or organization)
   


307 North Michigan Avenue, Chicago, Illinois
 
60601
(Address of principal executive office)
 
(Zip Code)



Registrant's telephone number, including area code: 312-346-8100


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes: x  No: ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes: x No: ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "accelerated filer", "large accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one).



Large accelerated filer x
Accelerated filer ¨
   
Non-accelerated filer ¨
Smaller reporting company ¨


Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes:¨ No:x


 
Class
 
Shares Outstanding
June 30, 2011
Common Stock / $1 par value
 
259,281,604





There are 43 pages in this report

 
 

 


OLD REPUBLIC INTERNATIONAL CORPORATION
 
Report on Form 10-Q / June 30, 2011
 
INDEX
   
   
   
 
PAGE NO.
   
PART I
FINANCIAL INFORMATION:
 
     
 
CONSOLIDATED BALANCE SHEETS
3
     
 
CONSOLIDATED STATEMENTS OF INCOME
4
     
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
4
     
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
5
     
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  6  - 14
     
 
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
  15  -  39
     
 
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
  40
     
 
CONTROLS AND PROCEDURES
  40
     
PART II
OTHER INFORMATION:
 
     
 
ITEM 1 – LEGAL PROCEEDINGS
  41
     
 
ITEM 1A – RISK FACTORS
  41
     
 
ITEM 6 – EXHIBITS
  41
   
SIGNATURE
  42
   
EXHIBIT INDEX
  43

 
2

 



Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets
($ in Millions, Except Share Data)
   
(Unaudited)
   
   
June 30,
 
December 31,
   
2011
 
2010
Assets
           
Investments:
           
Available for sale:
           
Fixed maturity securities (at fair value) (amortized cost: $8,144.7 and $8,070.4)
 
$
8,664.4
 
$
8,532.2
Equity securities (at fair value) (adjusted cost: $394.6 and $402.8)
   
622.2
   
672.4
Short-term investments (at fair value which approximates cost)
   
1,105.0
   
1,004.0
Miscellaneous investments
   
34.5
   
40.7
Total
   
10,426.2
   
10,249.4
Other investments
   
10.0
   
9.8
Total investments
   
10,436.2
   
10,259.3
             
Other Assets:
           
Cash
   
129.6
   
127.3
Securities and indebtedness of related parties
   
10.4
   
12.0
Accrued investment income
   
104.5
   
104.1
Accounts and notes receivable
   
1,055.5
   
1,022.9
Federal income tax recoverable:
Current
   
31.7
   
44.6
 
Deferred
   
97.5
   
45.3
Prepaid federal income taxes
   
63.5
   
102.9
Reinsurance balances and funds held
   
220.0
   
205.4
Reinsurance recoverable:
Paid losses
   
106.2
   
96.0
 
Policy and claim reserves
   
3,124.6
   
3,166.4
Deferred policy acquisition costs
   
231.3
   
230.6
Sundry assets
   
475.3
   
465.3
     
5,650.7
   
5,623.4
Total Assets
 
$
16,086.9
 
$
15,882.7
             
Liabilities, Preferred Stock, and Common Shareholders' Equity
           
Liabilities:
           
Losses, claims, and settlement expenses
 
$
8,680.7
 
$
8,814.6
Unearned premiums
   
1,265.9
   
1,232.4
Other policyholders' benefits and funds
   
187.2
   
192.4
Total policy liabilities and accruals
   
10,133.8
   
10,239.5
Commissions, expenses, fees, and taxes
   
395.0
   
424.0
Reinsurance balances and funds
   
405.7
   
383.8
Debt
   
923.1
   
475.0
Sundry liabilities
   
256.8
   
238.8
Commitments and contingent liabilities
           
Total Liabilities
   
12,114.5
   
11,761.3
             
Preferred Stock (1)
   
-
   
-
             
Common Shareholders' Equity:
           
Common stock (1)
   
259.2
   
259.2
Additional paid-in capital
   
653.5
   
649.6
Retained earnings
   
2,623.0
   
2,791.4
Accumulated other comprehensive income (loss)
   
472.2
   
459.1
Unallocated ESSOP shares (at cost)
   
(35.6)
   
(38.0)
Treasury stock (at cost)(1)
   
-
   
-
Total Common Shareholders' Equity
   
3,972.4
   
4,121.4
Total Liabilities, Preferred Stock and Common Shareholders' Equity
 
$
16,086.9
 
$
15,882.7
               
 
(1)  
At June 30, 2011 and December 31, 2010, there were 75,000,000 shares of $0.01 par value preferred stock authorized, of which no shares were outstanding. As of the same dates, there were 500,000,000 shares of common stock, $1.00 par value, authorized, of which 259,281,604 at June 30, 2011 and 259,222,360 at December 31, 2010 were issued. At June 30, 2011 and December 31, 2010, there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. There were no common shares classified as treasury stock as of June 30, 2011 and December 31, 2010.


See accompanying Notes to Consolidated Financial Statements.

 
3

 


Old Republic International Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
($ in Millions, Except Share Data)
   
Quarters Ended
 
Six Months Ended
   
June 30,
 
June 30,
   
2011
 
2010
 
2011
 
2010
Revenues:
                       
Net premiums earned
 
$
890.5
 
$
746.2
 
$
1,813.3
 
$
1,498.6
Title, escrow, and other fees
   
87.2
   
89.1
   
167.4
   
165.3
Total premiums and fees
   
977.7
   
835.4
   
1,980.8
   
1,663.9
Net investment income
   
93.1
   
95.0
   
184.6
   
191.3
Other income
   
27.0
   
4.8
   
55.5
   
9.6
Total operating revenues
   
1,097.9
   
935.3
   
2,221.0
   
1,864.9
Realized investment gains (losses):
                       
From sales
   
5.0
   
72.8
   
11.5
   
75.8
From impairments
   
(8.0)
   
-
   
(8.0)
   
-
Total realized investment gains (losses)
   
(2.9)
   
72.8
   
3.5
   
75.8
Total revenues
   
1,094.9
   
1,008.1
   
2,224.5
   
1,940.7
                         
Benefits, Claims and Expenses:
                       
Benefits, claims and settlement expenses
   
684.0
   
502.5
   
1,320.7
   
994.2
Dividends to policyholders
   
3.7
   
1.7
   
7.2
   
4.2
Underwriting, acquisition, and other expenses
   
500.9
   
417.6
   
1,004.5
   
818.3
Interest and other charges
   
14.6
   
5.3
   
25.3
   
11.8
Total expenses
   
1,203.3
   
927.3
   
2,357.8
   
1,828.6
Income (loss) before income taxes (credits)
   
(108.3)
   
80.8
   
(133.3)
   
112.1
                         
Income Taxes (Credits):
                       
Current
   
(1.4)
   
-
   
4.7
   
11.3
Deferred
   
(40.6)
   
23.4
   
(58.8)
   
18.2
Total
   
(42.0)
   
23.3
   
(54.0)
   
29.5
                         
Net Income (Loss)
 
$
(66.3)
 
$
57.4
 
$
(79.2)
 
$
82.5
                         
Net Income (Loss) Per Share:
                       
Basic:
 
$
(.26)
 
$
.24
 
$
(.31)
 
$
.35
Diluted:
 
$
(.26)
 
$
.23
 
$
(.31)
 
$
.35
                         
Average shares outstanding:
Basic
   
254,972,652
   
236,552,439
   
254,873,612
   
236,478,265
 
Diluted
   
254,972,652
   
264,227,861
   
254,873,612
   
264,081,560
                         
Dividends Per Common Share:
                       
Cash:
 
$
.1750
 
$
.1725
 
$
.3500
 
$
.3450
 
 
Consolidated Statements of Comprehensive Income (Unaudited)
   
Quarters Ended
 
Six Months Ended
   
June 30,
 
June 30,
   
2011
 
2010
 
2011
 
2010
Net income (loss) as reported
 
$
(66.3)
 
$
57.4
 
$
(79.2)
 
$
82.5
                         
Other comprehensive income (loss):
                       
Post-tax net unrealized gains (losses) on securities
   
32.2
   
(29.9)
   
9.2
   
81.5
Other adjustments
   
(1.8)
   
(1.8)
   
3.7
   
1.2
Net adjustments
   
30.4
   
(31.8)
   
13.0
   
82.8
                         
Comprehensive income (loss)
 
$
(35.8)
 
$
25.6
 
$
(66.2)
 
$
165.3


See accompanying Notes to Consolidated Financial Statements.

 
4

 


Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($ in Millions)
   
Six Months Ended
   
June 30,
   
2011
 
2010
         
Cash flows from operating activities:
           
Net income (loss)
 
$
(79.2)
 
$
82.5
Adjustments to reconcile net income (loss) to
           
net cash provided by operating activities:
           
Deferred policy acquisition costs
   
(.4)
   
6.6
Premiums and other receivables
   
(32.5)
   
(9.2)
Unpaid claims and related items
   
(67.6)
   
(313.6)
Other policyholders' benefits and funds
   
3.0
   
(23.2)
Income taxes
   
(45.7)
   
13.6
Prepaid federal income taxes
   
39.4
   
116.1
Reinsurance balances and funds
   
(2.9)
   
(26.8)
Realized investment (gains) losses
   
(3.5)
   
(75.8)
Accounts payable, accrued expenses and other
   
36.1
   
18.5
Total
   
(153.4)
   
(211.3)
             
Cash flows from investing activities:
           
Fixed maturity securities:
           
Maturities and early calls
   
478.6
   
338.7
Sales
   
226.1
   
621.8
Sales of:
           
Equity securities
   
.2
   
106.6
Other - net
   
16.0
   
5.4
Purchases of:
           
Fixed maturity securities
   
(787.8)
   
(626.2)
Equity securities
   
-
   
(129.4)
Other-net
   
(19.2)
   
(14.7)
Net decrease (increase) in short-term investments
   
(104.5)
   
(24.9)
Other-net
   
-
   
2.8
Total
   
(190.5)
   
280.2
             
Cash flows from financing activities:
           
Issuance of debentures and notes
   
537.0
   
190.0
Issuance of common shares
   
.8
   
2.7
Redemption of debentures and notes
   
(101.9)
   
(192.9)
Dividends on common shares
   
(89.1)
   
(81.4)
Other-net
   
(.4)
   
.6
Total
   
346.5
   
(80.8)
             
Increase (decrease) in cash:
   
2.3
   
(11.9)
Cash, beginning of period
   
127.3
   
77.3
Cash, end of period
 
$
129.6
 
$
65.3
             
Supplemental cash flow information:
           
Cash paid during the period for:
Interest
 
$
17.2
 
$
13.4
 
Income taxes
 
$
(8.6)
 
$
16.3








See accompanying Notes to Consolidated Financial Statements.

 
5

 


OLD REPUBLIC INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
($ in Millions, Except Share Data)

1.
Accounting Policies and Basis of Presentation:

The accompanying consolidated financial statements have been prepared 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").

Pertinent accounting and disclosure pronouncements issued from time to time by the FASB are adopted by the Company as they become effective. In October 2010, the FASB issued authoritative guidance regarding the deferral of acquisition costs incurred by insurance entities. The new guidance, which is effective for interim and annual periods beginning after December 15, 2011, limits the capitalization of acquisition costs to those that are incrementally or directly related to the successful acquisition of new or renewal insurance contracts. The Company is currently evaluating this recently ratified guidance, however at this time, it does not expect the impact to have a material effect on its consolidated financial statements.

The financial accounting and reporting process relies on estimates and on the exercise of judgment. In the opinion of management all adjustments, consisting only of normal recurring accruals necessary for a fair presentation of the results have been recorded for the interim periods. Amounts shown in the consolidated financial statements and applicable notes are stated (except as otherwise indicated and as to share data) in millions, which amounts may not add to totals shown due to truncation. Necessary reclassifications are made in prior periods' financial statements whenever appropriate to conform to the most current presentation.

2.
Common Share Data:

Earnings Per Share - Consolidated basic earnings per share excludes the dilutive effect of common stock equivalents and is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares actually outstanding for the period. Diluted earnings per share are similarly calculated with the inclusion of dilutive common stock equivalents. The following table provides a reconciliation of net income (loss) and number of shares used in basic and diluted earnings per share calculations.

     
Quarters Ended
 
Six Months Ended
     
June 30,
 
June 30,
     
2011
 
2010
 
2011
 
2010
                       
 
Numerator:
                       
 
Net Income (loss)
 
$
(66.3)
 
$
57.4
 
$
(79.2)
 
$
82.5
 
Numerator for basic earnings per share -
                       
 
income (loss) available to common stockholders
   
(66.3)
   
57.4
   
(79.2)
   
82.5
 
Adjustment for interest expense incurred on
                       
 
assumed conversions of convertible senior notes
   
-
   
4.6
   
-
   
9.2
 
Numerator for diluted earnings per share -
                       
 
income (loss) available to common stockholders
                       
 
after assumed conversions
 
$
(66.3)
 
$
62.0
 
$
(79.2)
 
$
91.7
 
Denominator:
                       
 
Denominator for basic earnings per share -
                       
 
weighted-average shares (a)
   
254,972,652
   
236,552,439
   
254,873,612
   
236,478,265
 
Effect of dilutive securities -
                       
 
stock based compensation awards
   
-
   
218,186
   
-
   
145,537
 
Effect of dilutive securities - convertible senior notes
   
-
   
27,457,236
   
-
   
27,457,758
 
Denominator for diluted earnings per share -
                       
 
adjusted weighted-average shares
                       
 
and assumed conversions (a)
   
254,972,652
   
264,227,861
   
254,873,612
   
264,081,560
 
Earnings per share:
Basic
 
$
(.26)
 
$
.24
 
$
(.31)
 
$
.35
   
Diluted
 
$
(.26)
 
$
.23
 
$
(.31)
 
$
.35
                           
 
Anti-dilutive common share equivalents
                       
 
excluded from earning per share computations:
                       
 
Stock based compensation awards
   
16,361,394
   
12,873,567
   
16,384,795
   
14,924,067
 
Convertible senior notes
   
62,881,492
   
-
   
49,920,053
   
-
 
Total
   
79,242,886
   
12,873,567
   
66,304,848
   
14,924,067
                             
 
(a)
In calculating earnings per share, pertinent accounting rules require that common shares owned by the Company's Employee Savings and Stock Ownership Plan that are as yet unallocated to participants in the plan be excluded from the calculation. Such shares are issued and outstanding, have the same voting and other rights applicable to all other common shares.
 
 
6

 

3.
Investments:

The Company may classify its invested assets in terms of those assets relative to which it either (1) has the positive intent and ability to hold until maturity, (2) has available for sale or (3) has the intention of trading. As of June 30, 2011 and December 31, 2010, substantially all the Company's invested assets were classified as "available for sale."

Fixed maturity securities classified as "available for sale" and other preferred and common stocks (equity securities) are included at fair value with changes in such values, net of deferred income taxes, reflected directly in shareholders' equity. Fair values for fixed maturity securities and equity securities are based on quoted market prices or estimates using values obtained from independent pricing services as applicable.

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 ("OTTI") in the portfolio's value are evaluated and established at each quarterly balance sheet date. In reviewing investments for OTTI, 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 OTTI. In the event the Company's estimate of OTTI is insufficient at any point in time, future periods' net income (loss) would be adversely affected by the recognition of additional realized or impairment losses, but its financial position would not necessarily be affected adversely inasmuch as such losses, or a portion of them, could have been recognized previously as unrealized losses in shareholders' equity. The Company recognized $8.0 of OTTI adjustments for the quarter and six months ended June 30, 2011 while recognizing no such adjustments for the comparative periods in 2010.

The amortized cost and estimated fair values of fixed maturity securities are as follows:

       
Gross
 
Gross
 
Estimated
   
Amortized
 
Unrealized
 
Unrealized
 
Fair
   
Cost
 
Gains
 
Losses
 
Value
Fixed Maturity Securities:
                       
June 30, 2011:
                       
U.S. & Canadian Governments
 
$
1,245.4
 
$
62.0
 
$
.6
 
$
1,306.8
Tax-exempt
   
1,253.0
   
73.2
   
.2
   
1,326.0
Corporates
   
5,646.1
   
395.2
   
9.8
   
6,031.5
   
$
8,144.7
 
$
530.4
 
$
10.7
 
$
8,664.4
                         
December 31, 2010:
                       
U.S. & Canadian Governments
 
$
1,366.1
 
$
57.6
 
$
4.3
 
$
1,419.4
Tax-exempt
   
1,391.0
   
69.2
   
.4
   
1,459.8
Corporates
   
5,313.2
   
360.2
   
20.5
   
5,652.9
   
$
8,070.4
 
$
487.0
 
$
25.3
 
$
8,532.2

The amortized cost and estimated fair value of fixed maturity securities at June 30, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

       
Estimated
   
Amortized
 
Fair
   
Cost
 
Value
Fixed Maturity Securities:
           
Due in one year or less
 
$
873.5
 
$
886.8
Due after one year through five years
   
4,193.0
   
4,459.9
Due after five years through ten years
   
2,821.3
   
3,063.4
Due after ten years
   
256.7
   
254.2
   
$
8,144.7
 
$
8,664.4

 
7

 

A summary of the Company's equity securities reflecting reported adjusted cost, net of OTTI adjustments totaling $253.0 at June 30, 2011 and $245.4 at December 31, 2010 follows:

       
Gross
 
Gross
 
Estimated
   
Adjusted
 
Unrealized
 
Unrealized
 
Fair
   
Cost
 
Gains
 
Losses
 
Value
                         
June 30, 2011
 
$
394.6
 
$
228.3
 
$
.7
 
$
622.2
                         
December 31, 2010
 
$
402.8
 
$
271.7
 
$
2.2
 
$
672.4

The following table reflects the Company's gross unrealized losses and fair value, aggregated by category and length of time that individual securities have been in an unrealized loss position employing fair value comparisons with an issuer's adjusted cost at June 30, 2011 and December 31, 2010:

 
12 Months or Less
 
Greater than 12 Months
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
June 30, 2011:
                                 
Fixed Maturity Securities:
                                 
U.S. & Canadian Governments
$
39.5
 
$
.6
 
$
-
 
$
-
 
$
39.5
 
$
.6
Tax-exempt
 
14.1
   
.2
   
-
   
-
   
14.1
   
.2
Corporates
 
570.5
   
9.4
   
3.1
   
.3
   
573.7
   
9.8
Subtotal
 
624.2
   
10.3
   
3.1
   
.3
   
627.4
   
10.7
Equity Securities
 
.6
   
.6
   
-
   
-
   
.6
   
.7
Total
$
624.9
 
$
11.0
 
$
3.1
 
$
.4
 
$
628.0
 
$
11.4
                                   
December 31, 2010:
                                 
Fixed Maturity Securities:
                                 
U.S. & Canadian Governments
$
318.7
 
$
4.3
 
$
-
 
$
-
 
$
318.7
 
$
4.3
Tax-exempt
 
14.2
   
.4
   
-
   
-
   
14.2
   
.4
Corporates
 
729.5
   
19.3
   
26.0
   
1.2
   
755.5
   
20.5
Subtotal
 
1,062.4
   
24.1
   
26.0
   
1.2
   
1,088.5
   
25.3
Equity Securities
 
6.3
   
-
   
96.7
   
2.1
   
103.0
   
2.2
Total
$
1,068.8
 
$
24.1
 
$
122.7
 
$
3.4
 
$
1,191.6
 
$
27.5

At June 30, 2011, the Company held 175 fixed maturity and 2 equity securities in an unrealized loss position, representing 8.7% as to fixed maturities and 4.8% as to equity securities of the total number of such issues it held. At December 31, 2010, the Company held 283 fixed maturity and 3 equity securities in an unrealized loss position, representing 13.5% as to fixed maturities and 7.1% as to equity securities of the total number of such issues it held. Of the securities in an unrealized loss position, 2 and 5 fixed maturity securities and 1 and 2 equity securities had been in a continuous unrealized loss position for more than 12 months as of June 30, 2011 and December 31, 2010, respectively. The unrealized losses on these securities are primarily attributable to a post-purchase rising interest rate environment and/or a decline in the credit quality of some issuers. As part of its assessment of other-than-temporary impairments, the Company considers its intent to continue to hold and the likelihood that it will not be required to sell investment securities in an unrealized loss position until cost recovery, principally on the basis of its asset and liability maturity matching procedures. The Company has not sold nor does it expect to sell investments for purposes of generating cash to pay claim or expense obligations.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price) at the measurement date. A fair value hierarchy is established that prioritizes the sources ("inputs") used to measure fair value into three broad levels: inputs based on quoted market prices in active markets (Level 1); observable inputs based on corroboration with available market data (Level 2); and unobservable inputs based on uncorroborated market data or a reporting entity's own assumptions (Level 3). Following is a description of the valuation methodologies and general classification used for securities measured at fair value.

The Company uses quoted values and other data provided by a nationally recognized independent pricing source as inputs into its quarterly process for determining fair values of its fixed maturity and equity securities. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; and (ii) comparing the fair value estimates to its knowledge of the current market and to independent fair value estimates provided by the investment custodian. The independent pricing source obtains market quotations and actual transaction prices for securities that have quoted prices in active markets and uses its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of

 
8

 

"matrix pricing" in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.

Level 1 securities include U.S. and Canadian Treasury notes, publicly traded common stocks, the quoted net asset value ("NAV") of mutual funds, and most short-term investments in highly liquid money market instruments. Level 2 securities generally include corporate bonds, municipal bonds, certain U.S. and Canadian government agency securities, and a restricted publicly traded common stock. Securities classified within Level 3 include non-publicly traded bonds, short-term investments, and common stocks. There were no significant changes in the fair value of assets measured with the use of significant unobservable inputs as of June 30, 2011 and December 31, 2010.

The following table shows a summary of assets measured at fair value segregated among the various input levels described above:

 
Fair value measurements as of June 30, 2011:
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale:
                     
Fixed maturity securities:
                     
U.S. & Canadian Governments
$
408.1
 
$
898.7
 
$
-
 
$
1,306.8
Tax-exempt
 
-
   
1,326.0
   
-
   
1,326.0
Corporates
 
-
   
6,001.0
   
30.5
   
6,031.5
Equity securities
 
546.5
   
73.6
   
2.0
   
622.2
Short-term investments
$
1,099.6
 
$
-
 
$
5.3
 
$
1,105.0

 
Fair value measurements as of December 31, 2010:
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale:
                     
Fixed maturity securities:
                     
U.S. & Canadian Governments
$
483.9
 
$
935.4
 
$
-
 
$
1,419.4
Tax-exempt
 
-
   
1,459.8
   
-
   
1,459.8
Corporates
 
-
   
5,622.2
   
30.6
   
5,652.9
Equity securities
 
525.0
   
145.0
   
2.4
   
672.4
Short-term investments
$
998.6
 
$
-
 
$
5.4
 
$
1,004.0

Investment income is reported net of allocated expenses and includes appropriate adjustments for amortization of premium and accretion of discount on fixed maturity securities acquired at other than par value. Dividends on equity securities are credited to income on the ex-dividend date. Realized investment gains and losses, which result from sales or write-downs of securities, are reflected as revenues in the income state­ment and are determined on the basis of amortized value at date of sale for fixed maturity securities, and cost in regard to equity securities; such bases apply to the specific securities sold. Unrealized investment gains and losses, net of any defer­red income taxes, are recorded directly as a component of accumulated other comprehensive income in shareholders' equity. At June 30, 2011, the Company and its subsidiaries had no non-income producing fixed maturity securities.

 
9

 


The following table reflects the composition of net investment income, net realized gains or losses, and the net change in unrealized invest­ment gains or losses for each of the years shown.

 
Quarters Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Investment income from:
                     
Fixed maturity securities
$
90.6
 
$
92.6
 
$
179.7
 
$
187.0
Equity securities
 
2.5
   
1.8
   
4.9
   
2.7
Short-term investments
 
.3
   
.3
   
.8
   
.6
Other sources
 
1.3
   
1.0
   
2.4
   
2.3
Gross investment income
 
94.9
   
95.8
   
188.0
   
192.8
    Investment expenses (a)   1.7      .7      3.3      1.4 
Net investment income
$
93.1
 
$
95.0
 
$
184.6
 
$
191.3
                       
Realized gains (losses) on:
                     
Fixed maturity securities:
                     
Gains
$
3.9
 
$
37.4
 
$
11.6
 
$
40.5
Losses
 
(.3)
   
-
   
(1.4)
   
(.1)
Net
 
3.6
   
37.4
   
10.1
   
40.3
                       
Equity securities & other long-term investments
 
(6.6)
   
35.4
   
(6.6)
   
35.5
Total
 
(2.9)
   
72.8
   
3.5
   
75.8
Income taxes (credits)(b)
 
(1.0)
   
25.4
   
1.2
   
26.5
Net realized gains (losses)
$
(1.9)
 
$
47.3
 
$
2.2
 
$
49.3
Changes in unrealized investment gains (losses) on:
                     
Fixed maturity securities
$
88.0
 
$
90.7
 
$
57.7
 
$
135.1
Less: Deferred income taxes (credits)
 
30.7
   
31.7
   
20.2
   
47.2
Net changes in unrealized investment gains (losses)
$
57.2
 
$
59.0
 
$
37.5
 
$
87.8
                       
Equity securities & other long-term investments
$
(38.5)
 
$
(137.0)
 
$
(43.6)
 
$
(9.7)
Less: Deferred income taxes (credits)
 
(13.4)
   
(47.9)
   
(15.3)
   
(3.4)
Net changes in unrealized investment gains (losses)
$
(25.0)
 
$
(89.0)
 
$
(28.2)
 
$
(6.3)
                         

 
(a)
Investment expenses consist of personnel costs and investment management and custody service fees, as well as interest incurred on funds held of $.5 and $.9 for the quarter and six months ended June 30, 2011, respectively, and negligible amounts incurred in comparative periods of 2010.
 
(b)
Reflects primarily the combination of fully taxable realized investment gains or losses and judgments about the recoverability of deferred tax assets.

4.
Pension Plans:

As of June 30, 2011, the Company has four pension plans covering a portion of its work force. The four plans are the Old Republic International Employees Retirement Plan (the Old Republic Plan), the Bituminous Casualty Corporation Retirement Income Plan (the Bituminous Plan), the Old Republic National Title Group Pension Plan (the Title Plan), and the PMA Capital Corporation Pension Plan (the PMA Plan). The plans are defined benefit plans pursuant to which pension payments are based primarily on years of service and employee compensation near retirement. It is the Company's policy to fund the plans' costs as they accrue. With the exception of the PMA Plan, these plans have been closed to new participants since December 31, 2004. The PMA Plan was frozen as of December 31, 2005. Under the terms of the freeze, the plan is closed to new participants and eligible employees retained all of their rights under the plan that they had vested as of December 31, 2005 but do not accrue any additional benefits thereafter. Plan assets are comprised principally of bonds, common stocks and short-term investments. Cash contributions of $11.0 were made to the pension plans in the first half of 2011, and additional cash contributions of $17.2 are expected to be made in the remaining portion of calendar year 2011.

5.
Information About Segments of Business:

The Company is engaged in the single business of insurance underwriting. It conducts its operations through a number of regulated insurance company subsidiaries organized into three major segments, namely its General Insurance (property and liability insurance), Mortgage Guaranty and Title Insurance Groups. The results of a small life & health insurance business are included with those of its corporate and minor service operations. Each of the Company's segments underwrites and services only those insurance coverages which may be written by it pursuant to state insurance regulations and corporate charter provisions. Segment results exclude net realized investment gains or losses and other-than-temporary impairments as these are aggregated in the consolidated totals. The contributions of Old Republic's insurance industry segments to consolidated totals are shown in the following table.

 
10

 



 
Quarters Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
General Insurance Group:
                     
Net premiums earned
$
519.0
 
$
401.0
 
$
1,051.4
 
$
812.8
Net investment income and other income
 
93.5
   
67.3
   
186.7
   
134.6
Total revenues before realized gains or losses
$
612.6
 
$
468.3
 
$
1,238.1
 
$
947.5
Income (loss) before income taxes (credits) and
                     
realized investment gains or losses (a)
$
71.0
 
$
29.3
 
$
139.5
 
$
98.6
Income tax expense (credits) on above
$
21.3
 
$
6.5
 
$
42.6
 
$
27.6
                       
Mortgage Guaranty Group:
                     
Net premiums earned
$
111.7
 
$
129.1
 
$
225.7
 
$
265.4
Net investment income and other income
 
16.5
   
23.0
   
33.8
   
47.2
Total revenues before realized gains or losses
$
128.3
 
$
152.1
 
$
259.5
 
$
312.6
Income (loss) before income taxes (credits) and
                     
realized investment gains or losses (a)
$
(175.8)
 
$
(22.1)
 
$
(277.0)
 
$
(56.3)
Income tax expense (credits) on above
$
(61.7)
 
$
(8.7)
 
$
(97.4)
 
$
(22.0)
                       
Title Insurance Group:
                     
Net premiums earned
$
239.8
 
$
197.4
 
$
492.5
 
$
376.5
Title, escrow and other fees
 
87.2
   
89.1
   
167.4
   
165.3
Sub-total
 
327.1
   
286.6
   
659.9
   
541.8
Net investment income and other income
 
7.5
   
6.9
   
14.7
   
13.7
Total revenues before realized gains or losses
$
334.6
 
$
293.5
 
$
674.6
 
$
555.6
Income (loss) before income taxes (credits) and
                     
realized investment gains or losses (a)
$
5.5
 
$
4.0
 
$
8.1
 
$
(4.6)
Income tax expense (credits) on above
$
1.6
 
$
1.3
 
$
2.4
 
$
(1.8)
                       
Consolidated Revenues:
                     
Total revenues of above Company segments
$
1,075.6
 
$
914.0
 
$
2,172.4
 
$
1,815.8
Other sources (b)
 
36.7
   
34.6
   
77.2
   
76.6
Consolidated net realized investment gains (losses)
 
(2.9)
   
72.8
   
3.5
   
75.8
Consolidation elimination adjustments
 
(14.4)
   
(13.3)
   
(28.6)
   
(27.4)
Consolidated revenues
$
1,094.9
 
$
1,008.1
 
$
2,224.5
 
$
1,940.7
                       
Consolidated Income (Loss) Before Taxes (Credits):
                     
Total income (loss) before income taxes (credits)
                     
and realized investment gains or losses of
                     
above Company segments
$
(99.2)
 
$
11.1
 
$
(129.2)
 
$
37.6
Other sources – net (b)
 
(6.1)
   
(3.2)
   
(7.5)
   
(1.4)
Consolidated net realized investment gains (losses)
 
(2.9)
   
72.8
   
3.5
   
75.8
Consolidated income (loss)
                     
before income taxes (credits)
$
(108.3)
 
$
80.8
 
$
(133.3)
 
$
112.1

Consolidated Income Tax Expense (Credits):
                     
Total income tax expense (credits)
                     
for above Company segments
$
(38.8)
 
$
(.8)
 
$
(52.4)
 
$
3.7
Other sources – net (b)
 
(2.2)
   
(1.2)
   
(2.8)
   
(.7)
Income tax expense (credits) on
                     
consolidated net realized investment gains (losses)
 
(1.0)
   
25.4
   
1.2
   
26.5
Consolidated income tax expense (credits)
$
(42.0)
 
$
23.3
 
$
(54.0)
 
$
29.5

   
June 30,
 
December 31,
   
2011
 
2010
Consolidated Assets:
           
General
 
$
12,251.2
 
$
12,189.8
Mortgage
   
2,239.2
   
2,537.9
Title
   
912.8
   
915.0
Other assets (b)
   
1,019.8
   
576.7
Consolidation elimination adjustments
   
(336.2)
   
(336.8)
Consolidated
 
$
16,086.9
 
$
15,882.7
               

 
11

 


 
(a)
Income (loss) before taxes (credits) is reported net of interest charges on intercompany financing arrangements with Old Republic's holding company parent for the following segments: General - $6.0 and $11.4 compared to $5.3 and $10.7 for the quarter and six months ended June 30, 2011 and 2010, respectively; Mortgage - $2.0 and $3.8 compared to $1.7 and $3.5 for the quarter and six months ended June 30, 2011 and 2010, respectively; and Title - $1.3 and $2.6 compared to $1.2 and $2.6 for the quarter and six months ended June 30, 2011 and 2010, respectively.
 
(b)
Represents amounts for Old Republic's holding company parent, minor corporate services subsidiaries, and a small life and health insurance operation.

6.
Commitments and Contingent Liabilities:

Legal proceedings against the Company 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 the Company or a subsidiary are discussed below.

Purported class action lawsuits are pending against the Company's principal title insurance subsidiary, Old Republic National Title Insurance Company ("ORNTIC"), in federal courts in two states – Pennsylvania (Markocki et al. v. ORNTIC, U.S. District Court, Eastern District, Pennsylvania, filed June 8, 2006), and Texas (Ahmad et al. v. ORNTIC, U.S. District Court, Northern District, Texas, Dallas Division, filed February 8, 2008). The plaintiffs allege that ORNTIC failed to give consumers reissue and/or refinance credits on the premiums charged for title insurance covering mortgage refinancing transactions, as required by rate schedules filed by ORNTIC or by state rating bureaus with the state insurance regulatory authorities. The Pennsylvania suit also alleges violations of the federal Real Estate Settlement Procedures Act ("RESPA"). The Court in the Texas suit dismissed similar RESPA allegations. Classes have been certified in both actions.

Beginning in early February 2008, some 80 purported consumer class action lawsuits were filed against the title industry's principal title insurance companies, their subsidiaries and affiliates, and title insurance rating bureaus or associations in at least 10 states. ORNTIC was a named defendant in actions filed in 5 of the states. The suits were substantially identical in alleging that the defendant title insurers engaged in illegal price-fixing agreements to set artificially high premium rates and conspired to create premium rates which the state insurance regulatory authorities could not evaluate and therefore, could not adequately regulate. Most of the suits have since been dismissed. Of those remaining, ORNTIC is currently among the named defendants in only one of these actions, in California. The anti-trust allegations in the California action have been dismissed and only the allegations of improper business practices under state law remain. On June 28, 2011, the Federal District Court for the Northern District of California granted a motion to stay the litigation and compel arbitration of individual claims, thus precluding the certification of a class action. The other suits in which ORNTIC was a named defendant have all been dismissed at the trial court level.

National class action suits have been filed against the Company's subsidiary, Old Republic Home Protection Company ("ORHP") in the California Superior Court, San Diego, and the U.S. District Court in Birmingham, Alabama. The California suit has been filed on behalf of all persons who made a claim under an ORHP home warranty contract from March 6, 2003 to the present. The suit alleges breach of contract, breach of the implicit covenant of good faith and fair dealing, violations of certain California consumer protection laws and misrepresentation arising out of ORHP's alleged failure to adopt and implement reasonable standards for the prompt investigation and processing of claims under its home warranty contracts. The suit seeks unspecified damages consisting of the rescission of the class members' contracts, restitution of all sums paid by the class members, punitive damages, and declaratory and injunctive relief. ORHP removed the action to the U.S. District Court for the Southern District of California, and on January 6, 2011 the Court denied plaintiff's motion for class certification. The Alabama suit alleges that ORHP pays fees to the real estate brokers who market its home warranty contracts and that the payment of such fees is in violation of Section 8(a) of RESPA. The suit seeks unspecified damages, including treble damages under RESPA. No class has been certified in the Alabama action.

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 seeking declaratory judgment to rescind or terminate 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. In February of 2009, 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 of March 31, 2011, Old Republic had rescinded or denied coverage on more than 18,000 defaulted loans, based upon material misrepresentations either by Countrywide as to the credit characteristics of the loans or by the borrowers in their loan applications.

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 for the Western District of North Carolina 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

 
12

 


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, pre and post judgment interest and unspecified punitive damages.

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"). 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 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. RMIC has appealed the Court's ruling.

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. 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 February 18, 2011, the Federal Deposit Insurance Corporation, as receiver of AmTrust Bank, filed a suit against 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 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, declaratory relief, pre-and post-judgment interest, attorneys' fees and costs.

The ultimate impact of these lawsuits and the arbitration, all of which seek unquantified damages, attorneys' fees and expenses, is uncertain and not reasonably estimable at this time. The Company and its subsidiaries intend to defend vigorously against each of the aforementioned actions. Although the Company does not believe that these actions will have a material adverse effect on its consolidated financial condition, results of operations or cash flows, there can be no assurance in those regards.

 
13

 


7.
Debt:

On March 9, 2011, the Company completed a public offering of $550.0 aggregate principal amount of Convertible Senior Notes. The notes bear interest at a rate of 3.75% per year, mature on March 15, 2018, and are convertible at any time prior to maturity by the holder into 64.3407 shares of common stock per one thousand dollar note.

Consolidated debt of Old Republic and its subsidiaries is summarized below:

   
June 30, 2011
 
December 31, 2010
 
   
Carrying
 
Fair
 
Carrying
 
Fair
   
Amount
 
Value
 
Amount
 
Value
3.75% Convertible Senior Notes due 2018
 
$
550.0
 
$
543.8
 
$
-
 
$
-
 
8% Convertible Senior Notes due 2012
   
316.2
   
348.6
   
316.2
   
399.2
 
ESSOP debt with an average yield of 3.74%
                         
and 3.77%, respectively
   
23.4
   
23.4
   
25.8
   
25.8
 
Junior subordinated debt due 2037 and 2033 - 2037,
                         
respectively, with average yields of 8.29%
                         
and 4.34% to 8.29%, respectively
   
20.0
   
20.0
   
62.5
   
62.5
 
8.5% Senior Notes due 2018
   
-
   
-
   
56.4
   
56.4
 
Surplus notes due 2035 with an
                         
average yield of 4.77% and 4.79%, respectively
   
10.0
   
10.0
   
10.0
   
10.0
 
Other miscellaneous debt
   
3.4
   
3.4
   
4.0
   
4.0
 
Total debt
 
$
923.1
 
$
949.3
 
$
475.0
 
$
558.1
 

On March 4, 2011, the Company terminated a $150.0 one year commercial paper credit facility.

8.
Income Taxes:

Tax positions taken or expected to be taken in a tax return by the Company are recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. To the best of management's knowledge, there are no tax uncertainties that are expected to result in significant increases or decreases to unrecognized tax benefits within the next twelve month period. The Company views its income tax exposures as primarily consisting of timing differences whereby the ultimate deductibility of a taxable amount is highly certain but the timing of its deductibility is uncertain. Such differences relate principally to the timing of deductions for loss and premium reserves. As in prior examinations, the Internal Revenue Service (IRS) could assert that claim reserve deductions were overstated thereby reducing the Company's statutory taxable income in any particular year. The Company believes that it establishes its reserves fairly and consistently at each balance sheet date, and that it would succeed in defending its tax position in these regards. Because of the impact of deferred tax accounting, the possible accelerated payment of tax to the IRS would not necessarily affect the annual effective tax rate. Examinations of the Company's consolidated Federal income tax returns through year-end 2006 have been completed and no significant adjustments have resulted. The Company classifies interest and penalties as income tax expense in the consolidated statement of income.

 
14

 


OLD REPUBLIC INTERNATIONAL CORPORATION
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
Six Months Ended June 30, 2011 and 2010
($ in Millions, Except Share Data)

OVERVIEW

This management analysis of financial position and results of operations pertains to the consolidated accounts of Old Republic International Corporation ("Old Republic" or "the Company"). The Company conducts its operations through three major regulatory segments, namely, its General (property and liability), Mortgage Guaranty, and Title insurance segments. A small life and health insurance business, accounting for 2.1% of consolidated operating revenues for the six months ended June 30, 2011 and 1.6% of consolidated assets as of June 30, 2011, is included within the corporate and other caption of this report.

The consolidated accounts are presented in conformity with the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") of accounting principles generally accepted in the United States of America ("GAAP"). As a publicly held company, Old Republic utilizes GAAP largely to comply with the financial reporting requirements of the Securities and Exchange Commission ("SEC"). From time to time the FASB and the SEC issue various releases, most of which require additional financial statement disclosures and provide related application guidance. Of particular relevance to the Company's financial statements are recent disclosure requirements pertaining to uncertainties affecting income tax provisions, methodologies for establishing the fair value and recording of other-than-temporary impairments of securities, possible consolidation of variable interest entities, and composition of plan assets held by the Company's defined benefit plans. In October 2010, the FASB also issued new guidance relative to the calculation of deferred acquisition costs incurred by insurance entities. The requisite disclosures and explanations for these matters are covered in the pertinent sections of this Management Analysis and/or footnotes to the Company's consolidated financial statements regularly included in its quarterly and annual reports to the SEC on Forms 10-Q and/or 10-K, respectively.

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

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

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

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

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

 
15

 



EXECUTIVE SUMMARY

Old Republic’s consolidated operating results remained unprofitable in the latest quarterly and year-to-date periods of 2011. This compares with slight profitability in the same periods of 2010 even though operations in last year’s second half negated those results and led to a relatively small loss for the entire year.

From a business segment standpoint, 2011 quarterly and year-to-date comparisons with 2010 reflect more positive general and title insurance results. Mortgage guaranty performance, however, suffered from worsening claim cost trends.

Second quarter and first half 2011 financial data includes the accounts of PMA Capital Corporation (“PMA”) whose merger with Old Republic occurred on October 1, 2010. The addition of PMA-related accounts in this year’s second quarter and first half had a positive effect on consolidated operating revenues of $137.5 and $279.5, and on net operating results of approximately $4.1 and $11.1, respectively.

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

 
Quarters Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
Change
 
2011
 
2010
 
Change
Operating revenues:
                                 
General insurance
$
612.6
 
$
468.3
 
30.8
%
 
$
1,238.1
 
$
947.5
 
30.7
%
Mortgage guaranty
 
128.3
   
152.1
 
-15.7
     
259.5
   
312.6
 
-17.0
 
Title insurance
 
334.6
   
293.5
 
14.0
     
674.6
   
555.6
 
21.4
 
Corporate and other
 
22.3
   
21.3
 
4.9
     
48.6
   
49.1
 
-1.0
 
Total
$
1,097.9
 
$
935.3
 
17.4
%
 
$
2,221.0
 
$
1,864.9
 
19.1
%
Pretax operating income (loss):
                                 
General insurance
$
71.0
 
$
29.3
 
142.0
%
 
$
139.5
 
$
98.6
 
41.5
%
Mortgage guaranty
 
(175.8)
   
(22.1)
 
N/M
     
(277.0)
   
(56.3)
 
-392.0
 
Title insurance
 
5.5
   
4.0
 
38.6
     
8.1
   
(4.6)
 
276.6
 
Corporate and other
 
(6.1)
   
(3.2)
 
-90.3
     
(7.5)
   
(1.4)
 
-432.6
 
Sub-total
 
(105.4)
   
7.9
 
N/M
     
(136.8)
   
36.2
 
-477.2
 
Realized investment gains (losses):
                                 
From sales
 
5.0
   
72.8
         
11.5
   
75.8
     
From impairments
 
(8.0)
   
-
         
(8.0)
   
-
     
    Net realized investment gains (losses)
 
(2.9)
   
72.8
 
-104.1
     
3.5
   
75.8
 
-95.4
 
Consolidated pretax income (loss)
 
(108.3)
   
80.8
 
-234.1
     
(133.3)
   
112.1
 
-218.9
 
Income taxes (credits)
 
(42.0)
   
23.3
 
-280.0
     
(54.0)
   
29.5
 
-282.7
 
Net income (loss)
$
(66.3)
 
$
57.4
 
-215.4
%
 
$
(79.2)
 
$
82.5
 
-196.0
%

Consolidated underwriting ratio:
                                 
Benefits and claim ratio
70.3
%
 
60.4
%
       
67.0
%
 
60.0
%
     
Expense ratio
48.1
   
48.8
         
47.6
   
48.1
       
Composite ratio
118.4
%
 
109.2
%
       
114.6
%
 
108.1
%
     

Diluted earnings per share:
                                 
Net operating income (loss)
$
(0.25)
 
$
0.05
       
$
(0.32)
 
$
0.16
     
Net realized investment gains (losses)
 
(0.01)
   
0.18
         
0.01
   
0.19
     
Net income (loss)
$
(0.26)
 
$
0.23
       
$
(0.31)
 
$
0.35
     
                                   
Cash dividends paid per share
$
0.1750
 
$
0.1725
 
1.4
%
 
$
0.3500
 
$
0.3450
 
1.4
%

Components of diluted
                                 
earnings per share:
                                 
Net operating income (loss):
                                 
General insurance
$
0.19
 
$
0.09
       
$
0.38
 
$
0.27
     
Mortgage guaranty
 
(0.45)
   
(0.05)
         
(0.70)
   
(0.13)
     
Title insurance
 
0.02
   
0.01
         
0.02
   
(0.01)
     
Corporate and other
 
(0.01)
   
-
         
(0.02)
   
0.03
     
Subtotal
 
(0.25)
   
0.05
         
(0.32)
   
0.16
     
Net realized investment gains (losses)
 
(0.01)
   
0.18
         
0.01
   
0.19
     
Net income (loss)
$
(0.26)
 
$
0.23
       
$
(0.31)
 
$
0.35
     

 
16

 


The recognition of realized investment gains or losses can be highly discretionary and arbitrary due to such factors as the timing of individual securities sales, recognition of estimated losses from write-downs of impaired securities, tax-planning considerations, and changes in investment management judgments relative to the direction of securities markets or the future prospects of individual investees or industry sectors. Likewise, non-recurring items which may emerge from time to time can distort the comparability of the Company’s results from period to period. Accordingly, management uses net operating income, a non-GAAP financial measure, to evaluate and better explain operating performance, and believes its use enhances an understanding of Old Republic’s basic business results. Operating income, however, does not replace net income determined in accordance with GAAP as a measure of total profitability.

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

 
Quarters Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Realized gains (losses) from sales of
                     
previously impaired securities:
                     
Actual tax basis (loss) on sales
$
-
 
$
(44.0)
 
$
-
 
$
(44.0)
Accounting adjustment for impairment
                     
charges taken in prior periods
 
-
   
71.9
   
.4
   
71.9
Net amount included herein
 
-
   
27.9
   
.4
   
27.9
Net realized gains from sales of all other securities
 
5.0
   
44.9
   
11.1
   
47.9
Net gain (loss) from actual sales
 
5.0
   
72.8
   
11.5
   
75.8
Net realized losses from impairments
 
(8.0)
   
-
   
(8.0)
   
-
Net realized investment gains (losses) reported herein
$
(2.9)
 
$
72.8
 
$
3.5
 
$
75.8

General Insurance Results – Operating earnings for 2011’s second quarter and first half were affected positively by moderately lower claim costs and the above-noted inclusion of PMA’s accounts. Key indicators of year-over-year performance are shown in the following table:

 
General Insurance Group
 
Quarters Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
Change
 
2011
 
2010
 
Change
Net premiums earned
$
519.0
 
$
401.0
 
29.4
%
 
$
1,051.4
 
$
812.8
 
29.4
%
Net investment income
 
68.2
   
64.7
 
5.5
     
134.6
   
129.3
 
4.1
 
Benefits and claims costs
 
368.3
   
318.4
 
15.7
     
758.0
   
609.2
 
24.4
 
Pretax operating income (loss)
$
71.0
 
$
29.3
 
142.0
%
 
$
139.5
 
$
98.6
 
41.5
%

Claim ratio
71.0
%
 
79.4
%
     
72.1
%
 
74.9
%
   
Expense ratio
26.9
   
27.8
       
25.8
   
27.3
     
Composite ratio
97.9
%
 
107.2
%
     
97.9
%
 
102.2
%
   

Second quarter, 2011 inclusion of the PMA-related accounts resulted in approximate increases of $108.8 in net premiums earned, $5.2 in net investment income, $76.9 in benefits and claims costs, and $5.9 in pretax operating income. For the first half of this year these amounts were $222.6, $8.8, $157.8, and $16.8, respectively.

Excluding PMA’s contribution, the remaining portion of general insurance net premiums earned reflected basically flat quarterly and year-to-date comparisons. As reported for the past several years, the combination of recessionary conditions and a soft pricing environment in the commercial insurance arena has constrained premium growth. Lessened economic activity affects such factors as insureds’ sales and employment levels, both of which are important elements upon which Old Republic’s insurance premiums are based.

Overall general insurance underwriting performance was relatively stable in this year’s first half. The consumer credit indemnity coverage which is in temporary run off and thus reflects only renewal premiums from 2008 and prior years’ production, continued to produce adverse underwriting results, albeit at a moderately reduced level. As a consequence, the overall general insurance claim ratio was burdened by an additional 1.7 and 11.0 percentage points in the second quarter of 2011 and 2010, respectively, and by 3.0 and 7.4, for the first half of 2011 and 2010, respectively.

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

 
17

 


Mortgage Guaranty Results – Operating performance in this year’s second quarter and first half was affected adversely by higher claim costs and the much lower investment income generated by a smaller invested asset base. Key indicators of this segment’s interim results are shown in the following tables:

 
Mortgage Guaranty Group
 
Quarters Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
Change
 
2011
 
2010
 
Change
Net premiums earned
$
111.7
 
$
129.1
 
-13.5
%
 
$
225.7
 
$
265.4
 
-15.0
%
Net investment income
 
16.0
   
21.9
 
-26.9
     
32.7
   
45.1
 
-27.5
 
Claims costs
 
283.7
   
153.6
 
84.6
     
496.5
   
327.0
 
51.8
 
Pretax operating income (loss)
$
(175.8)
 
$
(22.1)
 
N/M
   
$
(277.0)
 
$
(56.3)
 
-392.0
%

Claim ratio
253.9
%
 
119.0
%
     
220.0
%
 
123.2
%
   
Expense ratio
16.0
   
13.8
       
15.5
   
13.6
     
Composite ratio
269.9
%
 
132.8
%
     
235.5
%
 
136.8
%
   

In 2010’s first half, Old Republic’s mortgage guaranty subsidiaries had negotiated the terminations of various captive reinsurance and pool insurance contracts. From a financial accounting standpoint, premiums obtained upon terminations of captive reinsurance agreements are recognized as income when they are received rather than being deferred to future periods when the related claim costs are expected to arise. While terminations of pool insurance contracts cause a reduction of incurred claims due to the positive effect of reserves transferred, cash outflows ensue. As a result of these transactions, first half 2010 net premiums earned were enhanced by $10.7, net losses incurred were reduced by $51.7, and net operating cash outflows of $291.4 were sustained. No similar transactions of significance have occurred during 2011.

Mortgage Guaranty Group earned premiums continued to decline in the latest quarterly and year-to-date periods. The reduction stemmed from lower volumes of new insurance, premium refunds related to claim rescissions, and the above noted termination of pool insurance contracts which effectively ended subsequent periods' premium inflows. Moreover, new business volume reflected ongoing weakness from the downturn in overall mortgage originations, lower industry-wide penetration of the nation's current mortgage market, and the effects of the more selective underwriting guidelines employed since late 2007.

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

The effect of the above-noted captive and pool transactions on 2010 premiums and claim costs notwithstanding, mortgage guaranty recurring claim costs rose by 62.0% and 31.1% in this year’s second quarter and first half, respectively. While newly reported defaults have continued in a downtrend, the combination of much higher claim payments, reduced levels of claim rescissions or denials, and higher claim severity has placed renewed upward pressure on claim costs. The following table shows the major components of incurred claim ratios including the above noted effects of captive reinsurance and pool insurance contract terminations.

 
Mortgage Guaranty Group
 
Quarters Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Components of incurred claim ratio as a
                     
percent of earned premiums:
                     
Paid claims:
                     
Excluding captive and pool transactions
255.1
%
 
139.5
%
 
254.0
%
 
126.7
%
Captive and pool transactions
-2.3
   
94.6
   
-1.2
   
108.6
 
Paid claim ratio
252.8
   
234.1
   
252.8
   
235.3
 
Claim reserve provisions:
                     
Excluding captive and pool transactions
0.7
   
1.9
   
-33.2
   
22.0
 
Captive and pool transactions
0.4
   
-117.0
   
0.4
   
-134.1
 
Claim reserve provision ratio
1.1
   
-115.1
   
-32.8
   
-112.1
 
Incurred claim ratio:
As reported
253.9
%
 
119.0
%