form10q.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: September 30, 2008 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
incorporation or organization)
 
(IRS Employer Identification No.)


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 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
September 30, 2008
Common Stock / $1 par value
 
230,753,860





There are 36 pages in this report

 
 
 
 


OLD REPUBLIC INTERNATIONAL CORPORATION
 
Report on Form 10-Q / September 30, 2008
 
INDEX
   
   
   
 
PAGE NO.
   
PART I  FINANCIAL INFORMATION:
 
   
CONSOLIDATED BALANCE SHEETS
3
   
CONSOLIDATED STATEMENTS OF INCOME
4
   
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
5
   
CONSOLIDATED STATEMENTS OF CASH FLOWS
6
   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7 – 11
   
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
12 – 32
   
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
33
   
CONTROLS AND PROCEDURES
33
   
PART II  OTHER INFORMATION:
 
   
ITEM 1 – LEGAL PROCEEDINGS
34
   
ITEM 1A – RISK FACTORS
34
   
ITEM 6 – EXHIBITS
34
   
SIGNATURE
35
   
EXHIBIT INDEX
36


 
2
 
 



Old Republic International Corporation and Subsidiaries
Consolidated Balance Sheets
($ in Millions, Except Share Data)
   
(Unaudited)
September 30,
2008
 
December 31,
2007
Assets
           
Investments:
           
Available for sale:
           
Fixed maturity securities (at fair value) (adjusted cost: $7,381.1 and $7,312.2)
 
$
7,285.6
 
$
7,383.6
Equity securities (at fair value) (adjusted cost: $404.4 and $807.3)
   
484.1
   
842.1
Short-term investments (at fair value which approximates cost)
   
729.1
   
462.6
Miscellaneous investments
   
32.4
   
64.7
Total
   
8,531.3
   
8,753.1
Other investments
   
8.2
   
8.1
Total investments
   
8,539.6
   
8,761.2
             
Other Assets:
           
Cash
   
86.5
   
54.0
Securities and indebtedness of related parties
   
29.1
   
15.3
Accrued investment income
   
107.6
   
108.7
Accounts and notes receivable
   
838.8
   
880.3
Federal income tax recoverable: Current
   
9.5
   
6.2
Prepaid federal income taxes
   
501.3
   
536.5
Reinsurance balances and funds held
   
70.9
   
69.9
Reinsurance recoverable:
Paid losses
   
61.8
   
65.8
 
Policy and claim reserves
   
2,372.5
   
2,193.4
Deferred policy acquisition costs
   
234.3
   
246.5
Sundry assets
   
351.4
   
352.3
     
4,664.2
   
4,529.3
Total Assets
 
$
13,203.8
 
$
13,290.6
             
             
Liabilities, Preferred Stock, and Common Shareholders’ Equity
           
Liabilities:
           
Losses, claims, and settlement expenses
 
$
7,025.6
 
$
6,231.1
Unearned premiums
   
1,176.3
   
1,182.2
Other policyholders' benefits and funds
   
183.7
   
190.2
Total policy liabilities and accruals
   
8,385.6
   
7,603.5
Commissions, expenses, fees, and taxes
   
213.7
   
225.9
Reinsurance balances and funds
   
293.5
   
288.7
Federal income tax payable: Deferred
   
118.7
   
417.7
Debt
   
124.1
   
64.1
Sundry liabilities
   
153.6
   
148.8
Commitments and contingent liabilities
           
Total Liabilities
   
9,289.5
   
8,749.0
             
Preferred Stock:
           
Convertible preferred stock (1)
   
-
   
-
             
Common Shareholders’ Equity:
           
Common stock (1)
   
230.7
   
232.0
Additional paid-in capital
   
329.7
   
344.4
Retained earnings
   
3,353.0
   
3,900.1
Accumulated other comprehensive income
   
.7
   
93.3
Treasury stock (at cost)(1)
   
-
   
(28.3)
Total Common Shareholders' Equity
   
3,914.3
   
4,541.6
Total Liabilities, Preferred Stock and Common Shareholders’ Equity
 
$
13,203.8
 
$
13,290.6
               
               
(1)  
At September 30, 2008 and December 31, 2007, 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 230,753,860 at September 30, 2008 and 232,038,331 at December 31, 2007 were issued. At September 30, 2008 and December 31, 2007, there were 100,000,000 shares of Class B Common Stock, $1.00 par value, authorized, of which no shares were issued. Common shares classified as treasury stock were 0 and 1,566,100 as of September 30, 2008 and December 31, 2007, respectively.

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
September 30,
 
Nine Months Ended
September 30,
   
2008
 
2007
 
2008
 
2007
Revenues:
                       
Net premiums earned
 
$
784.7
 
$
870.1
 
$
2,372.5
 
$
2,537.4
Title, escrow, and other fees
   
50.4
   
50.9
   
144.9
   
166.7
Total premiums and fees
   
835.2
   
921.1
   
2,517.5
   
2,704.2
Net investment income
   
93.8
   
95.1
   
282.3
   
280.4
Other income
   
7.2
   
9.6
   
24.6
   
31.1
Total operating revenues
   
936.3
   
1,025.9
   
2,824.5
   
3,015.7
Realized investment gains (losses):
                       
From sales
   
18.3
   
3.9
   
26.0
   
20.3
From impairments
   
(11.5)
   
-
   
(448.9)
   
-
Total realized investment gains (losses)
   
6.7
   
3.9
   
(422.8)
   
20.3
Total revenues
   
943.1
   
1,029.8
   
2,401.6
   
3,036.0
                         
Benefits, Claims and Expenses:
                       
Benefits, claims, and settlement expenses
   
679.1
   
609.9
   
2,005.2
   
1,496.3
Dividends to policyholders
   
4.0
   
1.9
   
11.9
   
6.9
Underwriting, acquisition, and other expenses
   
333.2
   
381.8
   
1,014.1
   
1,168.8
Interest and other charges
   
-
   
1.1
   
1.4
   
6.0
Total expenses
   
1,016.5
   
994.8
   
3,032.8
   
2,678.1
Income (loss) before income taxes (credits)
   
(73.4)
   
35.0
   
(631.1)
   
357.9
                         
Income Taxes (Credits):
                       
Current
   
13.5
   
44.8
   
51.8
   
133.0
Deferred
   
(38.9)
   
(39.0)
   
(251.2)
   
(27.2)
Total
   
(25.3)
   
5.8
   
(199.3)
   
105.7
                         
Net Income (Loss)
 
$
(48.0)
 
$
29.2
 
$
(431.8)
 
$
252.1
                         
Net Income (Loss) Per Share:
                       
Basic:
 
$
(.21)
 
$
.13
 
$
(1.87)
 
$
1.09
Diluted:
 
$
(.21)
 
$
.12
 
$
(1.87)
 
$
1.08
                         
Average shares outstanding:
Basic
   
230,735,600
   
231,014,468
   
230,716,219
   
231,627,204
 
Diluted
   
230,735,600
   
232,298,642
   
230,716,219
   
233,448,109
Dividends Per Common Share:
                       
Cash
 
$
.17
 
$
.16
 
$
.50
 
$
.47





















See accompanying Notes to Consolidated Financial Statements.

 
4
 
 


Old Republic International Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
($ in Millions)
   
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
     
2008
   
2007
   
2008
   
2007
Net income (loss) as reported
 
$
(48.0)
 
$
29.2
 
$
(431.8)
 
$
252.1
                         
Other comprehensive income (loss):
                       
Unrealized gains (losses) on securities:
                       
Unrealized gains (losses) arising during period
   
(80.7)
   
106.5
   
(554.0)
   
75.9
Less: elimination of pretax realized gains (losses)
                       
included in income (loss) as reported
   
6.7
   
3.9
   
(422.8)
   
20.3
Pretax unrealized gains (losses) on securities
                       
carried at market value
   
(87.5)
   
102.5
   
(131.2)
   
55.6
Deferred income taxes (credits)
   
(30.6)
   
35.8
   
(45.9)
   
19.4
Net unrealized gains (losses) on securities
   
(56.8)
   
66.6
   
(85.2)
   
36.2
Other adjustments
   
(2.7)
   
7.9
   
(7.2)
   
20.2
Net adjustments
   
(59.6)
   
74.5
   
(92.5)
   
56.4
                         
Comprehensive income (loss)
 
$
(107.6)
 
$
103.8
 
$
(524.3)
 
$
308.6











































See accompanying Notes to Consolidated Financial Statements.

 
5
 
 


Old Republic International Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($ in Millions)
   
Nine Months Ended
September 30,
   
2008
 
2007
Cash flows from operating activities:
           
Net income (loss)
 
$
(431.8)
 
$
252.1
Adjustments to reconcile net income to
           
net cash provided by operating activities:
           
Deferred policy acquisition costs
   
11.3
   
13.7
Premiums and other receivables
   
41.5
   
26.4
Unpaid claims and related items
   
612.1
   
400.7
Other policyholders’ benefits and funds
   
(8.3)
   
20.7
Income taxes
   
(254.6)
   
(1.9)
Prepaid federal income taxes
   
35.2
   
(68.1)
Reinsurance balances and funds
   
7.9
   
(8.9)
Realized investment (gains) losses
   
422.8
   
(20.3)
Accounts payable, accrued expenses and other
   
31.3
   
28.3
Total
   
467.6
   
642.7
 
           
Cash flows from investing activities:
 
         
Fixed maturity securities:
 
 
       
Maturities and early calls
   
631.0
   
537.6
Sales
   
72.4
   
27.0
Sales of:
   
 
     
Equity securities
   
79.2
   
73.3
Other - net
   
42.7
   
13.0
Purchases of:
           
Fixed maturity securities
   
(814.7)
   
(986.7)
Equity securities
   
(96.9)
   
(123.8)
Other – net
   
(26.4)
   
(19.9)
Purchase of a business
   
(4.3)
   
(4.3)
Net decrease (increase) in short-term investments
   
(267.0)
   
30.3
Other-net
   
(.4)
   
(.8)
Total
   
(384.5)
   
(454.2)
 
           
Cash flows from financing activities:
 
         
Issuance of debentures and notes
 
 
93.0
   
81.3
Issuance of common shares
   
3.0
   
14.0
Redemption of debentures and notes
   
(33.1)
   
(131.3)
Dividends on common shares
   
(115.2)
   
(108.5)
Purchase of treasury shares
   
-
   
(28.3)
Other-net
   
1.9
   
3.3
Total
   
(50.5)
   
(169.5)
             
Increase (decrease) in cash:
   
32.5
   
18.9
Cash, beginning of period
   
54.0
   
71.6
Cash, end of period
 
$
86.5
 
$
90.5
 
           
Supplemental cash flow information:
 
         
Cash paid during the period for:
Interest
 
$
2.0
 
$
5.6
 
Income taxes
 
$
54.9
 
$
107.2











See accompanying Notes to Consolidated Financial Statements.

 
6
 
 

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 generally accepted accounting principles (“GAAP”) as described in the Company’s latest annual report to shareholders or otherwise disclosed herein. The financial accounting and reporting process relies on estimates and on the exercise of judgment, but in the opinion of management all adjustments, consisting only of normal recurring accruals, necessary for a fair statement of the results were 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.

The Financial Accounting Standards Board’s (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) became effective for the Company in the first quarter of 2007. FIN 48 provides recognition criteria and a related measurement model for uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. The Company’s unrecognized tax benefits, including interest and penalty accruals, are not considered material to the consolidated financial statements and have not changed significantly upon the adoption of FIN 48. 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 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 under GAAP, other than possible interest and penalties which are classified as income tax expense, the possible accelerated payment of tax to the IRS would not affect the annual effective tax rate. The Company’s consolidated Federal income tax returns through year-end 2004 are closed and no significant adjustments have resulted. On October 22, 2008 the IRS commenced their examination of the Company’s 2006 consolidated income tax return.

The Company’s adoption of Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS 157”), is discussed in Note 3 of the Notes to Consolidated Financial Statements.

The adoption of FIN 48 and FAS 157 result in additional financial statement disclosures for GAAP reporting purposes and has no effect on the conduct of the Company’s business, its financial condition and results of operations.

 
7
 
 



2.
Common Share Data:

Earnings Per Share - The following table provides a reconciliation of the income and number of shares used in basic and diluted earnings per share calculations.
 
 
     
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
     
2008
 
2007
 
2008
 
2007
 
Numerator:
                       
 
Net Income (loss)                                                           
 
$
(48.0)
 
$
29.2
 
$
(431.8)
 
$
252.1
 
Numerator for basic earnings per share -
                       
 
income (loss) available to common stockholders
   
(48.0)
   
29.2
   
(431.8)
   
252.1
 
Numerator for diluted earnings per share -
                       
 
income (loss) available to common stockholders
                       
 
after assumed conversions                                       
 
$
(48.0)
 
$
29.2
 
$
(431.8)
 
$
252.1
 
Denominator:
                       
 
Denominator for basic earnings per share -
                       
 
Weighted-average shares (a)                                  
   
230,735,600
   
231,014,468
   
230,716,219
   
231,627,204
 
Effect of dilutive securities – stock options
   
-
   
1,284,174
   
-
   
1,820,905
 
Denominator for diluted earnings per share -
                       
 
adjusted weighted-average shares
                       
 
and assumed conversions (a)
   
230,735,600
   
232,298,642
   
230,716,219
   
233,448,109
 
Earnings per share:
Basic
 
$
(.21)
 
$
.13
 
$
(1.87)
 
$
1.09
   
Diluted
 
$
(.21)
 
$
.12
 
$
(1.87)
 
$
1.08
                           
 
Anti-dilutive outstanding stock option awards
excluded from earning per share computations
   
15,284,846
   
6,773,862
   
15,284,846
   
3,847,875
                             
    (a)  All per share statistics have been restated to reflect all stock dividends and splits declared through September 30, 2008.
 
3      Investments:

Effective January 1, 2008, the Company adopted FAS 157, Fair Value Measurements, which establishes a framework for measuring fair value, and applies to existing accounting pronouncements that require or permit fair value measurements. 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). The adoption of FAS 157 has had no impact on the Company’s consolidated financial statements. Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy.

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 using its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “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 market value.

Level 1 securities include U.S. and Canadian Treasury notes, publicly traded common stocks, net asset value (“NAV”) quoted mutual funds and a substantial portion of its short-term investments in highly liquid money market instruments and U.S. and Canadian Treasury bills. Level 2 securities generally include corporate bonds, municipal bonds and certain U.S. and Canadian government agency securities. 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 during the nine months ended September 30, 2008.







 
8
 
 

The following table shows a summary of assets measured at fair value segregated among the various input levels required by FAS 157:

 
Fair value measurements as of September 30, 2008:
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale:
                     
Fixed maturity securities
$
277.4
 
$
6,997.6
 
$
10.5
 
$
7,285.6
Equity securities
 
440.2
   
.1
   
43.7
   
484.1
Short-term investments
 
721.9
   
-
   
7.1
   
729.1

Net unrealized gains (losses) on investments amounted to $(6.2) at September 30, 2008. Unrealized appreciation (depreciation) of investments, before applicable deferred income taxes (credits) of $(3.5) at September 30, 2008 included gross unrealized gains (losses) of $159.8 and $(169.6) respectively. For the nine months ended September 30, 2008 and 2007, changes in net unrealized appreciation (depreciation) of investments, net of deferred income taxes (credits), amounted to $(85.2) and $36.2, respectively. The amount of unrealized gains and losses is affected by the Company’s estimates of securities that have been classified as other-than-temporarily impaired (“OTTI”).

The Company completes a detailed analysis each quarter to assess whether the decline in the value of any investment below its cost basis is deemed other-than-temporary. All securities in an unrealized loss position are reviewed. 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. The decline in value of a security deemed OTTI is included in the determination of net income and a new cost basis is established for financial reporting purposes.

Realized investment gains (losses) included $11.5 and $448.9 of write downs for other-than-temporary declines in the estimated fair value of investments for the quarter and nine months ended September 30, 2008, respectively. There were no write downs for other-than-temporary declines in the estimated fair value of investments for the quarter and nine months ended September 30, 2007.

A valuation allowance of $42.0 (equivalent to a charge of $.18 per outstanding share) was established against a deferred tax asset related to the Company’s realized losses on investments at September 30, 2008. In valuing the deferred tax asset, the Company considered certain factors including primarily the scheduled reversals of certain deferred tax liabilities and the impact of available carryback and carryforward periods. Based on these considerations, the Company believes that it is more likely than not that it will realize the benefits of the deferred tax assets related to realized losses, net of the existing valuation allowance at September 30, 2008.


4.
Pension Plans:

The Company has three defined benefit pension plans covering a portion of its work force. All three plans have been closed to new participants since December 31, 2004. It is the Company’s policy to fund the plans’ costs as they accrue. Plan assets are comprised principally of bonds, common stocks and short-term investments. The Companies made cash contributions of approximately $.7 and $2.9 to their pension plans in the quarter and nine months ended September 30, 2008, respectively, and expect to make cash contributions of approximately $1.1 to their pension plans in the fourth quarter of 2008.

 
9
 
 

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 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.

   
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
   
2008
 
2007
 
2008
 
2007
 
General Insurance Group:
                     
 
Net premiums earned
$
500.3
 
$
549.5
 
$
1,507.4
 
$
1,611.4
 
Net investment income and other income
 
65.3
   
70.0
   
201.2
   
210.1
 
Total revenues before realized gains or losses
$
565.7
 
$
619.5
 
$
1,708.7
 
$
1,821.5
 
Income (loss) before income taxes (credits) and
realized investment gains or losses (a)
$
77.0
 
$
112.7
 
$
223.2
 
$
324.5
 
Income tax expense (credits) on above
$
22.0
 
$
34.6
 
$
63.3
 
$
98.9
                         
 
Mortgage Guaranty Group:
                     
 
Net premiums earned
$
148.4
 
$
133.9
 
$
445.2
 
$
377.0
 
Net investment income and other income
 
24.4
   
23.0
   
73.7
   
66.4
 
Total revenues before realized gains or losses
$
172.8
 
$
157.0
 
$
518.9
 
$
443.4
 
Income (loss) before income taxes (credits) and
realized investment gains or losses
$
(152.8)
 
$
 (83.0)
 
$
(415.9)
 
$
2.1
 
Income tax expense (credits) on above
$
(54.8)
 
$
 (30.3)
 
$
(149.7)
 
$
 (3.0)
                         
 
Title Insurance Group:
                     
 
Net premiums earned
$
117.9
 
$
168.1
 
$
357.1
 
$
491.9
 
Title, escrow and other fees
 
50.4
   
50.9
   
144.9
   
166.7
 
Sub-total
 
168.4
   
219.1
   
502.1
   
658.7
 
Net investment income and other income
 
6.3
   
7.0
   
19.1
   
21.2
 
Total revenues before realized gains or losses
$
174.7
 
$
226.1
 
$
521.2
 
$
679.9
 
Income (loss) before income taxes (credits) and
realized investment gains or losses (a)
$
(9.7)
 
$
 (3.3)
 
$
(27.0)
 
$
1.0
 
Income tax expense (credits) on above
$
(3.8)
 
$
 (1.4)
 
$
(10.6)
 
$
 (.8)
                         
 
Consolidated Revenues:
                     
 
Total revenues of above Company segments
$
913.3
 
$
1,002.8
 
$
2,748.8
 
$
2,945.0
 
Other sources (b)
 
30.6
   
31.4
   
99.7
   
96.5
 
Consolidated net realized investment gains (losses)
 
6.7
   
3.9
   
(422.8)
   
20.3
 
Consolidation elimination adjustments
 
(7.6)
   
(8.3)
   
(24.1)
   
(25.8)
 
Consolidated revenues
$
943.1
 
$
1,029.8
 
$
2,401.6
 
$
3,036.0
                         
 
Consolidated Income (Loss) Before Taxes (Credits):
                     
 
Total income (loss) before income taxes (credits)
and realized investment gains or losses of
above Company segments
$
(85.5)
 
$
26.4
 
$
(219.7)
 
$
327.7
 
Other sources – net (b)
 
5.3
   
4.6
   
11.4
   
9.9
 
Consolidated net realized investment gains (losses)
 
6.7
   
3.9
   
(422.8)
   
20.3
 
Consolidated income (loss)
before income taxes (credits)
$
(73.4)
 
$
35.0
 
$
(631.1)
 
$
357.9
                         
 
Consolidated Income Tax Expense (Credits):
                     
 
Total income tax expense (credits)
for above Company segments
$
(36.6)
 
$
2.7
 
$
(97.0)
 
$
95.1
 
Other sources – net (b)
 
1.8
   
1.6
   
3.6
   
3.5
 
Income tax expense (credits) on
consolidated net realized investment gains (losses)
 
9.4
   
1.3
   
(105.9)
   
7.1
 
Consolidated income tax expense (credits)
$
(25.3)
 
$
5.8
 
$
(199.3)
 
$
105.7

 
10
 
 


   
September
2008
 
December
2007
 
Consolidated Assets:
         
 
General
$
9,622.7
 
$
9,769.9
 
Mortgage
 
2,753.0
   
2,523.8
 
Title
 
741.8
   
770.4
 
Other assets (b)
 
444.5
   
437.9
 
Consolidation elimination adjustments
 
(358.3)
   
(211.5)
 
Consolidated
$
13,203.8
 
$
13,290.6
               
               
In the above tables, net premiums earned on a GAAP basis differ slightly from statutory amounts due to certain differences in calculations of unearned premium reserves under each accounting method.
(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 - $3.5 and $10.3 compared to $3.4 and $11.7 for the quarter and nine months ending September 30, 2008 and 2007, respectively; Title - $.5 and $1.8 compared to $.6 and $1.5 for the quarter and nine months ending September 30, 2008 and 2007, 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 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 legal proceedings 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 state and federal courts in Connecticut, New Jersey, Ohio, Pennsylvania and Texas. 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. In none of the actions against ORNTIC has a class yet been certified. Substantially similar lawsuits are also pending against other unaffiliated title insurance companies in these and other states as well, and additional lawsuits based upon similar allegations could be filed against ORNTIC in the future.

Since early February 2008, more than 75 purported consumer class action lawsuits have been filed nationwide 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. The suits are 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. A number of the suits also allege violations of the federal Real Estate Settlement Procedures Act (“RESPA”). The Company and its principal title insurance subsidiary, Old Republic National Title Insurance Company, are currently among the named defendants in 34 of these actions in 5 states, and are likely to be included in others. A second subsidiary, American Guaranty Title Insurance Company, is also named in most but not all of the same suits. No class has yet been certified.

Also pending certification as a class action is a suit against ORNTIC and Old Republic Title, Ltd. in the U.S. District Court for the Western District of Washington. Filed in May, 2008, the suit alleges that ORNTIC and its affiliate deceptively charged fees for reconveyancing services they did not perform and split the fees with settlement service providers in violation of RESPA. The action seeks damages, declaratory and injunctive relief. No class has yet been certified in the action.

At their present stage, the impact of these lawsuits, all of which seek unquantified damages, attorneys’ fees and expenses, is uncertain and not reasonably estimable. The Company and its subsidiaries intend to defend vigorously against each of the aforementioned actions. Although the Company does not believe that these lawsuits 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.

ORNTIC and Old Republic Title Company succeeded in having the Superior Court of Washington, King County, dismiss a previously disclosed lawsuit alleging that they had overcharged customers for escrow related fees and failed to disclose the interest or earnings credits realized on moneys deposited into escrow. The plaintiffs in that suit chose not to appeal the decision. ORNTIC also settled the previously disclosed suit brought by and on behalf of Hispanic home buyers in Monterey County, California, for  an immaterial amount.

 
11
 
 

OLD REPUBLIC INTERNATIONAL CORPORATION
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
Nine Months Ended September 30, 2008 and 2007
($ 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 2.4% of consolidated operating revenues for the nine months ended September 30, 2008 and 2.0% of consolidated assets as of September 30, 2008, is included within the corporate and other caption of this financial report. The consolidated accounts are presented on the basis of generally accepted accounting principles (“GAAP”). This management analysis should be read in conjunction with the consolidated financial statements and the footnotes appended to them.
 
The insurance business is distinguished from most others in that the prices (premiums) charged for various insurance coverages 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 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 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 managed without 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.

EXECUTIVE SUMMARY
 
 
Old Republic’s consolidated operating results, which exclude net realized investment gains or losses, continued to decline in this year’s third quarter and first nine months.  The much reduced performance stemmed from significant weakness in the Company’s housing-related mortgage guaranty and title insurance lines in particular.  Management currently believes that the substantial dislocations that have enveloped all businesses with housing and mortgage-lending exposures are likely to exert negative pressures on earnings well into 2009.  These lowered expectations aside, the Company’s strong financial underpinnings and the overall earnings sustainability of its general insurance business should provide reasonable earnings support and capital management flexibility for the anticipated resumption of positive operating earnings trends in 2010 and beyond.
 
The year-over-year decline in book value per share is mostly due to the shortfall in earnings, to cash outlays for regular dividends to shareholders, and to lower market valuations of fixed maturity and equity investments.


 
12
 
 

Consolidated Results – The major components of Old Republic’s consolidated results for the periods reported upon are shown below:

 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2008
 
2007
 
Change
 
2008
 
2007
 
Change
Operating revenues:
                                 
General insurance
$
565.7
 
$
619.5
 
-8.7
%
 
$
1,708.7
 
$
1,821.5
 
-6.2
%
Mortgage guaranty
 
172.8
   
157.0
 
10.1
     
518.9
   
443.4
 
17.0
 
Title insurance
 
174.7
   
226.1
 
-22.8
     
521.2
   
679.9
 
-23.3
 
Corporate and other
 
23.0
   
23.1
         
75.6
   
70.7
     
Total
$
936.3
 
$
1,025.9
 
-8.7
%
 
$
2,824.5
 
$
3,015.7
 
-6.3
%
Pretax operating income (loss):
                                 
General insurance
$
77.0
 
$
112.7
 
-31.7
%
 
$
223.2
 
$
324.5
 
-31.2
%
Mortgage guaranty
 
(152.8)
   
(83.0)
 
-84.1
     
(415.9)
   
2.1
 
N/M
 
Title insurance
 
(9.7)
   
(3.3)
 
-191.9
     
(27.0)
   
1.0
 
N/M
 
Corporate and other
 
5.3
   
4.6
         
11.4
   
9.9
     
Sub-total
 
(80.1)
   
31.0
 
-357.8
     
(208.3)
   
337.6
 
-161.7
 
Realized investment gains (losses):
                                 
From sales
 
18.3
   
3.9
         
26.0
   
20.3
     
From impairments
 
(11.5)
   
-
         
(448.9)
   
-
     
Net realized
investment gains (losses)
 
6.7
   
3.9
         
(422.8)
   
20.3
     
Consolidated pretax
income (loss)
 
(73.4)
   
35.0
 
-309.3
     
(631.1)
   
357.9
 
-276.3
 
Income taxes (credits)
 
(25.3)
   
5.8
 
-537.0
     
(199.3)
   
105.7
 
-288.4
 
Net income (loss)
$
(48.0)
 
$
29.2
 
-264.1
%
 
$
(431.8)
 
$
252.1
 
-271.2
%
Consolidated underwriting ratio:
                                 
Benefits and claims ratio
 
81.8%
   
66.4%
         
80.1%
   
55.6%
     
Expense ratio
 
38.8
   
40.2
         
39.0
   
41.7
     
Composite ratio
 
120.6%
   
106.6%
         
119.1%
   
97.3%
     
Components of diluted
earnings per share:
                                 
Net operating income (loss)
$
(0.20)
 
$
0.11
 
-281.8
%
 
$
(0.50)
 
$
1.02
 
-149.0
%
Net realized
investment gains (losses)
 
(0.01)
   
0.01
         
(1.37)
   
0.06
     
Net income (loss)
$
(0.21)
 
$
0.12
 
-275.0
%
 
$
(1.87)
 
$
1.08
 
-273.1
%
                                     
N/M = not meaningful
                                 
 
The above table shows both operating and net income to highlight the effects of realized investment gain or loss recognition and any non-recurring items on period-to-period comparisons. Operating income, however, does not replace net income computed in accordance with Generally Accepted Accounting Principles (“GAAP”) as a measure of total profitability.
 
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 for 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.
 
 
13
 
General Insurance Results – General insurance operating income for the first nine months of 2008 was affected mainly by moderately lower earned premiums and the higher claim ratios shown in the following table:

   
General Insurance Group
   
Quarters Ended September 30,
 
Nine Months Ended September 30,
   
2008
 
2007
 
Change
 
2008
 
2007
 
Change
 
Net premiums earned
$
500.3
 
$
549.5
 
-8.9
%
 
$
1,507.4
 
$
1,611.4
 
-6.5
%
 
Net investment income
 
61.9
   
65.3
 
-5.2
     
189.1
   
192.8
 
-1.9
 
 
Pretax operating income
$
77.0
 
$
112.7
 
-31.7
%
 
$
223.2
 
$
324.5
 
-31.2
%
                                 
 
Claims ratio
72.5
%
 
67.7
%
     
72.8
%
 
66.5
%
   
 
Expense ratio
23.8
   
23.0
       
24.2
   
24.5
     
 
Composite ratio
96.3
%
 
90.7
%
     
97.0
%
 
91.0
%
   
 
Year-to-date earned premiums trended lower as a moderately declining rate environment for most commercial insurance prices in the past three years or so has hindered retention of some business and precluded meaningful additions to Old Republic’s premium base. For this year’s first nine months, the slightly lower top line was accompanied by the above noted rise in claim ratios; these compare to an average of 66.8% for the five most recent calendar years. This year’s higher claim ratio is attributable to the combination of greater loss costs for most insurance coverages and to the cumulative effect of softening premium rates. The higher loss costs were most accentuated for Old Republic’s consumer credit indemnity, commercial multi-peril, and general aviation coverages.
 
Underwriting and other expenses have remained under good overall control; the resulting expense ratios compare favorably year over year and with the average of 24.8% for the five years through 2007.

Mortgage Guaranty Results – Claim costs continued to rise due to higher mortgage loan delinquencies, and claim frequency and severity. These higher costs were offset to some extent by strong premium revenue gains during this year’s first half in particular. However, pretax operating results were unprofitable for the fifth consecutive quarter. Key indicators of this cyclical reversal in profitability for Old Republic’s second largest business segment are shown below and in the accompanying statistical exhibit.

   
Mortgage Guaranty Group
   
Quarters Ended September 30,
 
Nine Months Ended September 30,
   
2008
 
2007
 
Change
 
2008
 
2007
 
Change
 
Net premiums earned
$
148.4
 
$
133.9
 
10.8
%
 
$
445.2
 
$
377.0
 
18.1
%
 
Net investment income
 
22.0
   
19.9
 
10.2
     
65.0
   
57.9
 
12.1
 
 
Pretax operating income (loss)
$
(152.8)
 
$
(83.0)
 
-84.1
%
 
$
(415.9)
 
$
2.1
 
N/M
 
                                 
 
Claims ratio
203.1
%
 
161.9
%
     
192.3
%
 
96.4
%
   
 
Expense ratio
14.8
   
15.0
       
15.8
   
18.4
     
 
Composite ratio
217.9
%
 
176.9
%
     
208.1
%
 
114.8
%
   
 
Mortgage guaranty premium growth in this year’s first nine months was mostly due to a 20.0% increase in traditional primary risk in force since September 2007. This increase stems from rising new insurance writings during the second half of 2007 and first half of 2008 as a result of greater market acceptance of traditional primary coverage and from higher business persistency (81.4% on an annualized basis as of September 2008 versus 76.6% through the same month end of 2007.)

The unprecedented cyclical downturn in housing and related mortgage finance industries contributed to the above noted offsetting impact of higher claim costs. Such costs reflect the combination of unfavorable loan default trends, greater claim severity caused by the larger insured loan values of recent years, and lessened opportunities to mitigate reported claims. Inflated inventories of unsold homes, weakening home values, and a more restrictive credit environment are main causes for the reduced mitigation opportunities, though greater numbers of submitted claims are being rescinded due to detected frauds and material deviations from required underwriting standards.

The disparity between paid and incurred loss ratios shown in the above table stems from much greater claim reserve provisions which accounted for 118.4 loss ratio points in this year’s third quarter, compared to 117.8 loss ratio points in the same quarter of 2007. For the first nine months, claim reserve provisions produced increases of 125.7 and 57.4 loss ratio points in 2008 and 2007, respectively. For all of 2007 reserve increases accounted for 76.3 points of that year’s loss ratio of 118.8%. As of September 30, 2008, net claim reserves of $1.20 billion were approximately 158.5% higher than they were twelve months earlier, and 86.7% greater than the amount posted at year end 2007.
 
The lower production and operating expense ratios for this year’s third quarter and first nine months continued to be a bright spot in operating trends as greater premium volume has not been accompanied by a corresponding increase in fixed operating costs. The beneficial effect of the relatively lower expense ratio, however, was fully offset by the more severe impact of the higher claim ratio.

 
14
 
 

   In combination, the above-cited factors produced a continuing uptrend in the composite underwriting ratios. Underlining the extreme severity of the current cyclical downturn in the housing and mortgage lending fields, this year’s nine month composite ratio of  208.1% compares with an average of 74.0% registered during the five years ended December 31, 2007.
 
Underwriting results notwithstanding, Old Republic’s Mortgage Guaranty segment continued to post strong operating cash flows. These have been additive to a high quality and liquid invested asset base which reached $1.95 billion as of September 30, 2008, up 14.4% from the level registered one year earlier. The greater invested asset base was mainly responsible for the investment income growth posted in the periods reported upon.

Title Insurance Results – Old Republic’s title insurance business registered an operating loss for each of this year’s quarters. Key operating performance indicators are shown in the following table:

   
Title Insurance Group
   
Quarters Ended September 30,
 
Nine Months Ended September 30,
   
2008
 
2007
 
Change
 
2008
 
2007
 
Change
 
Net premiums and fees earned
$
168.4
 
$
219.1
 
-23.1
%
 
$
502.1
 
$
658.7
 
-23.8
%
 
Net investment income
 
6.2
   
6.7
 
-6.9
     
19.1
   
20.2
 
-5.8
 
 
Pretax operating income (loss)
$
(9.7)
 
$
(3.3)
 
-191.9
%
 
$
(27.0)
 
$
1.0
 
N/M
 
                                 
 
Claims ratio
7.0
%
 
6.8
%
     
7.0
%
 
6.4
%
   
 
Expense ratio
102.2
   
97.5
       
102.0
   
96.3
     
 
Composite ratio
109.2
%
 
104.3
%
     
109.0
%
 
102.7
%
   
 
The ongoing cyclical downturn in the housing and related mortgage lending sectors of the U.S. economy also led to year-over-year reductions of premium and fee revenues for the Company’s Title segment. Direct production facilities in the Western United States continued to sustain the most significant bottom line adverse effects of this downturn. Claim ratios in 2008 have trended up slightly as they did for all of 2007. While overall 2008 production and operating expenses have dropped significantly, the decline continues to be insufficient to counter the much larger reduction in title premium and fees revenues.

Corporate and Other Operations – The Company’s small life and health insurance business and the net costs associated with the parent holding company and internal services subsidiaries produced net operating gains in this year’s first nine months.  Period-to-period earnings variations for these relatively minor elements of Old Republic’s operations usually stem from the volatility inherent to the small scale of its life and health business, fluctuations in the costs of external debt, and net interest on intra-system financing arrangements.

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

                 
% Change
     
September
2008
 
December
2007
 
September
2007
 
Sept ‘08/
Dec ‘07
 
Sept ‘08/
Sept ‘07
 
Cash and invested assets - at fair value
 
$
8,733.7
 
$
8,924.0
 
$
8,762.4
 
-2.1
%
 
-0.3
%
 
Cash and invested assets - at original cost
 
$
9,143.3
 
$
8,802.5
 
$
8,604.4
 
3.9
%
 
6.3
%
                                 
 
Shareholders’ equity:
                             
 
Total
 
$
3,914.3
 
$
4,541.6
 
$
4,563.9
 
-13.8
%
 
-14.2
%
 
Per common share
 
$
16.96
 
$
19.71
 
$
19.81
 
-14.0
%
 
-14.4
%
                                 
 
Composition of shareholders’ equity per share:
                             
 
Equity before items below
 
$
16.96
 
$
19.31
 
$
19.37
 
-12.2
%
 
-12.4
%
 
Unrealized investment gains or losses and other accumulated comprehensive income
   
-
   
0.40
   
0.44
           
 
Total
 
$
16.96
 
$
19.71
 
$
19.81
 
-14.0
%
 
-14.4
%
 
Consolidated cash flow from operating activities amounted to $467.6 for the first nine months of 2008 versus $642.7 for the same period in 2007.
 
The investment portfolio reflects a current allocation of approximately 85% to fixed-maturity securities and 6% to equities. As has been the case for many years, Old Republic’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.   The portfolio contains little or no insurance risk-correlated asset exposures to real estate, mortgage-backed securities, collateralized debt obligations (“CDO’s”), derivatives, junk bonds, 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 counter-party risk attributes.

 
15
 
 

Substantially all changes in the shareholders’ equity account reflect the Company’s net income or loss, dividend payments to shareholders, and changes in market valuations of invested assets for the periods reported upon. A summary of all changes in book value per share follows:

   
Shareholders’ Equity Per Share
   
Quarter
Ended
September 30,
2008
 
Nine Months
Ended
September 30,
2008
 
Fiscal Twelve
Months Ended
September 30,
2008
 
Beginning book value per share
$
17.59
 
$
19.71
 
$
19.81
 
Changes in shareholders’ equity for the periods:
               
 
Net operating income (loss)
 
(0.20)
   
(0.50)
   
(0.55)
 
Net realized investment gains (losses):
               
 
From sales
 
0.05
   
0.07
   
0.21
 
From impairments
 
(0.06)
   
(1.44)
   
(1.44)
 
Subtotal
 
(0.01)
   
(1.37)
   
(1.23)
 
Net unrealized investment gains (losses)
 
(0.25)
   
(0.37)
   
(0.48)
 
Total realized and unrealized investment gains (losses)
 
(0.26)
   
(1.74)
   
(1.71)
 
Cash dividends
 
(0.17)
   
(0.50)
   
(0.66)
 
Stock issuance, foreign exchange, and other transactions
 
-
   
(0.01)
   
0.07
 
Net change
 
(0.63)
   
(2.75)
   
(2.85)
 
Ending book value per share
$
16.96
 
$
16.96
 
$
16.96

As indicated in the table below, Old Republic’s significant investments in the stocks of two leading publicly held mortgage guaranty businesses (MGIC Investment Corp. and The PMI Group) and that of a national title insurer (LandAmerica Financial Group) account for a substantial portion of the investment losses reflected in the preceding summary. Unrealized losses, including such losses as are categorized as other-than-temporarily impaired (“OTTI”) represent the net difference between the most recently established cost and the quarter-end market values of the investments. These three significant investments account for approximately 85% of the total net investment losses from impairments sustained by the Company in 2008. The aggregate cost, market value, and latest underlying equity values reported by the three investees, are shown below.

     
Values of Three Significant Investments
     
As of
     
September 30,
2008
 
June 30,
2008
 
December 31,
2007
 
Total value of the three investments:
Original cost
$
512.9
 
$
509.8
 
$
435.7
   
Impaired cost
 
132.0
   
128.9
   
N/A
   
Market value
 
159.0
   
128.9
   
383.6
   
Underlying equity(*)
$
668.6
 
$
680.7
 
$
699.6
                       
 
(*) Underlying equity based on latest reports (usually lagging by one quarter) issued by investees.

When making investment decisions, management considers the Company’s ability to retain its holdings for a period sufficient to recover their cost and to obtain a competitive long-term total return. It also considers such factors as balance sheet effects of potential changes in market valuations, asset-liability matching objectives, long term ability to hold securities, tax planning considerations, and the investees’ reported book values and ability to continue as going concerns. The three above-noted holdings were acquired as passive long-term investment additions to two core segments of Old Republic’s business. In management’s judgment, the currently negative market valuations of companies operating in the housing and mortgage-lending sectors of the American economy have been impacted significantly by the cyclical macroeconomic conditions affecting these sectors and by the recently dysfunctional banking and mortgage lending industries.

For external GAAP reporting purposes, however, Old Republic uses a simplistic mark to market valuation process and relatively short time frames in making periodic OTTI adjustments in its income statement. In this context, absent issuer-specific circumstances that would result in a contrary conclusion, all unrealized investment losses pertaining to any equity security reflecting a 20% or greater decline for a six month period are included in the determination of net income. Unrealized losses that are deemed temporary and all unrealized gains are recorded directly as a separate component of the shareholders’ equity account and in the consolidated statement of comprehensive income. As a result of accounting idiosyncrasies, however, OTTI losses recorded in the income statement of one period can not be offset in the income statement of a subsequent period by market value gains on the previously impaired securities unless the gains are realized through actual sales.  Such unrealized market value gains can only be recognized through direct credits in the shareholders’ equity account and the consolidated statement of comprehensive income.


16

DETAILED MANAGEMENT ANALYSIS

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, and financial condition.
 
Old Republic believes that its most critical accounting estimates relate to: a) the determination of other-than-temporary impairments in the value of fixed maturity and equity investments; b) the establishment of deferred acquisition costs which vary directly with the production of insurance premiums; 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 Company’s 2007 Annual Report on Form 10K.
 
In July 2006, the Financial Accounting Standards Board (“FASB”) issued its Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which became effective for the Company in the first quarter of 2007. FIN 48 provides recognition criteria and a related measurement model for uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. The Company’s unrecognized tax benefits, including interest and penalty accruals, are not considered material to the consolidated financial statements and did not change significantly upon the adoption of FIN 48. 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. As indicated in Note 1 of the Notes to Consolidated Financial Statements, the Company believes that the major uncertainties relating to its tax position pertain to timing differences in the recognition of taxable income. Accordingly, the annual effective tax rate, other than possible interest and penalties, would be largely unaffected as an increase in currently due income taxes would likely be offset by a corresponding deferred income tax adjustment.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 Fair Value Measurements (“FAS 157”), which establishes a framework for measuring fair value. FAS 157 applies to existing accounting pronouncements that require or permit fair value measurements, and became effective for the Company in the first quarter of 2008. Disclosure requirements associated with the standard have been incorporated in Note 3 of the Notes to Consolidated Financial Statements.
 
The adoption of FIN 48 and FAS 157 result in additional financial statement disclosures for GAAP reporting purposes and has no effect on the conduct of the Company’s business, its financial condition and results of operations.

FINANCIAL POSITION
 
The Company’s financial position at September 30, 2008 reflected decreases in assets and common shareholders’ equity of .7%, and 13.8%, respectively, and increased liabilities of 6.2% when compared to the immediately preceding year-end. Cash and invested assets represented 66.1% and 67.1% of consolidated assets as of September 30, 2008 and December 31, 2007, respectively. Consolidated operating cash flow was positive at $467.6 in the first nine months of 2008 compared to $642.7 in the same period of 2007. As of September 30, 2008, invested assets decreased 2.5% to $8,539.6 principally as a result of a net decline in the market valuation of such assets.
 
Investments - During the first nine months of 2008 and 2007, the Company committed most investable funds to short to intermediate-term fixed maturity securities. At both September 30, 2008 and 2007, approximately 99% of the Company’s investments consisted of marketable securities. Old Republic continues to adhere to its long-term policy of investing primarily in investment grade, marketable securities. Investable funds have not been directed to so-called “junk bonds”, illiquid private equity investments, real estate, mortgage loans, mortgage-backed securities, collateralized debt obligations (“CDO’s”), or derivatives. In a similar vein, the Company does not invest in securities whose values are predicated on non-regulated financial instruments exhibiting amorphous counter-party risk attributes. At September 30, 2008, the Company had fixed maturity investments with an amortized cost of $13.1 in default as to principal and/or interest.

Relatively high short-term maturity investment positions continued to be maintained as of September 30, 2008. Such positions reflect a large variety of seasonal and intermediate-term factors including current operating needs, 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.

17
The Company 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 market value of the Company’s long-term fixed maturity investment portfolio is sensitive, however, to fluctuations in the level of 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 shareholders’ equity account, and as a separate component of the statement of comprehensive income. Given the Company’s inability to forecast or control the movement of interest rates, Old Republic sets the maturity spectrum of its fixed maturity securities portfolio within parameters of estimated liability payouts, and focuses the overall portfolio on high quality investments. By so doing, Old Republic 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.

Possible future declines in fair values for Old Republic’s bond and stock portfolios would negatively affect the common shareholders’ 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 market 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 market 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. In the event the Company’s estimate of other-than-temporary impairments is insufficient at any point in time, future periods’ net income 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.

 
18
 
 

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

Credit Quality Ratings of Fixed Maturity Securities (a)

   
September
2008
 
December
2007
 
Aaa
 
20.5
%
 
32.9
%
 
Aa
 
25.1
   
17.0
   
A
 
31.8
   
27.9
   
Baa
 
20.6
   
20.2
   
Total investment grade
 
98.0
   
98.0
   
All other (b)
 
2.0
   
2.0
   
Total
 
100.0
%
 
100.0
%
 
                 
                 
 
(a)
Credit quality ratings used are those assigned primarily by Moody’s; other ratings are assigned by Standard & Poor’s and converted to equivalent Moody’s ratings classifications.
 
(b)
“All other” includes non-investment grade or non-rated small issues of tax-exempt bonds.

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

   
September 30, 2008
 
   
Amortized
Cost
 
Gross
Unrealized
Losses
 
Fixed Maturity Securities by Industry Concentration:
             
Services
 
$
39.3
 
$
8.8
 
Consumer Durables
   
37.3
   
5.4
 
Financial
   
13.8
   
4.1
 
Retail
   
17.1
   
1.9
 
Other (includes 5 industry groups)
   
24.5
   
1.6
 
Total
 
$
132.2
(c)
$
22.0
 
                 
                 
 
(c)
Represents 1.8% of the total fixed maturity securities portfolio.

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

   
September 30, 2008
 
   
Amortized
Cost
 
Gross
Unrealized
Losses
 
Fixed Maturity Securities by Industry Concentration:
             
Banking
 
$
296.2
 
$
32.1
 
Utilities
   
590.3
   
21.9
 
Financial
   
221.0
   
15.8
 
Municipals
   
1,001.7
   
13.2
 
Other (includes 17 industry groups)
   
1,758.7
   
56.6
 
Total
 
$
3,868.1
(d)
$
139.7
 
                 
                 
 
(d)
Represents 52.4% of the total fixed maturity securities portfolio.

Gross Unrealized Losses Stratified by Industry Concentration for Equity Securities

   
September 30, 2008
 
   
 
 
Cost
 
Gross
Unrealized
Losses
 
Equity Securities by Industry Concentration:
             
Index Funds
 
$
112.8
 
$
4.4
 
Insurance
   
5.9
   
.4
 
Utilities
   
6.8
   
-
 
Total
 
$
125.5
(e)
$
4.8
(f)
                 
                 
 
(e)
Represents 31.1% of the total equity securities portfolio.
 
(f)
Represents 1.2% of the cost of the total equity securities portfolio, while gross unrealized gains represent 20.9% of the portfolio.

 
19
 
 


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

 
September 30, 2008
 
 
Amortized Costs 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
$
506.6
 
$
33.2
 
$
9.6
 
$
.6
 
Due after one year through five years
 
1,658.6