Investors Title Company's(the "Company") Annual Report on Form 10-K for the year ended December 31, 2021(the "2021 Form 10-K") as filed with the Securities and Exchange Commission(the "SEC") should be read in conjunction with the following discussion since it contains information which is important for evaluating the Company's operating results and financial condition. In addition, the Company may make forward-looking statements in the following discussion and analysis. Forward looking statements are based on certain assumptions and expectations of future events that are subject to a number of risks and uncertainties. Actual results may vary. See "Safe Harbor for Forward-Looking Statements" at the end of this discussion and analysis, as well as the sections titled "Risk Factors" in Part I, Item 1A of the 2021 Form 10-K for factors that could affect forward-looking statements.
The Company is a holding company that engages primarily in issuing title insurance through two subsidiaries,
Investors Title Insurance Company("ITIC") and National Investors Title Insurance Company("NITIC"). Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Total revenues from the title segment accounted for 96.1% of the Company's revenues for the nine-month period ended September 30, 2022. Title insurance protects against loss or damage resulting from title defects that affect real property. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a covered claim is made against real property, title insurance provides indemnification against insured defects. There are two basic types of title insurance policies - one for the mortgage lender and one for the real property owner. A lender often requires the property owner to purchase a lender's title insurance policy to protect its position as a holder of a mortgage loan, but the lender's title insurance policy does not protect the property owner. The property owner has to purchase a separate owner's title insurance policy to protect its investment. The Company issues title insurance policies directly and through a network of agents. Issuing agents are typically real estate attorneys, independent agents or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company's marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company's growth in title insurance premiums written.
Revenues for the title insurance segment primarily result from purchases of new
and existing residential and commercial real estate, refinance activity and
certain other types of mortgage lending such as home equity lines of credit.
Title insurance premiums vary from state to state and are subject to extensive regulation. Statutes generally provide that rates must not be excessive, inadequate or unfairly discriminatory. The process of implementing a rate change in most states involves pre-approval by the applicable state insurance regulator. Volume is a factor in the Company's profitability due to fixed operating costs that are incurred by the Company regardless of title insurance premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on the Company's profitability. The Company's profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and to minimize risks such as interest rate changes, defaults and impairments of assets. The Company's volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes property sales, mortgage financing and mortgage refinancing. Real estate activity, home sales and mortgage lending are cyclical in nature. Real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels, and general
United Stateseconomic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.
The Company’s title insurance premiums in future periods are likely to fluctuate
due to these and other factors which are beyond management’s control.
Historically, the title insurance business tends to be seasonal as well as cyclical. Because home sales are typically strongest in periods of favorable weather, the first calendar quarter tends to have the lowest activity levels, while the spring and summer quarters tend to be more active. Mortgage refinance activity tends to be influenced less by seasonality and more by economic cycles, with activity levels increasing during times of falling interest rates. 24 --------------------------------------------------------------------------------
Services other than title insurance provided by operating divisions of the
Company are not reported separately, but rather are reported collectively in a
group called “All Other.” These other services include those offered by the
Company and by its wholly owned subsidiaries,
The Company's exchange services division, consisting of the operations of ITEC and ITAC, provides customer services in connection with tax-deferred real property exchanges. ITEC acts as a qualified intermediary in tax-deferred exchanges of property held for productive use in a trade or business or for investment, and its income is derived from fees for handling exchange transactions and interest earned on client deposits held by the Company. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction, and its duties include drafting standard exchange documents, holding the exchange funds between the time the old property is sold and the new property is purchased, and accepting the formal identification of the replacement property within the required identification period. ITAC provides services as an exchange accommodation titleholder for accomplishing "parking transactions" as set forth in the safe harbor contained in Internal Revenue Procedure 2000-37. These transactions include reverse exchanges when taxpayers decide to acquire replacement property before selling the relinquished property, or "build to suit" exchanges, when improvements must be made to the replacement property before the taxpayer acquires the improved replacement property. The services provided by the Company's exchange services division, ITEC and ITAC, are pursuant to provisions in the Internal Revenue Code. From time to time, these laws are subject to review and changes, which may negatively affect the demand for tax-deferred exchanges in general, and consequently, the revenues and profitability of the Company's exchange services division.
The Company’s trust services division,
management and trust services to individuals, companies, banks and trusts.
ITMS offers various consulting and management services to provide clients with
the technical expertise to start and successfully operate a title insurance
Business Trends and Recent Conditions
The housing market is heavily influenced by government policies and overall economic conditions. Regulatory reform and initiatives by various governmental agencies, including the
Federal Reserve'smonetary policy and other regulatory changes, could impact lending standards or the processes and procedures used by the Company. The current real estate environment, including interest rates and general economic activity, typically influence the demand for real estate. Changes in either of these areas, in addition to ongoing supply constraints and volatility in the cost and availability of building materials, could impact the Company's results of operations in future periods. COVID-19 - COVID-19 could continue to affect the Company in a number of ways including, but not limited to, the impact of employees becoming ill, quarantined, or otherwise unable to work or travel due to illness or governmental restriction, potential decreases in net premiums written in the future, and future fluctuations in the Company's investment portfolio. The current period of inflation, as well as ongoing military conflict between Russiaand Ukraine, has created additional volatile market conditions and uncertainties in the global economy. These events have impacted and could continue to impact the Company in a number of ways including, but not limited to, future fluctuations in the Company's investment portfolio and potential decreases in net premiums written. The Federal Open Market Committee("FOMC") of the Federal Reservehas been highly attentive to the risks that these events have created, and in response has been raising the target federal funds rate at recent meetings. Although the federal funds rate does not directly impact mortgage interest rates, it can have a significant influence as lenders pass on the costs of rate increases to consumers. Higher mortgage interest rates could impact the demand and pricing of real estate.
FOMCissues disclosures on a periodic basis that include projections of the federal funds rate and expected actions. In March 2020, the FOMClowered the target federal funds rate twice by a total of 150 basis points in response to risk posed to economic activity by COVID-19, resulting in a target federal funds rate range between 0.00% and 0.25%. The FOMChad maintained this target range until March 2022, when the target federal funds rate range was increased to between 0.25% and 0.50%. The target federal funds rate range was further raised at subsequent meetings, with the FOMC'smost recent change increasing the target range in November 2022to between 3.75% and 4.00%. The FOMChas noted that it anticipates that ongoing increases in the target range will be appropriate and, in addition, has decided to continue with balance sheet holdings reductions that began in May of 2022. In normal economic situations, future adjustments to the FOMC'sstance of monetary policy are expected to be based on realized and expected economic developments to achieve maximum employment and inflation near the FOMC'ssymmetric long-term 2.0% objective. 25 -------------------------------------------------------------------------------- In 2008, the federal government took control of the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") in an effort to keep these government-sponsored entities from failing. The primary functions of Fannie Mae and Freddie Mac are to provide liquidity to the nation's mortgage finance system by purchasing mortgages on the secondary market, pooling them and selling them as mortgage-backed securities. In order to securitize, Fannie Mae and Freddie Mac typically require the purchase of title insurance for loans they acquire. Since the federal takeover, there have been various discussions and proposals regarding their reform. Changes to these entities could impact the entire mortgage loan process and, as a result, could affect the demand for title insurance. The timing and results of reform are currently unknown; however, any changes to these entities could affect the Company and its results of operations. In recent years, the Consumer Financial Protection Bureau("CFPB"), Office of the Comptroller of Currencyand the Federal Reservehave issued memorandums to banks that communicated those agencies' heightened focus on vetting third-party providers. Such increased regulatory involvement may affect the Company's agents and approved providers. Further proposals to change regulations governing insurance holding companies and the title insurance industry are often introduced in Congress, in state legislatures and before various insurance regulatory agencies. Although the Company regularly monitors such proposals, the likelihood and timing of passage of any such regulation, and the possible effects of any such regulation on the Company and its subsidiaries, cannot be determined at this time. The timing and nature of any reforms are currently unknown; however, the CFPBhas taken a significantly more aggressive approach to using its rulemaking, supervision, and enforcement authorities under President Biden'sadministration. Any changes to the CFPBor other governmental entities could affect the Company and its results of operations.
Real Estate Environment
Mortgage Bankers Association's("MBA") September 19, 2022Mortgage Finance Forecast ("MBA Forecast") projects 2022 purchase activity to decrease 13.2% to $1,618 billionand mortgage refinance activity to decrease 72.6% to $706 billion, resulting in a net decrease in total mortgage originations of 47.6% to $2,324 billion, all from 2021 levels. In 2021, purchase activity accounted for 42.0% of all mortgage originations and is projected in the MBA Forecast to represent 69.6% of all mortgage originations in 2022. According to data published by Freddie Mac, the average 30-year fixed mortgage interest rates in the United Stateswere 4.9% and 2.9% for the nine-month periods ended September 30, 2022and 2021, respectively. The FOMChas noted that it anticipates that ongoing increases in the federal funds rate will be appropriate in response to the current inflationary environment, with mortgage rates typically moving in conjunction with the federal funds rate. Per the MBA Forecast, mortgage interest rates are projected to stay at or around 5.5% for the remainder of 2022, before decreasing in both 2023 and 2024. Due to the rapidly changing environment brought on by COVID-19, supply constraints, inflationary pressures and geopolitical conflicts, these projections and the impact of actual future developments on the Company could be subject to material change. Historically, activity in real estate markets has varied over the course of market cycles by geographic region and in response to evolving economic factors. Operating results can vary from year to year based on cyclical market conditions and do not necessarily indicate the Company's future operating results and cash flows.
Critical Accounting Estimates and Policies
The preparation of the Company's unaudited Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures regarding contingencies and commitments. Actual results could differ from these estimates. During the nine-month period ended
September 30, 2022, the Company did not make any material changes to its critical accounting policies as previously disclosed in Management's Discussion and Analysis in the 2021 Form 10-K. 26 --------------------------------------------------------------------------------
Results of Operations
The following table presents certain unaudited Consolidated Statements of Operations data for the three- and nine-month periods ended
September 30, 2022and 2021: Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2022 2021 2022 2021 Revenues: Net premiums written $ 66,658 $ 72,345 $ 199,409 $ 201,349Escrow and other title-related fees 5,963 3,863 17,236 10,148 Non-title services 3,852 2,446 9,114 6,932 Interest and dividends 1,229 893 3,055 2,807 Other investment income 2,173 2,186 4,616 4,610 Net realized investment gains 2,481 268 6,266 771 Changes in the estimated fair value of equity security investments (4,635) (802) (22,722) 7,266 Other 277 217 924 4,572 Total Revenues 77,998 81,416 217,898 238,455 Operating Expenses: Commissions to agents 33,478 37,570 97,161 102,458 Provision for claims 1,966 1,993 3,452 5,020 Personnel expenses 21,586 15,457 63,738 47,524 Office and technology expenses 4,274 3,175 12,930 9,128 Other expenses 6,606 4,784 19,783 13,285 Total Operating Expenses 67,910 62,979 197,064 177,415 Income before Income Taxes 10,088 18,437 20,834 61,040 Provision for Income Taxes 2,175 3,934 4,457 12,932 Net Income $ 7,913 $ 14,503 $ 16,377 $ 48,10827
Insurance revenues include net premiums written and escrow and other title-related income that includes escrow fees, commissions and settlement fees. Non-title services revenue, investment-related revenues and other revenues are discussed separately below. Net Premiums Written Net premiums written decreased 7.9% and 1.0% for the three- and nine-month periods ended
September 30, 2022to $66.7 millionand $199.4 million, respectively, compared with $72.3 millionand $201.3 millionfor the same prior year periods. The decreases for the three- and nine-month periods ended September 30, 2022were primarily driven by an overall decline in the level of real estate transaction volume following the rise in mortgage interest rates, partially offset by higher average home prices and increased premiums in our Texasmarket. Total premiums include an estimate of premiums for policies that have been issued directly and by agents, but not reported to the Company as of the balance sheet date. To determine the estimated premiums, the Company uses historical experience, as well as other factors, to make certain assumptions about the average elapsed time between the policy effective date and the date the policies are reported. From time to time, the Company adjusts the inputs to the estimation process as reported transactions and new information becomes available from direct and agency business. In addition to estimating revenues, the Company also estimates and accrues agent commissions, claims provision, premium taxes, income taxes, and other expenses associated with the estimated revenues that have been accrued. The Company reflects any adjustments to the accruals in the results of operations in the period in which new information becomes available. Title insurance companies typically issue title insurance policies directly or through title agencies. Following is a breakdown of premiums generated by direct and agency operations for the three- and nine-month periods ended September 30, 2022and 2021, with certain balances for 2021 reclassified to conform to the 2022 presentation: Three Months Ended Nine Months Ended September 30, September 30, (in thousands, except percentages) 2022 % 2021 % 2022 % 2021 % Direct $ 21,81832.7 $ 21,80330.1 $ 68,47834.3 $ 61,61930.6 Agency 44,840 67.3 50,542 69.9 130,931 65.7 139,730 69.4 Total $ 66,658100.0 $ 72,345100.0 $ 199,409100.0 $ 201,349100.0 Direct Net Premiums - The Company's direct business consists of operations at the home office, branch offices, and wholly owned title insurance agencies. In the Company's direct operations, the Company issues a title insurance policy and retains the entire premium, as no commissions are recognized in connection with these policies. Net premiums written from direct operations increased 0.1% and 11.1% for the three- and nine-month periods ended September 30, 2022, respectively, compared with the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022and 2021 were driven by higher average home prices and increased premiums written by wholly owned agencies in our Texasmarket, partially offset by a decline in transaction volume associated with higher mortgage interest rates. Agency Net Premiums - When a policy is written through a non-wholly owned title agency, the premium is shared between the agency and the underwriter. The agent retains a majority of the premium as a commission and remits the net amount to the Company. Title insurance commissions earned by the Company's agents are recognized as expenses concurrently with premium recognition. Agency net premiums written decreased 11.3% and 6.3% for the three- and nine-month periods ended September 30, 2022, compared with the same prior year periods. The decreases for the three- and nine-month periods ended September 30, 2022were primarily driven by an overall decline in the level of real estate transaction volume following the rise in mortgage interest rates, partially offset by higher average home prices. 28 -------------------------------------------------------------------------------- Following is a schedule of net premiums written for the three- and nine-month periods ended September 30, 2022and 2021 in select states in which the Company's two insurance subsidiaries, ITIC and NITIC, currently underwrite title insurance: Three Months Ended Nine Months Ended September 30, September 30, State (in thousands) 2022 2021 2022 2021 North Carolina $ 23,622 $ 26,118 $ 71,392 $ 75,527Texas 21,081 18,079 60,457 42,317 Georgia 6,094 7,667 18,819 25,527 South Carolina 6,407 7,258 17,349 17,940 All Others 9,632 13,352 32,068 40,413 Premiums Written 66,836 72,474 200,085 201,724 Reinsurance Assumed - - - - Reinsurance Ceded (178) (129) (676) (375) Net Premiums Written $ 66,658 $ 72,345 $ 199,409 $ 201,349The increases in net premiums written in the state of Texasfor the three- and nine-month periods ended September 30, 2022primarily resulted from the Company's recent acquisitions of title insurance agencies doing business in the state of Texas. The Company evaluates nonorganic growth opportunities, such as acquisitions of title insurance agencies, from time to time in the ordinary course of business.
Escrow and Other Title-Related Fees
Escrow and other title-related fees consists primarily of commission income, escrow and other various fees associated with the issuance of title insurance policies including settlement, examination and closing fees. Escrow and other title-related fee revenues were
$6.0 millionand $17.2 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $3.9 millionand $10.1 millionfor the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022were mainly due to a larger share of business in markets that generate escrow income, and fee income associated with commercial activity.
Revenue from Non-Title Services
Revenue from non-title services includes trust services, agency management services and exchange services income. Non-title service revenues were
$3.9 millionand $9.1 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $2.4 millionand $6.9 millionfor the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022were primarily related to increases in like-kind exchange revenues.
Investment-related revenues include interest and dividends, other investment income, net realized investment gains and changes in the estimated fair value of equity security investments. Interest and Dividends The Company derives a substantial portion of its income from investments in fixed maturity securities, which are primarily municipal and corporate fixed maturity securities, and equity securities. The Company's investment policy is designed to comply with regulatory requirements and to balance the competing objectives of asset quality and investment returns. The Company's title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. The Company's investment strategy emphasizes after-tax income and principal preservation. The Company's investments are primarily in fixed maturity securities and equity securities. The average effective maturity of the majority of the fixed maturity securities is less than 10 years. The Company's invested assets are managed to fund its obligations and evaluated to ensure long term stability of capital accounts. 29 -------------------------------------------------------------------------------- As the Company generates cash from operations, it is invested in accordance with the Company's investment policy and corporate goals. The Company's investment policy has been designed to balance multiple goals, including the assurance of a stable source of income from interest and dividends, the preservation of principal, and the provision of liquidity sufficient to meet insurance underwriting and other obligations as they become payable in the future. Securities purchased may include a combination of taxable or tax-exempt fixed maturity securities and equity securities. The Company also invests in short-term investments that typically include money market funds, and, at times, the Company has or could invest in
U.S. Treasurybills, commercial paper and certificates of deposit. The Company strives to maintain a high quality investment portfolio. In 2022, the Company has purchased higher levels of short-term investments due to the downturns in other investment vehicles utilized by the Company and uncertainty in the investment market. Interest and dividends were $1.2 millionand $3.1 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $893 thousandand $2.8 millionfor the same prior year periods. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investments that meet the Company's investment policy.
Other Investment Income
Other investment income consists primarily of income related to investments in unconsolidated affiliates, typically structured as limited liability companies ("LLCs"), accounted for under either the equity method of accounting or the measurement alternative for investments that do not have readily determinable fair values. The measurement alternative method requires investments without readily determinable fair values to be recorded at cost, less impairments, and plus or minus any changes resulting from observable price changes. The Company monitors any events or changes in circumstances that may have had a significant adverse effect on the fair value of these investments and makes any necessary adjustments. Other investment income was
$2.2 millionand $4.6 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $2.2 millionand $4.6 millionfor the same prior year periods. Changes in other investment income are impacted by fluctuations in the carrying value of the underlying investment and/or distributions received.
Net Realized Investment Gains
Dispositions of equity securities at a realized gain or loss reflect such factors as industry sector allocation decisions, ongoing assessments of issuers' business prospects and tax planning considerations. Additionally, the amounts included in net realized investment gains are affected by assessments of securities' valuation for impairment. As a result of the interaction of these factors and considerations, the net realized investment gain or loss can vary significantly from period to period. The net realized investment gains were
$2.5 millionand $6.3 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $268 thousandand $771 thousandfor the same prior year periods. The Company recorded impairment charges of $35 thousandand $162 thousandon certain fixed maturity securities where the intent to hold has changed in the three- and nine-month periods ended September 30, 2022. There were no impairment charges recorded in 2021. Management believes unrealized losses on the remaining fixed maturity securities at September 30, 2022are temporary in nature. The securities in the Company's investment portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a fixed maturity security has occurred. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost. There are a number of risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated; the risk that the Company's assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the characteristics of that issuer; the risk that information obtained by the Company or changes in other facts and circumstances leads management to change its intent to sell the fixed maturity security; and the risk that management is making decisions based on inaccurate information.
Changes in the Estimated Fair Value of Equity Security Investments
Changes in the estimated fair value of equity security investments were
$(4.6) millionand $(22.7) millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $(802) thousandand $7.3 millionfor the same prior year periods. Such fluctuations are the result of changes in general market conditions during the respective periods. All major indices have experienced significant declines in 2022. 30 --------------------------------------------------------------------------------
Other revenues primarily include miscellaneous income and gains and losses on the disposal of fixed assets and real estate. Other revenues were
$277 thousandand $924 thousandfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $217 thousandand $4.6 millionfor the same prior year periods. The decrease for the nine-month period ended September 30, 2022was primarily related to a gain on the sale of a property recorded in 2021.
The Company's operating expenses consist primarily of commissions to agents, personnel expenses, office and technology expenses and the provision for claims. Operating expenses increased 7.8% and 11.1% for the three- and nine-month periods ended
September 30, 2022, compared with the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022were primarily due to increases in personnel expenses, title fees, and office and technology expenses. Following is a summary of the Company's operating expenses for the three- and nine-month periods ended September 30, 2022and 2021. Inter-segment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 4 to the unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Three Months Ended Nine Months Ended September 30, September 30, (in thousands, except percentages) 2022 % 2021 % 2022 % 2021 % Title Insurance $ 65,56796.5 $ 60,59996.2 $ 188,78895.8 $ 170,03295.8 All Other 2,343 3.5 2,380 3.8 8,276 4.2 7,383 4.2 Total $ 67,910100.0 $ 62,979100.0 $ 197,064100.0 $ 177,415100.0 On a combined basis, the after-tax profit margins were 10.1% and 7.5% for the three- and nine-month periods ended September 30, 2022, respectively, compared with 17.8% and 20.2% for the same prior year periods. The decreases for the three- and nine-month periods ended September 30, 2022were primarily due to reductions in the estimated fair value of equity security investments during the current year periods, a gain on the sale of property in the same prior year periods, and increases in total expenses that outpaced the changes in revenue. The Company continually strives to enhance its competitive strengths and market position, including ongoing initiatives to manage its operating expenses.
Personnel Expenses - Personnel expenses include base salaries, benefits and payroll taxes, bonuses paid to employees and contract labor expenses. Personnel expenses were
$21.6 millionand $63.7 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $15.5 millionand $47.5 millionfor the same prior year periods. On a consolidated basis, personnel expenses as a percentage of total revenues were 27.7% and 29.3% for the three- and nine-month periods ended September 30, 2022, respectively, compared with 19.0% and 19.9% for the same prior year periods. The increases in personnel expenses for the three- and nine-month periods ended September 30, 2022were primarily due to staffing of new offices, hiring to support growth initiatives, and increased employee benefit costs. Increases in staffing levels are the result of both organic growth and recent acquisitions of title insurance agencies, as the Company continues expansion of its geographic footprint. Employee headcount increased by 40.2% as of September 30, 2022, when compared to the same prior year period, primarily due to the Company's continued expansion efforts in the Texasmarket. Office and Technology Expenses - Office and technology expenses primarily include facilities expenses, software and hardware expenses, depreciation expense, telecommunications expenses, and business insurance. Office and technology expenses were $4.3 millionand $12.9 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $3.2 millionand $9.1 millionfor the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022were primarily in support of expanding the Company's geographic footprint, the result of adding new office locations due to both organic growth and recent acquisitions of title insurance agencies, and various ongoing technology initiatives. Other Expenses - Other expenses primarily include business development expenses, premium-related taxes and licensing, professional services, title and service fees, amortization of intangible assets and other general expenses. Other expenses were $6.6 millionand $19.8 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $4.8 millionand $13.3 millionfor the same prior year periods. The increases for the three- and nine-month periods ended September 30, 2022were primarily related to increases in title and service fees, technology fees and business development expenses. 31 --------------------------------------------------------------------------------
Commissions to Agents - Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. Commissions to agents decreased 10.9% and 5.2% for the three- and nine-month periods ended
September 30, 2022, respectively, compared with the same prior year periods. Commission expense as a percentage of net premiums written by agents was 74.7% and 74.2% for the three- and nine-month periods ended September 30, 2022, compared with 74.3% and 73.3% for the same prior year periods. The changes in commission expense, and commission expense as a percentage of net premiums written, were primarily related to the decreases in agent premium volume and changes in geographic mix. Commission rates vary by market due to local practice, competition and state regulations. Provision for Claims - The provision for claims decreased 1.4% and 31.2% for the three- and nine-month periods ended September 30, 2022, respectively, compared with the same prior year periods. The provision for claims as a percentage of net premiums written was 2.9% and 1.7% for the three- and nine-month periods ended September 30, 2022, compared with 2.8% and 2.5% for the same prior year periods. The decrease in the provision for claims for the nine-month period ended September 30, 2022was primarily due to changes in the geographic mix for underwriting risk and higher levels of favorable loss development in 2022. Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $2.6 millionand $1.8 millionfor the nine-month periods ended September 30, 2022and 2021, respectively. At September 30, 2022, the total reserve for claims was $37.6 million. Of that total, approximately $4.0 millionwas reserved for specific claims, and approximately $33.6 millionwas reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that claims may not materialize for several years, reserve estimates are subject to variability. Changes from prior periods in the expected liability for claims reflect the uncertainty of the claims environment, as well as the limited predictive power of historical data. The Company continually updates and refines its reserve estimates as current experience develops and credible data emerges. Such data includes payments on claims closed during the quarter, new details that emerge on open cases that cause claims adjusters to increase or decrease the case reserves, and the impact that these types of changes have on the Company's total loss provision. Adjustments may be required as new information develops, which often varies from past experience.
The provision for income taxes was
$2.2 millionand $4.5 millionfor the three- and nine-month periods ended September 30, 2022, respectively, compared with $3.9 millionand $12.9 millionfor the same prior year periods. Income tax expense, including federal and state taxes, as a percentage of income before income taxes was 21.6% and 21.4% for the three- and nine-month periods ended September 30, 2022, respectively, compared with 21.3% and 21.2% for the same prior year periods. The effective income tax rates for both 2022 and 2021 differ from the U.S.federal statutory income tax rate of 21% primarily due to the effect of tax-exempt income and state taxes. Tax-exempt income lowers the effective tax rate. The Company believes it is more likely than not that the tax benefits associated with recognized impairments and unrecognized losses recorded through September 30, 2022will be realized. However, this judgment could be impacted by further market fluctuations. 32 --------------------------------------------------------------------------------
Liquidity and Capital Resources
The Company's material cash requirements include general operating expenses, contractual and other obligations for the future payment of title claims, employment agreements, lease agreements, income taxes, capital expenditures, dividends on its common stock and other contractual commitments for goods and services needed for operations. All other arrangements entered into by the Company are not reasonably likely to have a material effect on liquidity or the availability of capital resources. Cash flows from operations have historically been the primary source of financing for expanding operations, whether through organic growth or outside investments. The Company believes its balances of cash, short-term investments and other readily marketable securities, along with cash flows generated by ongoing operations, will be sufficient to satisfy its cash requirements over the next 12 months and thereafter, including the funding of operating activities and commitments for investing and financing activities, in addition to potential purchases under the Company's repurchase plan described below. There are currently no known trends that the Company believes will materially impact the Company's capital resources, nor is the Company anticipating any material changes in the mix or relative cost of such resources except as otherwise disclosed in the Business Trends and Recent Conditions section of this Management's Discussion and Analysis. The Company evaluates nonorganic growth opportunities, such as mergers and acquisitions, from time to time in the ordinary course of business. Because of the episodic nature of these events, related incremental liquidity and capital resource needs can be difficult to predict. The Company's operating results and cash flows are heavily dependent on the real estate market. The Company's business has certain fixed costs; therefore, changes in the real estate market are monitored closely, and operating expenses such as staffing levels are managed and adjusted accordingly. The Company believes that its significant working capital position and management of operating expenses will aid its ability to manage cash resources through fluctuations in the real estate market. Cash Flows - Net cash flows provided by operating activities were
$20.3 millionand $35.7 millionfor the nine-month periods ended September 30, 2022and 2021, respectively. Cash flows provided by operating activities differ from net income due to adjustments for non-cash items, such as changes in the estimated fair value of equity security investments, gains and losses on investments and property, the timing of disbursements for taxes, claims and other accrued liabilities, and collections or changes in receivables and other assets. Cash flows from non-operating activities have historically consisted of purchases and proceeds from investing activities, the issuance of dividends and repurchases of common stock. Net cash was used in investing activities for the nine-month period ended September 30, 2022, compared with net cash being provided by investing activities in the prior year period, due primarily to an increase in purchases of investments, net of proceeds from investment sales and maturities, the purchase of a subsidiary during the current year period, and a decrease in proceeds from the sale of property. The Company maintains a high degree of liquidity within its investment portfolio in the form of cash, short-term investments and other readily marketable securities. As of September 30, 2022, the Company held cash and cash equivalents of $41.4 million, short-term investments of $80.8 million, available-for-sale fixed maturity securities of $55.3 millionand equity securities of $52.7 million. The net effect of all activities on total cash and cash equivalents was an increase of $4.2 millionin 2022. Capital Resources - The amount of capital resources the Company maintains is influenced by state regulation, the need to maintain superior financial ratings from third-party rating agencies and other marketing and operational considerations. The Company's significant sources of funds are dividends and distributions from its subsidiaries, primarily its two title insurance subsidiaries. Cash is received from its subsidiaries in the form of dividends and as reimbursements for operating and other administrative expenses that it incurs. The reimbursements are executed within the guidelines of management agreements between the Company and its subsidiaries. The ability of the Company's title insurance subsidiaries to pay dividends to the Company is subject to state regulation from their respective states of domicile. Each state regulates the extent to which title underwriters can pay dividends or make distributions and requires prior regulatory approval of the payment of dividends and other intercompany transfers. The maximum dividend permitted by law is not necessarily indicative of an insurer's actual ability to pay dividends. Depending on regulatory conditions, the Company may in the future need to retain cash in its title insurance subsidiaries in order to maintain their statutory capital position. As of September 30, 2022, both ITIC and NITIC met the minimum capital, surplus and reserve requirements for each state in which they are licensed. 33 -------------------------------------------------------------------------------- While state regulations and the need to cover risks may set a minimum level for capital requirements, other factors necessitate maintaining capital resources in excess of the required minimum amounts. For instance, the Company's capital resources help it maintain high ratings from insurance company rating agencies. Superior ratings strengthen the Company's ability to compete with larger, well known title insurers with national footprints. A strong financial position provides the necessary flexibility to fund potential acquisition activity, to invest in the Company's core business, and to minimize the financial impact of potential adverse developments. Adverse developments that generally require additional capital include adverse financial results, changes in statutory accounting requirements by regulators, reserve charges, investment losses or costs incurred to adapt to a changing regulatory environment, including costs related to CFPBregulation of the real estate industry. The Company bases its capitalization levels, in part, on net coverage retained. Since the Company's geographical focus has been and continues to be concentrated in states with average premium rates typically lower than the national average, capitalization relative to premiums will usually appear higher than industry averages. Due to the Company's historical ability to consistently generate positive cash flows from its consolidated operations and investment income, management believes that funds generated from operations will enable the Company to adequately meet its current operating needs for the foreseeable future. However, with any continued impact of COVID-19, ongoing inflationary pressures and the ongoing military conflict between Russiaand Ukraine, there can be no assurance that future experience will be similar to historical experience, since it is influenced by such factors as the interest rate environment, real estate activity, the Company's claims-paying ability and its financial strength ratings. In addition to operational and investment considerations, taking advantage of opportunistic external growth opportunities may necessitate obtaining additional capital resources. The Company is carefully monitoring the COVID-19 situation, inflation, the conflict in Ukraine, and other trends that could potentially result in material adverse liquidity changes, and will continually assess its capital allocation strategy, including decisions relating to payment of dividends, repurchasing the Company's common stock and/or conserving cash. Purchase of Company Stock - On November 9, 2015, the Board of Directors of the Company approved the purchase of an additional 163,335 shares pursuant to the Company's repurchase plan, such that there was authority remaining under the plan to purchase up to an aggregate of 500,000 shares of the Company's common stock pursuant to the plan immediately after this approval. Unless terminated earlier by resolution of the Board of Directors, the plan will expire when all shares authorized for purchase under the plan have been purchased. Pursuant to the Company's ongoing purchase program, the Company purchased 629 shares in the nine-month periods ended September 30, 2022and did not repurchase any shares in the corresponding period in 2021. The Company anticipates increasing its purchases under the repurchase plan during the remainder of 2022 and first half of 2023, subject to such factors as the prevailing market price of the Company's common stock, the Company's available cash and then existing alternative uses for such cash. Capital Expenditures - Capital expenditures were approximately $4.0 millionfor the nine-month period ended September 30, 2022. In 2022, the Company has plans for various capital improvement projects, including increased investment in a number of technology and system development initiatives and hardware purchases which are anticipated to be funded via cash flows from operations. All material anticipated capital expenditures are subject to periodic review and revision and may vary depending on a number of factors. Contractual Obligations - As of September 30, 2022, the Company had a claims reserve totaling $37.6 million. The amounts and timing of these obligations are estimated and not set contractually. Events such as fraud, defalcation, and multiple property title defects can substantially and unexpectedly cause increases in both the amount and timing of estimated title insurance loss payments and loss cost trends whereby increases or decreases in inflationary factors (including the value of real estate) will influence the ultimate amount of title insurance loss payments and could increase total obligations and influence claim payout patterns. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, claim estimates are subject to variability and future payments could increase or decrease from these estimated amounts in the future. ITIC, a wholly owned subsidiary of the Company, has entered into employment agreements with certain executive officers. The amounts accrued for these agreements at September 30, 2022and December 31, 2021, were $14.2 millionand $13.4 million, respectively, which includes postretirement compensation and health benefits, and were calculated based on the terms of the contracts. These executive contracts are accounted for on an individual contract basis. As payments are based upon the occurrence of specific events, including death, disability, retirement, termination without cause or upon a change in control, payment periods are currently uncertain. Information regarding retirement agreements and other postretirement benefit plans can be found in Note 5 to the unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. 34 -------------------------------------------------------------------------------- The Company enters into lease agreements that are primarily used for office space. These leases are accounted for as operating leases. A portion of the Company's current leases include an option to extend or cancel the lease term, and the exercise of such an option is solely at the Company's discretion. The total of undiscounted future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year after 2022 is $6.3 million, which includes lease payments related to options to extend or cancel the lease term if the Company determined at the date of adoption that the lease was expected to be renewed or extended. Information about leases can be found in Note 12 to the unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
In the normal course of business, the Company enters into other contractual
commitments for goods and services needed for operations. Such commitments are
not expected to have a material adverse effect on the Company’s liquidity.
Off-Balance Sheet Arrangements
As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying unaudited Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits. In addition, in administering tax-deferred like-kind exchanges pursuant to § 1031 of the Internal Revenue Code, ITEC serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. ITAC serves as exchange accommodation titleholder and, through LLCs that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property held by the Company for the purpose of completing such transactions totaled approximately
$477.9 millionand $763.9 millionas of September 30, 2022and December 31, 2021, respectively. These exchange deposits are held at third-party financial institutions. Exchange deposits are not considered assets of the Company and, therefore, are excluded from the accompanying unaudited Consolidated Balance Sheets; however, the Company remains contingently liable for the disposition of the transfers of property, disbursements of proceeds and the return on the proceeds at the agreed upon rate. Exchange services revenue includes earnings on these deposits; therefore, investment income is shown as non-title services rather than investment income. These like-kind exchange funds are primarily invested in money market funds and other short-term investments.
External assets under management of
assets of the Company and, therefore, are excluded from the accompanying
unaudited Consolidated Balance Sheets.
It is not the general practice of the Company to enter into off-balance sheet arrangements or issue guarantees to third parties. The Company does not have any material source of liquidity or financing that involves off-balance sheet arrangements. Other than items noted above, off-balance sheet arrangements are generally limited to the future payments due under various agreements with third-party service providers.
Recent Accounting Standards
No recent accounting pronouncements are expected to have a material impact on the Company's financial position and results of operations. Please refer to Note 1 to the unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information regarding the Company's basis of presentation and significant accounting policies. 35 --------------------------------------------------------------------------------
Safe Harbor for Forward-Looking Statements
This Quarterly Report on Form 10-Q, as well as information included in future filings by the Company with the
SECand information contained in written material, press releases and oral statements issued by or on behalf of the Company, contains, or may contain, "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), that reflect management's current outlook for future periods. These statements may be identified by the use of words such as "plan," "expect," "aim," "believe," "project," "anticipate," "intend," "estimate," "should," "could," "would" and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including statements about the Company's strategy for growth, product and service development, market share position, claims, expenditures, financial results and cash requirements, are forward-looking statements. Without limitation, projected developments in mortgage interest rates and the overall economic environment set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Trends and Recent Conditions" constitute forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events that are subject to a number of risks and uncertainties. Actual future results and trends may differ materially from historical results or those projected in any such forward-looking statements depending on a variety of factors, including, but not limited to, the following: •changes in interest rates and real estate values; •changes in general economic, business, and political conditions, including the performance of the financial and real estate markets; •the impact of inflation; •the impact of the ongoing military conflict between Russiaand Ukraine; •potential reform of government sponsored entities; •the level of real estate transaction volumes, the level of mortgage origination volumes (including refinancing), the mix of title insurance between markets with varying real estate values, changes to the insurance requirements of the participants in the secondary mortgage market, and the effect of these factors on the demand for title insurance; •the possible inadequacy of the provision for claims to cover actual claim losses; •the incidence of fraud-related losses; •the impact of cyberattacks (including ransomware attacks) and other cybersecurity events, including damage to the Company's reputation in the event of a serious IT breach or failure; •the impact of COVID-19, including its variants, or other pandemics, climate change, severe weather conditions or the occurrence of another catastrophic event; •unanticipated adverse changes in securities markets could result in material losses to the Company's investments; •significant competition that the Company's operating subsidiaries face, including the Company's ability to develop and offer products and services that meet changing industry standards in a timely and cost-effective manner and expansion into new geographic locations; •the Company's reliance upon the North Carolina, Texas, Georgiaand South Carolinamarkets for a significant portion of its premiums; •compliance with government regulation, including pricing regulation, and significant changes to applicable regulations or in their application by regulators; •the impact of governmental oversight of compliance of the Company's service providers, including the application of financial regulation designed to protect consumers; •possible downgrades from a rating agency, which could result in a loss of underwriting business; •the inability of the Company to manage, develop and implement technological advancements and prevent system interruptions or unauthorized system intrusions; •statutory requirements applicable to the Company's insurance subsidiaries that require them to maintain minimum levels of capital, surplus and reserves and that restrict the amount of dividends they may pay to the Company without prior regulatory approval; •the desire to maintain capital above statutory minimum requirements for competitive, marketing and other reasons; •heightened regulatory scrutiny and investigations of the title insurance industry; •the Company's dependence on key management and marketing personnel, the loss of whom could have a material adverse effect on the Company's business; •difficulty managing growth, whether organic or through acquisitions; •unfavorable economic or other conditions could cause the Company to record impairment charges for all or a portion of its goodwill and other intangible assets; •policies and procedures for the mitigation of risks may be insufficient to prevent losses; •the shareholder rights plan could discourage transactions involving actual or potential changes of control; and •other risks detailed elsewhere in this document and in the Company's other filings with the SEC. 36
These and other risks and uncertainties may be described from time to time in the Company's other reports and filings with the
SEC. For more details on factors that could affect expectations, see the 2021 Form 10-K, including under the heading "Risk Factors." The Company is not under any obligation (and expressly disclaims any such obligation) and does not undertake to update or alter any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. You should consider the possibility that actual results may differ materially from our forward-looking statements.
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