INVESTORS TITLE COMPANY Investors Title Company's (the "Company") Annual Report on Form 10-K for the year endedDecember 31, 2020 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 Company's Annual Report on Form 10-K and Part II, Item 1A of this Quarterly Report on Form 10-Q for factors that could affect forward-looking statements.
Overview
The Company is a holding company that engages primarily in issuing title insurance through two subsidiaries,Investors Title Insurance Company ("ITIC") andNational Investors Title Insurance Company ("NITIC"). Total revenues from the title segment accounted for 94.5% of the Company's revenues for the nine-month period endedSeptember 30, 2021 . Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. 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 through its home and branch offices 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 generalUnited States economic 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.
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Services other than title insurance provided by operating divisions of the
Company are not reported separately, but rather are reported collectively in a
category called "All Other". These other services include those offered by the
Company and by its wholly owned subsidiaries, Investors Title Exchange
Corporation ("ITEC"), Investors Title Accommodation Corporation ("ITAC"),
Investors Trust Company ("Investors Trust ") and Investors Title Management
Services, Inc. ("ITMS").
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,
ITMS offers various consulting and management services to provide clients with the technical expertise to start and successfully operate a title insurance agency.
Business Trends and Recent Conditions; COVID-19 Pandemic The housing market is heavily influenced by government policies and overall economic conditions. Regulatory reform and initiatives by various governmental agencies, including theFederal Reserve's monetary 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. Purchase volume and refinance activity were strong in the latter half of 2020, which has continued through the first three quarters of 2021. However, variability of interest rates combined with ongoing supply constraints and volatility in the cost and availability of building materials in recent months could result in reduced purchase volumes during future periods. While certain COVID-19 vaccines have been approved and are now generally available for use inthe United States and certain other countries, we are unable to predict how widely utilized the vaccines will be, and when or if normal economic activity and business operations will resume. It is expected that progress on vaccination levels will continue to reduce the effects of the public health crisis on the economy and, in light of the increasing percentage of vaccinated individuals, many previously implemented restrictions have gradually been lifted. Despite the availability of vaccines, COVID-19 (including its variant strains) continues to spread across the globe, including inU.S. states where the Company conducts business. The COVID-19 pandemic has negatively impacted worldwide economic activity and created significant volatility and disruptions of financial markets. In response, theU.S. government and its agencies have taken a number of significant measures to provide fiscal and monetary stimulus. Such actions included an unscheduled cut to the federal funds rate, the introduction of new programs to preserve market liquidity, extended unemployment and sick leave benefits, mortgage loan forbearance actions, low-interest loans for working capital access and payroll assistance, and other relief measures for both workers and businesses. The Company has remained fully operational throughout the pandemic and did not have any reductions in workforce during 2020 or the first three quarters of 2021. A large portion of the Company's workforce is performing their job functions remotely. The Company has not taken stimulus relief funding or incurred any other forms of debt. The COVID-19 pandemic has caused the Company to modify its business practices (including employee travel, employee work locations and cancellation of physical participation in meetings, events and conferences). The COVID-19 pandemic and any of its variants could continue to affect the Company in a number of ways including, but not limited to, the impact on 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 due to the pandemic and the economic disruption it is causing. Because of the inherent uncertainty regarding the duration and severity of the COVID-19 pandemic (including any of its variants) and its effects on the economy, as well as uncertainty regarding the effects of government measures already taken, and which may be taken or continued in the future, to combat the spread of the virus and any of its variants, and/or provide additional economic stimulus, the Company is currently unable to predict the ultimate impact of the pandemic. 26 --------------------------------------------------------------------------------
Regulatory Environment
TheFederal Open Market Committee ("FOMC") of theFederal Reserve issues disclosures on a periodic basis that include projections of the federal funds rate and expected actions. InMarch 2020 , theFOMC lowered the target federal funds rate twice by a total of 150 basis points in response to risk posed to economic activity by COVID-19. As a result of these actions, the target federal funds rate now ranges between 0.00% and 0.25%. TheFOMC has maintained this target range, although recent comments by several members of theFOMC have indicated the potential for future rate increases. Further, theFOMC hinted that they will begin tapering asset purchases, potentially as early as the fourth quarter of 2021, if economic progress continues. In normal economic situations, future adjustments to the rate are expected to be based on realized and expected economic developments to achieve maximum employment and inflation near theFOMC's symmetric long-term 2.0% objective. With inflation having run persistently below the 2.0% goal in recent years, the current period of elevated inflation is not necessarily problematic to theFOMC's long-term inflation objective. 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, theConsumer Financial Protection Bureau ("CFPB"),Office of the Comptroller of Currency and theFederal Reserve have issued memoranda 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 inCongress , 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, theCFPB is expected to take a significantly more aggressive approach to using its rulemaking, supervision, and enforcement authorities underPresident Biden's administration. Any changes to theCFPB or other governmental entities could affect the Company and its results of operations.
Real Estate Environment
TheMortgage Bankers Association's ("MBA")October 17, 2021 Mortgage Finance Forecast ("MBA Forecast") projects 2021 purchase activity to increase 7.1% to$1,587 billion and mortgage refinance activity to decrease 13.9% to$2,259 billion , resulting in a net decrease in total mortgage originations of 6.4% to$3,846 billion , all from 2020 levels. In 2020, purchase activity accounted for 36.1% of all mortgage originations and is projected in the MBA Forecast to represent 41.3% of all mortgage originations in 2021. The MBA Forecast is projecting fewer total mortgage originations in 2022 and 2023, compared with 2021 levels. Due to the rapidly changing environment brought on by COVID-19, these projections and the impact of actual future developments on the Company could be subject to material change. According to data published by Freddie Mac, the average 30-year fixed mortgage interest rates inthe United States were 2.9% and 3.2% for the nine-month periods endedSeptember 30, 2021 and 2020, respectively. Per the MBA Forecast, mortgage interest rates are projected to be 3.1% in the fourth quarter of 2021, and then further increase to 4.3% by 2023. 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. 27
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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 endedSeptember 30, 2021 , the Company did not make any material changes to its critical accounting policies as previously disclosed in Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 as filed with theSecurities and Exchange Commission (the "SEC").
Results of Operations
The following table presents certain unaudited Consolidated Statements of Operations data for the three- and nine-month periods endedSeptember 30, 2021 and 2020: Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2021 2020 2021 2020 Revenues: Net premiums written$ 72,345 $ 57,205 $ 201,349 $ 143,311 Escrow and other title-related fees 3,863 2,154 10,148 6,014 Non-title services 2,446 1,954 6,932 6,476 Interest and dividends 893 1,060 2,807 3,342 Other investment income 2,186 1,270 4,610 2,236 Net realized investment gains 268 186 771 327 Changes in the estimated fair value of equity security investments (802) 3,619 7,266 (2,867) Other 217 185 4,572 443 Total Revenues 81,416 67,633 238,455 159,282 Operating Expenses: Commissions to agents 37,570 29,068 102,458 73,344 Provision for claims 1,993 1,552 5,020 4,452 Personnel expenses 15,457 12,575 47,524 36,632 Office and technology expenses 3,175 2,456 9,128 7,328 Other expenses 4,784 3,125 13,285 9,276 Total Operating Expenses 62,979 48,776 177,415 131,032 Income before Income Taxes 18,437 18,857 61,040 28,250 Provision for Income Taxes 3,934 3,556 12,932 5,465 Net Income$ 14,503 $ 15,301 $ 48,108 $ 22,785 28
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Insurance Revenues
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 increased 26.5% and 40.5% for the three- and nine-month periods endedSeptember 30, 2021 to$72.3 million and$201.3 million , compared with$57.2 million and$143.3 million for the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were primarily driven by higher average home prices and continued low mortgage interest rates. Total premiums include an estimate of premiums for policies that have been issued by branches and 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 branches and agents report transactions and new information becomes available. 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
through home and branch offices or through title agencies. Following is a
breakdown of premiums generated by branch and agency operations for the three-
and nine-month periods ended
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands, except
percentages) 2021 % 2020 % 2021 % 2020 %
Home and Branch $ 18,496 25.6 $ 15,496 27.1 $ 52,904 26.3 $ 38,364 26.8
Agency 53,849 74.4 41,709 72.9 148,445 73.7 104,947 73.2
Total $ 72,345 100.0 $ 57,205 100.0 $ 201,349 100.0 $ 143,311 100.0
Home and Branch Office Net Premiums - In the Company's home and branch
operations, the Company issues a title insurance policy and retains the entire
premium, as no commissions are paid in connection with these policies. Net
premiums written from home and branch operations increased 19.4% and 37.9% for
the three- and nine-month periods ended September 30, 2021 , respectively,
compared with the same prior year periods. The increases for the three- and
nine-month periods ended September 30, 2021 were primarily driven by higher
average home prices and continued low mortgage interest rates.
All of the Company's home office operations and the majority of branch offices
are located in
Agency Net Premiums - When a policy is written through a 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 increased 29.1% and 41.4% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were primarily driven by higher average home prices and continued low mortgage interest rates. 29 -------------------------------------------------------------------------------- Following is a schedule of net premiums written for the three- and nine-month periods endedSeptember 30, 2021 and 2020 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) 2021 2020 2021 2020 North Carolina$ 26,118 $ 21,524 $ 75,527 $ 53,565 Texas 18,079 10,956 42,317 26,935 Georgia 7,667 6,347 25,527 15,751 South Carolina 7,258 4,646 17,940 12,285 All Others 13,352 13,904 40,413 35,146 Premiums Written 72,474 57,377 201,724 143,682 Reinsurance Assumed - - - 3 Reinsurance Ceded (129) (172) (375) (374) Net Premiums Written$ 72,345 $ 57,205 $ 201,349 $ 143,311
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$3.9 million and$10.1 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$2.2 million and$6.0 million for the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were mainly due to increases in commission income and title ancillary services.
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$2.4 million and$6.9 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$2.0 million and$6.5 million for the same prior year periods. The increase for the three-month period endedSeptember 30, 2021 was primarily related to increases in exchange services and trust fee income. The increase for the nine-month period endedSeptember 30, 2021 , was primarily related to increases in trust fee income and agency management services income, partially offset by a decline in exchange services income. Investment-Related 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, to a lesser extent, 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. 30 -------------------------------------------------------------------------------- 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 include money market funds and commercial paper. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment. Interest and dividends were$893 thousand and$2.8 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$1.1 million and$3.3 million for the same prior year periods. The decreases in 2021 were primarily related to lower interest rates, lower average balances of fixed maturity securities and lower levels of dividends received.
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 million and $4.6 million for the three- and
nine-month periods ended September 30, 2021 , respectively, compared with $1.3
million and $2.2 million for 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 other-than-temporary 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$268 thousand and$771 thousand for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$186 thousand and$327 thousand for the same prior year periods. The net realized investment gain for the nine-month period endedSeptember 30, 2020 included impairment charges of$482 thousand for certain fixed maturity securities the Company determined were other-than-temporarily impaired. There were no impairment charges recorded in 2021. Management believes unrealized losses on the remaining fixed maturity securities atSeptember 30, 2021 are temporary in nature. The securities in the Company's investment portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a fixed maturity security is other-than-temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost. There are a number of risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated; the risk that the Company's assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the characteristics of that issuer; the risk that information obtained by the Company or changes in other facts and circumstances leads management to change its intent to sell the fixed maturity security; and the risk that management is making decisions based on inaccurate information.
Changes in the Estimated Fair Value of Equity Security Investments
Changes in the estimated fair value of equity security investments were$(802) thousand and$7.3 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$3.6 million and$(2.9) million for the same prior year periods. Such fluctuations are the result of changes in general market conditions during the respective periods. 31 --------------------------------------------------------------------------------
Other Revenues
Other revenues primarily include gains and losses on the disposal of fixed assets and miscellaneous revenues. Other revenues were$217 thousand and$4.6 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$185 thousand and$443 thousand for the same prior year periods. The increase for the nine-month period endedSeptember 30, 2021 primarily related to a gain on the sale of a property.
Expenses
The Company's operating expenses consist primarily of commissions to agents, personnel expenses, office and technology expenses and the provision for claims. Operating expenses increased 29.1% and 35.4% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were primarily due to increases in commissions to agents and personnel expenses. Following is a summary of the Company's operating expenses for the three- and nine-month periods endedSeptember 30, 2021 and 2020. Inter-segment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 4 in the accompanying unaudited Consolidated Financial Statements. Three Months Ended Nine Months Ended September 30, September 30, (in thousands, except percentages) 2021 % 2020 % 2021 % 2020 % Title Insurance$ 60,599 96.2$ 46,951 96.3$ 170,032 95.8$ 124,588 95.1 All Other 2,380 3.8 1,825 3.7 7,383 4.2 6,444 4.9 Total$ 62,979 100.0$ 48,776 100.0$ 177,415 100.0$ 131,032 100.0 On a combined basis, after-tax profit margins were 17.8% and 20.2% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with 22.6% and 14.3% for the same prior year periods. 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$15.5 million and$47.5 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$12.6 million and$36.6 million for the same prior year periods. On a consolidated basis, personnel expenses as a percentage of total revenues were 19.0% and 19.9% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with 18.6% and 23.0% for the same prior year period. The increases in personnel expenses for the three- and nine-month periods endedSeptember 30, 2021 were primarily due to staffing additions in support of strategic growth initiatives and volume increases. 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$3.2 million and$9.1 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$2.5 million and$7.3 million for the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were primarily related to ongoing investments in software and technology related 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$4.8 million and$13.3 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$3.1 million and$9.3 million for the same prior year periods. The increases for the three- and nine-month periods endedSeptember 30, 2021 were primarily related to increases in premium-related taxes and licensing, professional services, title and service fees, and travel-related expenses. 32 --------------------------------------------------------------------------------
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 increased 29.2% and 39.7% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with the same prior year periods. Commission expense as a percentage of net premiums written by agents was 69.8% and 69.0% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with 69.7% and 69.9% 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 increased premiums written by agents and changes in geographic mix for the three- and nine-month periods endedSeptember 30, 2021 . Commission rates vary by market due to local practice, competition and state regulations. Provision for Claims - The provision for claims increased 28.4% and 12.8% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with the same prior year periods. The provision for claims as a percentage of net premiums written was 2.8% and 2.5% for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with 2.7% and 3.1% for the same prior year periods. The increases in the provision for claims for the three- and nine-month periods endedSeptember 30, 2021 were primarily due to additional underwriting risks caused by the increase in premiums written. 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$1.8 million and$2.3 million for the nine-month periods endedSeptember 30, 2021 and 2020, respectively. AtSeptember 30, 2021 , the total reserve for claims was$36.8 million . Of that total, approximately$3.4 million was reserved for specific claims, and approximately$33.4 million was 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.
Income Taxes
The provision for income taxes was$3.9 million and$12.9 million for the three- and nine-month periods endedSeptember 30, 2021 , respectively, compared with$3.6 million and$5.5 million for the same prior year periods. Income tax expense, including federal and state taxes, as a percentage of income before income taxes was 21.3% and 21.2% for the three- and nine-month periods endedSeptember 30, 2021 , compared with 18.9% and 19.3% for the same prior year periods. The increases in income tax expense as a percentage of income before income taxes primarily relate to a higher percentage of taxable income, relative to tax exempt income. The effective income tax rates for both 2021 and 2020 differ from theU.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 throughSeptember 30, 2021 will be realized. However, this judgment could be impacted by further market fluctuations.
Liquidity and Capital Resources
The Company's current cash requirements primarily include general operating expenses (including the payment of title claims), income taxes, capital expenditures and dividends on its common stock. Cash flows from operations have historically been the primary source of financing for expanding operations, whether through organic growth or outside investments.
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.
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The Company's operating results and cash flows are heavily dependent on the real
estate market. The Company's business has certain fixed costs such as personnel;
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.
The extent to which COVID-19 impacts the Company's future operations will depend
on future developments which cannot be predicted with certainty at this time,
including the duration and severity of the pandemic, actions taken to contain
the spread of the virus and its variants, regulatory actions taken as a result
of the outbreak and the availability and rate of vaccinations. Throughout the
pandemic, the Company has remained fully operational and has not had any
reductions in workforce during 2021 or 2020. A large portion of the Company's
workforce is performing their job functions remotely. The Company has not taken
stimulus relief funding or incurred any other forms of debt.
Cash Flows - Net cash flows provided by operating activities were $35.7 million
and $21.9 million for the nine-month periods ended September 30, 2021 and 2020,
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 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 and the payment of dividends.
Net cash was provided by investing activities for the nine-month period ended
September 30, 2021 , compared with net cash being used in investing activities in
the prior year period. Net cash provided by investing activities increased due
to proceeds received from investments outpacing purchase activity during the
current year period.
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, 2021 , the Company held cash and cash equivalents
of $48.5 million , short-term investments of $51.2 million , available-for-sale
fixed maturity securities of $82.3 million and equity securities of $69.5
million . The net effect of all activities on total cash and cash equivalents was
an increase of $34.8 million in 2021.
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, 2021 , both ITIC and NITIC
met the minimum capital, surplus and reserve requirements for each state in
which they are licensed.
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 CFPB regulation 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.
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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,
especially with the continued spread of COVID-19 and its variants, 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 and any other trends that are likely to 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 did not purchase any shares
in the nine-month periods ended September 30, 2021 or 2020. The Company
anticipates making further purchases under this plan from time to time in the
future, depending on 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 $6.8 million for
the nine-month period ended September 30, 2021 . In 2021, 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, 2021 , the Company had a claims
reserve totaling $36.8 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, 2021 and December 31, 2020 , were $13.4 million and
$12.5 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.
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 as of
September 30, 2021 is $3.4 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.
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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 $525.2 million and $237.9
million as of September 30, 2021 and December 31, 2020 , 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 and other short-term investments.
External assets under management of
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
For a description of recent accounting pronouncements, please refer to Note 1 in the unaudited Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
36
--------------------------------------------------------------------------------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 theSEC and 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, 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; COVID-19 Pandemic" 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: •the impact of COVID-19, including its variants, or other pandemics; •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; •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; •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 theNorth Carolina ,Texas andGeorgia markets 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 theSEC . 37
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These and other risks and uncertainties may be described from time to time in the Company's other reports and filings with theSEC . For more details on factors that could affect expectations, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 , including under the heading "Risk Factors", as well as the additional risk factor set forth in Part II, Item 1A of this Quarterly Report. 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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