INVESTORS TITLE COMPANY The Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 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
Investors Title Company (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 95.8% of the Company's revenues for the six-month period endedJune 30, 2020 . 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. Changes in either of these areas would likely impact the Company's results of operations. TheU.S. and other countries are experiencing an outbreak of a novel coronavirus which causes a disease designated as COVID-19 and, inMarch 2020 , theWorld Health Organization declared it a pandemic. This contagious disease outbreak has continued to spread across the globe, including inU.S. states where the Company conducts business, and is impacting worldwide economic activity and 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 include an unscheduled cut to the federal funds rate, the introduction of new programs to preserve market liquidity, extended unemployment and sick leave benefits, low-interest loans for working capital access and payroll assistance, and other relief measures for both workers and businesses. The Company is fully operational and has not had any reductions in workforce during 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. The primary impact of the COVID-19 pandemic on the Company's first quarter results of operations was a reduction in value of the investment portfolio. In the second quarter, the Company recognized income from changes in the estimated fair value of equity securities as the Company's equity holdings partially rebounded. Purchase volume and refinance activity strengthened in the second quarter, as lower average mortgage interest rates, a tight real estate supply and pent-up demand spurred real estate activity. It is unclear if real estate activity will remain as resilient in future periods. It is possible that net premiums written could decline in the future 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 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, the Company is currently unable to predict what the ultimate impact of the pandemic on its business will be. The Company has implemented a number of measures to protect the health of its employees and to provide for the continuity of its business during this unpredictable time of crisis, including moving portions of its workforce to telecommuting and restricting business travel. To help get mortgage transactions closed during the pandemic, temporary guidelines have been issued by several entities allowing certain technologies to be used to facilitate what would otherwise be traditional, in-person paper-based closings. Businesses involved in the real estate industry, including the Company, are expected to continue to evaluate the evolving COVID-19 situation and may take additional measures to adapt as the situation developments. 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. At theDecember 2015 meeting, theFOMC voted to raise the federal funds rate for the first time sinceDecember 2008 to a target range between 0.25% and 0.50%. SinceDecember 2015 , theFOMC has voted on several occasions to increase the federal funds rate, most recently at theDecember 2018 meeting to a target range between 2.25% and 2.50%. However, due to developments impacting the economic outlook, as well as muted inflation pressures, at theJuly 2019 meeting, theFOMC reversed course and decided to lower the target range for the federal funds rate to between 2.00% and 2.25%. TheFOMC has elected to lower rates at subsequent meetings. 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 2.0% objective. However, in response to risk posed to economic activity by COVID-19, onMarch 15, 2020 , theFOMC lowered the target range between 0.00% and 0.25%. TheFOMC has maintained this target range, and expects to continue to do so until it is confident that theU.S. economy has weathered recent events and is on track to meet its goals. 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 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 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. In recent periods, both the President and certain members ofCongress have indicated a desire for reform of theCFPB .The Supreme Court of the United States has ruled that the structure of theCFPB is unconstitutional, but has allowed the work of the agency to continue. The timing and nature of any reforms are currently unknown; however, any changes to theCFPB could affect the Company and its results of operations.
Real Estate Environment
TheMortgage Bankers Association's ("MBA")July 15, 2020 Mortgage Finance Forecast ("MBA Forecast"), which includes COVID-19 considerations, projects 2020 purchase activity to increase 2.2% to$1,300 billion and mortgage refinance activity to increase 68.3% to$1,516 billion , resulting in a net increase in total mortgage originations of 29.6% to$2,816 billion , all from 2019 levels. In 2019, purchase activity accounted for 58.5% of all mortgage originations and is projected in the MBA Forecast to represent 46.2% of all mortgage originations in 2020. The MBA Forecast is, however, projecting decreases in mortgage originations for 2021 and 2022. 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 3.4% and 4.2% for the six-month periods endedJune 30, 2020 and 2019, respectively. Per the MBA Forecast, mortgage interest rates are projected to be 3.3% in the fourth quarter of 2020, and then increase to 3.7% by 2022. 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 --------------------------------------------------------------------------------
Critical Accounting Estimates and Policies
The preparation of the Company's 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 six-month period endedJune 30, 2020 , the Company made the following 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, 2019 as filed with theSecurities and Exchange Commission .
The Company has updated the following accounting policies due to the adoption of Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326):
Allowance for Credit Losses -
For available-for-sale fixed maturity securities in an unrealized loss position,
the Company evaluates the securities to determine whether the decline in the
estimated fair value below the amortized cost basis (impairment) is due to
credit-related factors or noncredit-related factors. Any impairment that is not
credit related is recognized in other comprehensive income, net of applicable
taxes. Credit-related impairment is recognized as an allowance for credit losses
("ACL") on the Consolidated Balance Sheets, limited to the amount by which the
amortized cost basis exceeds the estimated fair value, with a corresponding
adjustment to earnings. Both the ACL and the adjustment to the Consolidated
Statements of Operations may be reversed if conditions change. However, if the
Company intends to sell an impaired available-for-sale fixed maturity security
or more likely than not will be required to sell such a security before
recovering its amortized cost basis, the entire impairment amount must be
recognized in earnings with a corresponding adjustment to the security's
amortized cost basis. Because the security's amortized cost basis is adjusted to
estimated fair value, there is no ACL in this situation.
In evaluating available-for-sale fixed maturity securities in unrealized loss
positions for impairment and the criteria regarding its intent or requirement to
sell such securities, the Company considers the extent to which estimated fair
value is less than amortized cost, whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies
have occurred, and the results of reviews of the issuers' financial condition,
among other factors.
Changes in the allowance for credit losses are recorded as provision for (or
reversal of) credit loss expense. Losses are charged against the ACL when
management believes the uncollectability of an available-for-sale fixed maturity
security is confirmed or when either of the criteria regarding intent or
requirement to sell is met.
Accrued interest receivable is excluded from the estimate of credit losses.
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--------------------------------------------------------------------------------Results of Operations
The following table presents certain Consolidated Statements of Operations data
for the three- and six-month periods ended
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands) 2020 2019 2020 2019
Revenues:
Net premiums written $ 47,479 $ 34,978 $ 86,106 $ 63,773
Escrow and other title-related fees 2,018 1,901 3,860 3,223
Non-title services 1,975 2,517 4,522 4,905
Interest and dividends 1,105 1,193 2,282 2,449
Other investment income 526 926 966 1,336
Net realized investment gains (losses) 553 (14) 141 776
Changes in the estimated fair value of equity security
investments 7,972 1,142 (6,486) 5,812
Other 120 90 258 405
Total Revenues 61,748 42,733 91,649 82,679
Operating Expenses:
Commissions to agents 24,089 16,275 44,276 31,333
Provision for claims 1,994 2,397 2,900 2,623
Personnel expenses 12,248 11,683 24,057 23,295
Office and technology expenses 2,457 2,230 4,872 4,453
Other expenses 3,038 3,228 6,151 5,742
Total Operating Expenses 43,826 35,813 82,256 67,446
Income before Income Taxes 17,922 6,920 9,393 15,233
Provision for Income Taxes 3,427 1,420 1,909 3,107
Net Income $ 14,495 $ 5,500 $ 7,484 $ 12,126
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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 35.7% and 35.0% for the three- and six-month periods endedJune 30, 2020 to$47.5 million and$86.1 million , compared with$35.0 million and$63.8 million for the same prior year periods. The increases for the three- and six-month periods endedJune 30, 2020 were primarily driven by increased refinance activity and strong purchase volume as lower average mortgage interest rates continued to spur real estate activity.
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 six-month periods ended
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands, except
percentages) 2020 % 2019 % 2020 % 2019 %
Home and Branch $ 12,973 27.3 $ 10,388 29.7 $ 22,868 26.6 $ 17,554 27.5
Agency 34,506 72.7 24,590 70.3 63,238 73.4 46,219 72.5
Total $ 47,479 100.0 $ 34,978 100.0 $ 86,106 100.0 $ 63,773 100.0
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 24.9% and 30.3% for
the three- and six-month periods ended June 30, 2020 , compared with the same
prior year periods. The increases for the three- and six-month periods ended
June 30, 2020 were primarily attributable to increased refinance activity and
strong purchase volume as lower average mortgage interest rates continued to
spur real estate activity.
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. Total premiums include an estimate of premiums for policies that have been issued 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 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. Agency net premiums written increased 40.3% and 36.8% for the three- and six-month periods endedJune 30, 2020 , compared with the same prior year periods. The increases for the three- and six-month periods endedJune 30, 2020 were primarily attributable to increased refinance activity and strong purchase volume as lower average mortgage interest rates continued to spur real estate activity. 30 -------------------------------------------------------------------------------- Following is a schedule of net premiums written for the three- and six-month periods endedJune 30, 2020 and 2019 in select states in which the Company's two insurance subsidiaries, ITIC and NITIC, currently underwrite title insurance: Three Months Ended Six Months Ended June 30, June 30, State (in thousands) 2020 2019 2020 2019 North Carolina$ 18,098 $ 14,456 $ 32,041 $ 24,661 Texas 8,462 6,235 15,979 12,350 Georgia 4,899 3,572 9,404 6,771 South Carolina 4,158 3,068 7,639 6,339 Virginia 1,951 1,452 3,603 2,630 All Others 9,990 6,290 17,639 11,272 Premiums Written 47,558 35,073 86,305 64,023 Reinsurance Assumed - - 3 - Reinsurance Ceded (79) (95) (202) (250) Net Premiums Written$ 47,479 $ 34,978 $ 86,106 $ 63,773
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 a title insurance policy including settlement, examination and closing fees. Escrow and other title-related fee revenues were$2.0 million and$3.9 million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$1.9 million and$3.2 million for the same prior year periods. The increases in 2020 primarily related to increased fee and commission income.
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
Investment-Related Revenues
Investment-related revenues include interest and dividends, other investment income, net realized investment gains (losses) 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.
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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 certificates of
deposit. 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 $1.1 million and $2.3 million for the three- and
six-month periods ended June 30, 2020 , respectively, compared with $1.2 million
and $2.4 million for the same prior year periods. The decreases in 2020 were
primarily related to less interest earned by fixed maturity securities due to
lower interest rates.
Other Investment Income
Other investment income consists primarily of income related to investments in
unconsolidated affiliates, typically structured as limited liability companies
("LLC's"), 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 $526 thousand and $966 thousand for the three- and
six-month periods ended June 30, 2020 , respectively, compared with $926 thousand
and $1.3 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 (Losses)
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 of net realized investment gains (losses) 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 (losses) were$553 thousand and$141 thousand for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$(14) thousand and$776 thousand for the same prior year periods. The net realized investment gains (losses) for the six-month period endedJune 30, 2020 included impairment charges of$482 thousand of certain fixed maturity securities the Company determined were other-than-temporarily impaired. There were no impairment charges recorded in 2019. Management believes unrealized losses on remaining fixed maturity securities atJune 30, 2020 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 misstated information in the financial statements provided by issuers.
Changes in the Estimated Fair Value of Equity Security Investments
Changes in the estimated fair value of equity security investments were$8.0 million and$(6.5) million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$1.1 million and$5.8 million for the same prior year periods. Such fluctuations are the result of changes in general market conditions during the respective periods. In the first quarter of 2020, all majorU.S. stock market indices substantially declined due to economic slowdowns and uncertainty resulting from COVID-19. The major stock market indices partially recovered the first quarter losses during the second quarter of 2020. 32 --------------------------------------------------------------------------------
Other Revenues
Other revenues primarily include state tax credit income, gains and losses on the disposal of fixed assets and miscellaneous revenues. Other revenues were$120 thousand and$258 thousand for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$90 thousand and$405 thousand for the same prior year periods. The decrease for the six-month period endedJune 30, 2020 primarily related to a decline in state tax credit income.
Expenses
The Company's operating expenses consist primarily of commissions to agents, personnel expenses, office and technology expenses and the provision for claims. Operating expenses increased 22.4% and 22.0% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with the same prior year periods. The increases for the three- and six-month periods endedJune 30, 2020 were primarily due to increases in commissions to agents and personnel expenses. Following is a summary of the Company's operating expenses for the three- and six-month periods endedJune 30, 2020 and 2019. Inter-segment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 4 in the accompanying Consolidated Financial Statements. Three Months Ended Six Months Ended June 30, June 30, (in thousands, except percentages) 2020 % 2019 % 2020 % 2019 % Title Insurance$ 41,519 94.7$ 33,359 93.1$ 77,637 94.4$ 62,786 93.1 All Other 2,307 5.3 2,454 6.9 4,619 5.6 4,660 6.9 Total$ 43,826 100.0$ 35,813 100.0$ 82,256 100.0$ 67,446 100.0 On a combined basis, after-tax profit margins were 23.5% and 8.2% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with 12.9% and 14.7% 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$12.2 million and$24.1 million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$11.7 million and$23.3 million for the same prior year periods. On a consolidated basis, personnel expenses as a percentage of total revenues were 19.8% and 26.2% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with 27.3% and 28.2% for the same prior year period. The increases in personnel expenses for the three- and six-month periods endedJune 30, 2020 were primarily related to normal inflationary increases in salaries and benefits and targeted staffing increases to support growth initiatives. 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$2.5 million and$4.9 million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$2.2 million and$4.5 million for the same prior year periods. The increases for the three- and six-month periods endedJune 30, 2020 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$3.0 million and$6.2 million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$3.2 million and$5.7 million for the same prior year periods. The decrease for the three-month period endedJune 30, 2020 was primarily related to a decrease in business development expenses on account of travel restrictions from COVID-19, partially offset by increases in professional services and premium-related taxes and licensing. The increase for the six-month period endedJune 30, 2020 was primarily related to increases in premium-related taxes and licensing and professional services, partially offset by a decline in business development expenses. 33 --------------------------------------------------------------------------------
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 48.0% and 41.3% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with the same prior year periods. Commission expense as a percentage of net premiums written by agents was 69.8% and 70.0% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with 66.2% and 67.8% 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 six-month periods endedJune 30, 2020 . Commission rates vary by market due to local practice, competition and state regulations. Provision for Claims - The provision for claims as a percentage of net premiums written was 4.2% and 3.4% for the three- and six-month periods endedJune 30, 2020 , respectively, compared with 6.9% and 4.1% for the same prior year periods. Notwithstanding premium volume increases in the current year, claims expense decreased for the three-month period endedJune 30, 2020 as a result of a large claim in the prior year quarter and increased for the six-month period endedJune 30, 2020 due to the recognition of favorable loss development in the prior year. 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$1.5 million and$1.3 million for the six-month periods endedJune 30, 2020 and 2019, respectively. AtJune 30, 2020 , the total reserve for claims was$32.7 million . Of that total, approximately$4.0 million was reserved for specific claims, and approximately$28.7 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$3.4 million and$1.9 million for the three- and six-month periods endedJune 30, 2020 , respectively, compared with$1.4 million and$3.1 million for the same prior year periods. Income tax expense, including federal and state taxes, as a percentage of income before income taxes was 19.1% and 20.3% for the three- and six-month periods endedJune 30, 2020 , compared with 20.5% and 20.4% for the same prior year periods. The effective income tax rates for both 2020 and 2019 differ from theU.S. federal statutory income tax rate of 21% primarily due to the effect of tax-exempt income. 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 throughJune 30, 2020 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.
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.
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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 regulatory actions taken as a result of the
outbreak. Currently, the Company is fully operational and has not had any
reductions in workforce during 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 $16.0 million
and $761 thousand for the three- and six-month periods ended June 30, 2020 and
2019, respectively. Cash flows provided by operating activities increased in
2020 from 2019, primarily due to net income increasing when adjusted for
non-cash items, such as changes in the estimated fair value of equity security
investments, and the timing of payable disbursements. This was partially offset
by changes in other assets and the timing of the collection of receivables.
Cash flows from non-operating activities have historically consisted of
purchases and proceeds from investing activities and the payment of dividends.
Net cash was used in investing activities in 2020, compared with net cash being
provided by investing activities in the prior year period, due to purchase
activity of investments outpacing proceeds received from investments.
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 June 30, 2020 , the Company held cash and cash equivalents of
$29.7 million , short-term investments of $24.7 million , available-for-sale fixed
maturity securities of $102.1 million and equity securities of $55.8 million .
The net effect of all activities on total cash and cash equivalents was an
increase of $3.8 million in 2020.
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 June 30, 2020 , 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 onset and continued spread of COVID-19, 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 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 0 and 66 shares
for the six-month periods ended June 30, 2020 and 2019, respectively. 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 $1.4 million for
the six-month period ended June 30, 2020 . In 2020, 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.
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 Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits. In addition, in administering tax-deferred property exchanges, 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 limited liability companies 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$171.4 million and$214.6 million as ofJune 30, 2020 andDecember 31, 2019 , 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 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 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 theSecurities and Exchange Commission 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" 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, 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; •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 . These and other risks and uncertainties may be described from time to time in the Company's other reports and filings with theSecurities and Exchange Commission . For more details on factors that could affect expectations, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , including under the heading "Risk Factors", as supplemented in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 , as well as the further updated 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. 37
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