Old Republic International Entering Value Territory

| About: Old Republic (ORI)

General Overview

Old Republic Insurance Corporation (NYSE:ORI) is an insurance company that is set up with 4 reporting segments. These segments, along with a brief description of what the segments entail, are listed below (descriptions are taken from the company's latest 10-K):

General Insurance Group: Old Republic's General Insurance segment is best characterized as a commercial lines insurance business with a strong focus on liability insurance coverages. Most of these coverages are provided to businesses, government, and other institutions. The Company does not have a meaningful exposure to personal lines insurance such as homeowners and private automobile coverages, nor does it insure significant amounts of commercial or other real property. In continuance of its commercial lines orientation, Old Republic also focuses on specific sectors of the North American economy, most prominently the transportation (trucking and general aviation), commercial construction, healthcare, education, retail and wholesale, forest products, energy, general manufacturing, and financial services industries.

Mortgage Guaranty Group: Private mortgage insurance protects mortgage lenders and investors from default related losses on residential mortgage loans made primarily to homebuyers who make down payments of less than 20% of the home's purchase price. The Mortgage Guaranty Group insures only first mortgage loans, primarily on residential properties incorporating one-to-four family dwelling units.

Title Insurance Group: Old Republic's title insurance business was founded in Minnesota in 1907. The business consists primarily of the issuance of policies to real estate purchasers and investors based upon searches of the public records, which contain information concerning interests in real property. The policy insures against losses arising out of defects, liens and encumbrances affecting the insured title and not excluded or excepted from the coverage of the policy.

Corporate and Other Operations: Corporate and other operations includes the accounts of a small life and health insurance business as well as those of the parent holding company and several minor corporate services subsidiaries that perform investment management, payroll, administrative and minor marketing services.

Recent Events and Financial Results

Q1 2012: ORI reported Q1 2012 results in April 2012 and without going into every detail, the summarized version is that the company showed significant year-over-year improvement across all segments. While the Mortgage Guaranty Group did show improvement, it continues to be a significant drag on earnings. The main mortgage insurance carrier is currently in "run-off" mode and thus not taking new premiums, but rather just winding down its current book of business. Key aspects of the results, by segment, are shown in the table below, but for more detail you should review the company's reported results.

Q1 2012 Segment Data
Segment Premium Growth % Pretax Operating Inc (Loss) Pretax Operating Inc Growth %
General Insurance 5% 71M 4%
Mortgage Guaranty -9% -81.8M 19%
Title Insurance 7% 9.4M 260%
Corp & Other -24% -4.2M -207%
Combined/Composite Percentage
Segment Q1 2012 Q1 2011 Annual 2011
General Insurance 97.4% 98.1% 96.9%
General Insurance - Ex CCI & DAC 93.8% 94.0% 94.4%
Mortgage Guaranty 187.2% 201.8% 261.5%
Title Insurance 98.8% 100.8% 99.0%

Diluted EPS
Q1 2012 Q1 2011
Net Operating Income (loss):
General Insurance 0.19 0.19
Mortgage Guaranty (0.21) (0.26)
Title insurance 0.02 0.01
Corporate and other (0.01) (0.01)
Sub-total (0.01) (0.07)
Realized investment gains (losses) 0.01 0.02
Net income (loss) 0.00 (0.05)

The General Insurance Group had strong results across product lines and according to the conference call the pricing environment has continued to improve. The company is struggling to generate more investment income, despite an increased asset base, as the low interest rate environment combined with a high portion of fixed income investments leaves little room for improvement. The premium growth will continue to be relatively muted unless the economy picks up steam.

The Mortgage Guaranty Insurance continues to face significant challenges as high levels of claims come in, but the situation was improved as compared to the prior year period. Keep in mind that the flagship mortgage insurer is in run-off mode and will be managed with the existing capital base, and will not have new premiums coming in.

The Title Insurance showed good results as refinancing activity in the market has been strong as a result of record low interest rates. The market factors, combining with what the company sees as a growth in market share, have produced significantly improved results.

Full Year 2011: The results for annual 2011 followed a similar trend as Q1 2012. The company saw improvement in the General and Title Insurance groups, but saw a large negative impact from the Mortgage Guaranty group. For the most part, the trends mentioned above related to Q1 2012, were basically the same trends that occurred in 2011 (improved premium pricing, low yield environment, etc). A couple of key performance indicators are shown in the table below.

Full Year 2011
Segment Premium Growth % Pretax Operating Income (Loss) Pretax Operating Income % Growth
General Insurance 22% 304.3M 76%
Mortgage Guaranty -11% -678.1M -160%
Title Insurance 17% 36.2M 285%
Corporate & Other -8% -14.6M -407%

Diluted EPS
2011 2010 2009
Net Operating Income (loss):
General Insurance 0.82 0.50 0.63
Mortgage Guaranty (1.74) (0.69) (1.32)
Title insurance 0.10 0.03 0.01
Corporate and other (0.04) 0.00 0.01
Subtotal (0.86) (0.16) (0.67)
Realized investment gains (losses) 0.31 0.29 0.25
Net income (loss) (0.55) 0.13 (0.42)


Every company has many risks, some of which are related to the market, the economy, the segment/industry, etc. Below is a list of risks that I see as specific to ORI and/or its business. By no means is this list meant to be exhaustive.

  1. ORI's Republic Mortgage Insurance Company ("RMIC") is currently in run-off and if the state of North Carolina were to place it into receivership, it would cause the company to be in breach of certain debt covenants. The company did just recently redeem almost $320M USD of its 2012 convertible debt, but it would still need a solution for its 3.75% 2018 convertible notes. While the company may not have enough cash to pay this debt off on demand, it would have several alternatives, such as accessing the capital markets, removal of this covenant language (for a price), or accessing other cash through dividend arrangements. I believe the company can mitigate this risk without significant impact to the financial statements.
  2. The company's dividend could be reduced or eliminated. Based on the results of 2011 and the first quarter of 2012, I believe the company has sufficient means to pay the dividend based on the results of the non-Mortgage Guaranty segment. However, it is by a wide margin. The company currently paid about 70 cents per share in annual dividends for 2011, as compared to earning about 88 cents per share (not considering realized investment gains/losses) combined for all of the reporting segments except the Mortgage Guaranty. For Q1 2012, the company showed about 20 cents per share, as compared to a quarterly dividend of almost 18 cents per share. So while I believe the company can continue to pay the dividend, it is not covered by a significant amount of earnings.
  3. The company's ability to improve the investment income is going to continue to be constrained. The low interest rate environment and the fact that about 80% of their investment based is in fixed income, means it will be a challenge to improve the investment income. Additionally, even though in general inflation remains low in the US, certain portions, such as the healthcare related inflation, could negatively impact the company (i.e. medical costs are increasing faster than overall inflation).
  4. An increasing interest rate environment would be both a negative and a positive to ORI. As rates increase, the value of the company's fixed income securities would decline. However, future asset investments would be at higher and higher yields, which would clearly be a benefit.


The case for my valuation of ORI is based on a two basic tenants.

  1. I believe the company has the willingness, ability, and regulatory freedom to continue paying the dividend. So, essentially I think you will get paid to wait.
  2. I believe the value of the General and Title insurance groups (combined with corporate) on their own offer a compelling value, along with what appears to be an improving rate environment (premiums).

Looking at December 2011 book value, by segment (see table below), I show the approximate book value should be very close to the original $3.7 billion USD. I also have made some adjustments for what I think could be intercompany exposure (I have a question out to the company to confirm) for financing arrangements to the Mortgage Guaranty segment (at December 2011 this was around 175M USD), in addition to some judgment on the equity investment side (total adjustment of 200M USD). This should be the most conservative estimation of book value.

Book Value Analysis
General 2,960
Mortgage Guaranty 16
Title 323
Corporate & Other 526
Consolidation adjustments (45)
Consolidated 3,779
Adjust out Mortgage Guaranty (16)
Adjust out - Judgments (200)
Adjusted Book Value 3,563
Sharecount 255K
Book Value Per Share 13.97

Assuming the book value is somewhere in the ballpark of $14 per share, the next step is to decide what price-to-book multiple would be appropriate to apply to this value. Remember, the entire premise here is that the overall company is being masked by the Mortgage segment, while the other segments are reasonably healthy, and in fact improving.

After a very preliminary and cursory review of some select competitors, I would feel comfortable apply a .8 multiple. The main competitors I looked at were Traveler's (NYSE:TRV), Chubb (NYSE:CB), Cincinnati Financial Corp (NASDAQ:CINF), and First American Financial Corporation (NYSE:FAF). The P/B ratio ranged from .8 to about 1.2. It is worthy to note, there could be many reasons that ORI shouldn't have a similar multiple applied. For example, these competitors operated in some cases in significantly different insurance lines, had more personal insurance exposure, much larger title exposure, better combined ratios, and other specific differences. That said, I would still advocate that a .8 multiple is reasonable.

Applying a multiple of .8 to the book value of $13.97, would give a value of just over $11 per share. Even with building in some margin of safety, it would suggest that the recent prices of between high 8's to mid 9's is a good entry point.

Disclosure: I am long ORI.

Disclaimer: This article is intended for information purposes only and should not be taken as investment advice. You should consider consulting an investment professional with any questions.

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