Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
Stewart Information Services Earnings 2018-12-31
STC 10K Annual Report
10-K 1 stewart201810-k.htm STEWART 2018 10-K Document
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-02658
STEWART INFORMATION SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
1980 Post Oak Blvd., Houston TX
(Address of principal executive offices)
Registrant’s telephone number, including area code: (713) 625-8100
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $1 par value
New York Stock Exchange (NYSE)
(Title of each class of stock)
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No þ
The aggregate market value of the Common Stock (based upon the closing sales price of the Common Stock of Stewart Information Services Corporation, as reported by the NYSE on June 30, 2018) held by non-affiliates of the Registrant was approximately $995.6 million.
At February 22, 2019, there were 23,725,004 outstanding shares of the issuer's Common Stock, $1 par value per share.
Documents Incorporated by Reference
Portions of the definitive proxy statement (the Proxy Statement), in connection with the Registrant's 2019 Annual Meeting of Stockholders, are incorporated herein by reference in Part III of this document.
As used in this report, “we,” “us,” “our,” the “Company” and “Stewart” mean Stewart Information Services Corporation and our subsidiaries, unless the context indicates otherwise.
Item 1. Business
Stewart Information Services Corporation (NYSE:STC) is a global real estate services company, incorporated in Delaware in 1970, and offering products and services through our direct operations, network of independent agencies and family of companies. From residential and commercial title insurance and closing and settlement services to specialized offerings for the mortgage industry, we offer the comprehensive service, deep expertise and solutions our customers need for any real estate transaction. We and our predecessors have been engaged in the title business since 1893.
Our international division delivers products and services protecting and promoting private land ownership worldwide. Our primary international operations are in Canada, the United Kingdom, Australia and Central Europe.
We currently report our business in two segments: title insurance and related services (title), and ancillary services and corporate. Refer to Note 19 to our audited consolidated financial statements and Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) for financial information related to the title and ancillary services and corporate segments.
During November 2017, we announced that our Board formed a strategic committee to actively assess a full range of strategic alternatives available to Stewart and that we retained Citi as financial advisor and Davis Polk & Wardwell LLP as legal advisor to assist us in the strategic alternatives review process. During March 2018, Stewart entered into an agreement and plan of merger (merger agreement) with Fidelity National Financial, Inc. (FNF), in which the outstanding shares of Stewart will be exchanged for a combination of cash and shares of FNF, and the Company will be merged into a subsidiary of FNF (the Mergers). After the merger announcement, the parties commenced the regulatory approval process by submitting applicable filings to the Federal Trade Commission (FTC), the states of Texas and New York, where our two main underwriters are domiciled, and other states and jurisdictions where necessary.
We continue to work through the regulatory process with FNF to satisfy all of the conditions for closing the Mergers, including those of the FTC, the Texas Department of Insurance (TDI) and the New York State Department of Financial Services (NYDFS). We have received approval from a majority of the other states and all of the international jurisdictions we notified about the Mergers. As previously disclosed in a Form 8-K filing, on January 31, 2019, the NYDFS provided written notice of its disapproval of FNF's application to acquire control of Stewart Title Insurance Company, our New York domiciled title insurance underwriter. Stewart and FNF are in the process of reaching out to the NYDFS to discuss the notice and seek to resolve the concerns raised therein, with which we and FNF respectfully disagree.
For details on the merger agreement, refer to Note 1 to our audited consolidated financial statements.
Title insurance and related services include the functions of searching, examining, closing and insuring the condition of the title to real property. The title segment also includes home and personal insurance services and Internal Revenue Code Section 1031 tax-deferred exchanges.
Examination and closing. The purpose of a title examination is to ascertain the ownership of the property being transferred, debts that are owed on it and the scope of the title policy coverage. This involves searching for and examining documents such as deeds, mortgages, wills, divorce decrees, court judgments, liens, paving assessments and tax records.
At the closing or “settlement” of a sale transaction, the seller executes and delivers a deed to the new owner. The buyer typically signs new mortgage documents. Closing funds are disbursed to the seller, the prior lender, real estate brokers, the title company and others. The documents are then recorded in the public records. A title insurance policy is generally issued to both the new lender and the owner.
Title insurance policies. Lenders in the United States generally require title insurance as a condition to making a loan on real estate, including securitized lending. This is to assure lenders of the priority of their lien position. The purchasers of the property want insurance to protect against claims that may arise against the title to the property. The face amount of the policy is normally the purchase price or the amount of the related loan.
Title insurance is substantially different from other types of insurance. Fire, auto, health and life insurance protect against future losses and events. In contrast, title insurance insures against losses from past events and seeks to protect the public by eliminating covered risks through the examination and settlement process. In essence, subject to its exceptions and exclusions, a title insurance policy provides a warranty to the policyholder that the title to the property is free from defects that might impair ownership rights, or in the case of a lender's policy, that there is priority of lien position. Most other forms of insurance provide protection for a limited period of time and, hence the policy must be periodically renewed. Title insurance, however, is issued for a one-time premium and the policy provides protection for as long as the owner owns the property, or has liability in connection with the property, or a lender under its policy has its insured lien on the property. Also, a title insurance policy does not have a finite contract term, whereas most other lines of insurance have a definite beginning and ending date for coverage. Although a title insurance policy provides protection as long as the owner owns the property being covered, the title insurance company generally does not have information about which policies are still effective. Most other lines of insurance receive periodic premium payments and policy renewals thereby allowing the insurance company to know which policies are effective.
Losses. Losses on policies occur when a title defect is not discovered during the examination and settlement process. Reasons for losses include forgeries, misrepresentations, unrecorded or undiscovered liens, the failure to pay off existing liens, mortgage lending fraud, mishandling or defalcation of settlement funds, issuance by independent agencies of unauthorized coverage and defending policyholders when covered claims are filed against their interest in the property.
Some claimants seek damages in excess of policy limits. Those claims are based on various legal theories. We vigorously defend against spurious claims and provide protection for covered claims up to the limits set forth in the policy. We have from time-to-time incurred losses in excess of policy limits.
Experience shows that most policy claims and claim payments are made in the first six years after the policy has been issued, although claims can also be incurred and paid many years later. By their nature, claims are often complex, vary greatly in dollar amounts and are affected by economic and market conditions and the legal environment existing at the time claims are processed.
Our liability for estimated title losses comprises both known claims and our estimate of claims that may be reported in the future. The amount of our loss reserve represents the aggregate future payments (net of recoveries) that we expect to incur on policy losses and in costs to settle claims. In accordance with industry practice, these amounts have not been discounted to their present values.
Estimating future title loss payments is difficult due to the complex nature of title claims, the length of time over which claims are paid, the significant variance in dollar amounts of individual claims and other factors. The amounts provided for policy losses are based on reported claims, historical loss payment experience, title industry averages and the current legal and economic environment. Estimated provisions for current year policy losses are charged to income in the same year the related premium revenues are recognized. Annual provisions for policy losses also include changes in the estimated aggregate liability on policies issued in prior years. Actual loss payment experience relating to policies issued in previous years, including the impact of large losses, is the primary reason for increases or decreases in our annual loss provision.
Amounts shown as our estimated liability for future loss payments are continually reviewed by us for reasonableness and adjusted as appropriate. We have consistently followed the same basic method of estimating and recording our loss reserves for more than 10 years. As part of our process, we also obtain input from third-party actuaries regarding our methodology and resulting reserve calculations. While we are responsible for determining our loss reserves, we utilize this actuarial input to assess the overall reasonableness of our reserve estimation.
See “Critical Accounting Estimates - Title Loss Reserves” under Item 7 - MD&A for information on current year policy losses and consolidated balance sheet reserves.
Factors affecting revenues. Title insurance revenues are closely related to the level of activity in the real estate markets we serve and the prices at which real estate sales are made. Real estate sales are directly affected by the availability and cost of money to finance purchases. Other factors include consumer confidence and demand by buyers. In periods of low interest rates, loan refinancing transactions are also an important contributor to revenues. These factors may override the seasonal nature of the title business. Generally, our first quarter is the least active and our second and third quarters are the most active in terms of title insurance revenues. Refer to "Industry Data" of Item 7 - MD&A for comparative information on home sales, mortgage interest rates and loan activity.
Customers. The primary sources of title insurance business are attorneys, builders, developers, home buyers and home sellers, lenders, mortgage brokers, and real estate brokers and agents. No individual customer was responsible for as much as 10% or more of our consolidated revenues in any of the last three years. Titles insured include residential and various asset classes of commercial properties, including but not limited to, office, multi family, industrial, retail, undeveloped acreage, farms, ranches, wind and solar power installations and other energy-related projects.
Service, location, financial strength, company size and related factors affect customer acceptance. Increasing market share is accomplished primarily by providing superior service. The parties to a closing are concerned with accuracy, timeliness and cost. The rates charged to customers are regulated, to varying degrees, in most states.
The financial strength and stability of the title underwriter are important factors in maintaining and increasing our business, particularly commercial business. We are rated as investment grade by the title industry’s leading rating companies. Our principal underwriter, Stewart Title Guaranty Company (Guaranty), is currently rated “A” by Demotech Inc., "A-" by Fitch Ratings Ltd., "A-" by A.M. Best and "B+" by Kroll Bond Rating Agency Inc. Similarly, our second largest underwriter, Stewart Title Insurance Company (STIC), is also highly rated by such rating companies.
Market share. Title insurance statistics are compiled quarterly by the title industry’s national trade association. Based on 2018 unconsolidated statutory net premiums written through September 30, 2018, Guaranty is one of the leading title insurers in the United States.
Our largest competitors are FNF, which includes Chicago Title Insurance Company, Fidelity National Title Insurance Company and Commonwealth Land Title Insurance Company; First American Financial Corporation (First American), which includes First American Title Insurance Company; and Old Republic Title Insurance Group (Old Republic), which includes Old Republic National Title Insurance Company. We also compete with other title insurer companies, as well as abstractors, attorneys who issue title opinions and attorney-owned title insurance funds. A number of homebuilders, financial institutions, real estate brokers and others own or control title insurance agencies, some of which issue policies underwritten by Guaranty.
Refer to "Title revenues by geographic location" within the Results of Operations discussion under Item 7 - MD&A for the breakdown of title revenues by major geographic location.
Regulations. Title insurance companies are subject to comprehensive state regulations covering premium rates, agency licensing, policy forms, trade practices, reserve requirements, investments and the transfer of funds between an insurer and its parent or its subsidiaries and any similar related party transactions. Kickbacks and similar practices are prohibited by most state and federal laws. See Item 1A - Risk Factors: Our Insurance Subsidiaries Must Comply With Extensive Government Regulations.
Ancillary Services and Corporate Segment
The segment is comprised of the parent holding company, our centralized administrative services departments and our ancillary services operations. Our ancillary services operations primarily provide search and valuation services to the mortgage industry through Stewart Lender Services (SLS).
Factors affecting ancillary services revenues. As in the title segment, ancillary services revenues are closely related to the level of activity in the real estate market, which includes the volume of new or refinancing originations.
Companies that compete with our ancillary services businesses vary across a wide range of industries and include the major title insurance underwriters mentioned under “Title Segment - Market share” as well as other real estate technology and business process outsourcing providers.
Customers. Customers for our ancillary services products and services primarily include mortgage lenders and servicers, mortgage brokers and mortgage investors. Many of the services and products offered by our ancillary services business are used by professionals and intermediaries who have been retained to assist consumers with the sale, purchase, mortgage, transfer, recording and servicing of real estate transactions. To that end, timely, accurate and compliant services are critical to our customers since these factors directly affect the service they provide to their customers. Financial strength, scale, robust processes to ensure legal and regulatory compliance, marketplace presence and reputation as a reliable, compliant solution are important factors in attracting new business.
Investment policies. Our investment portfolios reside in two domestic and two international regulated insurance underwriters. These underwriters maintain investments in accordance with certain statutory requirements for the funding of premium reserves and deposits, or, in the case of our international operations, for the maintenance of certain capital ratios required by regulators. The activities of the portfolios are overseen by investment committees comprised of certain senior executives. Their oversight includes such activities as policy setting, determining appropriate asset classes with different and distinct risk/return profiles so as to prudently diversify the portfolio, and to approve all service vendors (managers and custodians). We also utilize the expertise of third-party investment advisors to maximize returns while managing risk. Our investment policies are designed to comply with regulatory requirements as applicable law imposes restrictions upon the types and amounts of investments that may be made by the regulated insurance subsidiaries.
Our investment policies further provide that investments are to be managed with a view to balancing profitability, liquidity, and risk (interest rate risk, credit risk, currency rate risk and liquidity risk) while mindful of negatively impacting earnings per share and income taxes.
As of December 31, 2018, approximately 95% of our combined debt and equity investment portfolios consisted of fixed income securities. As of that date, approximately 90% of the fixed income investments are held in securities that are A-rated or higher, and substantially all of the fixed income portfolios are rated investment grade. Percentages are based on the market value of the securities. In addition to our debt and equity investment securities portfolios, we maintain certain money-market and other short-term investments. For more details on market risks related to our investment securities portfolio, refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk.
Trademarks. We have developed and acquired numerous automated products and processes that are crucial to both our title and ancillary services segments. These systems automate most facets of the real estate transaction. Among these trademarked products and processes are AIM+®, AgencySecure®, PropertyInfo®, SureClose®, TitleSearch®, eTitleSearch®, Virtual Underwriter® and Stewart Now®. We consider these trademarks, which can be renewed every ten years, to be important to our business.
Employees. As of December 31, 2018, we employed approximately 5,400 people. We consider our relationship with our employees to be good.
Available information. We electronically file annual, quarterly and other reports and information with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (Exchange Act). Our electronic filings can be accessed at the SEC's website at www.sec.gov. We also make available upon written request, free of charge, or through our Internet site (www.stewart.com), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Code of Ethics and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Transfer agent. Our transfer agent is Computershare, which is located at P.O. Box 505000, Louisville, KY, 40233-5000. Its phone number is (888) 478-2392 and website is (https://www-us.computershare.com/investor).
CEO and CFO certifications. The CEO and CFO certifications required under Section 302 of the Sarbanes-Oxley Act are filed as exhibits to our 2018 Form 10-K. Stewart Information Services Corporation submitted in 2018 its annual CEO Certification under Section 303A.12(a) of the New York Stock Exchange (NYSE) Listed Company Manual.
Item 1A. Risk Factors
You should consider the following risk factors, as well as the other information presented in this report and our other filings with the SEC, in evaluating our business and any investment in Stewart. These risks could materially and adversely affect our business, financial condition and results of operations. In that event, the trading price of our Common Stock could decline materially.
Adverse changes in economic conditions, especially those affecting the levels of real estate and mortgage activity, may reduce our revenues.
Our financial condition and results of operations are affected by changes in economic conditions, particularly mortgage interest rates, credit availability, real estate prices and consumer confidence. Our revenues and earnings have fluctuated in the past due to the cyclical nature of the housing industry and we expect them to fluctuate in the future.
The demand for our title insurance-related and mortgage services offerings is dependent primarily on the volume of residential and commercial real estate transactions. The volume of these transactions historically has been influenced by such factors as mortgage interest rates, availability of financing and the overall state of the economy. Typically, when interest rates are increasing or when the economy is experiencing a downturn, real estate activity declines. As a result, the title insurance industry tends to experience decreased revenues and earnings. Increases in interest rates may also have an adverse impact on our bond portfolio and the amount of interest we pay on our floating-rate bank debt.
Our revenues and results of operations have been and may in the future be adversely affected by a decline in home prices, real estate activity and the availability of financing alternatives. In addition, weakness or adverse changes in the level of real estate activity could have a material adverse effect on our consolidated financial condition or results of operations.
Our claims experience may require us to increase our provision for title losses or to record additional reserves, either of which would adversely affect our earnings.
We estimate our future loss payments and our assumptions about future losses may prove inaccurate. Provisions for policy losses on policies written within a given year are charged to income in the same year the related premium revenues are recognized. The amounts provided are based on reported claims, historical loss payment experience, title industry averages and the current legal and economic environment. Losses that are higher than anticipated are an indication that total losses for a given policy year may be higher than originally calculated. Changes in the total estimated future loss for prior policy years are recorded in the period in which the estimate changes. Claims are often complex and involve uncertainties as to the dollar amount and timing of individual payments. Claims are often paid many years after a policy is issued. From time-to-time, we experience large losses, including losses from independent agency defalcations, from title policies that have been issued or worsening loss payment experience, any of which may require us to increase our title loss reserves. These events are unpredictable and may have a material adverse effect on our earnings.
Competition in the title insurance industry may affect our revenues.
Competition in the title insurance industry is intense, particularly with respect to price, service and expertise. Larger commercial customers and mortgage originators also look to the size and financial strength of a title insurer. Although we are one of the leading title insurance underwriters based on market share, FNF, Old Republic and First American each has substantially greater revenues than we do and their holding companies have significantly greater capital. Further, the other title insurance companies collectively hold a considerable share of the market. Although we are not aware of any current initiatives to reduce regulatory barriers to entering our industry, any such reduction could result in new competitors, including financial institutions, entering the title insurance business. From time-to-time, new entrants enter the marketplace with alternative products to traditional title insurance, although many of these alternative products have been disallowed by title insurance regulators. Further, advances in technologies could, over time, significantly disrupt the traditional business model of financial services companies, including title insurance. These alternative products or disruptive technologies, if permitted by regulators, could have a material adverse effect on our revenues and earnings.
Availability of credit may reduce our liquidity and negatively impact our ability to fund operations.
We expect that cash flows from operations and cash available from our underwriters, subject to regulatory restrictions, will be sufficient to fund our operations, pay our claims and fund operational initiatives. To the extent that these funds are not sufficient, we may be required to borrow funds on less than favorable terms or seek funding from the equity market, which may be on terms that are dilutive to existing shareholders.
A downgrade of our underwriters by rating agencies may reduce our revenues.
Ratings are a significant component in determining the competitiveness of insurance companies with respect to commercial title policies. Our domestic underwriters, Guaranty and STIC, have historically been highly rated by the rating agencies that cover us. These ratings are not credit ratings. Instead, the ratings are based on quantitative, and in some cases qualitative, information and reflect the conclusions of the rating agencies with respect to our financial strength, results of operations and ability to pay policyholder claims. Our ratings are subject to continual review by the rating agencies, and we cannot be assured that our current ratings will be maintained. If our ratings are downgraded from current levels by the rating agencies, our ability to retain existing customers and develop new customer relationships may be negatively impacted, which could result in a material adverse impact on our consolidated financial condition or results of operations.
Our insurance subsidiaries must comply with extensive government regulations. These regulations could adversely affect our ability to increase our revenues and operating results.
The Consumer Financial Protection Bureau (CFPB) is charged with protecting consumers by enforcing Federal consumer protection laws and regulations. The CFPB is an independent agency and funded by the United States Federal Reserve System. Its jurisdiction includes banks, credit unions, securities firms, payday lenders, mortgage servicing operations, foreclosure relief services, debt collectors and other financial companies. The nature and extent of these regulations include, but are not limited to:
conducting rule-making, supervision, and enforcement of Federal consumer protection laws;
restricting unfair, deceptive, or abusive acts or practices;
taking consumer complaints;
promoting financial education;
researching consumer behavior;
monitoring financial markets for new risks to consumers; and
enforcing laws that outlaw discrimination and other unfair treatment in consumer finance.
The CFPB’s integrated disclosure rule for mortgage loan applications, known as "Know Before You Owe", imposes certain requirements for us and other mortgage industry participants regarding required mortgage disclosures and forms. Compliance with this integrated disclosure, which was introduced in 2015, has altered related business processes and interactions with customers.
Governmental authorities regulate our insurance subsidiaries in the various states and international jurisdictions in which we do business. These regulations generally are intended for the protection of policyholders rather than stockholders. The nature and extent of these regulations vary from jurisdiction to jurisdiction, but typically involve:
approving or setting of insurance premium rates;
standards of solvency and minimum amounts of statutory capital and surplus that must be maintained;
limitations on types and amounts of investments;
establishing reserves, including statutory premium reserves, for losses and loss adjustment expenses;
regulating underwriting and marketing practices;
regulating dividend payments and other transactions among affiliates;
prior approval for the acquisition and control of an insurance company or of any company controlling an insurance company;
licensing of insurers, agencies and, in certain states, escrow officers;
regulation of reinsurance;
restrictions on the size of risks that may be insured by a single company;
deposits of securities for the benefit of policyholders;
approval of policy forms;
methods of accounting; and
filing of annual and other reports with respect to financial condition and other matters.
These regulations may impede or impose burdensome conditions on rate increases or other actions that we might want to take to enhance our operating results.
We may also be subject to additional state or federal regulations prescribed by legislation such as the Dodd-Frank Act or by regulations issued by the CFPB, Department of Labor, Office of the Comptroller of the Currency, Department of the Treasury or other agencies. Changes in regulations may have a material adverse effect on our business. In addition, state regulators perform periodic examinations of insurance companies, which could result in increased compliance or litigation expenses.
Rapid changes in our industry require secure, timely and cost-effective technological responses. Our earnings may be adversely affected if we are unable to effectively use technology to address regulatory changes and increase productivity.
We believe that our future success depends, in part, on our ability to anticipate changes in the industry and to offer products and services that meet evolving standards on a timely and cost-effective basis. To do so requires a flexible technology architecture which can continuously comply with changing regulations, improve productivity, lower costs, reduce risk and enhance the customer experience. Inability to meet these requirements and any unanticipated downtime in our technology may have a material adverse effect on our earnings.
We rely on dividends from our insurance underwriting subsidiaries.
We are a holding company and our principal assets are our insurance underwriting subsidiaries. Consequently, we depend on receiving sufficient dividends from our insurance subsidiaries to meet our debt service obligations and to pay our parent company's operating expenses and dividends to our stockholders. The insurance statutes and regulations of some states require us to maintain a minimum amount of statutory capital and restrict the amount of dividends that our insurance subsidiaries may pay to us. Guaranty is a wholly owned subsidiary of Stewart and the principal source of our cash flow. In this regard, the ability of Guaranty to pay dividends to us is dependent on the approval of the Texas Insurance Commissioner. Refer to Note 3 to our audited consolidated financial statements for details on statutory surplus and dividend restrictions.
Claims by large classes of claimants may impact our financial condition or results of operations.
We are periodically involved in litigation arising in the ordinary course of business. In addition, we are currently, and have been in the past, subject to claims and litigation from large classes of claimants seeking substantial damages not arising in the ordinary course of business. Material pending legal proceedings, if any, not in the ordinary course of business, would be disclosed in Item 3—Legal Proceedings included elsewhere in this report. To date, the impact of the outcome of these proceedings has not been material to our consolidated financial condition or results of operations. However, an unfavorable outcome in any litigation, claim or investigation against us could have a material adverse effect on our consolidated financial condition or results of operations.
Information technology systems present potential targets for cyber security attacks.
Our operations are reliant on technology. These systems are used to store and process sensitive information regarding our operations, financial position and any information pertaining to our customers and vendors. While we take the utmost precautions, we cannot guarantee safety from all cyber threats, wire fraud and attacks to our systems. Any successful breach of security could result in the spread of inaccurate or confidential information, disruption of operations, theft of escrowed funds, endangerment of employees, damage to our assets and increased costs to respond. Although we maintain cyber liability insurance to protect us financially, there is no assurance that the instances noted above would not have a negative impact on cash flows, litigation status and/or our reputation, which could have a material adverse effect on our business, financial condition and results of operations.
Unfavorable economic or other business conditions could cause us to record an impairment of all or a portion of our goodwill and other intangible assets.
We annually perform an impairment test of the carrying value of goodwill and other indefinite-lived intangible assets in the third quarter using June 30 balances. However, an evaluation may be made whenever events may indicate an impairment has occurred. In assessing whether an impairment has occurred, we consider whether the performance of our reporting units may be below projections, unexpected declines in our market capitalization, negative macroeconomic trends or negative industry and company-specific trends. If we conclude that the carrying values of these assets exceed the fair value, we may be required to record an impairment of these assets. Any substantial impairment that may be required in the future could have a material adverse effect on our results of operations or financial condition.
Failures at financial institutions at which we deposit funds could adversely affect us.
We deposit substantial operating and fiduciary funds, which are third-party funds, in many financial institutions in excess of insured deposit limits. In the event that one or more of these financial institutions fail, there is no guarantee that we could recover the deposited funds in excess of federal deposit insurance, and, as such, we could be held liable for the funds owned by third parties. Under these circumstances, our liability could have a material adverse effect on our results of operations or financial condition.
Our investment portfolio is subject to interest rate and other risks and could experience losses.
We maintain a substantial investment portfolio, primarily consisting of fixed income debt securities and, to a lesser extent, equity securities. Our portfolio holdings are subject to certain economic and financial market risks, including credit and interest rate risk and/or liquidity risk. Instability in credit markets and economic conditions can increase the risk of loss in our portfolio. Periodically, we measure the fair value of the investments against the carrying value. If the carrying value of the investments exceeds the fair value, and we conclude the decline is other-than-temporary, we are required to record an impairment of the investments. The impairment could have a material adverse effect on our results of operations or financial condition.
Our business could be disrupted as a result of a threatened proxy contest and other actions of activist stockholders.
We have been the subject of actions taken by activist stockholders. When activist activities occur, our business could be adversely affected because we may have difficulty in attracting and retaining customers, agents, mortgage lenders, servicers, employees and board members due to perceived uncertainties as to our future direction and negative public statements about our business; such activities may materially harm our relationships with current and potential customers, investors, lenders, and others; may otherwise materially harm our business, may adversely affect our operating results and financial condition; responding to proxy contests and other similar actions by stockholders is likely to result in our incurring substantial additional costs, including, but not limited to, legal fees, fees for financial advisors, fees for investor relations advisors, and proxy solicitation fees; significantly divert the attention of management, our Board of Directors and our employees; and changes in the composition of our Board of Directors due to activist campaigns may affect the Company's current strategic plan.
We cannot predict, and no assurances can be given as to, the outcome or timing of any matters relating to actions by activist stockholders or the ultimate impact on our business, liquidity, financial condition or results of operations.
Changes in federal, state and local, or foreign tax laws, changing interpretation of existing tax laws, or adverse determinations by tax authorities could increase our tax burden or otherwise adversely affect our financial condition or results of operations.
We are subject to taxation at the federal, state and local levels in the United States, Canada, the United Kingdom, and various other countries and jurisdictions in which we operate. The laws, regulations and other authoritative guidance relating to tax matters are extremely complex and subject to varying interpretations. Although we believe our tax positions are reasonable, we are subject to audit by the Internal Revenue Service in the United States, the Canada Revenue Agency in Canada, HM Revenue and Customs in the United Kingdom, state and local tax authorities in the jurisdictions in which we operate, and other similar tax authorities in other international locations. While we believe we comply with all applicable tax laws, rules, and regulations in the relevant jurisdictions, tax authorities may elect to audit us and determine that we owe additional taxes based on different applications and interpretations, which could result in a significant increase in our liabilities for taxes, interest, and penalties in excess of our accrued liabilities.
New tax legislative initiatives may be proposed or enacted from time to time, which may or will impact our effective tax rate and which could adversely affect our tax positions or tax liabilities. Our future effective tax rate could be adversely affected by, among other things, changes in the composition of earnings in jurisdictions with differing tax rates, changes in statutory tax rates and other legislative changes, changes in interpretations of existing tax laws, or changes in determinations regarding the jurisdictions in which we are subject to tax. From time to time, United States federal, state and local, and foreign governments make substantive changes to tax rules and their application, which could result in materially higher taxes than would be incurred under existing tax law and which could adversely affect our financial condition or results of operations.
The Mergers may present certain risks to Stewart’s business and operations prior to the closing of the Mergers, including, among other things, the risks described below. Refer to Note 1-S to our audited consolidated financial statements for details of the merger agreement, including definition of terms.
FNF’s stock price may be negatively impacted by risks and conditions that apply to FNF, which are different from the risks and conditions applicable to Stewart.
Upon completion of the Mergers, our stockholders who elect to receive the Stock Election Consideration or Mixed Election Consideration will become holders of FNF Common Stock. The businesses and markets of FNF and the other companies it has acquired and may acquire in the future are different from those of Stewart. There is a risk that various factors, conditions and developments that would not affect the price of our Common Stock could negatively affect the price of FNF Common Stock.
The Mergers are subject to the receipt of consents and clearances from regulatory authorities that may impose conditions that could have an adverse effect on Stewart or that could delay or, if not obtained, could prevent completion of the Mergers.
The Mergers are subject to approvals or non-disapprovals from or notices to state insurance regulators, state financial institution regulators, state real estate regulators and various other federal, state and international insurance regulatory authorities. We are awaiting for the remaining state and other regulatory approvals. Additionally, the Mergers are currently under review by the FTC under the Hart-Scott-Rodino Act. Before the Mergers may be completed, applicable waiting periods must expire or terminate under antitrust laws and various approvals, consents or clearances may be required to be obtained from regulatory entities. In deciding whether to grant antitrust or other regulatory clearances, the relevant governmental entities will consider the effect of the Mergers on competition within their relevant jurisdictions. The terms and conditions of the approvals that are granted may impose requirements, limitations or costs or place restrictions on the conduct of FNF’s business following the Mergers. There can be no assurance that regulators will not impose conditions, terms, obligations or restrictions and that such conditions, terms, obligations or restrictions will not have the effect of delaying completion of the Mergers or imposing additional material costs on or materially limiting the revenues of FNF following the Mergers. In addition, neither FNF nor Stewart can provide assurance that any such conditions, terms, obligations or restrictions will not result in the delay or abandonment of the Mergers.
As previously disclosed in a Form 8-K filing, on January 31, 2019, the NYDFS provided written notice of its disapproval of FNF's application to acquire control of Stewart Title Insurance Company, our New York domiciled title insurance underwriter. Receipt of approval from the NYDFS is one of the conditions to the completion of the Mergers. Stewart and FNF are in the process of reaching out to the NYDFS to discuss the notice and seek to resolve the concerns raised therein, with which we and FNF respectfully disagree.
Our stockholders may not receive all consideration in the form they elect, and the form of consideration that they receive may have a lower value or less favorable tax consequences than the form of consideration that they elect to receive.
Our stockholders that make an election for either the Cash Election Consideration or the Stock Election Consideration will be subject to proration if holders of our Common Stock, in the aggregate, elect to receive more or less than the aggregate amount of cash consideration to be paid in the Mergers. Accordingly, some of the consideration our stockholders receive in the Mergers may differ from the type of consideration they select and such difference may be significant. This may result in, among other things, tax consequences that differ from those that would have resulted if our stockholders had received solely the form of consideration that they elected. The relative proportion of stock and cash that one of our stockholders receives may also have a value that is higher or lower than the relative proportion of stock and cash that such stockholder elected to receive.
We may have difficulty attracting, motivating and retaining executives and other employees in light of the Mergers.
Uncertainty about the effect of the Mergers on our employees may continue to have an adverse effect on us. This uncertainty may continue to affect our ability to attract, retain and motivate personnel until the Mergers are completed. We are dependent on the experience and industry knowledge of our officers and other key employees to execute our business plans. In addition, if employees of FNF and Stewart depart because of issues relating to the uncertainty and difficulty of integration or a desire not to become employees of the combined company, the combined company’s ability to realize the anticipated benefits of the Mergers could be reduced.
We will incur substantial transaction-related costs in connection with the Mergers.
We expect to incur a number of transaction-related costs associated with completing the Mergers, combining the operations of the two companies and achieving desired synergies. These fees and costs will be substantial. These transaction costs include, but are not limited to, fees paid to legal, financial and accounting advisors, filing fees and printing costs. Additional unanticipated costs may be incurred in the integration of the businesses of FNF and Stewart. There can be no assurance that the elimination of certain duplicative costs, as well as the realization of other efficiencies related to the integration of the two businesses, will offset the incremental transaction-related costs over time. Thus, any net benefit may not be achieved in the near term, the long term or at all.
The Mergers are subject to conditions, including certain conditions that may not be satisfied, and may not be completed on a timely basis, or at all. Failure to complete the Mergers could have material and adverse effects on us.
The completion of the Mergers is subject to a number of conditions which make the completion and timing of the completion of the Mergers uncertain. Also, absent an extension under the terms of the Mergers, either we or FNF may terminate the Merger Agreement if the Mergers have not been completed by March 18, 2019 (or the extended end date, if applicable), unless the failure of the Mergers to be completed by such date has resulted from the failure of the party seeking to terminate the Merger Agreement to perform its obligations.
If the Mergers are not completed on a timely basis, or at all, our ongoing businesses may be adversely affected and, without realizing any of the benefits of having completed the Mergers, we will be subject to a number of risks, including the following:
we may be required, under certain circumstances, to pay FNF a termination fee of $33 million if the Merger Agreement is terminated under qualifying circumstances, as described in the Merger Agreement;
we will be required to pay certain costs relating to the Mergers, whether or not the Mergers are completed, such as legal, accounting, financial advisor and printing fees;
under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the Mergers which may adversely affect our ability to execute certain of our business strategies;
time and resources committed by our management to matters relating to the Mergers could otherwise have been devoted to pursuing other beneficial opportunities;
the market price of our Common Stock could decline below current market prices to the extent that such current market prices reflect a market assumption that the Mergers will be completed; and
if the Merger Agreement is terminated and our board seeks another business combination, our stockholders cannot be certain that we will be able to find a party willing to enter into a business combination or other strategic transaction on terms equivalent to or more attractive than the terms that FNF has agreed to in the Merger Agreement.
In addition, if the Mergers are not completed, we may experience negative reactions from the financial markets and from our customers and employees. We could also be subject to litigation related to any failure to complete the Mergers or to enforcement proceedings commenced against us to perform our obligations under the Merger Agreement. If the Mergers are not completed, we cannot assure our stockholders that the risks described above will not materialize and will not adversely affect the business, financial results and stock prices of Stewart.
The Merger Agreement contains provisions that limit our ability to pursue alternatives to the Mergers, could discourage a potential competing acquirer from making a favorable alternative transaction proposal and, in specified circumstances, could require us to pay a termination fee of $33 million to FNF.
Under the Merger Agreement, we are restricted from entering into an alternative transaction. Unless and until the Merger Agreement is terminated, subject to specified exceptions, we are restricted from soliciting, initiating, knowingly facilitating, knowingly encouraging or knowingly inducing or negotiating, any inquiry, proposal or offer for a competing acquisition proposal with any person. Additionally, under the Merger Agreement, in the event of a potential change by our board of its recommendation with respect to the Mergers in light of a superior proposal, we must provide FNF with four business days’ notice to allow FNF to propose an adjustment to the terms and conditions of the Merger Agreement. We may terminate the Merger Agreement and enter into an agreement with respect to a superior proposal only if specified conditions have been satisfied, including compliance with the no solicitation and termination provisions of the Merger Agreement. These provisions could discourage a third party that may have an interest in acquiring all or a significant part of Stewart from considering or proposing that acquisition, even if such third party were prepared to pay consideration with a higher per share cash or market value than the market value proposed to be received or realized in the Mergers, or might result in a potential competing acquirer proposing to pay a lower price than it would otherwise have proposed to pay because of the added expense of the termination fee that may become payable in specified circumstances.
Under the Merger Agreement, we may be required to pay to FNF a termination fee of $33 million if the Merger Agreement is terminated under specified circumstances. If such a termination fee is payable, the payment of this fee could have material and adverse consequences to our financial condition and operations.
We are subject to business uncertainties and contractual restrictions while the Mergers are pending, which could adversely affect our business and operations.
Under the terms of the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the Mergers, which may adversely affect our ability to execute certain of our business strategies, including the ability in certain cases to enter into contracts or incur capital expenditures to grow our business. Such limitations could negatively affect our businesses and operations prior to the completion of the Mergers. Furthermore, the process of planning to integrate two businesses and organizations for the post-merger period can divert management attention and company resources and could ultimately have an adverse effect on us.
In connection with the pending Mergers, it is possible that some customers, suppliers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationships with us as a result of the proposed Mergers, which could negatively affect our revenues, earnings and cash flows, as well as the market price of shares of our Common Stock, regardless of whether the Mergers are completed.
Because the exchange ratio is fixed and because the market price of FNF Common Stock and our Common Stock will fluctuate, our stockholders receiving FNF Common Stock as part of the merger consideration cannot be sure of the market value of such merger consideration relative to the value of their shares of our Common Stock that they are exchanging.
If the Mergers are completed, each share of our Common Stock will be converted into the right to receive either $50.00 in cash, 1.2850 shares of FNF Common Stock or $25.00 in cash and 0.6425 shares of FNF Common Stock (subject to the adjustment and proration procedures set forth in the Merger Agreement). During the pendency of the Mergers, the market value of FNF Common Stock will fluctuate, and decreases in the market value of FNF Common Stock will negatively affect the value of the merger consideration that our stockholders receive. The market value of our Common Stock will also fluctuate during the pendency of the Mergers, and increases in the market value of our Common Stock may mean that the merger consideration issued to our stockholders will be worth less than the market value of the shares of our Common Stock such stockholders are exchanging. The exchange ratio was fixed at the time the Merger Agreement was executed, and the value of FNF and Stewart stock may vary significantly from their values on the date of the Merger Agreement, the date of this report, the date on which our stockholders make their election and the date on which our stockholders receive the merger consideration. Neither Stewart nor FNF is permitted to terminate the Merger Agreement solely due to changes in the market price of either party’s common stock.
There will be a time lapse between the date on which our stockholders make an election with respect to the form of merger consideration to be received by them in exchange for their Common Stock and the date on which our stockholders actually receive FNF Common Stock, depending on their election and subject to proration. Fluctuations in the market value of FNF stock during this time period will also affect the value of the merger consideration, once it is actually received.
If any of our stockholders makes a stock election or mixed election and the market value of FNF Common Stock falls between the time of the election and the time the merger consideration is actually received, the value of the merger consideration received may be less than the value of the merger consideration such stockholder would have received under a cash election. Conversely, if any of our stockholders makes a cash election and the market value of FNF Common Stock rises between the time of the election and the time the merger consideration is actually received, the value of the merger consideration received may be less than the value of the merger consideration such stockholder would have received under a stock or mixed election. Our stockholders are urged to obtain current market quotations for FNF Common Stock when they make their elections.
If the Mergers are approved, the date that our stockholders will receive the merger consideration is uncertain and, due to potential divestitures required by regulatory authorities, the per share purchase price may be adjusted downwards.
If the proposed Mergers are approved, the date that our stockholders will receive the merger consideration depends on the completion date of the Mergers, which is uncertain. Additionally, under the terms of the Merger Agreement, if the combined company is required to divest assets or businesses with 2017 annual revenues in excess of $75 million in order to receive required regulatory approvals (up to a cap of $225 million of 2017 annual revenues), the per share purchase price will be adjusted downwards on a sliding scale between such amounts of divestitures up to a maximum reduction of $4.50 in value in the event that businesses or assets with 2017 annual revenues of $225 million are divested.
There can be no assurance that a divestiture or divestitures of businesses and assets in excess of $75 million in 2017 annual revenues will not occur, and accordingly there can be no assurance that holders of our Common Stock will receive (i) for those who make an election for the Cash Election Consideration, $50.00 per share in cash instead of an amount less than $50.00 per share in cash (but in any case, no less than $45.50 per share in cash), (ii) for those who make an election for the Stock Election Consideration, an amount of FNF Common Stock equal to 1.2850 shares of FNF Common Stock per share of our Common Stock instead of an amount of FNF Common Stock less than 1.2850 shares of FNF common stock per share of our common stock calculated based on a reduced exchange ratio for the number of shares of FNF Common Stock per share of our Common Stock or (iii) for those who make an election for the Mixed Election Consideration, $25.00 per share in cash and an amount of FNF Common Stock equal to 0.6425 shares of FNF Common Stock per share of our Common Stock instead of an amount less than $25.00 per share in cash and an amount of FNF Common Stock less than 0.6425 shares of FNF Common Stock per share of our Common Stock calculated based on a reduced exchange ratio for the number of shares of FNF Common Stock per share of our Common Stock, as applicable.
Item 1B. Unresolved Staff Comments
Item 2. Properties
We currently lease under a non-cancelable operating lease that is expiring in September 2019 approximately 183,000 square feet of space in an office building in Houston, Texas, which is used for our corporate offices and for offices of several of our subsidiaries. Upon expiration of this lease, we plan to relocate our corporate and other subsidiaries' offices to an approximately 150,000 square feet of new space in Houston, Texas leased under a non-cancelable operating lease that expires in 2025. Additionally, we lease offices at approximately 513 locations for title office operations, production, administrative and technology centers. These additional locations include significant leased facilities in Glendale, California; Houston, Texas; New York, New York; Dallas, Texas; Denver, Colorado; St. Louis, Missouri; Austin, Texas; and San Diego, California.
Our leases expire from 2019 through 2029 and our typical lease term ranges from three to five years. We believe we will not have any difficulty obtaining renewals of leases as they expire or, alternatively, leasing comparable properties. The aggregate annual rent expense under all office leases was approximately $40.8 million in 2018.
We also own office buildings in Arizona, Texas, New York, New Mexico, Colorado and the United Kingdom. These owned properties are not material to our consolidated financial condition. We consider all buildings and equipment that we own or lease to be well maintained, adequately insured and generally sufficient for our purposes.
Item 3. Legal Proceedings
See discussion of legal proceedings in Note 18 to our audited consolidated financial statements, included in Item 15 of Part IV of this report on Form 10-K for the year ended December 31, 2018.
Item 4. Mine Safety Disclosures
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market and Holders Information. Our Common Stock is listed on the NYSE under the symbol “STC”. As of February 22, 2019, the number of stockholders of record was approximately 5,323 and the price of one share of our Common Stock was $43.17.
Stock Performance Graph. The following table and graph compares the yearly percentage change in our cumulative total stockholder return on Common Stock with the cumulative total return of the Russell 2000 Index and the Russell 2000 Financial Services Sector Index for the five years ended December 31, 2018. The presented information assumes that the value of the investment in our Common Stock and each index was $100 at December 31, 2013 and that all dividends were reinvested.
Russell 2000 Index
Russell 2000 Financial Services Sector Index
The performance graph above and the related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act, as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
Stock Repurchases. There were no stock repurchases during 2018, except for repurchases of approximately 28,600 shares (aggregate purchase price of approximately $1.2 million) related to statutory income tax withholding on the annual vesting of restricted share grants to executives and senior management.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial data, which were derived from our consolidated financial statements and should be read in conjunction with our audited consolidated financial statements, including the Notes thereto, beginning on page F-1 of this report. See also Item 7 - MD&A.
($ millions, except percentage, share and per share data)
Title operating revenues
Ancillary services revenues
Investment and other gains (losses) - net
Title loss provisions
% title operating revenues
Net income (loss) attributable to Stewart
Cash provided by operations
Notes payable and convertible senior notes
Per share data:
Diluted average shares outstanding (millions)
Basic earnings (loss) attributable to Stewart
Diluted earnings (loss) attributable to Stewart
(1) Pretax income figures are before noncontrolling interests.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We reported net income attributable to Stewart of $11.4 million ($0.48 per diluted share) for the fourth quarter 2018, compared to net income attributable to Stewart of $15.1 million ($0.64 per diluted share) for the fourth quarter 2017. Pretax income before noncontrolling interests for the fourth quarter 2018 was $19.7 million compared to pretax income before noncontrolling interests of $17.5 million for the fourth quarter 2017.
Fourth quarter 2018 results included:
$3.0 million of third-party advisory expenses related to the FNF merger transaction included in other operating expenses within the ancillary services and corporate segment,
$4.0 million of net unrealized losses relating to changes in fair value of equity securities investments (which were being recorded to other comprehensive income prior to the adoption of a new accounting standard in 2018),
$1.2 million of litigation expense related to a 2013 lender services acquisition included in other operating expenses within the ancillary services and corporate segment,
$1.0 million of executive severance expenses included in employee costs within the title and ancillary services and corporate segments, and
$0.8 million of office closure costs included in other operating expenses within the title segment.
Fourth quarter 2017 results included:
$2.9 million of third party advisory expenses relating to the strategic alternatives review included in other operating expenses within the ancillary services and corporate segment,
$3.5 million of office closure costs (primarily lease termination and litigation expenses) included in other operating expenses within the title segment,
$1.0 million of acquisition integration expenses included in other operating expenses within the title segment,
$1.7 million of executive severance and retention expenses included in employee costs within the title and ancillary services and corporate segments, and
$6.6 million of net income tax benefits related to the effects of the Tax Cuts and Jobs Act (the 2017 Act), which was enacted in December 2017.
Summary results of the title segment are as follows ($ in millions, except pretax margin):
For the Three Months Ended December 31,
Total operating revenues
Investment income and other net gains
Title operating revenues in the fourth quarter 2018 decreased 10% compared to the prior year quarter as direct title and independent agency revenues decreased 7% and 12%, respectively. Included in investment income and other net gains were $4.0 million of net unrealized losses relating to changes in fair value of equity securities investments in the fourth quarter 2018, as compared to $3.3 million of net realized gains from the sale of investments available-for-sale in the fourth quarter 2017. The segment’s pretax income improved to $29.5 million in the fourth quarter 2018, compared to $27.0 million in the fourth quarter 2017, as a result of the lower overall title operating expenses offsetting the segment’s reduced revenues.
Included in the non-commercial domestic revenues for the fourth quarter are revenues from purchase transactions, which decreased $5.0 million, and centralized title operations (processing primarily refinancing and default title orders), which declined $5.7 million compared to the fourth quarter 2017. These declines were primarily due to the lower purchase and refinancing closed orders, which, in total, decreased 16% in the fourth quarter 2018 compared to the prior year quarter. Total fourth quarter 2018 commercial revenues decreased $5.9 million, or 8%, compared to the fourth quarter 2017. Fourth quarter 2018 commercial fee per file increased 3% to approximately $10,300 due to increased transaction sizes, while domestic residential fee per file increased 11% to approximately $2,300 as a result of the mix shift to more purchase transactions. Commercial and domestic residential fees per file for the full year 2018 increased to $8,600 (22%) and $2,200 (8%), respectively, compared to last year.
For the Three Months Ended December 31,
($ in millions)
Total direct title revenues
Gross revenues from independent agency operations declined 12% in the fourth quarter 2018, as compared to last year’s quarter, primarily as a result of reductions in generally high agency volume states, which include New York, Texas, Florida and California. The independent agency remittance rate of 17.8% in the fourth quarter 2018 remained comparable to the prior year quarter.
Summary results of the ancillary services and corporate segment are as follows ($ in millions):
For the Three Months Ended December 31,
Fourth quarter 2018 segment revenues improved 8% compared to the prior year quarter, primarily due to increased revenues from search services. Excluding the non-operating charges noted above for the segment, the fourth quarter 2018 pretax loss would have been $5.2 million, compared to $5.6 million in the prior year quarter. Additionally, the segment’s results for the fourth quarter 2018 and 2017 included approximately $5.5 million and $5.1 million, respectively, of net expenses attributable to parent company and corporate operations (excluding the non-operating charges).
CRITICAL ACCOUNTING ESTIMATES
Actual results can differ from our accounting estimates. While we do not anticipate significant changes in our estimates, there is a risk that such changes could have a material impact on our consolidated financial condition or results of operations for future periods. The discussion of critical accounting estimates below should be read in conjunction with the related accounting policies disclosed within Note 1 to our audited consolidated financial statements.
Title loss reserves
Provisions for title losses, as a percentage of title operating revenues, were 3.9%, 5.1% and 4.8% for the years ended December 31, 2018, 2017 and 2016, respectively. Actual loss payment experience, including the impact of large losses, is the primary reason for increases or decreases in our loss provision. A 100 basis point change in the loss provisioning percentage, a reasonably likely scenario based on our historical loss experience, would have increased or decreased our provision for title losses and pretax operating results by approximately $18.4 million for the year ended December 31, 2018.
We consider our actual claims payments and incurred loss experience, including the frequency and severity of claims, compared to our actuarial estimates of claims payments and incurred losses in determining whether our overall loss experience has improved or worsened compared to prior periods. We also consider the impact of economic or market factors on particular policy years to determine whether the results of those policy years are indicative of future expectations. In addition, large claims, including large title losses due to independent agency defalcations, are analyzed and reserved for separately due to the potential higher dollar amount of loss, lower volume of claims reported and sporadic reporting of such claims. We evaluate the frequency and severity of large losses in determining whether our experience has improved or worsened. Our method for recording the reserves for title losses on both an interim and annual basis begins with the calculation of our current loss provision rate which is applied to our current premium revenues, resulting in a title loss expense for the period. This loss provision rate is set to provide for losses on current year policies and is primarily determined using moving average ratios of recent actual policy loss payment experience (net of recoveries) to premium revenues.
Due to the inherent uncertainty in predicting future title policy losses, significant judgment is required by our management and our third party actuaries in estimating reserves. As a consequence, our ultimate liability may be materially greater or lower than current reserves and/or our third party actuary’s calculated estimates.
Provisions for known claims arise primarily from prior policy years as claims are not typically reported until several years after policies are issued. Provisions - Incurred But Not Reported (IBNR) are estimates of claims expected to be incurred over the next 20 years; therefore, it is not unusual or unexpected to experience changes to those estimated provisions in both current and prior policy years as additional loss experience on policy years is obtained. This loss experience may result in changes to our estimate of total ultimate losses expected (i.e., the IBNR policy loss reserve). Current year provisions - IBNR are recorded on policies issued in the current year as a percentage of premiums earned (provisioning rate). As claims become known, provisions are reclassified from IBNR to known claims. Adjustments relating to large losses (those individually in excess of $1.0 million) may impact provisions either for known claims or for IBNR.
($ in millions)
Provisions – Known Claims:
Prior policy years
Provisions – IBNR
Prior policy years
Transferred IBNR to Known Claims
In 2018, total known claims provisions increased to $79.8 million from $77.5 million in 2017, as a result of slightly higher reported claims relating to prior year policies. Total 2018 provisions - IBNR decreased by $25.0 million to $53.3 million compared to the prior year, primarily due to a lower provisioning rate related to current year policies and a $4.0 million prior policy year reserve reduction during the year, both influenced by our favorable claims experience. In 2017, total known claims provisions decreased to $77.5 million from $85.4 million in 2016, as a result of lower dollar amounts of claims reported to us relating to both current and prior year policies. Total provisions - IBNR increased in 2017 by $7.8 million to $78.3 million compared to 2016, principally due to a higher current year loss provisioning rate related to certain foreign operations and an unfavorable loss experience related to prior years' policies. As a percentage of title operating revenues, current year provisions - IBNR were 2.8%, 3.8% and 3.8% in 2018, 2017 and 2016, respectively.
In addition to title policy claims, we incur losses in our direct operations from escrow, closing and disbursement functions. These escrow losses typically relate to errors or other miscalculations of amounts to be paid at closing, including timing or amount of a mortgage payoff, payment of property or other taxes and payment of homeowners’ association fees. Escrow losses also arise in cases of fraud, and in those cases, the title insurer incurs the loss under its obligation to ensure that an unencumbered title is conveyed. Escrow losses are recognized as expense when discovered or when contingencies associated with them (such as litigation) are resolved and are typically paid less than 12 months after the loss is recognized. For the years ended December 31, 2018, 2017 and 2016, we accrued approximately $6.9 million, $5.0 million and $8.3 million, respectively, for policy loss reserves relating to escrow losses arising principally from mortgage fraud.
Large title losses due to independent agency defalcations typically occur when the independent agency misappropriates funds from escrow accounts under its control. Such losses are usually discovered when the independent agency fails to pay off an outstanding mortgage loan at closing (or immediately thereafter) from the proceeds of the new loan. These incurred losses are typically more severe in terms of dollar value compared with traditional title policy claims since the independent agency is often able, over time, to conceal misappropriation of escrow funds relating to more than one transaction through the constant volume of funds moving through its escrow accounts. In declining real estate markets, lower transaction volumes result in a lower incoming volume of funds, making it more difficult to cover up the misappropriation with incoming funds. Thus, when the defalcation is discovered, it often relates to several transactions. In addition, the overall decline in an independent agency’s revenues, profits and cash flows increases the agency’s incentive to improperly utilize the escrow funds from real estate transactions. For the three years ended December 31, 2018, our net title losses due to independent agency defalcations were immaterial.
Internal controls relating to independent agencies include, but are not limited to, periodic audits, site visits and reconciliations of policy inventories and premiums. The audits and site visits cover examination of the escrow account bank reconciliations and an examination of a sample of closed transactions. In some instances, the scope of our review is limited by attorney agencies that cite client confidentiality. Certain states have mandated annual reviews of agencies by their underwriter. We also determine whether our independent agencies have appropriate internal controls as defined by the American Land Title Association's best practices and us. However, even with adequate internal controls in place, their effectiveness can be circumvented by collusion or improper override of the controls by management at the independent agencies. To aid in the selection of independent agencies to review, we have developed an agency risk model that aggregates data from different areas to identify possible issues. This is not a guarantee that all independent agencies with deficiencies will be identified. In addition, we are typically not the only underwriter for which an independent agency issues policies, and independent agencies may not always provide complete financial records for our review.
We recognize revenues on title insurance policies written by independent agencies when the policies are reported to us. In addition, where reasonable estimates can be made, we accrue for revenues on policies issued but not reported until after period end. We believe that reasonable estimates can be made when recent and consistent policy issuance information is available. Our estimates are based on historical reporting patterns and other information about our independent agencies. We also consider current trends in our direct operations and in the title industry. In this accrual, we are not estimating future transactions; we are estimating revenues on policies that have already been issued by independent agencies but not yet reported to or received by us. We have consistently followed the same basic method of estimating unreported policy revenues for more than 10 years.
Our accruals for revenues on unreported policies from independent agencies were not material to our consolidated financial statements as of December 31, 2018 and 2017. The differences between the amounts our independent agencies have subsequently reported to us compared to our estimated accruals are substantially offset by any differences arising from prior years’ accruals and have been immaterial relative to consolidated assets and stockholders’ equity during each of the three prior years. We believe our process provides the most reliable estimate of the unreported revenues on policies and appropriately reflects the trends in agency policy activity.
Goodwill is not amortized, but is reviewed annually during the third quarter using June 30 balances, or whenever occurrences of events indicate a potential impairment at the reporting unit level. We evaluate goodwill based on four reporting units with goodwill balances - direct operations, agency operations, international operations and ancillary services.
We have an option to assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. In performing the qualitative assessment, we consider factors that include macroeconomic conditions, industry and market considerations, overall actual and expected financial performance, market perspective on the Company, as well as other relevant events and circumstances determined by management. We evaluate the weight of each factor to determine whether an impairment more-likely-than-not exists. If we decide not to use a qualitative assessment or if the reporting unit fails the qualitative assessment, we perform the quantitative impairment analysis.
The quantitative analysis involves the comparison of the fair value of each reporting unit to its carrying amount. The goodwill impairment is calculated as the excess of the reporting unit's carrying amount over the estimated fair value and is charged to current operations. While we are responsible for assessing whether an impairment of goodwill exists, we utilize inputs from third-party appraisers in performing the quantitative analysis. We estimate the fair value using a combination of the income approach (discounted cash flow (DCF) technique) and the market approach (guideline company and precedent transaction analyses). The DCF model utilizes historical and projected operating results and cash flows, initially driven by estimates of changes in future revenue levels, and risk-adjusted discount rates. Our projected operating results are primarily driven by anticipated mortgage originations, which we obtain from projections by industry experts, for our title reporting units and expected contractual revenues for our ancillary services reporting unit. Fluctuations in revenues, followed by our ability to appropriately adjust our employee count and other operating expenses, or large and unanticipated adjustments to title loss reserves, are the primary reasons for increases or decreases in our projected operating results. Our market-based valuation methodologies utilize (i) market multiples of earnings and/or other operating metrics of comparable companies and (ii) our market capitalization and a control premium based on market data and factors specific to our ownership and corporate governance structure.
The valuation techniques performed in our quantitative analysis make use of our estimates and assumptions related to critical factors, which include revenue and operating margin growth rates, future market conditions, determination of market multiples and comparative companies, assignment of a control premium, and determination of risk-adjusted discount rates. Forecasts of future operations are based, in part, on actual operating results and our expectations as to future market conditions. Our calculation of fair value requires analysis of a range of possible outcomes and applying weights to each of the valuation technique used. Due to the uncertainty and complexity of performing the goodwill impairment analysis, actual results may not be consistent with our estimates and assumptions, which may result in a future material goodwill impairment.
During 2018 and 2017, we concluded that the goodwill related to each of our reporting units was not impaired after performing our impairment analysis. We utilized the quantitative analysis in 2018, while we performed the qualitative assessment in 2017. Refer to Note 8 to our audited consolidated financial statements for details on goodwill.
Operations. Our primary business is title insurance and settlement-related services. We close transactions and issue title policies on homes, commercial and other real properties located in all 50 states, the District of Columbia and international markets through policy-issuing offices, independent agencies and centralized title services centers. Our ancillary services and corporate segment includes our parent holding company expenses and certain enterprise-wide overhead costs, along with our ancillary services operations, principally search and valuation services.
Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and ancillary services and corporate segments include:
mortgage interest rates;
availability of mortgage loans;
number and average value of mortgage loan originations;
ability of potential purchasers to qualify for loans;
inventory of existing homes available for sale;
ratio of purchase transactions compared with refinance transactions;
ratio of closed orders to open orders;
consumer confidence, including employment trends;
demand by buyers;
number of households;
foreign currency exchange rates;
ability to attract and retain highly productive sales executives and associates;
independent agency remittance rates;
opening of new offices and acquisitions;
number and value of commercial transactions, which typically yield higher premiums;
government or regulatory initiatives, including tax incentives and the implementation of the new integrated disclosure requirements;
acquisitions or divestitures of businesses;
volume of distressed property transactions; and
seasonality and/or weather.
Premiums are determined in part by the values of the transactions we handle. To the extent inflation or market conditions cause increases in the prices of homes and other real estate, premium revenues are also increased. Conversely, falling home prices cause premium revenues to decline. As an overall guideline, a 5% change in median home prices results in an approximate 3.7% change in title premiums. Home price changes may override the seasonal nature of the title insurance business. Historically, our first quarter is the least active in terms of title insurance revenues as home buying is generally depressed during winter months. Our second and third quarters are the most active as the summer is the traditional home buying season, and while commercial transaction closings are skewed to the end of the year, individually large commercial transactions can occur any time of year.
Industry data. Published mortgage interest rates and other selected residential housing data for the years ended December 31, 2018, 2017 and 2016 are shown below (amounts shown for 2018 are preliminary and subject to revision). The amounts below may not relate directly to or provide accurate data for forecasting our operating revenues or order counts. Our statements on home sales, mortgage interest rates and loan activity are based on published industry data from sources including Fannie Mae, the National Association of Realtors®, the Mortgage Bankers Association and Freddie Mac.
Mortgage interest rates (30-year, fixed-rate) – %
Averages for the year
Mortgage originations – $ billions
Refinancings – % of originations
New home sales – in millions
New home sales – median sales price in $ thousands
Existing home sales – in millions
Existing home sales – median sales price in $ thousands
Total mortgage originations in 2018 declined for the second consecutive year as refinancing lending decreased 29% in 2018 compared to 2017. However, Fannie Mae forecasts total mortgage originations to stabilize in 2019 with purchase lending expected to modestly increase 2%, offsetting the forecasted 8% further decline in refinancing lending. Compared to the prior year, 2018 new home sales remained flat, while 2018 existing home sales declined 3% influenced by higher mortgage interest rates and increased home prices. For the three years ended December 31, 2018, average monthly mortgage interest rates (30-year, fixed-rate) have risen from a low of 3.44% in July 2016 to a high of 4.87% in November 2018. For the year 2019, Fannie Mae projects the 30-year mortgage rate to average at 4.5%, comparable to 2018, and new and existing home sales volumes to remain similar to 2018 volumes.
RESULTS OF OPERATIONS
A comparison of our consolidated results of operations for 2018 to 2017 and 2017 to 2016 is discussed as follows. Factors contributing to fluctuations in our results of operations are presented in the order of their monetary significance, and we have quantified, when necessary, significant changes. Results from our ancillary services and corporate segment are included in year-to-year discussions and, when relevant, are discussed separately. Our employee costs and certain other operating expenses are sensitive to inflation.
Title revenues. Direct title revenue information is presented below:
Year Ended December 31
2018 vs. 2017
2017 vs. 2016
($ in millions)
Total direct title revenues
Revenues from direct title operations in 2018 decreased $29.2 million, or 3%, compared to 2017, primarily as a result of lower non-commercial domestic and international revenues, which were partially offset by higher commercial revenues. Non-commercial domestic revenues include revenues from purchase transactions and centralized title operations (processing primarily refinancing and default title orders), which decreased 2% and 48%, respectively, primarily due to the lower purchase and refinancing orders. Total commercial revenues increased $11.3 million, or 5%, as influenced by our continued focus on delivering quality service and underwriting to our commercial customers. Total international revenues declined $12.2 million, or 10%, primarily due to lower transaction volumes from our Canada operations, partially offset by growth from our United Kingdom operations.
Revenues from direct title operations in 2017 decreased $31.9 million, or 4%, compared to 2016, primarily as a result of overall declines in refinancing and purchase transaction revenues, partially offset by higher commercial and international revenues. Revenues from purchase transactions and centralized title operations decreased 7% and 26%, respectively, primarily as a result of lower purchase and refinancing orders closed. Total commercial revenues improved $18.3 million, or 9%, primarily driven by a higher domestic commercial fee per file and increased input from our international operations. Total international revenues improved $12.6 million, or 11%, due to higher commercial revenues and transaction volume growth from our United Kingdom and Canada operations.
Closed and opened orders information is as follows:
Year Ended December 31
2018 vs. 2017
2017 vs. 2016
Gross revenues from independent agency operations declined $12.4 million, or 1%, in 2018 compared to 2017; while revenues increased $6.6 million, or approximately 1%, in 2017 compared to 2016. The 2018 gross revenue decrease was driven by decreases primarily in Massachusetts, Utah, Colorado, Michigan, California, Minnesota, and Georgia, partially offset by increases from Texas, Pennsylvania and Idaho. The 2017 gross revenue improvement was driven by increases, primarily from Michigan, California, Minnesota, Ohio, Colorado and Arizona, partially offset by declines in Massachusetts, Florida, Texas and New York. 2018 net agency revenues (net of agency retention) decreased $2.3 million, or 1%, compared to 2017, primarily due to lower gross agency revenues; while 2017 net agency revenues decreased $4.5 million, or 3%, compared to 2016, primarily due to the lower average agency remittance rate. Refer further to the "Retention by independent agencies" discussion under Expenses below.
Title revenues by geographic location. The approximate amounts and percentages of consolidated title operating revenues for the last three years were as follows:
Amounts ($ millions)
Ancillary services revenues. Ancillary services revenues in 2018 decreased $5.1 million, or 9%, compared to 2017, as a result of lower revenues from valuation services due to decreased demand, partially offset by increased revenues from our search services business. Ancillary services revenues in 2017 decreased $28.4 million, or 34%, in 2017, compared to 2016, primarily due to our divestitures of the loan file review, quality control services and government services lines of business at the end of 2016.
Investment income. Investment income for 2018 slightly increased to $19.7 million from $18.9 million in 2017, primarily due to increased income on higher short-term investments and cash equivalents balances. Investment income for 2017 was $18.9 million, which was comparable to 2016. Refer to Note 6 to our audited consolidated financial statements for additional details.
Realized investment and other gains (loss) - net. In 2018, investments and other gains - net included $1.3 million of realized gains from sales of equity investments with no previously readily determinable fair values and $2.2 million of net unrealized investment losses on equity securities held at year-end. Refer to Notes 1-Q and 6 to our audited consolidated financial statements for additional details.
In 2017, investment and other gains - net included $3.2 million of net realized gains from the sale of securities investments, partially offset by $0.8 million of net realized loss due to an increase in the fair value of a contingent consideration liability related to a prior acquisition.
In 2016, investment and other losses - net included $3.4 million of realized loss related to the exit of a service offering, and $3.3 million of realized losses from sale of certain businesses within ancillary services operations, partially offset by $4.0 million of net realized gains from the sale of securities investments and $1.2 million of realized gain related to an exchange transaction of an equity investment with previously no readily determinable fair value.
Expenses. An analysis of expenses is shown below:
Year Ended December 31
2018 vs. 2017
2017 vs. 2016
($ in millions)
Amounts retained by independent agencies
As a % of agency revenues
As a % of operating revenues
Other operating expenses
As a % of operating revenues
Title losses and related claims
As a % of title revenues
Expense comparisons for the three years ended December 31, 2018 are influenced by the following net charges:
Ancillary services and corporate segment:
FNF merger and strategic alternatives review expenses
Severance and retention expenses
Class B Common Stock exchange expenses
Shareholder activism and settlement charges
Accelerated depreciation from the exit of delinquent loan servicing activities
Cost Management Program and severance expenses
Total ancillary services and corporate segment
Office closures: early lease terminations and asset write-offs
Severance and retention expenses
Title365 acquisition and integration-related expenses
Prior policy reserve adjustments, net
Total title segment
Retention by independent agencies. Amounts retained by independent agencies are based on agreements between the agencies and our title underwriters. Amounts retained by independent agencies, as a percentage of revenues generated by them, averaged 82.4%, 82.4% and 81.8% in 2018, 2017 and 2016, respectively. The increase of the agency retention rate in 2017 compared to 2016 was primarily due to decreased revenues in higher-remitting states and increased revenues in lower-remitting states during 2017. The average retention percentage may vary from year-to-year due to the geographical mix of agency operations, the volume of title revenues and, in some states, laws or regulations. Due to the variety of such laws or regulations, as well as competitive factors, the average retention rate can differ significantly from state to state. In addition, a high proportion of our independent agencies are in states with retention rates greater than 80%. We continue to focus on increasing profit margins in every state, increasing premium revenue in states where remittance rates are above 20%, and maintaining the quality of our agency network, which we believe to be the industry’s best, in order to mitigate claims risk and drive consistent future performance. While market share is important in our agency operations channel, it is not as important as margins, risk mitigation and profitability.
Selected cost ratios (by segment). The following table shows employee costs and other operating expenses as a percentage of related segment operating revenues for the years ended December 31:
Other Operating Expenses
Ancillary services and corporate
Employee costs. Consolidated employee costs in 2018 and 2017, compared to the respective prior years, decreased $3.7 million, or approximately 1%, and $38.2 million, or 6%, respectively, primarily as a result of the reduction of 7% and 8%, respectively, in average employee counts related to volume declines in our title and ancillary services operations, which were partially offset by additional employee costs from title office acquisitions in 2018 and 2017. As a percentage of total operating revenues, employee costs were 29.8%, 29.3% and 30.4% in 2018, 2017 and 2016, respectively. Our total employee counts at December 31, 2018, 2017 and 2016 were approximately 5,400, 6,000 and 6,400, respectively. Average cost per employee increased 7% in 2018, compared to 2017, primarily due to increased incentive compensation on higher commercial revenues, increased retention and severance expenses, annual salary increases and the lower average employee count largely due to employee terminations in direct title operations. The average cost per employee in 2017 increased 3%, compared to 2016, primarily as a result of increased incentive compensation on higher commercial revenues and annual salary increases.
Employee costs in the title segment increased $5.2 million, or 1%, in 2018 compared to 2017, primarily due to increased incentive compensation on higher commercial revenues, which was partially offset by reduced salaries resulting from lower average employee counts, principally in direct operations. Title segment employee costs decreased $10.3 million, or 2%, in 2017 compared to 2016, due to reduced salaries and incentive compensation as a result of reductions in the average number of employees, also primarily in direct operations.
The ancillary services and corporate segment's employee costs in 2018 and 2017 decreased $8.9 million, or 24%, and $27.9 million, or 42%, compared to 2017 and 2016, respectively, due to employee count reductions relating to volume declines and the 2016 disposition of several lines of business within ancillary services.
Other operating expenses. Other operating expenses include costs that are fixed in nature, costs that follow, to varying degrees, changes in transaction volumes and revenues and costs that fluctuate independently of revenues. Costs that are fixed in nature include attorney and professional fees, third-party-outsourcing provider fees, equipment rental, insurance, rent and other occupancy expenses, repairs and maintenance, technology costs, telephone and title plant expenses. Costs that follow, to varying degrees, changes in transaction volumes and revenues include attorney fee splits, bad debt expenses, ancillary services cost of sales expenses, copy supplies, delivery fees, outside search fees, postage, premium taxes and title plant maintenance expenses. Costs that fluctuate independently of revenues include general supplies, litigation defense, business promotion and marketing and travel.
Consolidated other operating expenses decreased $6.2 million, or 2%, in 2018 compared to 2017 and also decreased $12.5 million, or 3%, in 2017 compared to 2016. As a percentage of total operating revenues, other operating costs were 18.3%, 18.2% and 18.3% in 2018, 2017 and 2016, respectively. In 2018, other operating expenses included $12.7 million of third-party advisory expenses related to the FNF merger transaction, $1.2 million of litigation expense related to a 2013 lender services acquisition and $0.8 million of office closure costs. In 2017, other operating expenses included $3.2 million of office closure costs, $2.9 million of third-party consulting fees related to the corporate strategic alternatives review, $2.4 million of Title365 acquisition integration expenses and $0.4 million of litigation expense. In 2016, other operating expenses included approximately $3.6 million for litigation-related accruals, $1.2 million of shareholder activism costs and $2.2 million of costs associated with the Class B common stock exchange agreement. Excluding the impact of these non-operating charges, other operating expenses, as a percentage of total operating revenues, would have been 17.5%, 17.7% and 18.0% in 2018, 2017 and 2016, respectively.
In 2018, excluding the charges listed above, costs fixed in nature decreased $2.4 million, or 2%, compared to 2017, primarily due to reduced professional and consulting fees and third-party outsourcing provider fees, partially offset by higher insurance expenses. Costs that follow, to varying degrees, changes in transaction volumes and revenues also decreased $9.8 million, or 6%, primarily due to lower cost of sales expenses and delivery fees in ancillary services as a result of lower ancillary services revenues, and lower attorney fee splits due to lower transaction volumes from our Canada operations. Excluding the non-operating litigation-related expenses and office closure costs, costs that fluctuate independently of revenues were comparable to the prior year.
In 2017, excluding the costs listed above, costs fixed in nature decreased $4.8 million, or 3%, compared to 2016, primarily due to reduced professional and consulting fees and insurance expense, partially offset by higher technology costs. Costs that follow, to varying degrees, changes in transaction volumes and revenues also decreased $8.3 million, or 5%, mainly due to lower bad debt expense and decreased outside search fees and cost of sales expenses in ancillary services as a result of lower ancillary services revenues. Excluding the non-operating litigation-related expenses and office closure costs, costs that fluctuate independently of revenues decreased $0.7 million, or 2%, primarily due to lower general supplies expenses.
Title losses. Provisions for title losses, as a percentage of title operating revenues, were 3.9%, 5.1% and 4.8% in 2018, 2017 and 2016, respectively. The title loss ratio in any given year can be significantly influenced by new large claims incurred as well as adjustments to reserves for existing large claims. We continue to manage and resolve large claims prudently and in keeping with our commitments to our policyholders.
For the year ended December 31, 2018, title losses decreased $25.0 million, or 26%, compared to 2017, primarily due to a lower provisioning rate related to current year policies and a $4.0 million prior policy year reserve reduction during the year, both influenced by our favorable claims experience.
For the year ended December 31, 2017, title losses increased $5.4 million, or 6%, compared to 2016, primarily due to the loss reserve reductions recorded in 2016, as detailed below. In 2017, we recorded increases to policy loss reserves of approximately $3.3 million relating to our European and Australian businesses which were more than offset by favorable adjustments to policy loss reserves for our U.S. business.
For the year ended December 31, 2016, we recorded a $3.1 million decrease to the reserve for existing large losses and a $5.4 million policy loss reserve reduction relating to non-large policy losses as a result of favorable loss development experience.
Title losses paid were $82.7 million, $84.2 million and $92.0 million in 2018, 2017 and 2016, respectively. The lower cash claims paid in 2018 compared to 2017 was due to lower payments on non-large claims; while the decrease in cash claims paid in 2017 compared to 2016 was primarily due to lower payments on large claims relating to prior policy years. Claim payments made on large title claims, net of insurance recoveries, during 2018, 2017 and 2016 were $7.3 million, $7.3 million and $14.6 million, respectively.
Our liability for estimated title losses as of December 31, 2018 and 2017 comprises both known claims and our IBNR. Known claims reserves are reserves related to actual losses reported to us. Our reserve for known claims comprises both claims related to title insurance policies as well as losses arising from escrow closing and funding operations due to fraud or error (which are recognized as expense when discovered). The amount of the reserve represents the aggregate, non-discounted future payments (net of recoveries) that we expect to incur on policy and escrow losses and in costs to settle claims.
Total title policy loss reserve balances at December 31 were as follows:
($ in millions)
Total estimated title losses
Title claims are generally incurred within the first six years after policy issuance and the timing of payments on these claims can significantly impact the balance of known claims, since claims, in many cases, may be open for several years before resolution and payment occur. As a result, the estimate of ultimate amount to be paid on any claim may be modified over that time period. As of December 31, 2018 and 2017, our reserve balance was above the actuarial midpoint of total estimated policy loss reserves.
Depreciation and amortization. Depreciation and amortization expense in 2018 decreased $0.9 million, or 4%, compared to 2017, primarily due to a lower depreciation expense resulting from reduced purchases of property and equipment, which was partially offset by increased amortization of intangible assets from our 2018 and mid-2017 acquisitions. Depreciation and amortization expense in 2017 decreased $4.2 million, or 14%, compared to 2016, primarily due to lower amortization expense in 2017 as a result of the disposal of certain intangible assets in connection with the divestitures in ancillary services, as earlier discussed, and the higher depreciation expense recorded in 2016 resulting from accelerated depreciation charges relating to our exit from the delinquent loan servicing operations.
Income taxes. Our effective tax rates for 2018, 2017 and 2016 were 22.1%, 23.5% and 26.1%, respectively, based on income before taxes (after deducting noncontrolling interests) of $61.0 million, $63.6 million and $75.1 million, respectively. Our 2018 effective tax rate included $2.7 million of income tax net benefits primarily related to adjustments in connection with the final determination of the tax effects of the 2017 Act, previously unrecognized research and development tax credits and other 2017 return-to-provision and true-up adjustments.
In comparison, our 2017 effective tax rate included $8.8 million of income tax net benefits primarily related to the effects of the 2017 Act and previously unrecognized research and development tax credits. Our 2016 effective tax rate included $7.5 million of income tax net benefits primarily related to 2015 return-to-provision and true-up adjustments and previously unrecognized research and development tax credits.
Excluding the above income tax effects, our effective tax rates were 26.6%, 37.3% and 36.1% for 2018, 2017 and 2016, respectively. The lower effective tax rate in 2018 was primarily the result of the reduced corporate tax rate enacted as part of the 2017 Act, Refer to Note 7 to our audited consolidated financial statements for details on income taxes.
Contractual obligations. Our material contractual obligations at December 31, 2018 were:
Payments due by period ($ millions)
Over 1 to 3
Over 3 to 5
Line of credit facility
Other notes payable
Estimated title losses
Material contractual obligations consist primarily of amounts drawn on our line of credit facility, other notes payable, operating leases and estimated title losses. The timing above for payments of notes payable is based upon contractually stated payment terms of each debt agreement. Operating leases are primarily for office space and expire over the next eleven years. The timing shown above for the payments of estimated title losses is not set by contract. Rather, it is projected based on historical payment patterns. The actual timing of estimated title loss payments may vary materially from the above projection since claims, by their nature, are complex and paid over long periods of time. Refer to Notes 10, 11 and 16 to our audited consolidated financial statements for details.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resources reflect our ability to generate cash flow to meet our obligations to shareholders, customers (payments to satisfy claims on title policies), vendors, employees, lenders and others. As of December 31, 2018, our cash and investments, including amounts reserved pursuant to statutory requirements, aggregated $851.0 million ($351.1 million, net of statutory reserves on cash and investments). Of our total cash and investments at December 31, 2018, $584.7 million ($281.4 million, net of statutory reserves) was held in the United States (U.S.) and the rest internationally, principally in Canada.
Cash and cash equivalents held at the parent company totaled $24.8 million at December 31, 2018. As a holding company, the parent company is funded principally by cash from its subsidiaries in the form of dividends, operating and other administrative expense reimbursements and pursuant to intercompany tax sharing agreements. The expense reimbursements are paid in accordance with management agreements, approved by the Texas Department of Insurance (TDI), among us and our subsidiaries. In addition to funding operating expenses, cash held at the parent company is used for dividend payments to common stockholders and for stock repurchases, if any. To the extent such uses exceed cash available, the parent company is dependent on distributions from its regulated title insurance underwriter, Stewart Title Guaranty Company (Guaranty).
A substantial majority of our consolidated cash and investments as of December 31, 2018 was held by Guaranty and its subsidiaries. The use and investment of these funds, dividends to the parent company, and cash transfers between Guaranty and its subsidiaries and the parent company are subject to certain legal and regulatory restrictions. In general, Guaranty may use its cash and investments in excess of its legally-mandated statutory premium reserve (established in accordance with requirements under Texas law) to fund its insurance operations, including claims payments. Guaranty may also, subject to certain limitations, provide funds to its subsidiaries (whose operations consist principally of field title offices and ancillary services operations) for their operating and debt service needs.
We maintain investments in accordance with certain statutory requirements in the states of domicile of our underwriters for the funding of statutory premium reserves. Statutory premium reserves are required to be fully funded and invested in high-quality securities and short-term investments. Statutory reserve funds are not available for current claim payments, which must be funded from current operating cash flow. Included within investments in debt and equity securities are statutory reserve funds of approximately $462.2 million and $490.8 million at December 31, 2018 and 2017, respectively. In addition, included within cash and cash equivalents are statutory reserve funds of approximately $37.7 million and $14.2 million at December 31, 2018 and 2017, respectively. Although these cash statutory reserve funds are not restricted or segregated in depository accounts, they are required to be held pursuant to state statutes. If the Company fails to maintain minimum investments or cash and cash equivalents sufficient to meet statutory requirements, the Company may be subject to fines or other penalties, including potential revocation of its business license. As of December 31, 2018, our known claims reserve totaled $66.9 million and our estimate of claims that may be reported in the future, under generally accepted accounting principles, totaled $394.7 million. In addition to this, we had cash and investments (excluding equity method investments) of $266.1 million which are available for underwriter operations, including claims payments.
The ability of Guaranty to pay dividends to its parent is governed by Texas insurance law. The TDI must be notified of any dividend declared, and any dividend in excess of the statutory maximum of 20% of surplus (which was approximately $115.0 million as of December 31, 2018) would be, by regulation, considered extraordinary and subject to pre-approval by the TDI. Also, the Texas Insurance Commissioner may raise an objection to a planned distribution during the notification period. Guaranty’s actual ability or intent to pay dividends to its parent may be constrained by business and regulatory considerations, such as the impact of dividends on surplus and the liquidity ratio, which could affect its ratings and competitive position, the amount of insurance it can write and its ability to pay future dividends. As of December 31, 2018, our liquidity ratio for our principal underwriter was 109% based on its statutory balance sheet. The liquidity ratio is calculated using Guaranty's total cash and investments divided over its total liabilities. Our internal objective is to maintain a ratio of at least 100%, as we believe that ratio is crucial to our competitiveness in the market and our insurer financial strength ratings. On an ongoing basis, this ratio will largely guide our decisions as to frequency and magnitude of dividends from Guaranty to the parent company. Further, depending on business and regulatory conditions, we may in the future need to retain cash in Guaranty or even raise cash in the capital markets to contribute to it in order to maintain its ratings or statutory capital position. Such a requirement could be the result of investment losses, reserve charges, adverse economic environment operating conditions or changes in interpretation of statutory accounting requirements by regulators. Guaranty paid dividends of $25.0 million and $20.0 million to its parent during 2018 and 2017, respectively.
As the parent company conducts no operations apart from its wholly-owned subsidiaries, the discussion below focuses on consolidated cash flows.
Net cash provided by operating activities
Net cash provided (used) by investing activities
Net cash used by financing activities
Operating activities. Our principal sources of cash from operations are premiums on title policies and revenue from title service-related transactions, ancillary services and other operations. Our independent agencies remit cash to us net of their contractual retention. Our principal cash expenditures for operations are employee costs, operating costs and title claims payments.
Cash provided by operations in 2018 decreased by approximately $23.9 million compared to 2017, primarily due to higher payments on accounts payable, lower collection on accounts receivable and lower 2018 net income, partially offset by lower payments on claims. Cash provided by operations in 2017 decreased by approximately $14.9 million compared to 2016, primarily as a result of the lower 2017 net income and lower collections on accounts receivable, partially offset by lower payments on claims.
Although our business is labor intensive, we are focused on a cost-effective, scalable business model which includes utilization of technology, centralized back and middle office functions and business process outsourcing. Our approach allows us to adjust more easily to seasonal and cyclical fluctuations in transaction volumes. We are continuing our emphasis on cost management, specifically focusing on lowering unit costs of production, which will result in improved margins. Our plans to improve margins also include additional automation of manual processes, and further consolidation of our various systems and production operations. We are currently investing in the technology necessary to accomplish these goals.
Investing activities. Cash provided or used by investing activities was primarily driven by purchases of investments, capital expenditures and acquisition of subsidiaries, offset by proceeds from matured and sold investments. During 2018, 2017 and 2016, total proceeds from securities investments sold and matured aggregated $79.1 million, $110.9 million and $108.2 million, respectively, while cash used for purchases of securities investments approximated $43.1 million, $179.7 million and $166.4 million, respectively. The lower purchases and sales of securities investments in 2018, compared to 2017 and 2016, was primarily the result of the rising interest rate environment in 2018. We continued to position the portfolio to reduce interest rate risk, which resulted in fewer opportunistic trades. As bonds matured, we generally moved to cash equivalents and short term investments, where interest rates are attractive in the current markets, on a risk adjusted basis.
During 2018 and 2017, we used $19.0 million and $17.8 million, respectively, of cash for acquisitions of new title offices, while cash used for purchases of property and equipment during 2018, 2017 and 2016 amounted to $10.7 million, $16.4 million and $18.2 million, respectively. We maintain investment in capital expenditures at a level that enables us to implement technologies for increasing our operational and back-office efficiencies and to pursue growth in key markets.
Financing activities and capital resources. Total debt and stockholders’ equity were $108.0 million and $679.8 million, respectively, as of December 31, 2018. Of the total notes payable activity during 2018, 2017 and 2016, proceeds of $14.5 million, $40.4 million and $37.8 million, respectively, and payments of $16.3 million, $42.7 million and $31.2 million, respectively, were related to short-term loan agreements in connection with our Section 1031 tax-deferred property exchange business. During 2017 and 2016, we drew $16.0 million and $20.0 million, respectively, from our unsecured line of credit facility, which had a total commitment of $125.0 million, and repaid $10.0 million and $25.1 million, respectively, on the line of credit facility. During 2018, we increased the line of credit facility to $150.0 million - refer to Note 10 to our audited consolidated financial statements for details.
As of December 31, 2018, the outstanding balance on the line of credit facility was $98.9 million, while the remaining balance of the line of credit available for use was $48.6 million, net of an unused $2.5 million letter of credit. Our debt-to-equity ratio at December 31, 2018, excluding our Section 1031 notes, was approximately 15.5%, below the 20% we have set as our unofficial internal limit on leverage.
During each of 2018, 2017 and 2016, we paid total dividends of $1.20 per common share, which aggregated $28.3 million, $28.1 million and $27.8 million, respectively. Additionally in 2016, we paid $12.0 million in cash as part of the consideration in exchange for the retirement of the outstanding Class B Common Stock shares in relation to the Class B Exchange Agreement approved by our stockholders (refer to Note 12 to our audited consolidated financial statements for details).
There were no stock repurchases during the three years ended December 31, 2018, except for repurchases of approximately 28,600 shares (aggregate purchase price of approximately $1.2 million) in 2018, 17,300 shares (aggregate purchase price of approximately $0.7 million) in 2017 and 22,800 shares (aggregate purchase price of approximately $1.1 million) in 2016 related to the statutory income tax withholding on the vesting of restricted share grants to executives and senior management.
Effect of changes in foreign currency rates. The effect of changes in foreign currency rates on the consolidated statements of cash flows was a net (decrease) increase in cash and cash equivalents of $(3.8) million, $2.9 million and $(0.1) million in 2018, 2017 and 2016, respectively. Our principal foreign operating unit is in Canada, and, on average, the value of the Canadian dollar relative to the U.S. dollar declined during 2018 and 2016 and appreciated during 2017.
We believe we have sufficient liquidity and capital resources to meet the cash needs of our ongoing operations. However, we may determine that additional debt or equity funding is warranted to provide liquidity for achievement of strategic goals or acquisitions or for unforeseen circumstances. Other than scheduled maturities of debt, operating lease payments and anticipated claims payments, we have no material contractual commitments. We expect that cash flows from operations and cash available from our underwriters, subject to regulatory restrictions, will be sufficient to fund our operations, including claims payments. However, to the extent that these funds are not sufficient, we may be required to borrow funds on terms less favorable than we currently have or seek funding from the equity market, which may not be successful or may be on terms that are dilutive to existing stockholders.
Other comprehensive (loss) income. Unrealized gains and losses on available-for-sale securities investments and changes in foreign currency exchange rates are reported net of deferred taxes in accumulated other comprehensive (loss) income, a component of stockholders’ equity, until realized. Beginning in 2018, only fair value changes on available-for-sale debt securities investments are recorded as part of other comprehensive income; while fair value changes on equity securities investments are recognized in net income as part of investment and other gains (losses). Refer to Notes 1-Q and 6 to our audited consolidated financial statements for details.
In 2018, net unrealized investment losses of $9.8 million, net of taxes, which increased our other comprehensive loss, were primarily related to temporary decreases in fair values of corporate bond securities investments driven by increases in the overall rate environment. Our net unrealized investment losses were consistent with the approximately 40 basis points increase of the five-year U.S. treasury yield, along with the approximately 40 basis points increase of applicable credit spreads on our investments in 2018. Also in 2018, we recorded foreign currency translation losses which increased our other comprehensive loss by $10.5 million, net of taxes, which was primarily driven by declines in the value of the Canadian dollar and United Kingdom pound against the U.S. dollar in 2018.
In 2017, net unrealized investment losses of $0.3 million, net of taxes, which decreased our other comprehensive income, were primarily related to temporary decreases in fair values of foreign bond and equity securities investments, partially offset by the increase in fair values of municipal and corporate investments. Changes in foreign currency exchange rates, primarily related to our Canadian operations, increased other comprehensive income by $8.4 million, net of taxes, in 2017.
In 2016, net unrealized investment losses of $1.6 million, net of taxes, which increased our other comprehensive loss, were primarily related to temporary decreases in fair values of municipal, corporate and foreign bond investments, partially offset by the increase in fair values of equity securities investments. Changes in foreign currency exchange rates, primarily related to our Canadian operations, increased other comprehensive loss by $3.4 million, net of taxes, in 2016.
Off-balance sheet arrangements. We do not have any material source of liquidity or financing that involves off-balance sheet arrangements, other than our contractual obligations under operating leases. We also routinely hold funds in segregated escrow accounts pending the closing of real estate transactions and have qualified intermediaries in tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code. The Company holds the proceeds from these transactions until a qualifying exchange can occur. In accordance with industry practice, these segregated accounts are not included on the balance sheet. See Note 17 to our audited consolidated financial statements included in Item 15 of Part IV of this report.
Forward-looking statements. Certain statements in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future, not past, events and often address our expected future business and financial performance. These statements often contain words such as "expect," "anticipate," "intend," "plan," "believe," "seek," "will," "foresee" or other similar words. Forward-looking statements by their nature are subject to various risks and uncertainties that could cause our actual results to be materially different than those expressed in the forward-looking statements. These risks and uncertainties include, among other things, the challenging economic conditions; adverse changes in the level of real estate activity; changes in mortgage interest rates, existing and new home sales, and availability of mortgage financing; our ability to respond to and implement technology changes, including the completion of the implementation of our enterprise systems; the impact of unanticipated title losses or the need to strengthen our policy loss reserves; any effect of title losses on our cash flows and financial condition; the ability to attract and retain highly productive sales associates; the impact of vetting our agency operations for quality and profitability; independent agency remittance rates; changes to the participants in the secondary mortgage market and the rate of refinancing that affects the demand for title insurance products; regulatory non-compliance, fraud or defalcations by our title insurance independent agencies or employees; our ability to timely and cost-effectively respond to significant industry changes and introduce new products and services; the outcome of pending litigation; the impact of changes in governmental and insurance regulations, including any future reductions in the pricing of title insurance products and services; our dependence on our operating subsidiaries as a source of cash flow; the continued realization of expense savings from our cost management program; our ability to successfully integrate acquired businesses; our ability to access the equity and debt financing markets when and if needed; our ability to grow our international operations; seasonality and weather; and our ability to respond to the actions of our competitors. We expressly disclaim any obligation to update, amend or clarify any forward-looking statements contained in this report to reflect events or circumstances that may arise after the date hereof, except as may be required by applicable law.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The discussion below about our risk management strategies includes forward-looking statements that are subject to risks and uncertainties. Management’s projections of hypothetical net losses in the fair values of our market rate-sensitive financial instruments, should certain potential changes in market rates occur, are presented below. While we believe that the potential market rate changes are possible, actual rate changes could differ from our projections. Although we are exposed to a currency exchange rate risk for our foreign operations, this risk is not material to Stewart’s financial condition or results of operations.
The material market risk in our investments in financial instruments is related to our debt securities portfolio. We invest primarily in municipal, corporate, foreign and U.S. Government debt securities. Our investments in equity securities represent approximately only 5% of our total securities investments. However, as a result of our adoption of the new accounting standard relating to financial instruments on January 1, 2018, fair value changes relating to equity securities are recognized in the statement of income; fair value changes relating to debt securities are still included within stockholders' equity (refer to Notes 1-Q, 4 and 6 to our audited consolidated financial statements). We do not invest in financial instruments of a derivative or hedging nature.
We have established policies and procedures to minimize our exposure to changes in the fair values of our investments. These policies include retaining an investment advisory firm, an emphasis upon credit quality, management of portfolio duration, maintaining or increasing investment income through high coupon rates and actively managing our risk profile and security mix depending upon market conditions. We have classified all of our debt securities investments as available-for-sale.
Investments in debt securities at December 31, 2018 mature, according to their contractual terms, as follows (actual maturities may differ because of call or prepayment rights):
In one year or less
After one year through two years
After two years through three years
After three years through four years
After four years through five years
After five years
We believe our investment portfolios are diversified and do not expect any material loss to result from the failure to perform by issuers of the debt securities we hold. Our investments are not collateralized. Foreign debt securities primarily include Canadian government and corporate bonds with aggregate fair values of $171.2 million and $198.7 million as of December 31, 2018 and 2017, respectively. Also included in foreign debt securities are United Kingdom treasury and corporate bonds with aggregate fair values of $23.0 million and $24.5 million as of December 31, 2018 and 2017, respectively.
Based on our foreign debt securities portfolio and foreign currency exchange rates at December 31, 2018, a 100 basis-point increase (decrease) in foreign currency exchange rates would result in an increase (decrease) of approximately $1.9 million in the fair value of our foreign debt securities portfolio. We do not currently employ hedging strategies with respect to foreign currency risk as we do not consider this risk as material to the Company. In addition, our international businesses conduct substantially all of their operations in their respective local currencies. Changes in foreign currency exchange rates may affect the fair value of the debt securities portfolio and may result in unrealized gains or losses.
Based on our debt securities portfolio and interest rates at December 31, 2018, a 100 basis-point increase (decrease) in interest rates would result in a decrease (increase) of approximately $24.4 million, or 4.0%, in the fair value of our portfolio. Changes in interest rates may affect the fair value of the debt securities portfolio and may result in unrealized gains or losses.
Unrealized gains or losses on investments from changes in foreign currency exchange rates or interest rates would only be realized upon the sale of such investments. Fair value changes relating to equity securities and other-than-temporary declines in fair values of debt securities are charged to operations.
Item 8. Financial Statements and Supplementary Data
The information required to be provided in this item is included in our audited consolidated financial statements, including the Notes thereto, beginning on page F-1 of this report, and such information is incorporated in this report by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Our principal executive officer and principal financial officer are responsible for establishing and maintaining disclosure controls and procedures. They evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2018 and have concluded that, as of such date, our disclosure controls and procedures are adequate and effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)). Our internal control over financial reporting is a process, under the supervision of our principal executive officer and principal financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management, with the participation of our principal executive officer and principal financial officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on this assessment, management believes that, as of December 31, 2018, our internal control over financial reporting is effective based on those criteria.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Due to such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
See page F-3 for the Report of Independent Registered Public Accounting Firm on our effectiveness of internal control over financial reporting.
There has been no change in our internal control over financial reporting during the quarter ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. As a result, no corrective actions were required or undertaken.
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
Information regarding our directors and management team will be included in our proxy statement for our 2019 Annual Meeting of Stockholders (Proxy Statement), to be filed within 120 days after December 31, 2018, and is incorporated in this report by reference.
Our Board of Directors and Management Team as of February 28, 2019 are:
Board of Directors:
Thomas G. Apel
Chairman of the Board of the Company and CEO of VLN, Inc.
Managing Partner of Engine Capital LP
Clifford Allen Bradley, Jr.
Former Chairman of the board and CEO of Amerisafe, Inc.
Director of Ancora Advisors LLC
Glenn C. Christenson
Managing Director of Velstand Investments, LLC
Robert L. Clarke
Of Counsel, Bracewell LLP
Frederick H. Eppinger
Director of Centene Corp. and former President and CEO of The Hanover Insurance Group, Inc.
Matthew W. Morris
Chief Executive Officer of Stewart
Matthew W. Morris
Chief Executive Officer
John L. Killea
President, Chief Legal Officer and Chief Compliance Officer
David C. Hisey
Chief Financial Officer, Secretary and Treasurer
Chief Corporate Development Officer
Chief Information Officer
Chief Human Resources Officer
The Board of Directors has adopted the Stewart Code of Business Conduct and Ethics and Guidelines on Corporate Governance, as well as the Code of Ethics for Chief Executive Officers, Principal Financial Officer and Principal Accounting Officer. Each of these documents can be found at our website, www.stewart.com.
Item 11. Executive Compensation
Information regarding compensation for our executive officers will be included in the Proxy Statement and is incorporated in this report by reference. The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management and based on that review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management and related stockholder matters will be included in the Proxy Statement and is incorporated in this report by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information regarding certain relationships and related transactions and director independence will be included in the Proxy Statement and is incorporated in this report by reference.
Item 14. Principal Accountant Fees and Services
Information regarding fees paid to and services provided by our independent registered public accounting firm will be included in the Proxy Statement and is incorporated in this report by reference.
Item 15. Exhibits and Financial Statement Schedules
Financial Statements and Financial Statement Schedules
The financial statements and financial statement schedules filed as part of this report are listed in the Index to Consolidated Financial Statements and Financial Statement Schedules on Page F-1 of this document. All other schedules are omitted, as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
Exhibits required to be filed by Item 601 of Regulation S-K are listed below.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Stewart Information Services Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Stewart Information Services Corporation and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income and comprehensive income, cash flows, and equity for each of the years in the three‑year period ended December 31, 2018, the related notes and financial statement schedules I to II (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three‑year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 1980.
February 28, 2019
F - 2
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Stewart Information Services Corporation:
Opinion on Internal Control Over Financial Reporting
We have audited Stewart Information Services Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of income and comprehensive income, cash flows, and equity for each of the years in the three-year period ended December 31, 2018, the related notes, and financial statement schedules I to II (collectively, the consolidated financial statements), and our report dated February 28, 2019 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
F - 3
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
February 28, 2019
F - 4
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31,
($000 omitted, except per share)
Investment and other gains (losses) – net
Amounts retained by independent agencies
Other operating expenses
Title losses and related claims
Depreciation and amortization
Income before taxes and noncontrolling interests
Income tax expense
Less net income attributable to noncontrolling interests