Old Republic Q3 Earnings: Likely To Trade In A Tight Range

Old Republic International (NYSE:ORI) recently reported an earnings beat, although expectations were lower in the current economic and interest rate environment.

While the company does have several headwinds it faces going forward, its diversified strategy allows it to offset some of the weaker segments of the company, partially mitigating the impact of them on the performance of the company.

In this article, we’ll go over some of the recent numbers, the areas the company is struggling in, and why I think it’s going to trade in a tighter range for a while.

Recent numbers

Not including investment gains and losses, the company reported net income in the third quarter of $206 million, down from the $240 million in the same reporting period of 2021. Income on a per-share basis was $0.68 against the $0.79 year-over-year.

Operating profit in the first three quarters was $608 million, down $60 million from last year’s $668 million. Management noted that last year was a record-setting year, and by historical standards the numbers were strong. As for net investment income, that has been under pressure because stocks and bonds are risky at this time. Its portfolio is weighted to 80 percent bonds and short-term investments, with the remaining 20 percent in stocks.

The company had losses of $207 million from its bond portfolio in the quarter. Unsurprisingly, the fair value of its bond portfolio plunged by $385 million, while its stock portfolio fell by $170 million in value.

While the company stated its bond portfolio consisted of 98 percent of investment-grade securities, I still see this as highly risky in this economic environment. This is definitely a risk to the company. I’ll get into that more later in the article. The quarter ended with a bond yield of 3.1 percent.

Even though its stock portfolio declined in value, the company’s strategy of rebalancing its investment portfolio resulted in $181 million in net investment gains from selling some of its stocks. It’s unlikely that will happen at that level in the near term.

Concerning loss reserves, its consolidated loss ratio improved to 3.4 points in the quarter, up from the 2.3 percentage points in the same quarter last year.

General Insurance

Operating income in its General Insurance segment climbed to $168 million, a gain of 15 percent. The loss ratio in the reporting period was 63 percent compared to 65 percent last year in the third quarter. The combined ratio for the company was a solid 90 percent compared to 91 percent year-over-year. Net premiums in the quarter were up close to 10 percent.

Net premiums in commercial auto were up 10 percent, with net premiums earned increasing by 7 percent. The loss ratio in auto improved to 64 percent from 73 percent last year in the same quarter. With auto damage severity increasing at mid-double-digit rates, the ORI is increasing rates in the high single-digits, which the company feels will cover the increase in frequency and severity in the segment.

With workers’ compensation, net premiums written grew by 11 percent in the quarter, while net premiums earning were up 7 percent. The loss ratio improved to 36 percent this quarter from 59 percent last year in the same reporting period.

Loss frequency in this segment has improved, with severity up a little. The company has increased rates for workers’ comp in the low single-digit range. These insurance segments did well for the company. Next we’ll look at some of the headwinds ORI faces.

Headwinds

The three areas I want to focus on in this part of the article is concerning the D&O line of coverage, Title Insurance, and weak investment environment that weakens the effect of the available capital from the float of the company.

In its D&O line of coverage (financial indemnity), management said unfavorable conditions rose from an increase in huge security class action claims that happened in 2018 and 2019.

The challenge there is there are a number of new entrants in the market that have driven down rates, which weakens the company’s position in being able to increase rates.

To mitigate that, management said it’s going to have to be more disciplined in underwriting decisions, to the point of not taking on accounts that it can’t comfortably price in the class action environment it now faces. The point there is it appears this is going to be a weaker insurance line for the company going forward.

In regard to title insurance, the Title group reported revenue of $968 million in the quarter, down 15 percent year-over-year. Agency premiums fell 12 percent to $103 million year-over-year, and direct premiums and fees dropped 28 percent to $71 million. Pretax operating income plunged from $136 million last year in the third quarter to $73 million this year. This is of course attributed to the increase in interest rates. While home purchases have declined, a lot of the pain comes from the significant drop in the number of homes refinanced.

On the positive side, ORI did enjoy strength on the commercial side, with premiums increasing 29 percent year-over-year, accounting for 21 percent of the overall premium total in the third quarter.

This is going to continue to weigh on the company over the next couple of years, depending on how long the recession lasts and the actions of the Federal Reserve concerning interest rates.

The last headwind, which I think isn’t being taken into account like it should be, is in relationship to the company to effectively deploy its float in stocks in particular.

With stocks and bonds highly risky at this time, even the decision to rebalance its investment portfolio to 80 percent bonds is highly risky, even if they’re considered investment grade.

I think this may have more impact on the performance of the company until market sentiment changes and money pours back into the stock market. I don’t think that will happen, at earliest, until the second half of 2023, and quite possibly, until early 2024.

Conclusion

ORI should continue to do okay taking into account the conditions it’s operating in, but I believe from the headwinds mentioned above, its share price is probably going to remain subdued when taking into account the visibility and clarity we have at this time.

Investors should take into consideration that the company isn’t likely to sell off stocks like it did in the reporting period to generate significant gains. That revenue stream is drying up for now.

As for bonds, they could just as easily blow up as the stock market has. I understand why the company made the decision to do it, but it’s not the safe bond market we’ve been used to in the past. It needs to be priced in as more of a risk than it would normally be.

With the diversified insurance portfolio ORI has, it does have the capacity to offset a lot of the headwinds it faces, but there is more risk in these economic and financial times than the company has faced for a long time. We can’t underestimate the risks.

For these reasons, I see ORI continuing to trade in a tight range, with the top probably capped for now. Its trading range will likely be from around $20 per share to $23 per share in the current environment the company faces.

Since I believe the Federal Reserve isn’t going to boost interest rates by more than 5 percent (possibly slightly higher), we do have a time frame to look at for all of this, which will be a lot clearer by the end of 2022, or at least by the first month of 2023. At that time, we’ll know what the Fed will do in 2023 and 2024, and have a better handle on how that will have an impact on ORI’s performance.

For now, I think expectations should be lowered concerning the company’s performance.