INVESTORS TITLE CO – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes in this report.

Overview

Investors Title Company (the "Company") is a holding company that engages primarily in issuing title insurance through two subsidiaries, Investors Title Insurance Company ("ITIC") and National Investors Title Insurance Company ("NITIC"). Operating revenues from the title segment accounted for 95.8% of the Company's operating revenues in 2011. Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Title insurance protects against loss or damage resulting from title defects that affect real property.

There are two basic types of title insurance policies - one for the mortgage lender and one for the real estate owner. A lender often requires property owners to purchase title insurance to protect its position as a holder of a mortgage loan, but the lender's title insurance policy does not protect the property owner. The property owner has to purchase a separate owner's title insurance policy to protect his investment. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a claim is made against real property, title insurance provides indemnification against insured defects.

The Company issues title insurance policies through issuing agencies and also directly through home and branch offices. Issuing agents are typically real estate attorneys or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company's marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company's growth in premiums written.

Revenues for this segment result from purchases of new and existing residential and commercial real estate, refinance activity and certain other types of mortgage lending such as home equity lines of credit.

Volume is a factor in the Company's profitability due to fixed operating costs which are incurred by the Company regardless of premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on the Company's profitability. The Company's profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and minimize risks such as interest rate changes, defaults and impairments of assets.

The Company's volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes sales, mortgage financing and mortgage refinancing. In turn, real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels and general United States economic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.

The cyclical nature of the residential and commercial real estate markets - and consequently, the land title industry - has historically caused fluctuations in revenues and profitability, and it is expected to continue to do so in the future. Additionally, there are seasonal influences in real estate activity and accordingly in revenue levels for title insurers.

Services other than title insurance provided by operating divisions of the Company that are not required to be reported separately are reported in a category called "All Other." These other services include those offered by the Company and by its smaller wholly owned subsidiaries, Investors Title Exchange Corporation ("ITEC"), Investors Title Accommodation Corporation ("ITAC"), Investors Trust Company ("Investors Trust"), Investors Capital Management Company ("ICMC") and Investors Title Management Services, Inc. ("ITMS").

The Company's exchange services division, ITEC and ITAC, provides customer services in connection with tax-deferred real property exchanges. ITEC serves as a qualified intermediary in like-kind exchanges of real or personal property under Section 1031 of the Internal Revenue Code of 1986, as amended. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction, and its duties include drafting standard exchange documents, holding the exchange funds between the sale of the old property and the purchase of the new property, and accepting the formal identification of the replacement property within the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. An exchange accommodation offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property.

In conjunction with Investors Trust, ICMC provides investment management and trust services to individuals, companies, banks and trusts. ITMS offers various consulting services to provide clients with the technical expertise to start and successfully operate a title insurance agency.

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Business Trends and Recent Conditions

By the mid 2000's, there had been a long-term trend of rising home values in the United States that resulted in inflated home values in many areas of the country. From 2001 to 2003, the Federal Reserve lowered short-term interest rates 13 times. Home sales reached record highs and simultaneously, lenders began to loosen their loan underwriting standards, particularly with non-traditional loan products. Lower underwriting standards and innovative loan products increased the supply of mortgage credit and resulted in more mortgage loans to high-risk borrowers. As a result, loan defaults and mortgage foreclosures increased. Beginning in September 2008, many financial firms failed or restructured, contributing to a widespread financial crisis in the United States. Lenders responded to the financial crisis by implementing stricter loan underwriting standards, which, combined with high unemployment and weakened consumer confidence, reduced the demand for homes. In an attempt to stabilize the struggling economy, the U.S. government took steps to provide economic stimulus during 2009 and 2010. The American Recovery and Reinvestment Act of 2009 included an $8,000 tax credit available for certain first time home buyers for the purchase of a principal residence on or after January 1, 2009. On November 6, 2009, the President signed a law which extended the first-time homebuyer credit to persons who signed a binding purchase contract by April 30, 2010 and closed on the purchase of their residence by September 30, 2010. A similar credit of $6,500 was also extended to homebuyers who had owned their current home at least five of the prior eight years.

According to data published by Freddie Mac, the average 30-year fixed mortgage interest rate in the United States was 4.45% for 2011, compared with 4.69% for 2010. Despite the decline in interest rates, real estate activity in 2011 declined from prior year levels. According to the Mortgage Bankers Association's ("MBA's") January 18, 2012 Mortgage Finance Forecast, 2011 annual mortgage originations decreased 19.7% to $1,262 billion from $1,572 billion in 2010. In 2012, mortgage originations are projected to decrease 21.4% from 2011 levels to $992 billion. Refinancing activity in 2011decreased 21.9% to $858 billion from $1,099 billion in 2010. In 2012, refinancing activity is projected to decrease 32.1% from 2011 levels to $583 billion. Purchasing activity in 2011 decreased 14.4% to $404 billion from $472 billion in 2010. In 2012, purchasing activity is projected to increase 1.5% from 2011 levels to $410 billion.

According to the MBA's January 18, 2012 Mortgage Finance Forecast, refinancing activity accounted for 69.9% of all mortgage originations in 2010. In 2011, refinancing transactions were 68.0% of mortgage originations and, for 2012, are projected to be 58.8% of mortgage originations. The projected decrease is attributable to the higher levels of refinance volume that occurred in prior years, as well as more stringent requirements being imposed by lenders. Despite current mortgage rates falling to the lowest levels in decades, the Company believes that many homeowners would need rates to fall even further to justify the closing costs involved with subsequent refinance transactions. The Company believes that lender-imposed limits have factored into the decrease in refinance volume, and that many homebuyers have too little equity in their homes to meet loan requirements or do not have the necessary credit scores to qualify for prime mortgage rates.

Currently, the U.S. economy is showing mixed signals with several federal programs in various stages. The Federal Reserve's program of purchasing U.S. Treasury Bonds to reduce long-term interest rates, Quantitative Easing 2, ended in the second quarter of 2011. In September 2011, the Federal Reserve announced "Operation Twist," which involves selling short-term Treasury bonds in exchange for the same amount of longer-term bonds. The intent is to push down yields on long-term bonds, noting that mortgage rates tend to track the yield on 10-year Treasury notes. The Federal Reserve has recently announced that it will be issuing disclosures on a periodic basis that will include projections of interest rates and when it expects to start raising interest rates. On January 25, 2012, the Federal Reserve announced that the benchmark interest rate would remain low until at least the end of 2014. In addition, a long-term goal of 2% inflation has been set and there is potential for a third round of U.S. Treasury Bond purchases that will be dependent upon certain economic conditions being met. Meanwhile, federal lawmakers have agreed to extend certain provisions of the Bush-era tax cuts and negotiations are in process concerning possible reforms of the U.S. mortgage financing system, including Fannie Mae and Freddie Mac. The MBA's January 18, 2012 Economic Forecast projects slight improvements in the unemployment rate, gross domestic product, the level of personal consumption and residential investment, but also projects decreases in business investments and inventory investments for 2012. In general, the overall economy remains uncertain with continued domestic and global concerns, which will likely result in a continuation of the sluggish real estate market for 2012.

Historically, activity in real estate markets has varied over the course of market cycles in response to evolving economic factors. Operating results can vary from year to year based on cyclical market conditions and do not necessarily indicate the Company's future operating results and cash flows.

Critical Accounting Estimates and Policies

This discussion and analysis of the Company's financial condition and results of operations is based upon the Company's accompanying Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The Company's management makes various estimates and judgments when applying policies affecting the preparation of the Consolidated Financial Statements. Actual results could differ from those estimates. Significant accounting policies of the Company are discussed in Note 1 to the accompanying Consolidated Financial Statements. Following are those accounting estimates and policies considered critical to the Company.

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Reserves for Claim Losses:

The Company's reserves for claims are established using estimates of amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future (incurred but not reported, or "IBNR"). The total reserve for all losses incurred but unpaid as of December 31, 2011 is represented by the reserve for claims of approximately $37,996,000 on the accompanying Consolidated Balance Sheets. Of that total, approximately $6,234,000 was reserved for specific claims which have been reported to the Company, and approximately $31,762,000 was reserved for IBNR claims.

A provision for estimated future claims payments is recorded at the time the related policy revenue is recorded. The Company records the claims provision as a percentage of net premiums written. This provisional rate is set to provide for losses on current year policies. By their nature, title claims can often be complex, vary greatly in dollar amounts, vary in number due to economic and market conditions such as an increase in mortgage foreclosures and involve uncertainties as to ultimate exposure. In addition, some claims may require a number of years to settle and determine the final liability for indemnity and loss adjustment expense. The payment experience may extend for more than twenty years after the issuance of a policy. Events such as fraud, defalcation and multiple property defects can substantially and unexpectedly cause increases in estimates of losses. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic and market conditions, these estimates are subject to variability.

Management considers factors such as the Company's historical claims experience, case reserve estimates on reported claims, large claims, actuarial projections and other relevant factors in determining its loss provision rates and the aggregate recorded expected liability for claims. In establishing reserves, actuarial projections are compared with recorded reserves to evaluate the adequacy of such recorded claims reserves and any necessary adjustments are then recorded in the current period's income statement. As the most recent claims experience develops and new information becomes available, the loss reserve estimate related to prior periods will change to more accurately reflect updated and improved emerging data. The Company reflects any adjustments to reserves in the results of operations in the period in which new information (principally claims experience) becomes available.

The Company initially reserves for each known claim based upon an assessment of specific facts and updates the reserve amount as necessary over the course of administering each claim. Loss ratios for earlier years tend to be more reliable than recent policy years as those years are more fully developed. In making loss estimates, management determines a loss provision rate, which it then applies to net premiums written.

There are key assumptions that materially affect the reserve estimates. The Company assumes the aggregate reported liability for known claims and IBNR, in the aggregate, will be comparable to its historical claims experience unless factors, such as loss experience, change significantly. The factors the Company considered for the recently completed fiscal year did not cause any of its key assumptions to change from assumptions used in the immediately preceding period. Also affecting the Company's assumptions are large losses related to fraud and defalcation, as these can cause significant variances in loss emergence patterns. Management defines a large loss as one where incurred losses exceed $250,000. Due to the small volume of large claims, the long-tail nature of title insurance claims and the inherent uncertainty in loss emergence patterns, large claim activity can vary significantly between policy years. The estimated development of large claims by policy year is therefore subject to significant changes as experience develops. The Company has generally followed the same methodology for estimating loss reserves. The loss provision rate is set to provide for losses on current year policies and to provide for estimated positive or negative development on prior year loss estimates.

Management also considers actuarial analyses in evaluating claims reserves. The actuarial methods used to evaluate reserves are loss development methods, expected loss methods and Cape Cod methods, all of which are accepted actuarial methods for estimating ultimate losses and, therefore, loss reserves. In the loss development method, each policy year's paid or incurred losses are projected to an "ultimate" level using loss development factors. In the expected loss method, losses for each policy year are estimated based on the loss development results for all policy years, trended to the level of the policy year being estimated. Expected loss methods produce more stable ultimate loss estimates than do loss development methods, which are more responsive to the current loss data but can lead to volatile results. The Cape Cod method, a special case of the Bornhuetter-Ferguson method, blends the results of the loss development and expected loss methods. For more recent policy years, the Cape Cod method gives more weight to the results of the expected loss methods; for older policy years, more weight is given to the loss development method results.

The key actuarial assumptions are principally loss development factors and expected loss ratios. The selected loss development factors are based on a combination of the Company's historical loss experience and title industry loss experience. Expected loss ratios are estimated for each policy year based on the Company's own experience and title industry loss ratios. When updated data is incorporated into the actuarial models, the resulting loss development factors and expected loss ratios will likely change from the prior values. Changes in these values from 2010 through 2011 have been the result of actual Company and industry experience during the calendar year and not changes in assumptions.

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If one or more of the variables or assumptions used changed such that the Company's recorded loss ratio, or loss provision as a percentage of net title premiums, increased or decreased two loss ratio percentage points, the impact on after-tax income for the year ended December 31, 2011, would be as follows. Company management believes that using a sensitivity of two loss percentage points for the loss ratio provides a reasonable benchmark for analysis of the calendar year loss provision of the Company based on historical loss ratios by year.

           Increase in Loss Ratio of two percentage points   $ (1,076,000 )            Decrease in Loss Ratio of two percentage points   $  1,076,000

Despite the variability of such estimates, management believes that, based on historical claims experience and actuarial analysis, the Company's reserves are adequate to cover claim losses resulting from pending and future claims for policies issued through December 31, 2011. The ultimate settlement of policy and contract claims will likely vary from the reserve estimates included in the Company's Consolidated Financial Statements. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. There are no known claims that are expected to have a materially adverse effect on the Company's financial position or operating results.

Premiums Written and Commissions to Agents:

Generally, title insurance premiums are recognized at the time of closing of the related real estate transaction, as the earnings process is then considered complete. Policies or commitments are issued upon receipt of final certificates or preliminary reports with respect to titles. Title insurance commissions earned by the Company's agents are recognized as expenses concurrent with recognition of related premium revenue.

The Company's premium revenues from certain agency operations include accruals based on estimates using historical information, as well as other relevant trends and data. The accruals for premiums are necessary because of the lag between policy effective dates and the reporting of these transactions to the Company by the agents. In addition to accruing these earned but unreported agency premiums, the Company also accrues agent commission expenses, premium taxes and income taxes, and records a provision for claim losses at the prevailing provision rate as of the balance sheet date.

Valuation and Impairment of Investments in Securities:

Securities held principally for resale in the near term are classified as trading securities and recorded at fair values. Realized and unrealized gains and losses on trading securities are included in other income. Securities not classified as either trading securities or held-to-maturity securities, securities for which the Company has the intent and ability to hold to maturity, are classified as available-for-sale and reported at fair value with unrealized gains and losses, adjusted for other-than-temporary declines in fair value, reported as accumulated other comprehensive income. As of December 31, 2011 and 2010, all of the Company's invested securities were classified as available-for-sale. Realized gains and losses on the sale of investments are determined using the specific identification method.

Securities are regularly evaluated and reviewed for differences between the cost and estimated fair value of each security for factors that may indicate that a decline in fair value is other-than-temporary. When, in the opinion of management, a decline in the fair value of an investment is considered to be other-than-temporary, such investment is written down to its fair value. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include, but are not limited to:

· the duration and extent to which the fair value has been less than cost;

· with respect to equity securities, whether the Company's ability and intent to

retain the investment for a period of time is sufficient to allow for a

recovery in value; and

· with respect to fixed maturity securities, whether the Company has the intent

   to sell or will more likely than not be required to sell a particular security    before recovery in value.   

These factors are reviewed quarterly and any material degradation in the prospect for recovery will be considered in the other-than-temporary impairment analysis. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. The fair values of the majority of the Company's investments are based on quoted market prices from independent pricing services. See Note 3 to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information on the Company's valuation techniques.

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Deferred Taxes:

The Company recorded a net deferred tax liability at December 31, 2011 primarily related to net unrealized gains on investments and recorded reserves for claims, net of statutory premium reserves. A net deferred tax asset was recorded at December 31, 2010 related primarily to reserves for claims, allowance for doubtful accounts, employee benefits and other-than-temporary impairment of assets. Based upon the Company's historical results of operations, the existing financial condition of the Company and management's assessment of all other available information, management believes that it is more likely than not that the benefit of these assets will be realized. See Note 8 to the Consolidated Financial Statements in this Annual Report on Form 10-K for further information on the Company's deferred taxes.

Cyclicality and Seasonality

Title insurance premiums are closely related to the level of real estate activity and real estate values. The availability of credit directly affects real estate sales. Home sales and mortgage lending are highly cyclical businesses. Other factors include mortgage interest rates, consumer confidence, economic conditions, supply and demand of real estate, and family income levels. The Company's premiums in future periods will continue to be subject to these and other factors which are beyond management's control and, as a result, likely to fluctuate.

Historically, real estate transactions have produced seasonal premium levels for title insurers. Residential real estate activity has been generally slower in the fall and winter months because fewer real estate transactions occur, while the spring and summer months are more active. Refinance activity is generally less seasonal than purchase activity, but it is more subject to interest rate volatility and is therefore more cyclical. However, fluctuations in mortgage interest rates, as well as other economic factors, can cause shifts in real estate activity outside of the normal traditional seasonal pattern.

Results of Operations

Operating Revenues

Operating revenues include net premiums written plus other fee income, trust income, management services income, and exchange services income. Investment income and realized investment gains and losses are not included in operating revenues and are discussed separately under "Non-Operating Revenues" below. The following is a summary of the Company's operating revenues with intersegment eliminations netted with each segment; therefore, the individual segment amounts will not agree to Note 13 in the accompanying Consolidated Financial Statements.

                         2011            %            2010            % Title Insurance   $ 83,420,562        95.8 %   $ 63,502,167        94.8 % All Other            3,640,999         4.2 %      3,481,336         5.2 % Total             $ 87,061,561       100.0 %   $ 66,983,503       100.0 %   

Title Insurance

Net Premiums and Title Orders: Net premiums written increased 32.6% in 2011 to $81,529,333, compared with $61,462,441 in 2010. The volume of title orders decreased 1.0% in 2011 to 204,230 compared with 206,384 in 2010. The Company's entry into Texas in late 2010 was the primary reason for the increase in net premiums written. The increase in premium revenue is reflective of increased business from markets with higher premium rates, primarily Texas.

  Title insurance companies typically issue title insurance policies directly through branch offices or through title agencies. Following is a breakdown of premiums generated by branch and agency operations for the years ended December 31:                        2011            %            2010            % Home and Branch   $ 16,485,973        20.2 %   $ 17,961,144        29.2 % Agency              65,043,360        79.8 %     43,501,297        70.8 % Total             $ 81,529,333       100.0 %   $ 61,462,441       100.0 %   

Home and Branch Office Net Premiums: In the Company's home and branch operations, the Company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. Net premiums written from home and branch operations decreased 8.2% to $16,485,973 in 2011 compared with $17,961,144 in 2010. The decrease in 2011 for home and branch operations primarily reflects stagnation in the real estate market and a decline in mortgage refinancing. All of the Company's home office operations and the majority of branch offices are located in North Carolina; as a result, the home and branch office net premiums written are primarily for North Carolina policies.

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Agency Net Premiums: When a policy is written through a title agency, agents retain the majority of the title premium collected, with the balance remitted to the title underwriter for bearing the risk of loss in the event that a claim is made under the title insurance policy. The increase in the percentage of total premiums written by agencies in 2011 is primarily due to the Company's strategy of growth through expansion of its agency base and the influence of local geographic trends. Agency net premiums written increased 49.5% to $65,043,360 in 2011 compared with $43,501,297 in 2010, primarily due to the Company's entry into Texas.

  Following is a schedule of net premiums written in select states where the Company's two insurance subsidiaries ITIC and NITIC currently underwrite title insurance:  State                      2011             2010 Texas                  $ 26,321,570     $  2,144,909 North Carolina           21,693,505       23,458,494 South Carolina            6,707,675        6,333,057 Michigan                  4,344,196        4,151,277 Virginia                  4,191,295        4,267,550 All Others               18,431,055       21,275,877 Premiums                 81,689,296       61,631,164 Reinsurance Assumed          17,147           33,184 Reinsurance Ceded          (177,110 )       (201,907 ) Net Premiums Written   $ 81,529,333     $ 61,462,441    Other Revenues 

Other revenues primarily include other fee income, trust income, management services income, exchange services income, and income related to the Company's equity method investments. Other revenues were $5,532,228 and $5,521,062 for 2011 and 2010, respectively. The increase in 2011 is related primarily to increases in trust and management services income, offset by decreases in earnings of unconsolidated affiliates, ancillary title fees and exchange services income.

Non-operating Revenues

Investment income and realized gains and losses from investments are included in non-operating revenues.

Investment Income

The Company derives a substantial portion of its income from investments in municipal and corporate bonds and equity securities. The Company's title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders. Bonds totaling approximately $6,704,000 and $6,570,000 at December 31, 2011 and 2010, respectively, are deposited with the insurance departments of the states in which business is conducted.

In formulating its investment strategy, the Company has emphasized after-tax income. The Company's investments are primarily in bonds and, to a lesser extent, equity securities. The effective maturity of the majority of the bonds is within 10 years. The Company's invested assets are managed to fund its obligations and evaluated to ensure long term stability of capital accounts.

As the Company generates cash from operations, it is invested in accordance with the Company's investment policy and corporate goals. The Company's investment policy has been designed to balance multiple goals, including the assurance of a stable source of income from interest and dividends, the preservation of principal, and the provision of liquidity sufficient to meet insurance underwriting and other obligations as they become payable in the future. Securities purchased may include a combination of taxable bonds, tax-exempt bonds and equity securities. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment.

Investment income was $3,595,036 in 2011 compared with $3,671,178 in 2010. The decline in investment income in 2011 was due primarily to lower investment balances and levels of interest earned on fixed maturities and short-term funds, partially offset by higher levels of dividends received as a result of a greater investment balance of equity securities. See Note 3 in the accompanying Consolidated Financial Statements for the major categories of investments, scheduled maturities, amortized cost, fair values of investment securities and earnings by security category.

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Net Realized Gain (Loss) on Investments

Dispositions of equity securities at a realized gain or loss reflect such factors as industry sector allocation decisions, ongoing assessments of issuers' business prospects and tax planning considerations. Additionally, the amounts of net realized investment gains and losses are affected by assessments of securities' valuation for other-than-temporary impairment. As a result of the interaction of these factors and considerations, net realized investment gains or losses can vary significantly from period to period.

Net realized gain on investments was $28,559 for 2011 compared with $654,674 for 2010. The year-to-date 2011 net gain included impairment charges of $325,391 on certain investments and other assets, including property acquired in the settlement of claims, that were deemed to be other-than-temporarily impaired, offset by net realized gains on the sales of investments and other assets of $353,950. The 2010 net realized gain included impairment charges of $430,241 on certain investments and other assets, including property acquired in the settlement of claims, offset by net realized gains on the sales of investments and other assets of $1,084,915. Management believes unrealized losses on remaining fixed income and equity securities at December 31, 2011 are temporary in nature.

The securities in the Company's portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a security is other-than-temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost.

There are a number of risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, the risk that the Company's assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the characteristics of that issuer, the risk that information obtained by the Company or changes in other facts and circumstances leads management to change its intent to hold the equity security until it recovers in value or its intent to sell the debt security, and the risk that management is making decisions based on misstated information in the financial statements provided by issuers.

Expenses

The Company's operating expenses consist primarily of commissions to agents, salaries, employee benefits and payroll taxes, provisions for claims and office occupancy and operations. Operating expenses in 2011 increased 29.5% compared with 2010 primarily due to increases in commissions, salaries, employee benefits and payroll taxes and premium and retaliatory taxes as a result of the increase in premium revenues. Following is a summary of the Company's operating expenses. Intersegment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 13 in the accompanying Consolidated Financial Statements.

                         2011            %            2010            % Title Insurance   $ 76,539,187        94.3 %   $ 58,028,574        92.6 % All Other            4,647,033         5.7 %      4,665,155         7.4 % Total             $ 81,186,220       100.0 %   $ 62,693,729       100.0 %   

On a combined basis, the after-tax profit margins were 7.6% and 8.9% in 2011 and 2010, respectively. The decrease in profit margin from 2010 to 2011 is primarily the result of an increase in agent business from markets with higher commission rates than our historical market mixes. The Company continually strives to enhance its competitive strengths and market position, including ongoing initiatives to reduce its operating expenses.

Title Insurance

Profit Margin: The Company's title insurance after-tax profit margin varies according to a number of factors, including the volume and type of real estate activity. Profit margins for the title insurance segment were 8.7% and 10.4% in 2011 and 2010, respectively. The decrease in after-tax profit margin in 2011 compared with 2010 is related to an increase in agent business from markets with higher premium and commission rates, primarily Texas.

Commissions: Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. Commissions to agents increased 59.0% from 2010 to 2011. This increase was primarily due to increased premiums from agency operations in Texas in 2011 due to the Company's entry into Texas in late 2010. Commission expense as a percentage of net premiums written by agents was 76.3% and 71.7% in 2011 and 2010, respectively. The increase in the average commission rate in 2011 compared with 2010 is related to an increase in agent business from markets with higher premium and commission rates, primarily Texas. Commission rates may vary due to geographic locations, different levels of premium rate structures and state regulations.

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Provisions for Claims: The provision for claims as a percentage of net premiums written was 4.1% and 7.2% in 2011 and 2010, respectively. The lower loss provision rate for 2011 is primarily due to favorable loss development in prior policy years, as well as a decline in the relative share of North Carolina business relative to the total versus the prior year period. Since North Carolina's premium rates are less than half the national average, the resulting loss ratio for North Carolina business is higher than for our other markets.

The improvement in the loss provision rate in 2011 from the 2010 level resulted in approximately $2,541,000 less in reserves than would have been recorded at the higher 2010 level. Loss provision ratios are subject to variability and are reviewed and adjusted as experience develops.

Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $3,545,127 and $5,726,366 in 2011 and 2010, respectively.

Reserves for Claims: At December 31, 2011, the total reserve for claims was $37,996,000. Of that total, approximately $6,234,000 was reserved for specific claims, and approximately $31,762,000 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.

Changes from prior periods in the expected liability for claims reflect the uncertainty of the claims environment, as well as the limited predictive power of historical data. The Company continually updates and refines its reserve estimates as current experience develops and credible data emerges. Adjustments may be required as new information develops which often varies from past experience.

Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data, rather than as a result of material changes to underlying key actuarial assumptions or methodologies. Such changes include payments on claims closed during the quarter, new details that emerge on still-open cases that cause claims adjusters to increase or decrease the case reserves and the impact that these types of changes have on the Company's total loss provision.

Salaries, Employee Benefits and Payroll Taxes: Personnel costs include base salaries, benefits and bonuses paid to employees. Salaries, employee benefits and payroll taxes were $18,552,504 and $17,695,956 for 2011 and 2010, respectively. Salaries and related costs increased by approximately 4.8% in 2011 compared with 2010. The increase in 2011 was primarily due to increased levels of business and higher levels of profitability driving increases in levels of variable compensation. On a consolidated basis, salaries and employee benefits as a percentage of total revenues were 20.5% and 24.8% in 2011 and 2010, respectively.

Office Occupancy and Operations: Overall office occupancy and operations as a percentage of total revenues was 4.1% and 5.5% in 2011 and 2010, respectively. The decrease in office occupancy and operations expense in 2011 compared with 2010 was due primarily to decreases in building and equipment rental, telecommunications expenses, depreciation and storage expenses.

Business Development: Business development expenses for 2011 increased $162,246 compared with 2010 primarily due to increases in marketing expenses related to higher levels of marketing efforts associated with the Company's entry into Texas.

Premium and Retaliatory Taxes: Title insurance companies are generally not subject to state income or franchise taxes. However, in most states they are subject to premium and retaliatory taxes, as defined by statute. Premium tax rates vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of operating revenues. Premium and retaliatory taxes as a percentage of net premiums written were 2.1% in both 2011 and 2010.

Professional and Contract Labor Fees: Professional and contract labor expenses for 2011 remained virtually unchanged from 2010 and include fees associated with audit, legal, tax and labor expenses related to contract employees.

Other Expenses: Other operating expenses primarily include miscellaneous operating expenses of the trust division and other miscellaneous expenses of the title segment. These amounts typically fluctuate with transaction volume of the title segment and the trust division.

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Income Taxes

The provision for income taxes was $2,565,000 and $2,243,000 for the years ended December 31, 2011 and 2010, respectively. Income tax expense as a percentage of earnings before income taxes was 27.0% and 26.0%, for the years ended December 31, 2011 and 2010, respectively. The increase for 2011 from 2010 was primarily due to a higher proportion of taxable to tax-exempt investment income. The effective income tax rate for both 2011 and 2010 was below the U.S. federal statutory income tax rate (34%), primarily due to the effect of tax-exempt income. Tax-exempt income lowers the effective tax rate.

The Company believes it is more likely than not that the tax benefits associated with recognized, impairment and unrecognized losses recorded through December 31, 2011 will be realized. However, this judgment could be impacted by further market fluctuations. Information regarding the components of the income tax expense and items included in the reconciliation of the effective rate with the federal statutory rate can be found in Note 8 to the accompanying Consolidated Financial Statements.

Net Income

The Company reported net income of $6,933,936 and $6,372,626, or $3.20 and $2.78 per share on a diluted basis in 2011 and 2010, respectively. Total revenues for 2011 increased 27.2% to $90,685,156 from $71,309,355 while expenses for 2011 increased 29.5% to $81,186,220 from $62,693,729. The increases in both revenues and expenses related primarily to an increase in business from markets with higher premium and commission rates.

Liquidity and Capital Resources

Cash flows from operating activities increased from 2010 to 2011, primarily due to the pace of the collection of receivables relative to sales, lower claim payments and the deferral of accounts payable and accrued liability payments. Cash and cash equivalents at year end increased approximately $9,900,000 from the prior year to approximately $18,000,000, due to cash provided by operating activities in 2011. Cash flows from operations have historically been the primary source of financing for expanding operations, additions to property and equipment, dividends to shareholders, and operating requirements.

Cash and cash equivalents provided by or used in non-operating activities have historically been purchases and proceeds from investing activities and repurchases of common stock and the issuance of dividends. Net cash provided by non-operating activities was $918,068</money> in 2011 and net cash used by non-operating activities was $4,842,691 in 2010. Compared with 2010, 2011 had a lower level of investment purchase activity offset by an increase in the repurchases of shares of common stock.

The net effect of all activities on total cash and cash equivalents was an increase of $9,925,227 for 2011 and a decrease of $616,190 for 2010. As of December 31, 2011, the Company held cash and cash equivalents of $18,042,258, short-term investments of $14,112,262, fixed maturity securities of $85,407,365 and equity securities of $22,549,975.

Due to the Company's historical ability to consistently generate positive cash flows from its consolidated operations and investment income, management believes that funds generated from operations will enable the Company to adequately meet its current operating needs for the foreseeable future. However, there can be no assurance that future experience will be similar to historical experience, since it is influenced by such factors as the interest rate environment, the Company's claims-paying ability and its financial strength ratings. The Company is unaware of any trend that is likely to result in material adverse liquidity changes, but continually assesses its capital allocation strategy, including decisions relating to repurchasing the Company's stock and/or conserving cash. The Company's current cash requirements include general operating expenses, income taxes, capital expenditures, dividends on its common stock declared by the Board of Directors and share repurchases of its common stock.

In addition to operational liquidity, the Company maintains a high degree of liquidity within its investment portfolio in the form of short-term investments and other readily marketable securities.

The Company's investment portfolio is considered as available-for-sale. The Company reviews the status of each of its securities quarterly to determine whether an other-than-temporary impairment has occurred.

As noted previously, the Company's operating results and cash flows are heavily dependent on the real estate market. The Company's business has certain fixed costs such as personnel; therefore, changes in the real estate market are monitored closely and operating expenses such as staffing levels, are managed and adjusted accordingly. The Company believes that its significant working capital position and management of operating expenses will aid its ability to manage cash resources through fluctuations in the real estate market.

Receipt of Dividends from Subsidiaries: The Company believes that all anticipated cash requirements for current operations will be met from internally generated funds, through cash dividends and distributions from subsidiaries and cash generated by investment securities. The Company's significant sources of funds are dividends and distributions from its subsidiaries. The holding company receives cash from its subsidiaries in the form of dividends and as reimbursements for operating and other administrative expenses that it incurs. The reimbursements are executed within the guidelines of management agreements between the holding company and its subsidiaries.

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The Company's ability to pay dividends and operating expenses is dependent on funds received from the insurance subsidiaries, which are subject to regulation in the states in which they do business. Each state regulates the extent to which title underwriters can pay dividends or make distributions. As of December 31, 2011, approximately $73,216,000 of the consolidated stockholders' equity represented net assets of the Company's subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior approval from the respective state insurance department. These regulations require prior regulatory approval of the payment of dividends and other intercompany transfers. The Company believes, however, that amounts available for transfer from the insurance and other subsidiaries are adequate to meet the Company's current operating needs.

The maximum dividend permitted by law is not necessarily indicative of an insurer's actual ability to pay dividends, which may be constrained by regulatory and business considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings. Further, depending on regulatory and business conditions, the Company may in the future need to retain cash in its underwriters in order to maintain their ratings or their statutory capital position. Such requirements could be the result of adverse financial results, changes in statutory accounting requirements by regulators, reserve charges or investment losses.

Purchase of Company Stock: On November 10, 2008, the Board of Directors of the Company approved the purchase of an additional 394,582 shares pursuant to the Company's stock repurchase plan, such that there was authority remaining under the plan to purchase up to an aggregate of 500,000 shares of the Company's common stock pursuant to the plan immediately after the approval. Pursuant to this approval, the Company purchased 182,615 shares in the twelve months ended December 31, 2011 and 12,138 shares in the twelve months ended December 31, 2010 at an average per share price of $32.53 and $31.21, respectively.

Capital Expenditures: During 2012, the Company has plans for various capital improvement projects, including hardware purchases and software projects that are anticipated to be funded via cash flows from operations. All material anticipated capital expenditures are subject to periodic review and revision and may vary depending on a number of factors.

Off-Balance Sheet Arrangements

As a service to its customers, the Company, through ITIC, administers escrow and trust deposits representing earnest money received under real estate contracts, undisbursed amounts received for settlement of mortgage loans and indemnities against specific title risks. Cash held by the Company for these purposes was approximately $15,562,000 and $17,472,000 as of December 31, 2011 and 2010, respectively. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets. However, the Company remains contingently liable for the disposition of these deposits.

In addition, in administering tax-deferred property exchanges, ITEC serves as a qualified intermediary for exchanges, holding the net sales proceeds from relinquished property to be used for purchase of replacement property. ITAC serves as exchange accommodation titleholder and, through limited liability companies that are wholly owned subsidiaries of ITAC, holds property for exchangers in reverse exchange transactions. Like-kind exchange deposits and reverse exchange property held by the Company for the purpose of completing such transactions totaled $35,359,000 and $23,044,000 as of December 31, 2011 and 2010, respectively. These exchange deposits are held at third-party financial institutions. These amounts are not considered assets of the Company for accounting purposes and, therefore, are excluded from the accompanying Consolidated Balance Sheets. Exchange services revenues include earnings on these deposits; therefore, investment income is shown as exchange services revenue, rather than investment income. The Company remains contingently liable to customers for the transfers of property, disbursements of proceeds, and the return on the proceeds at the agreed upon rate.

External assets managed by the Investors Trust Company totaled over $600,000,000 for each of the years ended December 31, 2011 and 2010. These amounts are not considered assets of the Company and, therefore, are excluded from the accompanying Consolidated Balance Sheets.

Potential Acquisition

In January 2012, the Company executed a membership interest purchase and sale agreement under which the Company has agreed to acquire a majority 70% ownership interest of a previously unaffiliated agency. The agreement also contains an option for the Company to acquire the entire agency. No estimated purchase price can be calculated at this time. The membership interest purchase and sale agreement stipulates a maximum purchase price of $1,041,250 for only the majority interest, and a minimum purchase price of $1,000,000 for the entire agency. The actual purchase cost may deviate from both the maximum and minimum amounts. The closing, subject to the satisfaction of certain conditions, is anticipated to be in the second quarter of 2012.

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Recent Accounting Standards

In January 2010, the Financial Accounting Standards Board ("FASB") updated the requirements for fair value measurements and disclosures to provide for additional disclosure related to transfers in and out of fair value hierarchy Levels 1 and 2, and to require companies to present purchases, sales, issuances and settlements of Level 3 securities on a gross rather than net basis. Refer to Note 3 for a discussion of valuation hierarchy levels. The new disclosures are clarifications of existing disclosures and are effective for interim and annual reporting periods beginning after December 15, 2009, except that the disclosures requiring the presentation of Level 3 securities trading activity on a gross basis are effective for fiscal years beginning after December 15, 2010. This update did not have an impact on the Company's financial condition or results of operations.

Pending Accounting Standards

In May 2011, FASB updated requirements for measuring and disclosing fair value information, resulting in common principles and requirements in accordance with accounting principles generally accepted in the United States of America ("GAAP") and International Financial Reporting Standards ("IFRS"). For public entities, this guidance becomes effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Management does not expect the adoption of this standard to have a material impact on the Company's Consolidated Financial Statements.

In June 2011, FASB updated requirements relating to the presentation of comprehensive income. The objectives of this accounting update are to facilitate convergence of GAAP and IFRS, to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The main provisions of the guidance require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. For public entities, this update becomes effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Management does not expect the adoption of this standard to have a material impact on the Company's Consolidated Financial Statements.

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