UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934.
/ / Transaction report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the fiscal year ended _______December 31, 1999_______________________
Commission file number _______0-20766____________________________________
HCC Insurance Holdings, Inc.
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(Exact name of registrant as specified in its
charter)
Delaware 76-0336636
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
13403 Northwest Freeway, Houston, Texas 77040-6094
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(Address of principal executive offices) (Zip Code)
(713) 690-7300
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE OF WHICH REGISTERED:
COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: NONE
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 __X__ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. / /
The aggregate market value on March 10, 2000, of the voting stock held by
non-affiliates of the registrant was approximately $501.7 million. For purposes
of the determination of the above stated amount, only directors and executive
officers are presumed to be affiliates, but neither the registrant nor any such
person concede that they are affiliates of the registrant.
The number of shares outstanding of the registrant's Common Stock, $1.00 par
value, as of March 10, 2000 was 49,095,126.
Documents incorporated by reference: Information called for in Part III of this
Form 10-K is incorporated by reference to the Registrant's definitive Proxy
Statement to be filed within 120 days of the close of the Registrant's fiscal
year in connection with the Registrant's annual meeting of shareholders.
TABLE OF CONTENTS
HCC INSURANCE HOLDINGS, INC.
PAGE
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PART I.
ITEM 1. Business.................................................... 3
ITEM 2. Properties.................................................. 26
ITEM 3. Legal Proceedings........................................... 26
ITEM 4. Submission of Matters to a Vote of Security Holders......... 26
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters......................................... 27
ITEM 6. Selected Financial Data..................................... 28
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 30
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk... 42
ITEM 8. Financial Statements and Supplementary Data................. 43
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................... 43
PART III.
ITEM 10. Directors and Executive Officers of the Registrant.......... 44
ITEM 11. Executive Compensation...................................... 44
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
ITEM 13. Certain Relationships and Related Transactions.............. 44
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................... 45
SIGNATURES......................................................................... 46
THIS REPORT ON FORM 10-K (THIS "REPORT") CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS
ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND
UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL
DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY
OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR
CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, THE
IMPACT OF POTENTIAL YEAR 2000 INSURANCE COVERAGE ISSUES, CHANGING LICENSING
REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN COUNTRIES, THE
ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, THE EFFECT
OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY
BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING.
ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR
INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR
DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE
FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL
EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND
MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND
GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE
SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDE WORDS SUCH AS "ANTICIPATE",
"BELIEVE", "ESTIMATE", "EXPECT", "INTEND", "PLAN", "PROBABLY" AND OTHER SIMILAR
EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY
BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO
BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN
LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING
STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE
REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE
OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED.
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PART I
ITEM 1. BUSINESS
GENERAL
HCC Insurance Holdings, Inc. ("HCC") is a Delaware corporation with
principal and executive offices located at 13403 Northwest Freeway, Houston,
Texas 77040. HCC and its consolidated subsidiaries are collectively referred to
herein as the "Company" unless the context otherwise requires. HCC, through its
subsidiaries, provides specialized property and casualty and life and health
insurance coverages, underwriting agency and intermediary services and other
insurance related services both to commercial customers and individuals. The
Company's insurance products are underwritten on both a direct and reinsurance
basis and are marketed directly by the Company and through a network of
independent and affiliated agents and brokers. The Company's principal insurance
company subsidiaries are Houston Casualty Company ("HC") in Houston, Texas and
London, England; HCC Life Insurance Company ("HCCL") in Houston, Texas; U.S.
Specialty Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance
Company ("AIC") in Frederick, Maryland. The principal underwriting agency
subsidiaries are LDG Reinsurance Corporation ("LDG Re") in Wakefield,
Massachusetts and New York City, New York; LDG Re (London), Ltd. ("LDG
Re-London") in London, England; HCC Aviation Insurance Group, Inc. ("HCCA") in
Dallas, Texas and Glendale, California; HCC Employer Services, Inc. ("HCCES") in
Northbrook, Illinois, Montgomery, Alabama and Dallas, Texas; and HCC Benefits
Corporation ("HCCB") in Atlanta, Georgia, Costa Mesa, California, Wakefield,
Massachusetts, Minneapolis, Minnesota and Dallas, Texas. The Company's principal
intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston,
Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas; and Rattner
Mackenzie Limited ("RML") in London, England.
Since its founding in 1974, the Company and its predecessor companies have
been consistently profitable on an annual basis, generally reporting annual
increases in gross written premium ("GWP"), management fees, brokerage income
and total revenue. During the period 1997 through 1999, the Company's insurance
company subsidiaries had an average combined ratio, before the effects of the
provision for reinsurance recorded in 1999, of 88.6% versus the less favorable
105.0% recorded by the U.S. property and casualty insurance industry overall.
During the same period, the Company's GWP increased from $346.4 million to
$568.3 million, an increase of 64%; management fees increased from
$51.0 million to $90.7 million, an increase of 78%; commission income increased
from $24.2 million to $54.6 million, an increase of 125%; and total revenue
increased from $280.3 million to $341.9 million, an increase of 22%.
The Company's insurance companies' underwriting activities are focused on
providing accident and health reinsurance, aviation, marine, offshore energy,
property, workers' compensation, group health and medical stop-loss insurance.
As an insurer in the United States, the Company operates on a surplus lines or a
non-admitted basis through HC and on an admitted basis through HCCL, AIC and
USSIC.
The Company's insurance company subsidiaries HC, AIC and USSIC are rated
"A+" (Superior) by A.M. Best Company ("A.M. Best") and are rated "AA" (Very
Strong) by Standard & Poor's Corporation ("S&P"). HCCL, a life insurance
company, is rated "A-" (Excellent) by A.M. Best. An A.M. Best or S&P rating is
intended to provide an independent opinion of an insurer's ability to meet its
obligations to policyholders and should not be considered as an investment
recommendation.
The Company's underwriting agencies underwrite on behalf of affiliated and
non-affiliated insurance companies. These agency operations specialize in
aviation, medical stop-loss, occupational accident and workers' compensation
insurance and a variety of accident and health related reinsurance products.
Beginning in 1996 with the acquisition of LDG Re, the Company commenced a
strategy of acquiring through merger or purchase, a number of companies whose
business was underwriting agency activities, primarily in the aviation, medical
stop-loss and workers' compensation insurance businesses. This was done in an
effort to further diversify the Company's operations and to enhance the
Company's ability to
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anticipate and capitalize on opportunities resulting from changing market
conditions in the insurance industry. The Company continued this expansion in
December, 1999, with the acquisition of The Centris Group, Inc. ("Centris") with
its underwriting agency subsidiary, USBenefits Insurance Services, Inc. ("USB"),
the operations of which have been integrated with HCCB. During 1999, the
Company's management fees from underwriting agencies were $90.7 million,
generated by $848.1 million in written premium. Management fees and written
premium are expected to increase in 2000 with the inclusion of USB's business.
Brokerage operations are performed by the Company's intermediary
subsidiaries. The Company's intermediary operations consist of marketing,
placing, consulting on and servicing insurance risks for its clients, which
include insurance companies and other risk taking entities. The Company's
intermediary subsidiaries specialize in employee benefits on a retail basis and
reinsurance for both accident and health and property and casualty clients. In
recent years, the Company has significantly expanded its intermediary operations
internally and through acquisitions. The latest acquisition in this area, RML,
was consummated in January, 1999. During 1999, the Company's commission income
from its intermediary operations was $54.6 million.
Subsidiaries of the Company also provide insurance claims adjustment and
servicing to the Company's insurance company and agency subsidiaries and for
unrelated entities. Additionally, from time to time, the Company will make
strategic investments, generally in companies or operations in or related to the
insurance industry. Certain of these investments are intended to enhance the
Company's operations through strategic partnering in areas common to the
investee and the Company. The Company's revenue from these investments is
comprised of equity in earnings of the investee, dividends and gains on the sale
of these investments.
STRATEGY
The Company's operating philosophy as an insurer is to maximize underwriting
profits while protecting shareholders' equity. The Company concentrates its
writings in selected, narrowly defined lines of business in which it believes
there is a substantial opportunity to achieve underwriting profits. The Company
primarily underwrites lines of business which have relatively short lead times
between the occurrence of an insured event and the reporting of claims to the
Company. The Company's insurance products are marketed both directly and through
independent and affiliated agents. With respect to its underwriting management,
marketing and related services, the Company seeks to offer quality underwriting,
decision-making, support, reinsurance capacity and financial and other resources
to take advantage of market opportunities.
The property and casualty insurance underwriting business has historically
been cyclical and particular lines of business even experience their own cycles.
These cycles are characterized by periods of excess capital and significant
competition in policy pricing, terms and conditions, followed by periods of
capital shortages, typically resulting from adverse loss experience, which lead
to decreased competition, higher premium rates and stricter underwriting
standards. The position of a particular line of business in its respective
underwriting cycle depends on prevailing premium rates, availability and cost of
reinsurance, and other market conditions. The Company considers each of these
factors in determining when to increase or decrease premium volume in each line.
With this approach, the Company focuses on increasing net earnings rather than
premium volume or market share.
The Company purchases a substantial amount of reinsurance to limit its net
loss from both individual and catastrophic risks. The degree to which the
Company reinsures varies by, among other things, the particular risks inherent
in the policies underwritten, pricing of available reinsurance and competitive
conditions within the relevant line of business.
In its insurance company operations, the Company believes its operational
flexibility, experienced underwriting personnel and access to and expertise in
the reinsurance marketplace allow the Company to
4
implement its strategy of emphasizing more profitable lines of business during
periods of increased premium rates and de-emphasizing less profitable lines of
business during periods of severe competition. In addition, through its
acquisition and ownership of insurance underwriting agencies and intermediary
businesses, the Company believes that those service based businesses can both
complement the Company's underwriting activities and serve as a source of
revenue which may not be subject to the same level of volatility as traditional
underwriting revenues. Many of the Company's insurance underwriting agency and
intermediary subsidiaries act as agents or intermediaries on behalf of the
Company's insurance company subsidiaries as well as for non-affiliated insurers.
Additionally, claims adjusting and servicing subsidiaries provide services for
the insurance company subsidiaries and their customers. The ability of the
Company's insurance company subsidiaries to utilize an affiliated insurance
underwriting agency, intermediary or service provider, and the corollary ability
of such insurance underwriting agency, intermediary and service subsidiaries to
place business with or provide other services to an affiliated insurer, permits
the Company to earn a greater portion of the total income derived from generated
premium.
The Company's business plan is to expand its underwriting activities and
continue the growth of its insurance underwriting agency and intermediary
operations. The Company will also, from time to time, make strategic investments
in companies that present an opportunity for future profit from sale or for
enhancement of the Company's business. However, the Company's business plan is
shaped by its underlying operating philosophy, which is to maximize underwriting
profit opportunities, while protecting shareholders' equity. The Company expects
to continue to seek to acquire complementary businesses with established
managements and reputations in the insurance industry, whose business, the
Company believes, can be enhanced through the synergism created by the Company's
underwriting capabilities and its other insurance related businesses. As a
result, the Company's primary interests are not necessarily in expanding market
share or GWP, but rather in increasing net earnings. To accomplish this
objective, the Company: (i) has been and is prepared to emphasize or reduce
underwritings in certain lines of business as premium rates, the availability
and cost of reinsurance and other market conditions warrant; (ii) will continue
to attempt to limit its net loss exposure through the effective, prudent and
conservative use of reinsurance; and (iii) will continue to review the possible
acquisition of other specialty insurance companies and of other strategic
operational investments.
INDUSTRY SEGMENT INFORMATION
Financial information concerning the Company's operations by industry
segment is set forth in the Consolidated Financial Statements and the Notes
thereto.
MAJOR ACQUISITIONS
On May 24, 1996, the Company issued 6,250,000 shares of its Common Stock to
acquire all of the outstanding shares of LDG. LDG, now operating as LDG Re, acts
on behalf of insurance and reinsurance companies as a reinsurance underwriting
manager in the following lines of business: accident and health, special risks
and alternative workers' compensation.
On June 17, 1997, the Company issued 8,511,625 shares of its Common Stock
and 604,575 options to purchase its Common Stock in order to acquire all of the
outstanding shares and options to purchase shares of Avemco Corporation
("Avemco"), the parent corporation of a group of insurance companies,
underwriting agencies and insurance related service companies. Avemco, through
its insurance company subsidiaries, provided property and casualty insurance
principally in the general aviation line of business. Avemco's primary insurance
company subsidiaries were AIC and USSIC. The operations of USSIC were relocated
to Houston, Texas and it became a subsidiary of HC.
On February 27, 1998, the Company issued 1,600,000 shares of its Common
Stock to acquire all of the outstanding shares of The Kachler Corporation
("Kachler"), now known as HCCEB. Kachler was a retail
5
insurance agency specializing in life, accident and health insurance for
employee benefit plans of medium and large commercial customers throughout the
United States.
On January 31, 1999, the Company acquired all of the outstanding stock of
PEPYS Holdings, Limited ("PEPYS"). PEPYS is the sole shareholder of RML. The
total initial consideration was $54.8 million in cash and deferred payments of
$8.3 million in cash and 414,207 shares of the Company's Common Stock.
Additional amounts may be paid in the future based upon the attainment of
certain earnings benchmarks over the next four years. RML, the operating entity,
provides intermediary services for reinsurance business placed by the Company's
insurance company subsidiaries as well as unaffiliated insurance and reinsurance
companies and underwriting agencies, primarily in the accident and health
marketplace.
On December 20, 1999, the Company acquired all of the outstanding shares of
Centris following a tender offer at a price of $12.50 per share. The total
consideration paid by the Company in connection with the Centris acquisition was
$149.5 million. Centris was the parent corporation of a group of insurance
companies and underwriting agencies principally operating in the medical
stop-loss line of business. Centris' primary insurance company subsidiary was
the entity now known as HCCL, whose operations are being relocated to Houston,
and it has become a subsidiary of HC. The medical stop-loss underwriting agency
operations of Centris have been combined with HCCB's operations.
The Company continues to evaluate possible acquisition candidates and may
complete one or more acquisitions during the remainder of 2000. The Company
believes these future acquisitions will expand and strengthen its existing lines
of business and perhaps provide access to additional specialty sectors, which
management expects will contribute to the growth of the Company.
DISPOSITIONS
In January, 1999, the Company sold its 21% interest in Underwriters
Indemnity Holdings, the parent of Underwriters Indemnity Company, to RLI
Corporation for $8.2 million. The Company realized a pre-tax gain of
$4.9 million in connection with the sale. The Company's investment in
Underwriters Indemnity Holdings was not material to the Company's' financial
position and results of operations.
In March, 2000, the Company sold Trafalgar Insurance Company ("TIC"), its
Oklahoma domiciled surplus lines insurance company subsidiary, for consideration
which approximated TIC's shareholders' equity determined on a GAAP basis. The
operations of TIC and the gain realized on the sale were not material to the
Company's revenue or net earnings.
INSURANCE COMPANY OPERATIONS
LINES OF BUSINESS
The following table sets forth the Company's insurance company subsidiaries'
GWP by line of business and the percent to total GWP for the three years ended
December 31, 1999 (dollars in thousands):
1999 1998 1997
------------------- ------------------- -------------------
Accident and health reinsurance............... $157,719 28% $114,787 23% $ 39,845 12%
Aviation...................................... 210,029 37 203,573 40 164,519 47
Marine........................................ 11,967 2 13,259 3 22,847 6
Medical stop-loss............................. 69,258 12 7,046 1 3,388 1
Offshore energy............................... 6,727 1 21,682 5 7,469 2
Property...................................... 63,309 11 106,515 21 85,379 25
Workers' compensation......................... 27,747 5 8,958 2 -- --
Other......................................... 21,575 4 22,456 5 22,952 7
-------- --- -------- --- -------- ---
Total GWP................................... $568,331 100% $498,276 100% $346,399 100%
======== === ======== === ======== ===
6
The following table sets forth the Company's insurance company subsidiaries'
net written premium ("NWP") by line of business and the percent to total NWP for
the three years ended December 31, 1999 (dollars in thousands):
1999 1998 1997
------------------- ------------------- -------------------
Accident and health reinsurance............... $ 37,725 27% $ 39,949 33% $ 24,777 17%
Aviation...................................... 68,513 49 53,030 44 75,280 53
Marine........................................ 5,483 4 5,654 5 17,271 12
Medical stop-loss............................. 20,332 15 3,415 3 3,388 2
Offshore energy............................... 1,133 1 2,324 2 1,416 1
Property...................................... 2,945 2 8,356 6 8,636 6
Workers' compensation......................... 673 -- 1,059 1 -- --
Other......................................... 3,120 2 8,096 6 12,085 9
-------- --- -------- --- -------- ---
Total NWP................................... $139,924 100% $121,883 100% $142,853 100%
======== === ======== === ======== ===
UNDERWRITING
DIRECT--The Company underwrites direct business produced through independent
agents and brokers, affiliated intermediaries, and, by direct marketing efforts,
primarily in small general aviation business.
REINSURANCE ASSUMED--The Company's current reinsurance underwriting
activities are primarily in: 1) the accident and health lines of business where
the Company's insurance company subsidiaries participate in various insurance
and reinsurance underwriting pools managed by its underwriting agency
subsidiaries, and 2) facultative (individual account) reinsurance, particularly
in the aviation and property lines of business. Typically, the facultative
reinsurance is on international business in order to comply with local licensing
requirements or as reinsurance of captives, and usually can be considered direct
business, as the Company maintains underwriting and claims control. However, all
of this business is recorded under the caption of "Reinsurance Assumed".
AVIATION--Aviation underwriting was the Company's largest overall line of
business in 1999 and in recent years the Company has grown into a market leader
in the aviation insurance industry. The Company insures general aviation risks,
including private aircraft owners and pilots, fixed base operations, rotor wing
aircraft, corporate aircraft, cargo operations, commuter airlines and similar
operations, both domestically and internationally. At this time, the Company
does not generally insure major airlines, major manufacturers or satellites. The
coverages underwritten include hull (including engines, avionics and other
systems), liabilities, war, cargo and various ancillary coverages. Insurance
claims related to general aviation business tend to be seasonal, with the bulk
of claims incurring during the spring and summer months.
The Company has been underwriting aviation risks since 1981 through HC. AIC
has been insuring aviation risks since 1959. GWP has risen consistently since
1997, increasing from a combined $164.5 million to $210.0 million in 1999. This
growth has occurred due to internal growth and acquisitions. Although, due to
market conditions, domestic risks had not been a focus for the Company since the
early 1990's, HC increased its writing of domestic general aviation risks late
in 1996. With the acquisition of AIC and USSIC in mid-1997, the Company achieved
the position of a major participant in the domestic general aviation insurance
market. The Company's position is further enhanced by its aviation underwriting
agency, HCCA. In 1997 and 1998, the Company experienced a decline in NWP due to
the implementation of the Company's reinsurance program at AIC following its
acquisition in 1997. Aviation NWP increased during 1999 as HCC increased its
retentions.
Reinsurance is maintained on both a proportional and an excess of loss basis
to protect the Company against individual risk severity of loss and catastrophe
exposure. Management believes that the aviation risks underwritten by the
Company carry a relatively low level of catastrophe exposure.
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MARINE--The Company underwrites marine risks for ocean going vessels ("Blue
Water"), inland and coastal trading vessels ("Brown Water") and fishing vessels.
The coverages written include hull and machinery, liabilities (including
protection and indemnity), marine cargo and various ancillary coverages.
The Company has underwritten marine risks since 1984, primarily in HC.
Premium rates were adequate through 1995 but competition has created downward
pressure on these rates causing a reduction in the Company's GWP from
$22.8 million in 1997 to $12.0 million in 1999 and a corresponding decrease in
NWP from $17.3 million to $5.5 million for the same period. Underwriting
operations have been moved to HC's branch office in London, where a substantial
amount of the Company's business originates and experienced underwriters are
more available.
Reinsurance is maintained on an excess of loss basis to protect the Company
against individual risk severity of loss and catastrophe exposure. Management
believes that the marine risks underwritten by the Company carry a relatively
low level of catastrophe exposure.
OFFSHORE ENERGY--The Company has been underwriting offshore energy risks
since 1988, primarily in HC. Offshore energy risks include drilling rigs,
production and gathering platforms, and pipelines. Coverages underwritten
include physical damage, liabilities, business interruption and various
ancillary coverages.
Rates have declined significantly during the past few years to levels where
underwriting profitability is unlikely. Underwriting has been on a very
selective basis, striving for quality rather than quantity. The
disproportionately high GWP and NWP during 1998 was the result of one large
policy that was substantially reinsured. Underwriting operations have been moved
to HC's branch office in London, where a substantial amount of the Company's
business originates and experienced underwriters are more available.
Reinsurance is maintained on both a proportional and an excess of loss basis
to protect the Company against individual risk severity of loss and the
catastrophic exposure that exists, for example, from a hurricane in the Gulf of
Mexico or a major platform explosion.
PROPERTY--The Company specializes in writing the property risks of large,
often multinational, corporations covering such commercial risks as hotels,
office buildings, retail locations, factories, industrial plants, utilities,
refineries, natural gas facilities and petrochemical plants. Coverage includes
business interruption and physical damage and catastrophe risks including flood
and earthquake.
The Company has written property business since 1986, primarily in HC.
During 1996, premium rates began to soften and this trend has continued through
1999 due in a large part to excess capacity and the absence of significant
catastrophe losses. GWP has declined from $85.4 million in 1997 to
$63.3 million in 1999 and is expected to decline further in 2000. NWP also
declined from $8.6 million to $2.9 million in the same period. Property NWP will
always be substantially less than GWP due to the amount of reinsurance purchased
in order to protect the Company from catastrophe exposure. Underwriting
operations have been moved to HC's branch office in London, where a substantial
amount of the Company's business originates and experienced underwriters are
more available.
Reinsurance is maintained on both a proportional and an excess of loss basis
to ensure adequate protection, particularly against catastrophic exposures. As
an example, through December 31, 1999, the Company had gross losses of
$60.8 million with respect to hurricanes Georges and Mitch both of which
occurred during 1998. The after-tax net loss, after reinsurance, with respect to
these hurricanes was $4.3 million. The Company conservatively estimates its
aggregate exposure in any individual catastrophe zone and maintains catastrophe
reinsurance to cover its exposure to any one occurrence.
ACCIDENT AND HEALTH REINSURANCE--The Company began underwriting accident and
health reinsurance risks in HC during 1996. These risks are underwritten
primarily by LDG Re, which was acquired by the Company during that year. The
risks underwritten include reinsurance in the accident and health special risks
and alternative workers' compensation areas and occupational accident insurance
for self-employed
8
truckers. The Company's GWP increased from $39.8 million in 1997 to
$157.7 million in 1999. This growth is from the Company's increased
participation in and the growth of the business underwritten by LDG Re. NWP has
not increased as dramatically as HC does not retain a large percentage of this
premium.
MEDICAL STOP-LOSS--Medical stop-loss business is written on an aggregate and
specific basis for employer sponsored self-insured health plans. This business
is underwritten by HCCB. The Company first began writing this business in 1996,
and GWP and NWP have increased as a result of greater participation in and the
growth of the business underwritten by HCCB. This growth is expected to continue
in the future.
WORKERS' COMPENSATION--The Company began writing statutory workers'
compensation business primarily in USSIC in 1998 by participating in the
business underwritten by HCCES. It is the intent of the Company to grow this
line of business in the future internally and possibly through acquisition. GWP
and NWP will rise in 2000, although substantial proportional reinsurance will
continue to be purchased. There is relatively no catastrophe exposure in this
line of business as there is very little business currently written in
California or Florida. Losses in this line of business generally take longer to
develop than in the Company's other lines of business.
INSURANCE COMPANY SUBSIDIARIES
HOUSTON CASUALTY COMPANY--HC, the Company's principal insurance company
subsidiary, is a Texas domiciled property and casualty insurer. HC is rated "A+,
VIII" by A.M. Best and "AA" by Standard & Poor's and operates worldwide in most
of the lines of business in which the Company specializes. HC's business is
produced by independent agents and brokers, the group's underwriting agency and
intermediary subsidiaries, and other insurance and reinsurance companies
worldwide. HC has a highly experienced staff of underwriters trained to deal
with the high value, complicated exposures prevailing in many of the lines of
business in which the Company specializes. As of December 31, 1999, HC had
statutory policyholders' surplus of $250.2 million.
HOUSTON CASUALTY COMPANY--LONDON--HC was authorized by Her Majesty's
Treasury in 1998 to operate a full branch office in the United Kingdom. HC
established its London branch operation in order to more closely align its
underwriting operations with the London market, a historical focal point for
many of the markets in which HC operates. To this end, the Company has
transferred most of the underwriting responsibility for the lines of business HC
writes, except aviation and, to some extent, accident and health to this branch.
HCC LIFE INSURANCE COMPANY--HCCL is an Indiana domiciled life insurance
company and former subsidiary of Centris, which became a direct subsidiary of HC
in December, 1999 following the Centris acquisition. HCCL is rated "A-"
(Excellent) by A.M. Best and operates as an accident and health insurer on an
admitted basis in 41 states and the District of Columbia. The Company expects to
expand HCCL's operations through its utilization as an insurer of medical
stop-loss and related life insurance products underwritten by HCCB. At
December 31, 1999, HCCL had statutory policyholder's surplus of $70.5 million.
U.S. SPECIALTY INSURANCE COMPANY--USSIC is a Texas domiciled property and
casualty insurance company. It is a direct subsidiary of HC. USSIC is rated "A+,
VII" by A.M. Best and "AA" by Standard & Poor's. USSIC operates on an admitted
basis throughout the United States primarily writing general aviation, workers'
compensation and alternative workers' compensation insurance produced by
underwriting agency subsidiaries of the Company. As of December 31, 1999, USSIC
had statutory policyholders' surplus of $104.4 million.
AVEMCO INSURANCE COMPANY--AIC was organized in 1959 and became a subsidiary
of the Company in June, 1997. AIC is a Maryland domiciled property and casualty
insurer, is rated "A+, VI" by A.M. Best and "AA" by Standard & Poor's and
operates primarily as a direct market underwriter of general aviation
9
business on an admitted basis throughout the United States and Canada (except
Quebec). In addition, as a part of the Company's overall operations, AIC has
become an insurer of medical stop-loss products underwritten by HCCB. At
December 31, 1999, AIC had statutory policyholders' surplus of $62.5 million.
UNDERWRITING AGENCY OPERATIONS
The Company's underwriting agency subsidiaries act on behalf of insurance
and reinsurance companies, conducting business in the areas of insurance
underwriting management and claims administration. The underwriting agency
subsidiaries do not assume any insurance or reinsurance risk themselves and the
revenues generated are based entirely on management fees and profit commissions.
These subsidiaries are in a position to direct and control business that they
produce. In addition, certain of the business written by the underwriting
agencies is insured or reinsured by the Company's insurance company
subsidiaries. In some cases, the insurance company subsidiaries serve as policy
issuing companies for this business. The insurance company subsidiaries may
retain a portion of the risk and reinsure the remainder with other unaffiliated
insurance companies or reinsure all of the risk.
LINES OF BUSINESS
The following table sets forth the Company's underwriting agency
subsidiaries' premium by lines of business for the three years ended
December 31, 1999 (dollars in thousands):
1999 1998 1997
------------------- ------------------- -------------------
Accident and health reinsurance................ $452,017 53% $356,530 50% $258,716 55%
Aviation....................................... 91,156 11 92,668 13 49,581 10
Medical stop-loss.............................. 184,302 22 182,528 26 93,435 20
Occupational accident.......................... 54,000 6 48,100 7 46,909 10
Workers' compensation.......................... 52,758 6 4,429 1 -- --
Other.......................................... 13,883 2 21,932 3 24,798 5
-------- --- -------- --- -------- ---
Total premium.............................. $848,116 100% $706,187 100% $473,439 100%
======== === ======== === ======== ===
UNDERWRITING AGENCY SUBSIDIARIES
LDG REINSURANCE CORPORATION--LDG Re, with operations in Wakefield,
Massachusetts and New York City, New York, acts as an underwriting manager
writing accident and health, special risks and alternative workers' compensation
reinsurance. In 1999, LDG Re generated approximately $360.2 million of written
premium, the majority of which was written on behalf of non-affiliated insurance
companies.
LDG RE (LONDON), LTD.--LDG Re-London, located in London, England, is an
underwriting manager writing accident and health reinsurance business. During
1999, LDG Re-London generated approximately $90.1 million of written premium.
During 2000, LDG Re-London will underwrite primarily on behalf of HC-London.
HCC BENEFITS CORPORATION--HCCB, with its home office in Atlanta, Georgia and
regional offices in Costa Mesa, California, Wakefield, Massachusetts,
Minneapolis, Minnesota and Dallas, Texas, acts as an underwriting manager
writing medical stop-loss and excess medical insurance products to employer
sponsored self-insured health plans. In 1999, HCCB generated approximately
$184.3 million of medical stop-loss written premium and $6.7 million of other
written premium, the majority of which was underwritten on behalf of
non-affiliated insurance companies. In 1999, the acquired Centris agencies
generated approximately $214.2 million of written premium. It is expected that
in 2000 a substantial part of the overall written premium for HCCB will be
issued through HCCL and AIC.
HCC AVIATION GROUP, INC.--HCCA, with offices in Dallas, Texas and Glendale,
California, together with the Company's insurance company subsidiary AIC,
provides the base for the Company's presence in
10
the domestic general aviation market. HCCA acts as an underwriting manager on
behalf of USSIC in the areas of private and corporate aircraft, commercial
agricultural aircraft, antique and vintage military aircraft, small to medium
sized airports, and commercial operators. During 1999, HCCA generated
approximately $91.1 million of written premium.
HCC EMPLOYER SERVICES, INC.--HCCES, with operations in Northbrook, Illinois,
Montgomery, Alabama and Dallas, Texas, acts as an underwriting manager on behalf
of affiliated and non-affiliated insurance companies, providing occupational
accident and health insurance to self-employed truckers and workers'
compensation insurance to small and medium size businesses. HCCES generated
approximately $101.6 million in premium in 1999.
Management fees generated by underwriting agency subsidiaries in 1999
amounted to $90.7 million, an increase of 23% over 1998.
COMBINED INSURANCE COMPANY AND UNDERWRITING AGENCY OPERATIONS
The Company's combined GWP was over $1.1 billion, after intercompany
eliminations, in 1999 with its insurance company operations writing
$568.3 million and its underwriting agency operations writing $848.1 million,
before intercompany eliminations.
INTERMEDIARY OPERATIONS
The services performed by the Company's insurance intermediary subsidiaries
consist of marketing, placing, consulting on and servicing insurance risks for
their clients, which include medium to large corporations, insurance and
reinsurance companies or other risk taking entities. The intermediary
subsidiaries earn commission income and to a lesser extent fees for certain
services, generally from the underwriters with whom the business is placed.
Certain of these risks may be initially underwritten by the Company's insurance
company subsidiaries who may retain a portion of the risk.
HCC EMPLOYEE BENEFITS, INC.,--HCCEB, based in Houston, Texas, is a retail
insurance agency and consulting firm specializing in life, accident and health
insurance for employee benefit plans of medium and large commercial customers
throughout the United States.
HCC INTERMEDIARIES, INC.--HCCI, based in Houston, Texas, is an intermediary
specializing in marketing and servicing large, complicated insurance and
reinsurance programs placed on behalf of multinational clients operating in the
same lines of business that the Company underwrites. This business is placed
with domestic and international insurance companies, including affiliated
insurance companies, on a direct basis and through other intermediaries. In
addition, HCCI acts as a reinsurance intermediary on behalf of affiliated and
non-affiliated insurance companies.
RATTNER MACKENZIE LIMITED--RML is an intermediary based in London, England.
RML is a Lloyd's broker specializing in accident and health reinsurance and
certain specialty property and casualty lines of business. Management believes
that RML is considered a market leader in its core businesses. RML serves as an
intermediary for reinsurance business placed by unaffiliated insurance and
reinsurance companies and underwriting agencies as well as the Company's
insurance company subsidiaries.
Commission income generated by intermediary subsidiaries in 1999 amounted to
$54.6 million, an increase of 42% over 1998.
11
OTHER OPERATIONS
The Company's other operations consist of subsidiaries that are not
insurance companies, underwriting agencies or intermediaries. These operations
generally are insurance related services that may be performed for the Company's
subsidiaries, its reinsurers or unaffiliated entities. The revenue earned from
these services primarily consist of fees, commissions or the sales price of
products sold. The subsidiaries currently operating in this segment provide
insurance claims adjusting services and the development and sale of insurance
industry related software. Additionally, other operations include the returns
received from certain insurance related strategic operational investments which
the Company makes from time to time. Certain of these investments provide
strategic partnering opportunities. These returns may be in the form of equity
in the earnings of the investee, dividends or gains from the disposition of
these investments.
Other operating income was $28.5 million in 1999, up 28% from 1998.
REINSURANCE CEDED
The Company principally utilizes reinsurance to reduce its net liability on
individual risks, to protect against catastrophic losses and to achieve a
desired ratio of NWP to policyholders' surplus. Various intermediaries,
including HCCI and RML, facilitate the placement of this reinsurance coverage on
behalf of the Company and are compensated, directly or indirectly, by the
reinsurers.
Reinsurance is ceded on both a proportional and an excess of loss basis.
Management believes that the Company reinsures its risks to a greater extent
than most of its competitors and most other insurance companies. This strategy
greatly reduces the likelihood of a significant net loss from insurance company
operations and is also intended to protect the Company's shareholders' equity.
Under its current reinsurance protections, the Company has limited its net
retained loss, across any single line of business, to a maximum of approximately
$1.0 million for any one risk, but significantly less on most risks.
The type, cost and limits of reinsurance purchased can vary from year to
year based upon the Company's desired retention levels and the availability of
quality reinsurance at a reasonable price. The Company's reinsurance programs
renew throughout the year. Excess of loss programs that expired in 1999 have
been renewed with some increase in reinsurance costs. Additionally, the Company
retained higher percentages of its business in connection with certain lines of
business reinsured on a proportional basis. The Company plans to continue to
increase its retentions as underwriting conditions improve.
The availability of reinsurance continues to be an important part of the
Company's business plan, protecting shareholders' equity from catastrophe losses
and the inconsistencies of the insurance cycle. Important relationships have
been built up over the years with many core reinsurers who have supported the
Company in good and bad times. The Company intends to continue to share its
business with these partners as underwriting profitability returns, to allow
them to recoup losses and build even stronger relationships for the future.
Management believes that increased retentions during profitable periods are made
possible not at the sacrifice of core reinsurers but through reduction of
facultative reinsurance and the natural attrition of certain reinsurers who exit
lines of business or severely curtail their writings. This reduction in
reinsurance market capacity causes rates to rise but the increased rates
historically have been passed on to the primary market clients.
The Company structures a specific reinsurance program for each line of
business it underwrites. This reinsurance is placed in order to protect the
Company from exposure to foreseeable events. The Company places reinsurance
proportionally to cover loss frequency and catastrophe exposure. The Company
places additional reinsurance on an excess of loss basis to cover individual
risk severity of loss and on a catastrophe basis to cover exposure from
occurrences involving multiple risks, such as those resulting from a hurricane
or an earthquake. The Company does not intend to expose itself to any net loss
in excess of its reinsurance protection.
12
The Company writes business in areas exposed to catastrophic losses and has
exposures to this type of loss in California, the Atlantic Coast of the United
States, certain United States Gulf Coast states, particularly in Florida and
Texas, the Caribbean and Mexico. The Company carefully assesses its overall
exposures to a single catastrophic event and applies procedures that it believes
are more conservative than are typically used by the industry to ascertain the
Company's probable maximum loss ("PML") from any single event. The Company
maintains reinsurance protection which it believes is sufficient to cover any
foreseeable event.
The Company receives an overriding (ceding) commission on the premium ceded
to reinsurers. This compensates the Company for the direct costs associated with
the production of the premium, the servicing of the business during the term of
the policies ceded and the costs associated with the placement of the related
reinsurance. In addition, certain of the Company's reinsurance treaties allow
the Company to share with the reinsurers in any net profits generated under such
treaties.
The ceding of reinsurance does not discharge the Company from liability to
its policyholders. The Company is required to pay losses even if the reinsurer
fails to meet its obligations under the reinsurance contract. To minimize its
exposure to reinsurance credit risk, the Company places its reinsurance with a
diverse group of financially sound reinsurers. The Company's 2000 treaty
reinsurance programs were placed with more than 92 domestic and foreign
reinsurers. As of December 31, 1999, the total amount recoverable from
reinsurers with respect to property and casualty insurance was approximately
$683.3 million, of which $91.3 million represents paid losses recoverable (in
the ordinary course of business) and $597.5 million represents outstanding
losses and estimated incurred but not reported loss recoverables, less a
$5.5 million reserve for potentially uncollectible reinsurance. In addition,
ceded unearned premium was $133.7 million. Of the $683.3 million,
$122.8 million was added as a result of the Centris acquisition in late
December, 1999. As of December 31, 1999, the Company held $154.1 million of
irrevocable letters of credit and $19.9 million in cash to collateralize a
portion of the total amount recoverable and had other payable balances due to
its reinsurers of $213.0 million as potential offsets against reinsurance
recoverables. The estimated duration for the Company's outstanding losses is two
years, as the majority of the Company's business has historically had shorter
lead times between the occurrence of an insured event and the final settlements.
The following table shows property and casualty reinsurance balances relating to
the reinsurers with net recoverable balances greater than $10.0 million as of
December 31, 1999. The total recoverables column includes paid loss recoverable,
outstanding loss recoverable, IBNR recoverable and ceded unearned premium.
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- ------------ --------------- ------------ ------------------ ------------
December 31, 1999:
Underwriters at Lloyd's................... A United Kingdom $156,650,000 $22,805,000 $133,845,000
Underwriters Indemnity Company *.......... A- Texas 50,451,000 4,201,000 46,250,000
SCOR Reinsurance Company.................. A+ New York 41,137,000 1,740,000 39,397,000
AXA Reinsurance Company................... A+ Delaware 37,690,000 5,013,000 32,677,000
NAC Reinsurance Company **................ A+ New York 23,153,000 6,105,000 17,048,000
Transamerica Occidental Life Ins. Co...... A+ California 22,481,000 6,102,000 16,379,000
St. Paul Fire and Marine Insurance Co..... A+ Minnesota 17,577,000 1,721,000 15,856,000
Odyssey America Reinsurance Corp.......... A Connecticut 19,114,000 5,891,000 13,223,000
Sun Life Assurance Company of Canada...... A++ Canada 17,996,000 4,786,000 13,210,000
GE Reinsurance............................ A++ Illinois 16,535,000 4,869,000 11,666,000
Chartwell Reinsurance Company ***......... A Minnesota 12,736,000 2,074,000 10,662,000
- ------------------------------
* Underwriters Indemnity Company was acquired by RLI Corporation in January,
1999.
** NAC Reinsurance Corporation was acquired by XL Capital, Ltd. in June, 1999.
*** Chartwell Reinsurance Company was acquired by Trenwick Group, Inc. in
October, 1999.
13
Prior to our acquisition of Centris, its life insurance company subsidiary,
now HCCL, sold its entire block of life insurance and annuity business to Life
Reassurance Corporation of America in the form of an indemnity reinsurance
contract. Ceded life and annuity benefits amounted to $95.8 million as of
December 31, 1999.
In 1999, the Company recorded a $43.5 million provision for reinsurance to
reflect an estimated $29.5 million pre-tax loss for the insolvency of one of the
Company's reinsurers and an estimated $14.0 million pre-tax loss, the majority
of which represents the discount on ceded reserves, related to the commutation
of all liabilities with another reinsurer. This commutation, made at the
Company's request, was finalized and settled in February, 2000. In connection
with the commutation, the Company received cash and other amounts totaling
$56.5 million. Additionally, as of December 31, 1999 the Company has established
a reserve of $5.5 million which management believes is sufficient to absorb any
potential losses related to its reinsurance recoverables. However, the adverse
economic environment in the worldwide insurance industry has placed great
pressure on reinsurers and the results of their operations and these conditions
could, ultimately, affect reinsurers' solvency. Historically, there have been
insolvencies following a period of competitive pricing in the industry, such as
the marketplace has experienced for the last several years. Therefore, while
management believes that the reserve is adequate based upon current available
information, conditions may change or additional information might be obtained
that would affect management's estimate of the adequacy of the level of the
reserve and which may result in a future increase or decrease in the reserve.
Management continually reviews the Company's financial exposure to the
reinsurance market and will continue to take actions to protect shareholders'
equity.
OPERATING RATIOS
PREMIUM TO SURPLUS RATIO
The following table shows, for the periods indicated, the ratio of statutory
GWP and NWP to statutory policyholders' surplus for the Company's property and
casualty insurance company subsidiaries:
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
GWP....................................... $576,184 $500,962 $346,094 $340,367 $338,753
NWP....................................... 150,261 123,315 143,068 189,022 184,028
Policyholders' surplus.................... 315,474 369,401 331,922 288,863 251,125
GWP ratio................................. 182.6% 135.6% 104.3% 117.8% 134.9%
GWP industry average (1).................. * 147.9 154.7 179.9 194.0
NWP ratio................................. 47.6% 33.4% 43.1% 65.4% 73.3%
NWP industry average (1).................. * 84.3 89.7 105.2 113.0
- ------------------------
* Not available
(1) Source: A.M. Best.
While there is no statutory requirement regarding a permissible premium to
surplus ratio, guidelines established by the National Association of Insurance
Commissioners ("NAIC") provide that a property and casualty insurer's annual
statutory GWP should not exceed 900% and NWP should not exceed 300% of its
policyholders' surplus. However, industry standards and rating agency criteria
place these ratios at 300% and 200%, respectively. In keeping with its
philosophy of protecting its shareholders' equity and limiting its aggregate
loss exposure, the Company maintains premium to surplus ratios significantly
lower than such guidelines and generally well below industry norms. These ratios
are expected to increase, however, as the Company's insurance company
subsidiaries continue to increase their participation as policy issuers for
business written by the Company's underwriting agency subsidiaries and their
retention of that business.
14
COMBINED RATIO
The underwriting experience of a property and casualty insurance company is
indicated by its combined ratio. The Company's insurance subsidiaries' loss
ratio, expense ratio and combined ratio, determined on the basis of statutory
accounting principles ("SAP"), are shown in the following table:
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Loss ratio.......................................... 107.1% 67.2% 61.6% 64.4% 66.4%
Expense ratio....................................... 22.8 15.7 17.2 19.2 18.1
----- ----- ----- ----- -----
Combined ratio...................................... 129.9% 82.9% 78.8% 83.6% 84.5%
===== ===== ===== ===== =====
Combined ratio excluding the effects of the
provision for reinsurance in 1999................. 104.1%
=====
Industry average (1)................................ 107.7% 105.6% 101.6% 105.7% 106.3
- ------------------------
(1) Source: A.M. Best.
The SAP basis ratio data is not intended to be a substitute for results of
operations on the basis of generally accepted accounting principles ("GAAP").
The differences between SAP and GAAP are described in Note (15) of the Company's
consolidated financial statements. Including this information on a SAP basis is
meaningful and useful to allow a comparison of the Company's operating results
with those of other companies in the insurance industry. A.M. Best reports on
insurer performance on a SAP basis to provide for more standardized comparisons
among individual companies, as well as overall industry performance.
RESERVES
Applicable insurance laws and regulations require that reserves be
maintained for the payment of loss and loss adjustment expense ("LAE") with
respect to both reported and incurred but not reported ("IBNR") claims under
insurance and reinsurance policies issued by the Company's insurance company
subsidiaries. In most cases, the Company establishes reserves through an
evaluation of individual claims. In some types of aviation claims, an average
reserving method is utilized until more information becomes available which will
permit a more specific individual evaluation of claims. In the case of direct
and facultative reinsurance business, loss reserves are determined by evaluating
reported claims on the basis of the type of loss, jurisdiction of the
occurrence, knowledge of the circumstances surrounding the claim, severity of
injury or damage, potential for ultimate exposure, experience with the insured
and the line of business and policy provisions relating to the particular type
of claim. The Company establishes loss reserves for excess of loss and
proportional reinsurance claims based on information and reports received from
ceding companies. Loss reserves for IBNR losses are determined in part on the
basis of statistical information and in part on industry experience with respect
to the probable number and nature of claims arising from occurrences which have
not been reported. The Company does not discount any of its loss reserves.
With respect to some classes of risks, the period of time between the
occurrence of an insured event and the final settlement of a claim may be many
years, and during this period it often becomes necessary to adjust the claim
estimates either upward or downward. Certain classes of marine and offshore
energy insurance and workers' compensation insurance underwritten by the Company
have historically had longer lead times between the occurrence of an insured
event, reporting of the claim to the Company, and final settlement. In such
cases, the Company is forced to estimate reserves over long periods of time with
the possibility of several adjustments to reserves. Other classes of insurance
the Company underwrites, such as most aviation, property and medical stop-loss,
historically have shorter lead times between the occurrence of an insured event,
reporting of the claim to the Company and final settlement. The reserves with
respect to such classes are, therefore, less likely to be adjusted. The classes
of insurance with shorter lead times
15
currently represent the majority of the risks underwritten by the Company's
insurance company operations.
The reserving process is intended to provide implicit recognition of the
impact of inflation and other factors affecting loss payments by taking into
account changes in historical payment patterns and perceived probable trends.
However, there is no precise method for the subsequent evaluation of the
adequacy of the consideration given to inflation, or to any other specific
factor, some of which are interdependent.
The Company underwrites, directly and through reinsurance, risks which are
denominated in a number of foreign currencies, and therefore establishes and
maintains loss reserves with respect to these policies in the respective
currencies. These reserves are subject to exchange rate fluctuations, which may
have an effect on the Company's earnings. From time to time, the Company may
attempt to limit its exposure to future currency fluctuations through the use of
foreign currency forward contracts.
The following loss development triangles show changes in reserves in
subsequent years from the prior loss estimates based on experience as of the end
of each succeeding year on the basis of GAAP. The estimate is increased or
decreased as more information becomes known about the frequency and severity of
losses for individual years. A redundancy means the original estimate was higher
than the current estimate; a deficiency means that the current estimate is
higher than the original estimate.
The first line of each loss development triangle presents, for each of the
years indicated, the gross reserve liability including the reserve for IBNR
losses. The first section of each table shows, by year, the cumulative amounts
of loss and LAE paid as of the end of each succeeding year. The second section
sets forth the re-estimates in later years of incurred losses, including
payments, for the years indicated. The "cumulative redundancy (deficiency)"
represents, as of December 31, 1999, the difference between the latest
re-estimated liability and the reserves as originally estimated.
The following loss development triangle shows development in loss reserves
on a gross basis:
1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- ---------
Balance sheet
reserves:.......... $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $ 129,503
Cumulative paid as
of:
One year later..... 229,746 160,324 119,453 118,656 97,580 82,538 83,574
Two years later.... 209,724 179,117 167,459 143,114 126,290 130,379
Three years
later............ 193,872 207,191 166,541 157,509 158,973
Four years later... 214,046 192,540 176,472 182,193
Five years later... 195,930 195,269 192,512
Six years later.... 197,147 213,052
Seven years
later............ 215,280
Re-estimated
liability as of:
End of year........ 871,104 460,511 275,008 229,049 200,756 170,957 144,178 129,503
One year later..... 550,545 308,501 252,236 243,259 186,898 163,967 162,827
Two years later.... 316,250 249,013 248,372 207,511 183,015 176,817
Three years
later............ 250,817 247,053 214,738 203,137 194,419
Four years later... 248,687 220,695 211,546 215,531
Five years later... 217,892 218,182 222,746
Six years later.... 214,498 234,115
Seven years
later............ 231,269
Cumulative redundancy
(deficiency)....... $(90,034) $(41,242) $(21,768) $(47,931) $(46,935) $(70,320) $(101,766)
16
The gross deficiencies result from three principal conditions. The first is
the development of large claims on individual policies which were either
reported late by or for which reserves were increased as subsequent information
became available from the insurance companies that are responsible for adjusting
the claims. However, as these policies were substantially reinsured, there was
no material effect to the Company's net earnings. Secondly, during 1999 in
connection with the insolvency of one of the Company's reinsurers and with the
commutation, finalized subsequent to year-end, of all liabilities with another,
the Company re-evaluated all reserves and IBNR related to business placed with
these reinsurers to determine the ultimate losses it might conservatively
expect. These reserves were then used as the basis for the determination of the
provision for reinsurance recorded in 1999. Thirdly, for the years prior to
1997, the runoff of the retrocessional excess of loss business, which the
Company underwrote between 1988 and 1991, experienced gross development. This
development is due primarily to the delay in reporting of losses by the London
insurance market, coupled with the unprecedented number of catastrophe losses
during that period. This business is substantially reinsured, thereby not having
a material effect on the Company's net earnings.
17
The following loss development triangle shows development in loss reserves
on a net basis:
1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- --------
Gross reserves for loss and LAE.... $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $129,503
Less reinsurance recoverables...... 597,498 341,599 155,374 111,766 101,497 95,279 82,289 81,075
-------- -------- -------- -------- -------- -------- -------- --------
Reserves for loss and LAE, net of
reinsurance...................... 273,606 118,912 119,634 117,283 99,259 75,678 61,889 48,428
Effect on loss reserves of 1999
write off of ceded outstanding
and IBNR reinsurance
recoverables..................... -- 63,851 15,008 2,636 1,442 51 -- --
-------- -------- -------- -------- -------- -------- -------- --------
Reserves for loss and LAE net of
reinsurance and adjusted for
writeoff......................... 273,606 182,763 134,642 119,919 100,701 75,729 61,889 48,428
Cumulative paid, net of
reinsurance, as of:
One year later................... 56,052 48,775 47,874 41,947 36,500 29,258 18,978
Two years later.................. 64,213 66,030 56,803 49,283 41,207 32,733
Three years later................ 72,863 64,798 56,919 46,576 36,536
Four years later................. 67,355 60,441 51,536 38,480
Five years later................. 61,781 53,110 40,327
Six years later.................. 53,879 40,550
Seven years later................ 41,133
Eight years later................
Nine years later.................
Ten years later..................
Re-estimated liability, net of
reinsurance, as of:
End of year...................... 273,606 182,763 134,642 119,919 100,701 75,729 61,889 48,428
One year later................... 187,377 120,049 116,145 95,764 72,963 59,659 45,812
Two years later.................. 116,745 101,595 94,992 74,887 60,079 44,964
Three years later................ 97,353 85,484 76,474 62,224 46,129
Four years later................. 80,890 73,660 64,377 48,993
Five years later................. 69,528 64,103 50,785
Six years later.................. 59,408 50,585
Seven years later................ 46,071
Eight years later................
Nine years later.................
Ten years later..................
Cumulative redundancy
(deficiency)..................... $ (4,614) $ 17,897 $ 22,566 $ 19,811 $ 6,201 $ 2,481 $ 2,357
1991 1990 1989
-------- -------- --------
Gross reserves for loss and LAE.... $123,248 $108,027 $96,477
Less reinsurance recoverables...... 83,727 60,194 45,160
-------- -------- -------
Reserves for loss and LAE, net of
reinsurance...................... 39,521 47,833 51,317
Effect on loss reserves of 1999
write off of ceded outstanding
and IBNR reinsurance
recoverables..................... -- -- --
-------- -------- -------
Reserves for loss and LAE net of
reinsurance and adjusted for
writeoff......................... 39,521 47,833 51,317
Cumulative paid, net of
reinsurance, as of:
One year later................... 18,416 23,450 22,660
Two years later.................. 23,057 33,815 34,300
Three years later................ 31,903 35,912 40,806
Four years later................. 33,875 42,465 41,878
Five years later................. 34,970 43,422 46,734
Six years later.................. 36,203 43,690 47,164
Seven years later................ 35,413 44,611 47,229
Eight years later................ 35,960 43,715 47,928
Nine years later................. 44,203 46,308
Ten years later.................. 46,646
Re-estimated liability, net of
reinsurance, as of:
End of year...................... 39,521 47,833 51,317
One year later................... 38,575 44,887 49,475
Two years later.................. 38,656 45,435 47,313
Three years later................ 39,176 44,689 48,085
Four years later................. 40,407 45,507 47,884
Five years later................. 43,418 46,805 47,933
Six years later.................. 45,142 48,932 48,086
Seven years later................ 43,924 50,190 49,392
Eight years later................ 39,858 49,732 50,324
Nine years later................. 47,422 50,101
Ten years later.................. 48,479
Cumulative redundancy
(deficiency)..................... $ (337) $ 411 $ 2,838
18
The Company believes that its loss reserves are adequate to provide for all
material net incurred losses.
The following table provides a reconciliation of the gross liability of loss
and LAE on a GAAP basis for the three years ended December 31, 1999 (dollars in
thousands):
1999 1998 1997
-------- -------- --------
Reserves for loss and LAE at beginning of year.............. $460,511 $275,008 $229,049
Reserves acquired with purchase of subsidiaries............. 146,233 3,877 1,919
Provision for loss and LAE for claims occurring in the
current year.............................................. 595,425 461,429 269,505
Increase in estimated loss and LAE for claims occurring in
prior years (1)........................................... 90,034 33,493 23,187
-------- -------- --------
Incurred loss and LAE....................................... 685,459 494,922 292,692
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year.............................................. 191,353 152,972 129,199
Prior years............................................... 229,746 160,324 119,453
-------- -------- --------
Loss and LAE payments....................................... 421,099 313,296 248,652
-------- -------- --------
Reserves for loss and LAE at end of the year................ $871,104 $460,511 $275,008
======== ======== ========
- ------------------------
(1) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the gross effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
The following table provides a reconciliation of the liability for loss and
LAE, net of reinsurance ceded, on a GAAP basis for the three years ended
December 31, 1999 (dollars in thousands):
1999 1998 1997
-------- -------- --------
Reserves for loss and LAE at beginning of year.............. $118,912 $119,634 $117,283
Reserves acquired with purchase of subsidiaries............. 55,523 3,877 1,919
Effect on loss reserves of write off of ceded outstanding
and IBNR reinsurance recoverables......................... 82,343 -- --
Provision for loss and LAE for claims occurring in the
current year.............................................. 105,036 105,895 100,288
Increase (decrease) in estimated loss and LAE for claims
occurring in prior years (2).............................. 4,614 (14,593) (3,774)
-------- -------- --------
Incurred loss and LAE....................................... 109,650 91,302 96,514
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year.............................................. 36,770 47,126 48,208
Prior years............................................... 56,052 48,775 47,874
-------- -------- --------
Loss and LAE payments....................................... 92,822 95,901 96,082
-------- -------- --------
Reserves for loss and LAE at end of the year................ $273,606 $118,912 $119,634
======== ======== ========
- ------------------------
(2) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in
prior years, reflect the net effect of the resolution of losses for other
than the reserve value and the subsequent adjustments of loss reserves.
Although the Company experienced a gross loss deficiency during the three
years ended December 31, 1999, because the business is substantially reinsured
in the lines where adverse development has occurred, there is no material
adverse effect on a net loss basis.
19
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to redundancies of $14.6 million in 1998
and $3.8 million in 1997. The deficiencies and redundancies in the net reserves
result from the Company's and its actuaries' continued review of its loss
reserves and the increase or reduction of such reserves as losses are finally
settled and claims exposures are reduced. The Company believes it has provided
for all material net incurred losses.
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominately related to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This deficiency is
included in the net redundancy recorded for 1997. This increase in reserves was
made in an effort to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
The Company expects the increase in loss reserves to be adequate to cover any
subsequent adverse development of AIC's prior losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by HCCL, AIC and USSIC, because of the types of risks
insured, are not considered to have significant environmental exposures.
Therefore, the Company does not expect to experience any material development in
reserves from environmental pollution claims.
INVESTMENTS
Insurance company investments must comply with applicable laws and
regulations which prescribe the type, quality and concentration of investments.
In general, these laws and regulations permit investments, within specified
limits and subject to certain qualifications, in Federal, state and municipal
obligations, corporate bonds and preferred and common equity securities. As of
December 31, 1999, the Company had $581.3 million of investment assets, the
majority of which were held by its insurance company subsidiaries.
The Company's investment policy is determined by the Company's Board of
Directors and its Investment Committee and is reviewed on a regular basis.
Pursuant to its investment policy, the Company concentrates its investments in
obligations of states, municipalities and political subdivisions, the interest
income from which is predominantly exempt from Federal income tax. The Company
generally intends to hold such securities to maturity, however, the Company
regularly re-evaluates its position based upon market conditions, which may
cause the Company to restructure its portfolio and realize gains or losses in
order to maximize its total return on investments. Accordingly, all fixed income
securities are classified as available for sale and are recorded at market
value.
The Company engaged a nationally prominent investment advisor, New England
Asset Management, a subsidiary of Berkshire Hathaway, Inc., in January, 2000 to
oversee the Company's investments, subject to the Company's investment policies.
Previously, the Company had managed its own investments. Therefore, it is
possible that the Company's investment policies may be changed based on the
advice of the investment advisor, although no material change is anticipated.
The insurance companies acquired in the Centris acquisition had portfolios
of preferred and common stocks which are recorded at market value for financial
reporting purposes. It has not been the Company's policy to invest in equity
securities. These equity securities were sold during the first quarter of 2000.
The Company's financial statements reflect an unrealized loss on fixed
income securities available for sale as of December 31, 1999, of $893,000. Since
the Company's intention is to hold these securities until maturity, it does not
currently expect to realize any significant gain or loss on these investments.
The Company has maintained a substantial level of cash and liquid short-term
instruments in its insurance company subsidiaries in order to maintain the
ability to fund losses of the Company's insureds. The underwriting agencies and
intermediaries typically have short-term investments, which are fiduciary funds
held on behalf of others. As of December 31, 1999, the Company had cash and
short-term
20
investments of approximately $242.2 million, of which, $73.8 million are in the
Company's insurance company subsidiaries.
The following tables reflect the investments of the Company (dollars are
expressed in thousands). The table set forth below reflects the average amount
of investments, income earned, and the yield thereon for the three years ended
December 31, 1999:
1999 1998 1997
-------- -------- --------
Average investments......................................... $552,654 $522,209 $496,010
Net investment income....................................... 30,933 29,335 27,587
Average yield (1)........................................... 5.6% 5.6% 5.6%
Average tax equivalent yield (1)............................ 7.1% 7.3% 7.3%
- ------------------------
(1) Excluding realized and unrealized capital gains and losses.
The table set forth below summarizes, by type, the investments of the
Company as of December 31, 1999:
AMOUNT PERCENT OF TOTAL
-------- ----------------
Short-term investments...................................... $215,694 37%
U.S. Treasury securities.................................... 57,505 10
Obligations of states, municipalities and political
subdivisions.............................................. 99,459 17
Special revenue............................................. 163,644 28
Other fixed income securities............................... 22,033 4
Marketable equity securities................................ 19,970 3
Other investments........................................... 3,017 1
-------- ---
Total investments......................................... $581,322 100%
======== ===
The table set forth below indicates the expected maturity distribution of
the Company's fixed income securities as of December 31, 1999:
AMOUNT PERCENT OF TOTAL
-------- ----------------
One year or less............................................ $ 37,052 11%
One year to five years...................................... 107,647 32
Five years to ten years..................................... 97,250 28
Ten years to fifteen years.................................. 68,695 20
More than fifteen years..................................... 31,997 9
-------- ---
Total fixed income securities............................. $342,641 100%
======== ===
The value of the Company's portfolio of fixed income securities is inversely
correlated to changes in market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company invests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time. The Company's fixed income securities have a weighted average maturity
of seven years and a weighted average duration of five years.
BANK LOAN
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing under the Facility may be made from time to
time by the Company for general corporate purposes until the Facility's
expiration on
21
December 18, 2004. Outstanding advances under the Facility bear interest at
agreed upon rates. The Facility is collateralized in part by the pledge of the
stock of HC, HCCL, AIC and USSIC and by the pledge of stock and guarantees
entered into by the Company's principal underwriting agency and intermediary
subsidiaries. The Facility agreement contains certain restrictive covenants,
including, without limitation, minimum net worth requirements for the Company
and certain subsidiaries, restrictions on certain extraordinary corporate
actions, notice requirements for certain material occurrences, and required
maintenance of specified financial ratios. Management believes that the
restrictive covenants and other obligations of the Company which are contained
in the Facility agreement are typical for financing arrangements comparable to
the Facility. The initial funding available under the Facility was used, among
other things, to refinance existing indebtedness of the Company including all
outstanding indebtedness under the Company's $150.0 million Revolving Credit
Facility and $100.0 million Short-term Revolving Loan Facility entered into as
of March 8, 1999, which has been terminated, and to partially fund the Centris
acquisition. As of December 31, 1999, total debt outstanding under the Facility
was $235.0 million. Unrelated to the Facility, in December, 1999, the Company
entered into an $80 million bridge loan with a bank in connection with the
Centris acquisition. The full amount of the bridge loan was repaid prior to
December 31, 1999, immediately following the Centris acquisition.
FOREIGN EXCHANGE
The Company's balances denominated in foreign currency fluctuate as
transactions are recorded and settled. On a very limited basis in the past, the
Company has entered into foreign currency forward contracts as a hedge against
foreign currency fluctuations. RML, purchased by the Company during January,
1999, has a revenue stream in US Dollars but incurs expenses in British Pound
Sterling ("GBP"). To mitigate the foreign exchange risk, the Company entered
into foreign currency forward contracts expiring at staggered times through
December, 2000. As of December 31, 1999, the Company had forward contracts to
sell US $12.0 million for GBP at an average rate of 1.00 GBP equals US $1.60.
The foreign currency forward contracts are used to convert currency at a known
rate in an amount which approximates average monthly expenses. Thus, the effect
of these transactions is to limit the foreign currency exchange risk of the
recurring monthly expenses. In the future, the Company may continue to limit its
exposure to currency fluctuations through the use of foreign currency forward
contracts. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than as a form of speculative or trading investment.
COMPETITION
The insurance business is generally highly competitive. The Company faces
competition from domestic and foreign insurers, underwriting agencies and
intermediaries. The Company's profitability is affected by many other factors,
including rate competition, severity and frequency of claims, interest rates,
state regulations, the judicial climate and general business conditions, all of
which are outside the control of the Company. In addition to competition in the
operation of its business, the Company faces competition from a variety of
sources in attracting and retaining qualified employees.
REGULATION
The activities of the Company are subject to licensing requirements and
extensive regulation under the laws of the United States and its various states,
territories and possessions, as well as the laws of other countries in which the
Company's subsidiaries operate. Currently, insurance companies are generally not
subject to any Federal regulation of their insurance business because of the
existence of a Federal law commonly known as the McCarran-Ferguson Act, which
provides the insurance industry with immunity from certain aspects of the
Federal anti-trust law and exempts the business of insurance from Federal
regulation. Therefore, in the United States, the Company's operations are
regulated primarily at the state level. The Company's business depends on the
validity of, and continued good standing under, the licenses
22
and approvals pursuant to which it operates, as well as compliance with
pertinent regulations. The Company therefore devotes significant efforts toward
obtaining and maintaining its licenses and compliance with a diverse and complex
regulatory structure.
The Company's insurance subsidiaries, in common with other insurers, are
subject to regulation and supervision by the states and by other jurisdictions
in which they do business. Within the states, the method of such regulation
varies but generally has its source in statutes that delegate regulatory powers
to an insurance official. The regulation relates primarily to approval of policy
forms and rates, the standards of solvency that must be met and maintained,
including risk based capital measurements, the licensing of insurers and their
agents, the nature of and limitations of investments, restrictions of the size
of risks which may be insured under a single policy, deposits of securities for
the benefit of policyholders, methods of accounting, periodic examinations of
the affairs of insurance companies, the form and content of records of financial
condition required to be filed, and reserves for unearned premiums, losses and
other purposes. In general, such regulations are intended primarily for the
protection of policyholders rather than shareholders. Compliance is monitored by
the state insurance departments through periodic reporting procedures and
examinations. The quarterly and annual financial reports to the regulators in
the United States utilize accounting principles which are different from the
GAAP used by the Company in its reports to shareholders. SAP, in keeping with
the intent to assure the protection of policyholders, is generally based on a
liquidation concept while GAAP is based on a going-concern concept.
In addition to the regulatory supervision of the insurance company
subsidiaries of the Company, as an insurance holding company, the Company is
subject to the insurance holding company system regulatory requirements of the
states of California, Indiana, Maryland, Missouri, Pennsylvania and Texas. Under
such regulations, the Company is required to report information regarding its
capital structure, financial condition and management. The Company is also
required to provide prior notice to insurance regulatory authorities of certain
agreements and transactions between the Company and its affiliates. These
agreements and transactions must satisfy certain regulatory requirements.
State insurance laws regulate the payment of dividends and other
distributions by insurance companies to their shareholders. Generally, insurance
companies are limited by such laws to the payment of dividends above a specified
level. Dividends in excess of those thresholds are "extraordinary dividends" and
subject to prior regulatory approval.
Additionally, the underwriting agency, intermediary and services operations
of the Company are subject to state insurance laws and regulations which may
require the licensing of insurance agents, brokers, reinsurance intermediaries,
reinsurance underwriting managers, third party administrators and underwriting
agents and which regulate certain aspects of their business. These laws and
regulations may include requirements for certain provisions in contracts entered
into between the Company and various insurers or reinsurers, record keeping and
reporting requirements, limitations on authority, advertising and business
practice rules, and other matters. The manner of operating the Company's agency
activities in particular states may vary according to the licensing requirements
of the particular state, which may require, among other things, that a firm
operate in the state through a local corporation. In a few states, licenses are
issued only to individual residents or locally-owned business entities. In such
cases, the Company may have arrangements with residents or business entities
licensed to act in the state.
In all jurisdictions, the applicable laws and regulations are subject to
amendment or interpretation by regulatory authorities. Generally, such
authorities are vested with relatively broad discretion to grant, renew and
revoke licenses and approvals, and to implement regulations, and licenses may be
denied or revoked for various reasons, including the violation of such
regulations. In some instances, the Company follows practices based on its
interpretations, or those that it believes may be generally followed by the
industry, of laws and regulations, which may be different from requirements or
interpretations of regulatory authorities. There can be no assurance that the
Company has all such required licenses, approvals or complying contracts or that
such licenses, approvals or complying contracts can always be
23
obtained or continued. Accordingly, the possibility exists that the Company may
be precluded or temporarily suspended from carrying on some or all of its
activities or otherwise penalized in a given jurisdiction. Such preclusion or
suspension could have a material adverse effect on the business and results of
operations of the Company.
HC is domiciled in Texas. It operates on an admitted basis in Texas and may
write reinsurance on all lines of business that it may write on a direct basis.
HC is an accredited reinsurer in 34 states and is an approved surplus lines
insurer or is otherwise permitted to write surplus lines insurance in 46 states,
three U.S. territories and the District of Columbia. When a reinsurer obtains
accreditation from a particular state, insurers within that state are permitted
to obtain statutory credit for risks ceded to the reinsurer. Surplus lines
insurance is offered by non-admitted companies on risks which are not insured by
admitted companies. All surplus lines insurance is written through licensed
surplus lines insurance brokers, who are required to be knowledgeable of and
follow specific state laws prior to placing a risk with a surplus lines insurer.
Additionally, HC operates a branch office in London, England which is subject to
regulation by regulatory authorities in the United Kingdom. AIC is domiciled in
Maryland and operates as a licensed admitted insurer in all states, the District
of Columbia, and all Canadian provinces (except Quebec). USSIC is domiciled in
Texas and operates as a licensed admitted insurer in all states and the District
of Columbia. HCCL is domiciled in Indiana, and operates as a licensed admitted
insurer in 41 states and the District of Columbia.
The NAIC has developed a formula for analyzing insurance companies called
risk-based capital. The risk-based capital formula is intended to establish
"minimum" capital threshold levels that vary with the size and mix of a
company's business. It is designed to identify companies with the capital levels
that may require regulatory attention. As of December 31, 1999, each of the
Company's domestic insurance company subsidiaries' total adjusted capital is
significantly in excess of the NAIC authorized control level risk-based capital.
The NAIC has also developed a rating system, the Insurance Regulatory
Information System ("IRIS"), primarily intended to assist state insurance
departments in overseeing the financial condition of all insurance companies
operating within their respective states. IRIS consists of eleven key financial
ratios that address various aspects of each insurer's financial condition and
stability. The Company's insurance company subsidiaries IRIS ratios generally
fall within the usual prescribed ranges except in satisfactorily explainable
circumstances such as when there is a large reinsurance transaction, capital
change or merger.
PENDING OR PROPOSED LEGISLATION
In recent years, state legislatures have considered or enacted laws that
modify and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. The majority of state insurance
regulators are members of the NAIC, which seeks to promote uniformity of, and to
enhance the state regulation of, insurance. In addition, the NAIC and state
insurance regulators, as part of the NAIC's state insurance department
accreditation program, have re-examined existing laws and regulations,
specifically focusing on insurance company investments, issues relating to the
solvency of insurance companies, licensing and market conduct issues,
interpretations of existing laws, the development of new laws, and the
definition of extraordinary dividends. Also, Congress and certain Federal
agencies have conducted investigations of the current condition of the insurance
industry in the United States to determine whether to impose Federal regulation
of insurers and reinsurers. In the past several years there have been a number
of recommendations that the McCarran-Ferguson Act (which generally exempts the
insurance business from Federal regulation) be repealed entirely or modified to
remove the industry's anti-trust exemption and subject it to Federal regulation.
If the McCarran-Ferguson Act were to be repealed or modified, state regulation
of the insurance business would likely continue. This could result in an
additional layer of Federal regulation. In addition, in recent years, various
measures have been proposed at the Federal level to reform the current process
of Federal and state regulation of the financial services industries in the
United States, which are generally considered to include the banking, insurance
24
and securities industries. Such measures, which are often referred to as
financial services modernization, have as a principal objective the elimination
or modification of current regulatory impediments to cross-industry combinations
involving banks, securities firms and insurance companies. A form of financial
services modernization legislation was enacted at the Federal level in 1999
through the Gramm-Leach-Bliley Act of 1999. Such legislation could have
significant implications on the banking, insurance and securities industries and
could result in significant cross-industry consolidations among banks, insurance
companies and securities firms and increased competition in many of the areas of
the Company's operations. Also from time to time, Congress and certain states
have considered various legislative proposals which would provide for
governmental earthquake insurance coverage. The Company does not know at this
time the full extent to which such Federal or state legislative or regulatory
initiatives will or may affect the Company's operations, and no assurance can be
given that they would not, if adopted, have a material adverse effect on the
Company or its results of operations.
The NAIC adopted Statements of Statutory Accounting Principles ("SSAPs") in
March, 1998 as a product of its attempt to codify statutory accounting
principles. While subject to adoption by the individual states, the NAIC has
established an effective date of January 1, 2001 for the SSAPs. Prior to the
codification project, a comprehensive guide to statutory accounting principles
did not exist. Codification is new and will evolve over time. Based upon the
SSAPs as currently published, the Company does not expect their adoption to have
a material effect on the policyholders' surplus of its individual insurance
company subsidiaries. The only material effect on statutory net income is that
the statutory net income for HC will be decreased or increased by a change in
the method of recording equity in earnings or losses of subsidiaries. Currently
HC records the equity in earnings or losses of its subsidiaries as a component
of statutory net income. When codification becomes effective, the equity in
earnings or losses of subsidiaries will be recorded as an unrealized gain or
loss which is a direct increase or decrease to policyholders' surplus. Income
will not be recognized until such time (if any) that dividends are received from
the subsidiaries and recorded in statutory net income.
EMPLOYEES
As of December 31, 1999, the Company had 1,182 employees, including
employees of the acquired Centris entities. The Company is in the process of
reorganizing and combining Centris' operations with HCCB's operations. In
accordance with the restructuring and integration plans, the Company expects to
eliminate 86 employee positions. The employees who are expected to remain after
the Centris integration include five executive officers, 11 senior management,
111 management and 969 other personnel. Of this number, 168 are employed by the
Company's insurance subsidiaries, 585 are employed by the Company's underwriting
agency subsidiaries, 129 are employed by the Company's insurance intermediary
subsidiaries, 144 are employed by the Company's insurance services subsidiaries
and 70 are employed at the corporate headquarters. The Company is not a party to
any collective bargaining agreement and has not experienced work stoppages or
strikes as a result of labor disputes. The Company considers relations with its
employees to be good.
25
ITEM 2. PROPERTIES
The Company's principal and executive offices are located in Houston, Texas,
in an approximately 51,000 square foot building owned by HC. HC also owns an
77,000 square foot building, acquired in 1998, adjacent to its home office
building. The Company also maintains sales and administration offices or other
facilities in over 40 locations elsewhere in the United States and in England.
The majority of these additional locations are in leased facilities.
Principal office facilities of the Company, other than HC's owned
facilities, are as follows:
SQUARE
SUBSIDIARY LOCATION FOOTAGE LEASE TERMINATION DATE
- ---------- ------------------------ --------- ----------------------
LDG Re Wakefield, Massachusetts 34,000 October 31, 2001
AIC Frederick, Maryland 40,000 Owned
HCCB Costa Mesa, California 22,000 March 31, 2007
Atlanta, Georgia 21,000 January 31, 2006
HCCA Dallas, Texas 40,000 March 31, 2004
HCCEB Houston, Texas 27,000 August 31, 2001 and
October 31, 2002
HCCES Northbrook, Illinois 19,000 April 1, 2005
RML London, England 15,000 September 29, 2003
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to numerous claims and lawsuits which arise in the
normal course of its business. Many of such claims or lawsuits involve claims
under policies underwritten or reinsured by the Company, the liabilities for
which management believes have been adequately included in its established loss
reserves. The Company believes the resolution of these lawsuits or claims will
not have a material adverse effect on its financial condition, results of
operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1999.
26
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's Common Stock trades on the New York Stock Exchange ("NYSE")
under the ticker symbol "HCC".
The high and low sales prices for quarterly periods during the period
January 1, 1998 through December 31, 1999, as reported by the NYSE were as
follows:
1999 1998
----------------------------- -----------------------------
HIGH LOW HIGH LOW
------------- ------------- ------------- -------------
First quarter.............................................. 21 7/16 16 23 15/16 15 5/8
Second quarter............................................. 22 11/16 17 15/16 23 11/16 19 5/8
Third quarter.............................................. 25 1/8 13 7/8 22 15/16 18 1/8
Fourth quarter............................................. 16 11/16 8 21 1/4 16 1/16
On March 24, 2000, the closing sales price of the Company's Common Stock as
reported by the NYSE was $13 7/8.
SHAREHOLDERS
The Company has one class of authorized capital stock: 250,000,000 shares of
Common Stock, par value $1.00 per share. As of March 10, 2000, there were
49,095,126 shares of issued and outstanding Common Stock held by 1,119
shareholders of record; however, the Company believes there are in excess of
15,000 beneficial owners.
DIVIDENDS
Beginning in June, 1996, the Company announced a planned quarterly program
of paying cash dividends to shareholders. The Company paid a cash dividend in
July, 1996 of $0.02 per share and in each succeeding quarter through the first
quarter of 1997. The Company increased the quarterly cash dividend to $0.03 per
share in April, 1997, to $0.04 per share beginning in April, 1998 and to $0.05
per share beginning in April, 1999. The Board of Directors may review the
Company's dividend policy from time to time, and any determination with respect
thereto will be made in light of regulatory and other conditions then existing,
including the Company's earnings, financial condition, capital requirements,
loan covenants, and other related factors. Under the terms of the Facility, the
Company is prohibited from paying dividends in excess of an agreed upon maximum
amount in any fiscal year. Such limitation will not affect the ability of the
Company to pay dividends in a manner consistent with its past practice and
current expectations.
27
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below has been derived
from the Consolidated Financial Statements. All information contained herein
should be read in conjunction with the Consolidated Financial Statements, the
related notes thereto and Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Report.
FOR THE YEARS ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3)
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
STATEMENT OF EARNINGS DATA:
Revenue
Net earned premium...................... $141,362 $143,100 $162,571 $170,068 $158,632
Management fees......................... 90,713 74,045 51,039 28,651 25,373
Commission income....................... 54,552 38,441 24,209 21,477 21,053
Net investment income................... 30,933 29,335 27,587 23,593 21,757
Net realized investment gain (loss)..... (4,164) 845 (328) 8,341 1,636
Other operating income.................. 28,475 22,268 15,239 18,656 10,371
-------- -------- -------- -------- --------
Total revenue......................... 341,871 308,034 280,317 270,786 238,822
Expense
Loss and LAE............................ 109,650 91,302 96,514 114,464 105,374
Operating expense
Policy acquisition costs, net......... 8,177 10,978 13,580 8,218 10,634
Compensation expense.................. 77,488 56,077 51,458 42,102 48,162
Provision for reinsurance............. 43,462 -- -- -- --
Restructuring expense................. 5,489 -- -- -- --
Other operating expense............... 47,247 36,063 31,628 26,382 26,540
Merger expense........................ -- 107 8,069 26,160 --
-------- -------- -------- -------- --------
Total operating expense............. 181,863 103,225 104,735 102,862 85,336
Interest expense.......................... 12,964 6,021 6,004 4,993 6,471
-------- -------- -------- -------- --------
Total expense....................... 304,477 200,548 207,253 222,319 197,181
-------- -------- -------- -------- --------
Earnings before income tax provision...... 37,394 107,486 73,064 48,467 41,641
Income tax provision...................... 12,271 35,208 23,305 9,885 9,896
-------- -------- -------- -------- --------
Net earnings........................ $ 25,123 $ 72,278 $ 49,759 $ 38,582 $ 31,745
======== ======== ======== ======== ========
BASIC EARNINGS PER SHARE DATA:
Earnings per share (1).................... $ 0.51 $ 1.51 $ 1.06 $ 0.86 $ 0.75
======== ======== ======== ======== ========
Weighted average shares outstanding (1)... 49,061 47,920 46,995 44,795 42,577
======== ======== ======== ======== ========
DILUTED EARNINGS PER SHARE DATA:
Earnings per share (1).................... $ 0.51 $ 1.48 $ 1.03 $ 0.84 $ 0.74
======== ======== ======== ======== ========
Weighted average shares outstanding (1)... 49,649 48,936 48,209 46,043 43,113
======== ======== ======== ======== ========
Cash dividends declared, per share........ $ 0.20 $ 0.16 $ 0.12 $ 0.06
======== ======== ======== ========
28
DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(3)
----------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- -------- --------
BALANCE SHEET DATA:
Total investments..................... $ 581,322 $ 525,646 $ 518,772 $468,725 $454,831
Premium, claims and other
receivables......................... 607,986 382,630 252,618 168,300 155,164
Reinsurance recoverables.............. 683,275 372,672 176,965 132,328 117,700
Ceded unearned premium................ 133,657 149,568 84,610 71,758 78,460
Goodwill.............................. 263,687 88,043 34,758 10,922 11,211
Total assets.......................... 2,650,623 1,709,069 1,198,132 965,793 896,476
Loss and LAE payable.................. 871,104 460,511 275,008 229,049 200,756
Unearned premium...................... 188,524 201,050 152,094 156,268 151,976
Total debt............................ 242,546 121,600 80,750 72,917 71,628
Shareholders' equity.................. 457,428 439,863 365,601 296,524 255,484
Book value per share (1) (2).......... 9.29 9.12 7.66 6.49 5.70
- ------------------------
(1) These amounts have been adjusted to reflect the effects of the five-for-two
stock split payable as a 150% stock dividend to shareholders of record April
30, 1996.
(2) Book value per share is calculated by dividing the sum of shares outstanding
plus contractually issuable shares into total shareholders' equity.
(3) Certain amounts in the 1998, 1997, 1996 and 1995 selected consolidated
financial data have been reclassified to conform to the 1999 presentation.
Such reclassifications had no effect on the Company's net earnings,
shareholders' equity, or cash flows.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT ON FORM 10-K (THIS "REPORT") CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
WHICH ARE INTENDED TO BE COVERED BY THE SAFE HARBORS CREATED THEREBY. INVESTORS
ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS NECESSARILY INVOLVE RISKS AND
UNCERTAINTY, INCLUDING, WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL
DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY
OF ITS LOSS RESERVES, THE FINANCIAL VIABILITY OF REINSURERS, THE EXPANSION OR
CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, THE
IMPACT OF POTENTIAL YEAR 2000 INSURANCE COVERAGE ISSUES, CHANGING LICENSING
REQUIREMENTS AND REGULATIONS IN THE UNITED STATES AND IN FOREIGN COUNTRIES, THE
ABILITY OF THE COMPANY TO INTEGRATE ITS RECENTLY ACQUIRED BUSINESSES, THE EFFECT
OF PENDING OR FUTURE ACQUISITIONS AS WELL AS ACQUISITIONS WHICH HAVE RECENTLY
BEEN CONSUMMATED, GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING.
ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICAL FACTS, INCLUDED OR
INCORPORATED BY REFERENCE IN THIS REPORT THAT ADDRESS ACTIVITIES, EVENTS OR
DEVELOPMENTS THAT THE COMPANY EXPECTS OR ANTICIPATES WILL OR MAY OCCUR IN THE
FUTURE, INCLUDING, WITHOUT LIMITATION, SUCH THINGS AS FUTURE CAPITAL
EXPENDITURES (INCLUDING THE AMOUNT AND NATURE THEREOF), BUSINESS STRATEGY AND
MEASURES TO IMPLEMENT SUCH STRATEGY, COMPETITIVE STRENGTHS, GOALS, EXPANSION AND
GROWTH OF THE COMPANY'S BUSINESSES AND OPERATIONS, PLANS, REFERENCES TO FUTURE
SUCCESS, AS WELL AS OTHER STATEMENTS WHICH INCLUDE WORDS SUCH AS "ANTICIPATE,",
"BELIEVE", "ESTIMATE", "EXPECT", "INTEND", "PLAN", "PROBABLY" AND OTHER SIMILAR
EXPRESSIONS, CONSTITUTE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY
BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN ARE REASONABLE, ANY OF THE ASSUMPTIONS COULD OVER TIME PROVE TO
BE INACCURATE AND THEREFORE, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS REPORT WILL THEMSELVES PROVE TO BE ACCURATE. IN
LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING
STATEMENTS INCLUDED HEREIN, THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE
REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE
OBJECTIVES AND PLANS OF THE COMPANY WILL BE ACHIEVED.
GENERAL
The Company's primary sources of revenue are earned premium and investment
income derived from its insurance company operations, management fees generated
from its underwriting agency operations, commission income produced by its
intermediary operations and other operating income. The Company's core
underwriting activities involve providing accident and health reinsurance,
aviation, marine, offshore energy, property, workers' compensation, group health
and medical stop-loss insurance, marketed directly by the Company and produced
by independent agents.
The Company has substantially increased its shareholders' equity through the
issuance of equity securities and earnings, thereby enabling it to increase the
underwriting capacity of its insurance company subsidiaries. The Company has
utilized this additional equity by increasing underwriting activity across many
of its core lines of business, emphasizing lines of business and individual
opportunities with the most favorable underwriting characteristics at a
particular point in time. In each line of business, as an insurer, the Company
also cedes premium through the purchase of reinsurance in types and amounts
appropriate to the line of business, market conditions and the Company's desired
net risk retention profile.
The Company's underwriting agency operations underwrite aviation, medical
stop-loss, occupational accident and workers' compensation insurance and and a
variety of accident and health related reinsurance products.
The Company's intermediary operations also place insurance and reinsurance
for the Company's insurance company and underwriting agency operations and other
non-affiliated insurance companies and risk taking entities, as well as on
behalf of medium to large corporate clients.
Since 1996, the Company has focused its acquisition activities on expanding
its underwriting agency and intermediary operations for three principal reasons.
The first reason is an attempt to increase the
30
management fees and commission income components of the Company's total revenue,
which management believes has been a more predictable and stable source of
revenue than the potential underwriting profits from insurance company
operations. The second reason is an effort to insulate the Company from a
decline in its revenue growth rate as insurance premium rates become more
competitive in the lines of business in which the Company specializes and the
Company becomes more selective in its underwriting approach, resulting in
reduced earned premium. The third reason is to provide a future source of
premium revenue to the Company's insurance company subsidiaries and more control
of its distribution channels.
Operations whose revenue are included in other operating income consist of
insurance related service operations which may support the Company's operations
as well as service unaffiliated customers. Additionally, this revenue includes
revenue from strategic operational investments and gains and losses from their
disposition. The Company may make such strategic investments from time to time,
generally in businesses that complement the Company's operations.
RESULTS OF OPERATIONS
The following table sets forth certain premium revenue information for the
three years ended December 31, 1999 (dollars in thousands):
1999 1998 1997
--------- --------- ---------
Direct...................................................... $ 291,513 $ 228,629 $ 177,728
Reinsurance assumed......................................... 276,818 269,647 168,671
--------- --------- ---------
Gross written premium..................................... 568,331 498,276 346,399
Reinsurance ceded........................................... (428,407) (376,393) (203,546)
--------- --------- ---------
Net written premium....................................... 139,924 121,883 142,853
Change in unearned premium.................................. 1,438 21,217 19,718
--------- --------- ---------
Net earned premium.......................................... $ 141,362 $ 143,100 $ 162,571
========= ========= =========
The following table sets forth the relationships of certain income statement
items as a percent of total revenue for the three years ended December 31, 1999:
1999 1998 1997
-------- -------- --------
Net earned premium.......................................... 41.4% 46.5% 58.0%
Management fees............................................. 26.5 24.0 18.2
Commission income........................................... 16.0 12.5 8.7
Net investment income....................................... 9.0 9.5 9.8
Net realized investment gain (loss)......................... (1.2) 0.3 (0.1)
Other operating income...................................... 8.3 7.2 5.4
----- ----- -----
Total revenue............................................. 100.0 100.0 100.0
Loss and LAE................................................ 32.1 29.6 34.4
Net operating expense *..................................... 53.2 33.5 37.4
Interest expense............................................ 3.8 2.0 2.1
----- ----- -----
Earnings before income tax provision...................... 10.9 34.9 26.1
Income tax provision........................................ 3.6 11.4 8.3
----- ----- -----
Net earnings.............................................. 7.3% 23.5% 17.8%
===== ===== =====
- ------------------------
* Includes restructuring expense, provision for reinsurance and merger
expense.
31
YEAR END DECEMBER 31, 1999 VERSUS YEAR END DECEMBER 31, 1998
Total revenue increased 11% to $341.9 million in 1999, from $308.0 million
in 1998. The revenue increase was principally a result of increases in non-risk
bearing management fees and commission income. This growth is from new business
and acquisitions. It is anticipated that revenue from the insurance company
subsidiaries will begin to grow in 2000 as earned premium and investment income
begin to rise as a result of higher retentions and cash flow from increased
gross written premium.
Net investment income increased 5% to $30.9 million in 1999 from $29.3
million in 1998, reflecting a slightly higher level of investment assets and
increased interest rates earned on short-term investments. During 2000, the
Company will utilize its available cash flow to reduce its debt but,
nevertheless, it is anticipated that net investment income will continue to
grow.
Net realized investment losses from sales or write-downs of equity
securities were $3.9 million in 1999, compared to losses of $166,000 in 1998. In
1999, the Company recognized a $4.3 million realized loss from the write down of
one equity investment to its estimated fair market value based upon market
quotations and a sale expectation. Net realized investment losses from
disposition of fixed income securities were $164,000 in 1999, compared to gains
of $1.0 million in 1998. The losses in 1999 resulted from the sale of bonds by
HC in connection with the funding of the Centris acquisition.
Compensation expense increased to $77.5 million in 1999, from $56.1 million
in 1998. This increase reflects a normal progressional increase due to business
growth as well as the effect of acquisitions. Other operating expenses increased
$11.1 million to $47.2 million during the same period for similar reasons.
Currency conversion gains amounted to $442,000 in 1999, compared to gains of
$219,000 in 1998.
Interest expense was $13.0 million for 1999, an increase of $6.9 million
from 1998. The increase is a result of increased debt outstanding as a result of
fundings for acquisitions.
Income tax expense was $12.3 million in 1999 compared to $35.2 million in
1998. The decrease was due to the reduction in earnings before income tax. The
effective tax rates for both years were approximately the same. The effective
tax rate is expected to increase in 2000 as a result of increased goodwill
amortization which is not deductible for tax purposes, higher state income taxes
and foreign taxes for which credit against United States taxes may be limited.
The increased state income taxes result from expected increased income from
intermediaries and brokers subject to state income taxes as well as an expected
increase in income in states with higher income tax rates.
Net earnings in 1999 decreased to $25.1 million from $72.3 million in 1998,
due to the provision for reinsurance, which equated to $28.3 million after
income taxes, or $0.57 per diluted share, the higher net loss ratio and the
restructuring expense, which, after income taxes, amounted to $0.07 per diluted
share. Diluted earnings per share decreased to $0.51 per share from $1.48 per
share during the same period.
The Company's book value per share was $9.29 as of December 31, 1999, up
from $9.12 as of December 31, 1998.
32
SEGMENTS
INSURANCE COMPANIES
GWP increased 14% to $568.3 million in 1999, from $498.3 million in 1998.
Accident and health reinsurance, medical stop-loss and workers' compensation
premium showed strong growth, as the insurance company subsidiaries continue to
participate in more of the business written by underwriting agency subsidiaries.
This growth was partially offset by reductions in property and offshore energy
premium as a result of the continuing extremely soft conditions in these
markets. NWP in 1999 increased 15% to $139.9 million from $121.9 million in
1998, as a result of increases in retained aviation and medical stop-loss
premium. Net earned premium in 1999 decreased slightly to $141.4 million from
$143.1 million in 1998 as changes in earned premium lag behind changes in
written premium. It is anticipated that NWP will rise during 2000, as the
insurance company subsidiaries begin to increase retentions as rates start to
improve.
Loss and LAE increased to $109.7 million in 1999, from $91.3 million in
1998, and the GAAP net loss ratio increased to 77.6% in 1999, from 63.8% in
1998. The GAAP gross loss ratio was 116.8% in 1999 compared to 109.2% in 1998.
The deterioration is primarily from poor results in the aviation, property and
medical stop-loss lines of business. The Company has taken steps to reduce these
gross loss ratios, primarily by increasing premium rates and more selective risk
selection. The statutory net combined ratio was 129.9% (104.1% excluding the
effects of the provision for reinsurance) in 1999 compared to 82.9% in 1998.
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to a redundancy of $14.6 million in 1998.
During 1999, the Company had gross loss and LAE deficiency of $90.0 million
compared to a deficiency of $33.5 million in 1998. The gross deficiency results
from the development of large claims on individual policies which were either
reported late or reserves were increased as subsequent information became
available. However, as these policies were substantially reinsured, there is no
material effect to the Company's net earnings. The deficiencies and redundancies
in the net reserves result from the Company's and its actuaries' continued
review of its loss reserves and the increase or reduction of such reserves as
losses are finally settled and claims exposures are reduced. The Company
continues to believe it has materially provided for all material net incurred
losses.
In 1999, the insurance company subsidiaries recorded a $43.5 million
provision for reinsurance to reflect an estimated $29.5 million pre-tax loss for
the insolvency of one of the subsidiaries' reinsurers and an estimated $14.0
million pre-tax loss, the majority of which represents the discount on ceded
reserves, related to the commutation of all liabilities with another reinsurer.
This commutation, made at the Company's request, was finalized and settled in
February, 2000. In connection with the commutation, the subsidiaries received
cash and other amounts totaling $56.5 million. Additionally, as of December 31,
1999 the Company has a reserve of $5.5 million which management believes is
sufficient to absorb any potential losses related to its reinsurance
recoverables. However, the adverse economic environment in the worldwide
insurance industry has placed great pressure on reinsurers and the results of
their operations and these conditions could, ultimately, affect reinsurers'
solvency. Historically, there have been insolvencies following a period of
competitive pricing in the industry, such as the marketplace has experienced for
the last several years. Therefore, while management believes that the reserve is
adequate based upon current available information, conditions may change or
additional information might be obtained that would affect management's estimate
of the adequacy of the level of the reserve and which may result in a future
increase or decrease in the reserve. Management continually reviews the
Company's financial exposure to the reinsurance market and will continue to take
actions to protect shareholders' equity.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $2.8 million to $8.2 million in 1999, from $11.0 million in
1998, reflecting a greater amount of gross premium ceded and, therefore, a
higher level of ceding commissions.
33
Net earnings of the insurance companies decreased to a loss of $10.7 million
in 1999, from a profit of $33.8 million in 1998, as a result of the provision
for reinsurance, the effect of restructuring and the higher net loss ratio.
Generally, underwriting profitability has deteriorated as the extremely
competitive market conditions continue to affect current results. These results
will probably continue to deteriorate even as there is a transition to a harder
market but, eventually, should become profitable as rates increase and
underwriting becomes more selective.
UNDERWRITING AGENCIES
Management fees increased 23% to $90.7 million in 1999, from $74.0 million
in 1998. Premium underwritten on behalf of affiliated and unaffiliated insurance
companies increased to $848.1 million in 1999, an increase of 20% from $706.2
million in 1998. Both increases resulted from acquisitions and internal growth
of existing operations. Management fees and premium underwritten are expected to
continue to increase in 2000 as a result of the Centris acquisition and
increased premium.
Net earnings of the underwriting agencies decreased to $17.2 million in
1999, from $19.4 million in 1998. Recent acquisitions have not yet had a
positive impact on net earnings due to licensing and other regulatory
requirements, which are in process. In addition, the underwriting agency segment
incurred a $1.4 million, net of income tax, restructuring expense in 1999.
Growth in underwriting agency premium has a positive impact on both the
insurance company segment and the intermediary segment.
INTERMEDIARIES
Commission income increased 42% to $54.6 million in 1999, from $38.4 million
in 1998, primarily as a result of the acquisition of RML, effective January 1,
1999. Net earnings of the intermediaries decreased to $13.6 million in 1999 from
$16.9 million in 1998. The increase in net earnings generated by RML was offset
by fewer large brokerage transactions in 1999 and other reductions, including a
$551,000 (net of income tax) restructuring expense in 1999.
OTHER OPERATIONS
Other operating revenue increased 28% to $28.5 million in 1999, from $22.3
million in 1998. There was a general increase in revenue of the service
operations, net of the decrease in revenue related to operations disposed of in
late 1998. Other operating net earnings increased to $7.6 million in 1999, from
$4.8 million in 1998 due principally to the higher earnings of the service
operations. Period to period comparisons may vary substantially depending on
activity in the purchase or disposition of strategic investments.
ACQUISITIONS
In connection with the Centris acquisition, a plan was formulated, approved
and implemented prior to December 31, 1999 to eliminate Centris' corporate
staff, combine the Centris medical stop-loss operations with those of HCCB and
combine certain Centris and HCCB production and underwriting facilities. In
accordance with the plan, certain Centris employees were terminated with
severance benefits to be paid in accordance with Centris' employment contracts
for executives or the HCC severance plan for Centris employees who did not have
employment contracts. These severance obligations were accrued as of the
acquisition date, included in the purchase price allocation and will not be
included in expense in the Company's statements of earnings. Additionally,
accruals of $848,000 were made at that date for future
34
lease costs of office space made redundant by the plan. The following table
provides a detailed analysis of the accruals:
ACCRUED AT ACCRUED AT
PURCHASE DECEMBER 31,
DATE PAID IN 1999 1999
---------- ------------ ------------
Contractual executive severance accruals................. $6,744,000 $878,000 $5,866,000
Other severance accruals................................. 397,000 -- 397,000
Lease obligation accruals................................ 848,000 -- 848,000
---------- -------- ----------
Total.................................................. $7,989,000 $878,000 $7,111,000
========== ======== ==========
It is expected that the significant portion of the severance accruals will
be paid prior to April 30, 2000, in accordance with the contractual terms of the
severance agreements. Management is still evaluating what additional actions, if
any, are necessary to finalize the integration of the Centris operations. Any
additional accruals will be recorded as an adjustment to the purchase price
allocation.
RESTRUCTURING
The Company recorded a restructuring charge and associated expenses of $5.5
million during the fourth quarter of 1999. Since its initial public offering in
1992, the Company has completed more than fifteen acquisitions for a total value
exceeding $750.0 million. During that time, total employees have grown from less
than 100 to more than 1,000. As a result of this rapid growth, management
believes certain operating inefficiencies occurred. At the beginning of the
fourth quarter of 1999, management made a review of its operations and
determined that they could be made more efficient, principally by reducing the
employee count in certain of its operations. Management believes that this
restructuring will strengthen the Company's corporate and management structure
and enhance future earnings by improving operating efficiency and therefore
profitability. The savings, principally in compensation expense, from the
restructuring is estimated to be approximately $10.0 million to $12.0 million in
the year 2000 and annually thereafter. The terminations that generated the
compensation savings took place in the fourth quarter.
A total of 92 employees were terminated in the fourth quarter as a result of
the Company's restructuring which affected all segments. The Company accrued
severance payments for 27 of these terminated employees at December 31, 1999,
substantially all of which was paid in January, 2000. The restructuring charge
also includes accruals of $911,000 related to future lease costs of office space
made redundant as a result of the restructuring plan and a write down of
$647,000 principally of leasehold improvements and other assets related to the
redundant space. The following table provides a detailed analysis of the charge:
PAID IN ACCRUED EXPENSED
1999 AT 12/31/99 IN 1999
-------- ----------- ----------
Severance.................................................. $691,000 $3,115,000 $3,806,000
Other...................................................... 125,000 911,000 1,036,000
-------- ---------- ----------
$816,000 $4,026,000 4,842,000
======== ==========
Write down of assets..................................... 647,000
----------
Total restructuring expense.............................. $5,489,000
==========
YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997
Total revenue increased 10% to $308.0 million in 1998 from $280.3 million in
1997. The revenue growth resulted from increases in non-risk bearing management
fees, commission income, and other
35
operating income as a result of internal growth and acquisitions. The decrease
in insurance company net earned premium offsets these increases.
Net investment income increased 6% to $29.3 million in 1998 from $27.6
million in 1997 reflecting a slightly higher level of investment assets. In
1998, the Company also utilized a substantial amount of its non-insurance
company subsidiary cash flow to reduce debt and therefore interest expense,
limiting the amount of cash subject to short-term investment.
Net realized investment losses from sales of equity securities were $166,000
in 1998, compared to losses of $154,000 in 1997. Net realized investment gains
from disposition of fixed income securities were $1.0 million in 1998, compared
to losses of $174,000 in 1997. The gains in 1998 resulted principally from the
sale of bonds upon the liquidation of a subsidiary.
Compensation expense increased $4.6 million or 9% in 1998 to $56.1 million
due to the increase in personnel resulting from acquisitions completed during
1998, along with an increase in management personnel hired to oversee the
integration of the Company's many acquisitions.
Other operating expense increased 14% to $36.1 million in 1998. These
expenses reflect increased expenditures required to meet the overall growth in
business and from acquisitions. Currency conversion gains amounted to $219,000
in 1998, compared to losses of $884,000 in 1997.
Merger expense represents non-recurring items incurred to consummate the
acquisitions and mergers which are accounted for as pooling-of-interests.
Income tax expense was $35.2 million in 1998, compared to $23.3 million in
1997. The Company's effective tax rate was 32.8% in 1998 compared to 31.9% in
1997. As net income from the underwriting agency and intermediary operations
grow, the Company's effective tax rate increases due to state income taxes and
the mitigation of the effect of tax exempt municipal bond income on the combined
effective tax rate.
Net earnings increased 45% to $72.3 million in 1998, from $49.8 million in
1997. Diluted earnings per share increased 44% to $1.48 in 1998 from $1.03 in
1997.
SEGMENTS
INSURANCE COMPANIES
GWP increased 44% to $498.3 million in 1998 from $346.4 million in 1997, due
primarily to increased aviation, property, medical stop-loss and accident and
health reinsurance premium. NWP for 1998 decreased to $121.9 million from
$142.9 million in 1997, due to an increase in the amount of ceded reinsurance.
Net earned premium decreased to $143.1 million in 1998 compared to
$162.6 million in 1997 reflecting the reduction in NWP and the reduced
retentions of the Company.
Operating earnings for 1998 were impacted by Hurricanes Georges and Mitch.
The gross loss from these hurricanes amounted to more than $50.0 million before
reinsurance, with Georges being the largest catastrophe loss ever incurred by
the Company. The net retained loss after reinsurance and taxes was
$3.8 million, or $0.08 per share. This catastrophe further demonstrates how the
Company's conservative reinsurance philosophy protects shareholders' equity and
limits the impact of a major catastrophe loss.
AIC, acquired in June, 1997, recorded a $10.0 million increase in loss and
LAE reserves during December, 1997, predominantly relating to 1995 and 1996
claims incurred prior to the Company's acquisition of AIC. This increase in
reserves was made to bring AIC's reserving practices consistent with the more
conservative method used by the Company's other insurance company operations.
Management expects the increase in AIC's loss reserves to be adequate to cover
any subsequent adverse development of AIC's prior losses.
36
Loss and LAE decreased $5.2 million in 1998, to $91.3 million, reflecting
the increased use of reinsurance, despite the catastrophe loss in 1998 from the
hurricanes Georges and Mitch. Excluding the effect of the catastrophe loss in
1998 and AIC's reserve strengthening in 1997, loss and LAE decreased $692,000
and the Company's GAAP loss ratio increased to 60.0% in 1998 from 53.2% in 1997.
Including these effects, the Company's GAAP loss ratio increased to 63.8% for
1998 from 59.4% in 1997. Both increases reflect the higher incurred losses and
LAE on substantially lower earned premium in 1998 when compared to 1997.
Additionally, the increased loss ratios reflect a general deterioration in
pricing in 1998 coupled with a higher frequency of attritional losses. The
Company's insurance company subsidiaries statutory combined ratio was 82.9% for
1998 compared to 78.8% for 1997.
During 1998, the Company had net loss and LAE redundancy of $14.6 million
relating to prior year losses compared to a redundancy of $3.8 million in 1997.
During 1998, the Company had gross loss and LAE deficiency of $33.5 million
compared to a deficiency of $23.2 million in 1997. The gross deficiency results
from the development of several large claims on individual policies which were
either reported late or reserves were increased as subsequent information became
available. However, as these policies were substantially reinsured, there is no
material effect to the Company's net earnings. The redundancies in the net
reserves result from the Company's and its actuaries' continued review of its
loss reserves and the reduction of such reserves as losses are finally settled
and claims exposures are reduced.
Policy acquisition costs, which are net of ceding commissions on reinsurance
ceded, decreased $2.6 million to $11.0 million in 1998, from $13.6 million in
1997, reflecting a greater amount of gross premium ceded and, therefore, a
higher level of ceding commissions.
Net earnings of the insurance companies decreased to $33.8 million in 1998
from $40.6 million in 1997, as a result of a general deterioration in
underwriting results.
UNDERWRITING AGENCIES
Management fees in 1998 increased 45% to $74.0 million from $51.0 million in
1997. Premium underwritten on behalf of affiliated and unaffiliated insurance
companies increased to $706.2 million in 1998, an increase of 49% from $473.4
million in 1997. Both increases resulted from acquisitions and internal growth.
Net earnings of the underwriting agencies increased 46% to $19.4 million in
1998 from $13.3 million in 1997 due to acquisitions and internal growth.
INTERMEDIARIES
Commission income increased to $38.4 million in 1998 from $24.2 million in
1997 an increase of 59%. Net earnings of the intermediaries increased 139% to
$16.9 million in 1998 from $7.1 million in 1997. The increases result from
internal growth and a number of large brokerage transactions.
OTHER OPERATIONS
Other operating income increased 46% to $22.3 million in 1998, from $15.2
million in 1997, principally as a result of a $4.0 million pre-tax gain on the
sale of one of the Company's subsidiaries whose operations were not material to
those of the Company. Additionally, revenue of a service company subsidiary
increased $2.0 million in 1998. Net earnings from other operations increased for
the same reasons.
LIQUIDITY AND CAPITAL RESOURCES
The Company receives substantial cash from premiums, reinsurance
recoverables, and management fee and commission income and, to a lesser extent,
investment income, and proceeds from sales and redemptions of investment assets.
The principal cash outflows are for the payment of claims and LAE,
37
payment of premiums to reinsurers, purchase of investments, debt service, policy
acquisition costs, operating expenses, income and other taxes and dividends.
As of December 31, 1999, several of the Company's subsidiaries maintained
revolving lines of credit with a bank in the combined maximum amount of $40.0
million available through December 31, 2000. Advances under the lines of credit
are primarily used to fund draws, if any, on letters of credit issued by the
bank on behalf of the subsidiaries. The lines of credit are collateralized by
securities having an aggregate market value of up to $50.0 million, the actual
amount of collateral at any one time being 125% of the aggregate amount
outstanding. Interest on the lines is payable at the bank's prime rate of
interest (8.5% at December 31, 1999). At December 31, 1999, letters of credit
totaling $17.2 million had been issued to insurance companies by the bank on
behalf of the subsidiaries, with total securities collateralizing the line of
$21.5 million.
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing under the Facility may be made from time to
time by the Company for general corporate purposes until the Facility's
expiration on December 18, 2004. Outstanding advances under the Facility bear
interest at agreed upon rates. The Facility is collateralized in part by the
pledge of the stock of HC, HCCL, AIC and USSIC and by the pledge of stock and
guarantees entered into by the Company's principal underwriting agency and
intermediary subsidiaries. The Facility agreement contains certain restrictive
covenants, including, without limitation, minimum net worth requirements for the
Company and certain subsidiaries, restrictions on certain extraordinary
corporate actions, notice requirements for certain material occurrences, and
required maintenance of specified financial ratios. Management believes that the
restrictive covenants and other obligations of the Company which are contained
in the Facility agreement are typical for financing arrangements comparable to
the Facility. The initial funding available under the Facility was used, among
other things, to refinance existing indebtedness of the Company including all
outstanding indebtedness under the Company's $150.0 million Revolving Credit
Facility and $100.0 million Short-term Revolving Loan Facility entered into as
of March 8, 1999 which has been terminated, and to partially fund the Centris
acquisition. As of December 31, 1999, total debt outstanding under the Facility
was $235.0 million. Unrelated to the Facility, in December, 1999, the Company
entered into an $80.0 million bridge loan with a bank in connection with the
Centris acquisition. The full amount of the bridge loan was repaid prior to
December 31, 1999, immediately following the Centris acquisition.
The Company maintains a substantial level of cash and liquid short-term
investments which are used to meet anticipated payment obligations. As of
December 31, 1999, the Company had cash and short-term investments of
approximately $242.2 million. The Company's consolidated investment portfolio of
$581.3 million as of December 31, 1999, of which $216.3 million is short-term
investments, is available to provide additional liquidity.
Property and casualty insurance companies domiciled in the State of Texas
are limited in the payment of dividends to their shareholders in any 12 month
period, without the prior written consent of the Commissioner of Insurance, to
the greater of statutory net income or 10% of statutory policyholders' surplus.
HC and USSIC paid no dividends in 1999. During 2000, HC and USSIC's ordinary
dividend capacity is approximately $25.0 million and $10.4 million,
respectively.
Under the laws of the State of Maryland, AIC may only pay dividends out of
statutory earned surplus. The maximum amount of dividends that AIC may pay
without prior regulatory approval in any 12 month period is the greater of its
statutory net income (under certain conditions) or 10% of its statutory
policyholders' surplus. Because AIC paid an extraordinary dividend of
$45.0 million during December, 1999, any dividends paid by AIC during 2000 will
need prior regulatory approval. No dividends from AIC are anticipated during
2000.
HCCL is limited by the State of Indiana in the amount of dividends it may
pay in any twelve month period, without prior regulatory approval, to the
greater of net gain from operations for the prior calendar
38
year or ten percent (10%) of statutory capital and surplus as of the prior year
end. During 2000, HCCL's ordinary dividend capacity will be approximately
$7.0 million.
The Company believes that its operating cash flows, short-term investments
and the Facility will provide sufficient sources of liquidity to meet its
anticipated needs for the foreseeable future.
The value of the Company's portfolio of fixed income securities is inversely
correlated to changes in market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company reinvests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time.
As of December 31, 1999, the Company had a net deferred tax asset of $18.3
million compared to $3.4 million as of December 31, 1998. Due to the Company's
history of consistent earnings and expectations for the future, it is more
likely than not that the Company will be able to realize the benefit of its
deferred tax asset.
The overall increase in activities at the insurance company subsidiaries and
the acquisition of Centris in late December, 1999 resulted in increases in gross
loss reserves, life and annuity policy benefits, gross unearned premiums and
deferred policy acquisition costs since 1997. Related amounts of reinsurance
recoverables, ceded life and policy benefits, ceded unearned premium and
deferred ceding commissions also increased. The Company continues to collect its
receivables and recoverables generally in the ordinary course of business and
has not incurred and does not expect to incur any significant liquidity
difficulties as a result of the substantial growth in gross amounts due. The
Company limits its liquidity exposure by holding funds, letters of credit or
other security such that net balances due to it are significantly less than the
gross balances shown in the consolidated balance sheets.
As of December 31, 1999, each of the domestic insurance company
subsidiaries' total adjusted capital is significantly in excess of the NAIC
authorized control level risk-based capital.
Industry and regulatory guidelines suggest that a property and casualty
insurer's annual statutory GWP should not exceed 900% of its statutory
policyholders' surplus and NWP should not exceed 300% of its statutory
policyholders' surplus. However, industry standards and rating agency criteria
place these ratios at 300% and 200%, respectively. The Company's property and
casualty insurance company subsidiaries maintain a premium to surplus ratio
significantly lower than such guidelines, generally well below industry norms
and for the year ended December 31, 1999, their annual statutory GWP was 182.6%
of their statutory policyholders' surplus and their NWP was 47.6% of their
statutory policyholders' surplus.
IMPACT OF INFLATION
The Company's operations, like those of other property and casualty
insurers, are susceptible to the effects of inflation, as premiums are
established before the ultimate amounts of loss and LAE are known. Although
management considers the potential effects of inflation when setting premium
rates, for competitive reasons, such premiums may not adequately compensate the
Company for the effects of inflation. However, as the majority of the Company's
business is comprised of lines which have short lead times between the
occurrence of an insured event, reporting of the claims to the Company and the
final settlement of the claims, the effects of inflation are minimized.
A significant portion of the Company's revenue is related to healthcare
insurance and reinsurance products which are subject to the effects of the
underlying inflation of medical costs. Such inflation in the costs of healthcare
tends to generate increases in premiums for medical stop-loss coverage,
resulting in greater revenue, but also higher claim payments. Inflation may have
a negative impact on insurance and reinsurance operations by causing higher
claim settlements than may originally have been estimated without an immediate
increase in premiums to a level necessary to maintain profit margins. No express
39
provision for inflation is made, although trends are considered when setting
underwriting terms and claim reserves. Claim reserves are subject to a
continuing review process to assess their adequacy and are adjusted as deemed
appropriate. In addition, the market value of the investments held by the
Company varies depending on economic and market conditions and interest rates,
which are highly sensitive to the policies of governmental and regulatory
authorities. Any significant increase in interest rates could therefore have a
material adverse effect on the market value of the Company's investments. In
addition, the Company's $300.0 million Facility's interest rate floats with that
of the market. Any significant increase in interest rates could have a material
adverse effect on earnings.
EXCHANGE RATE FLUCTUATIONS
The Company underwrites risks which are denominated in a number of foreign
currencies. It establishes and maintains loss reserves with respect to these
policies in their respective currencies. These reserves are subject to exchange
rate fluctuations which can have an effect on the Company's net earnings. The
Company's principal area of exposure is with respect to fluctuation in the
exchange rate between the major European currencies and the United States
Dollar. For the years ended December 31, 1999, 1998 and 1997, the gain (loss)
from currency conversion was $442,000, $219,000 and ($884,000), respectively.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US$1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to limit
its exposure to currency fluctuations through the use of foreign currency
forward contracts. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than a form of speculative or trading investment.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June, 1998 and is now effective for all fiscal quarters of fiscal years
beginning after June 15, 2000, with early adoption permitted. The Company has
utilized derivatives or hedging strategies only infrequently in the past and in
immaterial amounts, although it is currently using derivatives and hedging
strategies to a greater extent as it expands its foreign operations. The effects
of SFAS No. 133, as well as the timing of its adoption, are currently being
reviewed by management.
During December, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in Financial
Statements" which becomes effective for the Company during the second quarter of
2000. The Company does not expect the adoption of SAB No. 101 to have a material
effect on the Company's financial position, results of operations or
shareholders' equity.
YEAR 2000
The Year 2000 issue is the result of date coding within computer programs
that were written using just two digits rather than four digits to define the
applicable year. If not corrected, these date codes could cause computers to
fail to calculate dates beyond 1999 and, as a result, computer applications
could fail or create erroneous information as a result of the Year 2000 date
change. The Company's expenditures in
40
connection with the Year 2000 issues associated with its own systems did not
have a material effect on the Company's results of operations. No additional
costs are anticipated.
Although the Company experienced no material system failures attributed to
the Year 2000 changeover, the Company may have exposure in the property and
casualty operations of its insurance company subsidiaries to claims asserted
under certain insurance policies for damages caused by an insured's failure to
address its own Year 2000 computer problems. As with other companies in the
insurance industry, the Company has evaluated and continues to evaluate the
potential Year 2000 insurance exposures. The Company's insurance company
subsidiaries did not generally offer policies of insurance marketed as Year 2000
liability coverage. However, due to the nature of certain of the policies, such
as policies of property insurance, insureds may submit purported claims for
coverage under such policies which may result from Year 2000 related causes. In
this regard, the Company continues to assess appropriate responses to such
attempted claims in light of Year 2000 coverage issues under the insurance
coverages offered by such subsidiaries. The nature of the Company's response to
such attempted claims are generally dependent on the particular facts and
circumstances of the underlying claims and coverage. Management does not believe
that Year 2000 coverage issues associated with the insurance coverages offered
by the Company's insurance company subsidiaries will have a material adverse
effect on the Company's results of operations.
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union
irrevocably fixed the conversion rates between their national currencies and a
common currency, the "Euro", which became their common legal currency on that
date. The participating countries' former national currencies will continue to
serve as legal tender and denominations of the Euro between January 1, 1999 and
January 1, 2002. The conversion to the Euro is scheduled to be completed on
July 1, 2002, when the national currencies will cease to exist. The Company does
not expect the introduction of the Euro to have a material effect on the
Company's business, software plans, financial condition or results of
operations.
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41
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's principal assets and liabilities are financial instruments
which are subject to the market risk of potential losses from adverse changes in
market rates and prices. The Company's primary market risk exposures are:
interest rate risk on fixed income securities and interest expense on variable
rate debt, equity risk on marketable equity securities, credit risk on its
reinsurance recoverables and foreign currency exchange rate risk.
To manage its exposures of investment risks, the Company generally invests
in investment grade securities with characteristics of duration and liquidity to
reflect the underlying characteristics of its insurance liabilities. The Company
has not used derivatives to manage any of its investment related market risks.
Caution should be used in evaluating overall market risk from the
information below. Actual results could differ materially from estimates below
for a variety of reasons, including (but not limited to):
- market changes could be different from market changes assumed below,
- amounts and balances on which the estimates are based are likely to change
over time,
- not all factors and balances are taken into account, and
- assumptions used in the models may prove to be inaccurate.
INTEREST RATE RISK
The value of the Company's portfolio of fixed income securities is inversely
correlated to changes in the market interest rates. In addition, some of the
Company's fixed income securities have call or prepayment options. This could
subject the Company to reinvestment risk should interest rates fall or issuers
call their securities and the Company reinvests the proceeds at lower interest
rates. The Company mitigates this risk by investing in securities with varied
maturity dates, so that only a portion of the portfolio will mature at any point
in time. The fair value of the Company's fixed income securities as of December
31, 1999 and 1998 was $342.6 million and $393.2 million, respectively. If
interest rates were to change 1%, the fair value of the Company's fixed income
securities would change approximately $17.2 million as of December 31, 1999.
This compares to change in value of $21.9 million as of December 31, 1998 for
the same 1% change in interest rates. The change in fair value was determined
using duration modeling assuming no prepayments.
The Facility entered into by the Company is subject to variable interest
rates. Thus, the Company's interest expense is directly correlated to market
interest rates. As of December 31, 1999, the Company had $235.0 million in debt
outstanding under the Facility. At this debt level, a 1% change in market
interest rates would change the Company's annual interest expense by $2.4
million. As of December 31, 1998, the Company had $105.0 million in debt
outstanding under its previous facility. At that debt level, the 1% change in
market interest rates would have changed interest expense by $1.1 million.
EQUITY RISK
The Company's portfolio of marketable equity securities is subject to equity
price risk due to market changes. The fair value of the Company's marketable
equity securities (including those designated as strategic operational
investments, if any) as of December 31, 1999 was $20.0 million, compared to
$18.2 million as of December 31, 1998. If the market price of all marketable
equity securities were to change by 10% as of these dates, the fair value of the
Company's equity portfolio would have changed $2.0 million as of December 31,
1999 and $1.8 million as of December 31, 1998.
42
CREDIT RISK
See Reinsurance Ceded section contained in Item 1., Business, and Footnote
(8) in the Notes to Consolidated Financial Statements.
FOREIGN EXCHANGE RISK
The Company underwrites risks which are denominated in a number of foreign
currencies. It establishes and maintains loss reserves with respect to these
policies in their respective currencies, as well as having varying receivable
and payable balances at any point in time. These amounts are subject to exchange
rate fluctuations which can have an effect on the Company's net earnings. The
Company's principal area of exposure is with respect to fluctuation in the
exchange rate between the major European currencies and the United States
Dollar.
The table below shows the net amounts of significant foreign currency
balances at December 31, 1999 and 1998 converted to US Dollars. It also shows
the expected dollar change in fair value that would occur if exchange rates
changed 10% from exchange rates in effect at those times:
1999 1998
----------------------------- -----------------------------
HYPOTHETICAL 10% HYPOTHETICAL 10%
US DOLLAR CHANGE IN US DOLLAR CHANGE IN
EQUIVALENT FAIR VALUE EQUIVALENT FAIR VALUE
---------- ---------------- ---------- ----------------
British Pound Sterling.................. $5,974,000 $597,000 $8,086,000 $809,000
Euro and 11 national currencies......... 1,054,000 105,000 2,296,000 230,000
On a historical basis, the eleven national currencies which are now in the
process of being converted to the Euro have not always had their relative
exchange rates change together. However, with the fixing of exchange rates on
January 1, 1999 relative to the new Euro, these currencies will now behave as
one currency.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US$1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to limit
its exposure to currency fluctuations through the use of foreign currency
forward contracts. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than as a form of speculative or trading investment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedules listed in the
accompanying index are filed as part of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding Directors and Executive Officers of the
Registrant, reference is made to the Registrant's definitive proxy statement for
its Annual Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission within 120 days after December 31, 1999, and which is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information regarding Executive Compensation, reference is made to the
Registrant's definitive proxy statement for its Annual Meeting of Shareholders,
which will be filed with the Securities and Exchange Commission within 120 days
after December 31, 1999, and which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information regarding Security Ownership of Certain Beneficial Owners
and Management, reference is made to the Registrant's definitive proxy statement
for its Annual Meeting of Shareholders, which will be filed with the Securities
and Exchange Commission within 120 days after December 31, 1999, and which is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information regarding Certain Relationships and Related Transactions,
reference is made to the Registrant's definitive proxy statement for its Annual
Meeting of Shareholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 1999, and which is incorporated
herein by reference.
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44
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) EXHIBITS
The exhibits listed on the accompanying Index to Exhibits are filed as part
of this Report.
(B) FINANCIAL STATEMENT SCHEDULES
The financial statements and financial statement schedules listed in the
accompanying index are filed as part of this Report.
(C) REPORTS ON FORM 8-K
On December 20, 1999, the Company filed a report on Form 8-K/A related to
its acquisition of Centris. Such report, as amended, included financial
statements of Centris and certain required pro forma financial information.
[THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK]
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HCC INSURANCE HOLDINGS, INC.
(Registrant)
By: /s/ STEPHEN L. WAY
------------------------------------------
(Stephen L. Way)
CHAIRMAN OF THE BOARD
Dated: March 30, 2000 AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
Chairman of the Board of
/s/ STEPHEN L. WAY Directors and Chief
------------------------------------------- Executive Officer (Principal March 30, 2000
(Stephen L. Way) Executive Officer)
/s/ JAMES M. BERRY*
------------------------------------------- Director March 30, 2000
(James M. Berry)
/s/ MARVIN P. BUSH*
------------------------------------------- Director March 30, 2000
(Marvin P. Bush)
/s/ FRANK J. BRAMANTI*
------------------------------------------- Director and Executive Vice March 30, 2000
(Frank J. Bramanti) President
/s/ PATRICK B. COLLINS*
------------------------------------------- Director March 30, 2000
(Patrick B. Collins)
/s/ JAMES R. CRANE*
------------------------------------------- Director March 30, 2000
(James R. Crane)
/s/ J. ROBERT DICKERSON*
------------------------------------------- Director March 30, 2000
(J. Robert Dickerson)
/s/ EDWARD H. ELLIS, JR. Senior Vice President and
------------------------------------------- Chief Financial Officer March 30, 2000
(Edward H. Ellis, Jr.) (Chief Accounting Officer)
/s/ EDWIN H. FRANK, III*
------------------------------------------- Director March 30, 2000
(Edwin H. Frank, III)
/s/ ALAN W. FULKERSON*
------------------------------------------- Director March 30, 2000
(Alan W. Fulkerson)
/s/ WALTER J. LACK*
------------------------------------------- Director March 30, 2000
(Walter J. Lack)
46
/s/ STEPHEN J. LOCKWOOD*
------------------------------------------- Director and Vice Chairman March 30, 2000
(Stephen J. Lockwood)
/s/ JOHN N. MOLBECK, JR.
------------------------------------------- Director, President and Chief March 30, 2000
(John N. Molbeck, Jr.) Operating Officer
*By: /s/ JOHN N. MOLBECK, JR.
--------------------------------------
John N. Molbeck, Jr., March 30, 2000
ATTORNEY-IN-FACT
47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Report of Independent Accountants........................... F-1
Consolidated Balance Sheets at December 31, 1999 and 1998... F-2
Consolidated Statements of Earnings for the three years
ended December 31, 1999................................... F-3
Consolidated Statements of Comprehensive Income for the
three years ended December 31, 1999....................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the three years ended December 31, 1999............... F-5
Consolidated Statements of Cash Flows for the three years
ended December 31, 1999................................... F-8
Notes to Consolidated Financial Statements.................. F-9
SCHEDULES:
Report of Independent Accountants on Financial
Statement Schedules..................................... S-1
Schedule 1 Summary of Investments other than Investments
in Related Parties...................................... S-2
Schedule 2 Condensed Financial Information of
Registrant.............................................. S-3
Schedule 3 Supplementary Insurance Information............ S-8
Schedule 4 Reinsurance.................................... S-9
Schedule 5 Valuation and Qualifying Accounts.............. S-10
Schedules other than those listed above have been omitted because they are
either not required, not applicable, or the required information is shown in the
Consolidated Financial Statements and related notes thereto or other Schedules.
48
INDEX TO EXHIBITS
(ITEMS DENOTED BY A LETTER ARE INCORPORATED BY REFERENCE TO OTHER DOCUMENTS
PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AS SET FORTH AT THE
END OF THIS INDEX. ITEMS NOT DENOTED BY A LETTER ARE BEING FILED HEREWITH.)
EXHIBIT
NUMBER
- -------
(A)3.1 --Bylaws of HCC Insurance Holdings, Inc., as amended.
(B)3.2 --Restated Certificate of Incorporation of HCC Insurance
Holdings, Inc., filed with the Delaware Secretary of State
on July 23, 1996.
(A)4.1 --Specimen of Common Stock Certificate, $1.00 par value, of
HCC Insurance Holdings, Inc.
(C)10.1 --Stock Purchase Agreement dated effective October 1, 1998
by and among HCC Insurance Holdings, Inc., and Sun
Employer Services, Inc. and Howard V. Barton and
Elizabeth A. Barton.
(D)10.2 --Share Purchase Agreement dated January 29, 1999, among HCC
Insurance Holdings, Inc. and Gerald Axel, Barry J. Cook,
Gary J. Lockett, Christopher F.B. Mays, Mark E. Rattner,
Marshall Rattner, Inc., John Smith and Keith W. Steed.
(E)10.3 --Loan Agreement ($150,000,000 Revolving Loan Facility and
$100,000,000 Short Term Revolving Loan Facility) dated as
of March 8, 1999 among HCC Insurance Holdings, Inc. as
Borrower, Wells Fargo Bank (Texas), National Association,
as Agent and as Lender, Nationsbank, N.A., as
Documentation Agent and as a Lender, and The Other Lenders
Now or Hereafter Parties Thereto.
(F)10.4 --Loan Agreement ($300,000,000 Revolving Loan Facility)
dated as of December 17, 1999 among HCC Insurance
Holdings, Inc. as Borrower, Wells Fargo Bank (Texas),
National Association, as Agent, lead arranger and lender,
Bank of America, N.A. as documentation agent and lender,
Bank of New York as senior managing agent and lender, Bank
One, N.A. as co-agent and lender, First Union National
Bank as syndications agent and lender and Dresdner Bank
AG, New York and Grand Cayman Branches, as co-agent and a
lender.
(F)10.5 --$80,000,000 Note dated December 17, 1999 executed by HCC
Insurance Holdings, Inc. and payable to the order of Wells
Fargo Bank (Texas), National Association.
(G)10.6 --HCC Insurance Holdings, Inc. 1994 Nonemployee Director
Stock Option Plan.
10.7 --HCC Insurance Holdings, Inc. 1992 Incentive Stock Option
Plan, as amended and restated.
10.8 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan,
as amended and restated.
10.9 --HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan,
as amended and restated.
10.10 --HCC Insurance Holdings, Inc. 1996 Nonemployee Director
Stock Option Plan, as amended and restated.
(D)10.11 --Employment Agreement effective as of January 1, 1999,
between HCC Insurance Holdings, Inc. and Stephen L. Way.
(C)10.12 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and John N. Molbeck.
Jr.
10.13 --Employment Agreement effective as of December 7, 1998,
between HCC Insurance Holdings, Inc. and Benjamin D.
Wilcox.
49
EXHIBIT
NUMBER
- -------
(C)10.14 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and Frank J.
Bramanti.
10.15 --Employment Agreement effective as of January 1, 1998,
between HCC Insurance Holdings, Inc. and Edward H. Ellis,
Jr.
(H)10.16 --Agreement and Plan of Merger dated as of October 11, 1999
among HCC Insurance Holdings, Inc., Merger Sub of
Delaware, Inc. and The Centris Group, Inc.
12 --Statement Regarding Computation of Ratios
21 --Subsidiaries of HCC Insurance Holdings, Inc.
23 --Consent of Independent Accountants--PricewaterhouseCoopers
LLP dated March 30, 2000
24 --Powers of Attorney
27 --EDGAR Financial Data Schedule--December 31, 1999
- ------------------------
(A) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-1 (Registration No. 33-48737) filed
October 27, 1992.
(B) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Registration Statement on Form S-8 (Registration No. 333-14479)
filed October 18, 1996.
(C) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 10-K for the fiscal year ended December 31, 1998.
(D) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-Q for the fiscal quarter ended March 31, 1999.
(E) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 8-K filed March 15, 1999.
(F) Incorporated by reference to the Exhibits to HCC Insurance Holdings,
Inc.'s Form 8-K filed December 20, 1999.
(G) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Registration Statement on Form S-8 (Registration No. 33-94472) filed
July 11, 1995.
(H) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Schedule 14D-1 Tender Offer Statement in respect to shares of The Centris
Group, Inc. filed October 18, 1999.
50
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
HCC Insurance Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of earnings, of comprehensive income, of changes in
shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of HCC Insurance Holdings, Inc. and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
Houston, Texas
March 30, 2000
F-1
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------------
1999 1998
-------------- --------------
ASSETS
Investments:
Fixed income securities, at market
(cost: 1999 $343,534,000; 1998 $375,107,000)............ $ 342,641,000 $ 393,238,000
Marketable equity securities, at market
(cost: 1999 $22,493,000; 1998 $1,750,000)............... 19,970,000 2,252,000
Short-term investments, at cost, which approximates
market.................................................. 215,694,000 129,084,000
Other investments, at cost, which approximates fair
value................................................... 3,017,000 1,072,000
-------------- --------------
Total investments..................................... 581,322,000 525,646,000
Cash........................................................ 26,533,000 16,018,000
Restricted cash and cash investments........................ 84,112,000 84,276,000
Commuted receivable......................................... 53,210,000 --
Premium, claims and other receivables....................... 607,986,000 382,630,000
Reinsurance recoverables.................................... 683,275,000 372,672,000
Ceded unearned premium...................................... 133,657,000 149,568,000
Ceded life and annuity benefits............................. 95,760,000 --
Deferred policy acquisition costs........................... 40,450,000 27,227,000
Property and equipment, net................................. 37,804,000 32,983,000
Goodwill.................................................... 263,687,000 88,043,000
Other assets................................................ 42,827,000 30,006,000
-------------- --------------
TOTAL ASSETS.......................................... $2,650,623,000 $1,709,069,000
============== ==============
LIABILITIES
Loss and loss adjustment expense payable.................... $ 871,104,000 $ 460,511,000
Life and annuity policy benefits............................ 95,760,000 --
Reinsurance balances payable................................ 113,373,000 90,983,000
Unearned premium............................................ 188,524,000 201,050,000
Deferred ceding commissions................................. 39,792,000 30,842,000
Premium and claims payable.................................. 584,537,000 337,909,000
Notes payable............................................... 242,546,000 121,600,000
Accounts payable and accrued liabilities.................... 57,559,000 26,311,000
-------------- --------------
Total liabilities..................................... 2,193,195,000 1,269,206,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares
authorized;
(issued: 1999 48,839,027 shares; 1998 48,252,478
shares)................................................... 48,839,000 48,252,000
Additional paid-in capital.................................. 176,359,000 162,102,000
Retained earnings........................................... 234,922,000 219,804,000
Accumulated other comprehensive income (loss)............... (2,692,000) 9,705,000
-------------- --------------
Total shareholders' equity............................ 457,428,000 439,863,000
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............ $2,650,623,000 $1,709,069,000
============== ==============
See Notes to Consolidated Financial Statements.
F-2
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
REVENUE
Net earned premium................................. $141,362,000 $143,100,000 $162,571,000
Management fees.................................... 90,713,000 74,045,000 51,039,000
Commission income.................................. 54,552,000 38,441,000 24,209,000
Net investment income.............................. 30,933,000 29,335,000 27,587,000
Net realized investment gain (loss)................ (4,164,000) 845,000 (328,000)
Other operating income............................. 28,475,000 22,268,000 15,239,000
------------ ------------ ------------
Total revenue................................ 341,871,000 308,034,000 280,317,000
EXPENSE
Loss and loss adjustment expense................... 109,650,000 91,302,000 96,514,000
Operating expense:
Policy acquisition costs, net.................... 8,177,000 10,978,000 13,580,000
Compensation expense............................. 77,488,000 56,077,000 51,458,000
Provision for reinsurance........................ 43,462,000 -- --
Restructuring expense............................ 5,489,000 -- --
Other operating expense.......................... 47,247,000 36,063,000 31,628,000
Merger expense................................... -- 107,000 8,069,000
------------ ------------ ------------
Total operating expense...................... 181,863,000 103,225,000 104,735,000
Interest expense................................... 12,964,000 6,021,000 6,004,000
------------ ------------ ------------
Total expense................................ 304,477,000 200,548,000 207,253,000
------------ ------------ ------------
Earnings before income tax provision......... 37,394,000 107,486,000 73,064,000
Income tax provision............................... 12,271,000 35,208,000 23,305,000
------------ ------------ ------------
NET EARNINGS................................. $ 25,123,000 $ 72,278,000 $ 49,759,000
============ ============ ============
BASIC EARNINGS PER SHARE DATA:
Earnings per share................................. $ 0.51 $ 1.51 $ 1.06
============ ============ ============
Weighted average shares outstanding................ 49,061,000 47,920,000 46,995,000
============ ============ ============
DILUTED EARNINGS PER SHARE DATA:
Earnings per share................................. $ 0.51 $ 1.48 $ 1.03
============ ============ ============
Weighted average shares outstanding................ 49,649,000 48,936,000 48,209,000
============ ============ ============
See Notes to Consolidated Financial Statements
F-3
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
------------ ----------- -----------
Net earnings.......................................... $ 25,123,000 $72,278,000 $49,759,000
Other comprehensive income net of tax:
Foreign currency translation adjustment............. 167,000 (344,000) (215,000)
Investment gains (losses):
Investment gains (losses) during the year, net of
deferred tax charge (benefit) of ($8,042,000) in
1999, $1,283,000 in 1998 and $2,373,000 in
1997............................................ (15,271,000) 2,598,000 4,470,000
Less reclassification adjustment for (gains)
losses included in net earnings, net of deferred
tax (charge) benefit of $1,457,000 in 1999,
($296,000) in 1998 and $115,000 in 1997......... 2,707,000 (549,000) 213,000
------------ ----------- -----------
Other comprehensive income (loss)................. (12,397,000) 1,705,000 4,468,000
------------ ----------- -----------
COMPREHENSIVE INCOME.............................. $ 12,726,000 $73,983,000 $54,227,000
============ =========== ===========
See Notes to Consolidated Financial Statements.
F-4
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK EQUITY
----------- ------------ ------------ ------------- ------------ -------------
BALANCE AS OF DECEMBER 31, 1996........ $49,017,000 $138,515,000 $162,132,000 $3,532,000 $(56,670,000) $296,526,000
Net earnings........................... -- -- 49,759,000 -- -- 49,759,000
Other comprehensive income............. -- -- -- 4,468,000 -- 4,468,000
726,898 shares of Common Stock issued
for exercise of options, including tax
benefit of $1,725,000................. 727,000 9,743,000 -- -- -- 10,470,000
1,332,024 shares of Common Stock issued
for acquisitons....................... 1,332,000 9,805,000 (1,507,000) -- -- 9,630,000
Cash dividends declared, $0.12 per
share................................. -- -- (5,219,000) -- -- (5,219,000)
Repurchase of 14,895 shares of common
stock by pooled company prior to
merger................................ -- -- -- -- (324,000) (324,000)
Retirement of 3,316,636 shares of
treasury stock........................ (3,317,000) (3,430,000) (50,247,000) -- 56,994,000 --
Other.................................. -- -- 291,000 -- -- 291,000
----------- ------------ ------------ ---------- ------------ ------------
BALANCE AS OF DECEMBER 31, 1997.... $47,759,000 $154,633,000 $155,209,000 $8,000,000 $ -- $365,601,000
=========== ============ ============ ========== ============ ============
See Notes to Consolidated Financial Statements.
F-5
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(CONTINUED)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
BALANCE AS OF DECEMBER 31, 1997....................... $47,759,000 $154,633,000 $155,209,000 $8,000,000 $365,601,000
Net earnings.......................................... -- -- 72,278,000 -- 72,278,000
Other comprehensive income............................ -- -- -- 1,705,000 1,705,000
206,504 shares of Common Stock issued for exercise of
options, including tax benefit of $925,000........... 206,000 1,997,000 -- -- 2,203,000
287,025 shares of Common Stock issued for purchased
companies............................................ 287,000 5,472,000 -- -- 5,759,000
Cash dividends declared, $0.16 per share.............. -- -- (7,683,000) -- (7,683,000)
----------- ------------ ------------ ---------- ------------
BALANCE AS OF DECEMBER 31, 1998................... $48,252,000 $162,102,000 $219,804,000 $9,705,000 $439,863,000
=========== ============ ============ ========== ============
See Notes to Consolidated Financial Statements.
F-6
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(CONTINUED)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
BALANCE AS OF DECEMBER 31, 1998....................... $48,252,000 $162,102,000 $219,804,000 $ 9,705,000 $439,863,000
Net earnings.......................................... -- -- 25,123,000 -- 25,123,000
Other comprehensive income (loss)..................... -- -- -- (12,397,000) (12,397,000)
505,555 shares of Common Stock issued for exercise of
options, including tax benefit of $1,156,000......... 506,000 4,277,000 -- -- 4,783,000
101,330 shares of Common Stock issued for purchased
companies............................................ 101,000 1,899,000 -- -- 2,000,000
414,207 shares of Common Stock contractually issuable
in the future........................................ -- 8,271,000 -- -- 8,271,000
Cash dividends declared, $0.20 per share.............. -- -- (9,733,000) -- (9,733,000)
Other................................................. (20,000) (190,000) (272,000) -- (482,000)
----------- ------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1999................... $48,839,000 $176,359,000 $234,922,000 $ (2,692,000) $457,428,000
=========== ============ ============ ============ ============
See Notes to Consolidated Financial Statements.
F-7
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------
1999 1998 1997
------------- ------------- ------------
Cash flows from operating activities:
Net earnings.................................... $ 25,123,000 $ 72,278,000 $ 49,759,000
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Change in commuted receivable................. (53,210,000) -- --
Change in premium, claims and other
receivables................................. (92,206,000) (102,804,000) (84,309,000)
Change in reinsurance recoverables............ (231,294,000) (195,707,000) (70,972,000)
Change in ceded unearned premium.............. 31,408,000 (64,958,000) (12,852,000)
Change in deferred policy acquisition costs,
net......................................... (4,659,000) 5,666,000 5,857,000
Change in other assets........................ (12,081,000) 410,000 (4,501,000)
Change in loss and loss adjustment expense
payable..................................... 264,360,000 181,626,000 45,959,000
Change in reinsurance balances payable........ (15,098,000) 47,069,000 24,800,000
Change in unearned premium.................... (31,138,000) 46,074,000 (4,174,000)
Change in premium and claims payable, net of
restricted cash............................. 102,114,000 64,364,000 98,952,000
Change in accounts payable and accrued
liabilities................................. 4,707,000 (9,205,000) (2,794,000)
Net realized investment (gain) loss........... 4,164,000 (845,000) 328,000
Gains on sales of strategic investments....... (5,523,000) (4,694,000) --
Provision for reinsurance..................... 43,462,000 -- --
Depreciation and amortization expense......... 13,398,000 7,388,000 5,189,000
Other, net.................................... (2,630,000) 3,382,000 2,875,000
------------- ------------- ------------
Cash provided by operating activities....... 40,897,000 50,044,000 54,117,000
Cash flows from investing activities:
Sales of fixed income securities................ 131,485,000 18,212,000 27,090,000
Maturity or call of fixed income securities..... 17,050,000 30,202,000 19,173,000
Sales of equity securities...................... 2,886,000 4,160,000 17,656,000
Sales of strategic investments.................. 15,905,000 3,324,000 --
Change in short-term investments................ (14,935,000) (24,667,000) (26,562,000)
Cash paid for companies acquired, net of cash
received...................................... (186,923,000) (33,011,000) (12,948,000)
Cost of investments acquired.................... (70,736,000) (43,968,000) (87,084,000)
Purchase of property and equipment and other.... (9,076,000) (15,320,000) (6,718,000)
------------- ------------- ------------
Cash used by investing activities........... (114,344,000) (61,068,000) (69,393,000)
Cash flows from financing activities:
Proceeds from notes payable..................... 547,000,000 74,200,000 97,500,000
Sale of Common Stock............................ 4,783,000 2,203,000 10,470,000
Payments on notes payable....................... (458,600,000) (49,950,000) (89,667,000)
Dividends paid.................................. (9,221,000) (7,139,000) (4,550,000)
Repurchase of common stock...................... -- -- (324,000)
------------- ------------- ------------
Cash provided by financing activities....... 83,962,000 19,314,000 13,429,000
------------- ------------- ------------
Net change in cash.......................... 10,515,000 8,290,000 (1,847,000)
Cash as of beginning of year................ 16,018,000 7,728,000 9,575,000
------------- ------------- ------------
CASH AS OF END OF YEAR...................... $ 26,533,000 $ 16,018,000 $ 7,728,000
============= ============= ============
See Notes to Consolidated Financial Statements
F-8
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
HCC Insurance Holdings, Inc. ("the Company" or "HCC"), and its subsidiaries
include domestic and foreign property and casualty and life insurance companies,
underwriting agencies, intermediaries and service companies. HCC, through its
subsidiaries, provides specialized property and casualty and life and health
insurance to commercial customers in the areas of accident and health
reinsurance, aviation, marine, property, offshore energy, workers' compensation,
group health and medical stop-loss insurance. The principal insurance company
subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, and London,
England; HCC Life Insurance Company ("HCCL") in Houston, Texas; U.S. Specialty
Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance Company
("AIC") in Frederick, Maryland. The underwriting agency subsidiaries provide
underwriting management and claims servicing for insurance and reinsurance
companies, specializing in aviation, medical stop-loss, occupational accident
and workers' compensation insurance and a variety of accident and health related
reinsurance products. The principal agency subsidiaries are LDG Reinsurance
Corporation ("LDG Re") in Wakefield, Massachusetts and New York City, New York;
LDG Re (London), Ltd. ("LDG Re-London") in London, England; HCC Aviation
Insurance Group, Inc. ("HCCA") in Dallas, Texas and Glendale, California; HCC
Employer Services, Inc. ("HCCES") in Northbrook, Illinois, Montgomery, Alabama
and Dallas, Texas; and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia,
Costa Mesa, California, Wakefield, Massachusetts, Minneapolis, Minnesota and
Dallas, Texas. The intermediary subsidiaries provide brokerage, consulting and
other intermediary services to insurance and reinsurance companies, commercial
customers and individuals in the same lines of business as the insurance
companies operate. The Company's principal intermediary subsidiaries are HCC
Intermediaries, Inc. ("HCCI") in Houston, Texas; HCC Employee Benefits, Inc.
("HCCEB") in Houston, Texas; and Rattner Mackenzie Limited ("RML") in London,
England. The service company subsidiaries perform various insurance related
services for insurance companies.
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions. This affects amounts reported in the financial statements and
the disclosure of contingent assets and liabilities. Actual results could differ
from those estimates.
A description of the significant accounting and reporting policies utilized
by the Company in preparing the consolidated financial statements is as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
INVESTMENTS
Fixed income securities and marketable equity securities are classified as
available for sale and are carried at quoted market value, if readily
marketable, or at management's estimated fair value, if not readily marketable.
The change in unrealized gain or loss with respect to these securities is
recorded as a component of other comprehensive income, net of the related
deferred income tax effects, if any. Fixed income securities available for sale
are purchased with the original intent to hold to maturity, but they may be
available for sale if market conditions warrant, or if the Company's investment
policies dictate, in order to maximize the Company's investment yield.
Short-term investments and restricted short-term investments are carried at
cost, which approximates market value.
F-9
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
The realized gain or loss on investment transactions is determined on an
average cost basis and included in earnings on the trade date. When impairment
of the value of an investment is considered other than temporary, the decrease
in value is reported in earnings as a realized investment loss and a new cost
basis is established.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, net of accumulated depreciation.
Depreciation expense is provided using the straight-line method over the
estimated useful lives of the related assets. Amortization of leasehold
improvements is provided using the straight-line method over the shorter of the
estimated useful life or the term of the respective lease. Upon disposal of
assets, the cost and related accumulated depreciation are removed from the
accounts and the resulting gain or loss is included in earnings.
Costs incurred in developing or purchasing management information systems
are capitalized and included in property and equipment. These costs are
amortized over their estimated useful lives from the dates the systems are
placed in service.
EARNED PREMIUM, DEFERRED POLICY ACQUISITION COSTS AND CEDING COMMISSIONS OF
INSURANCE COMPANY SUBSIDIARIES
Written premium, net of reinsurance, is primarily included in earnings on a
pro rata basis over the lives of the related policies. However, for certain
types of business, it is recognized over the period of risk in proportion to the
amount of insurance risk provided. Policy acquisition costs, including
commissions, taxes, fees and other direct costs of underwriting policies, less
ceding commissions allowed by reinsurers, including expense allowances, are
deferred and charged or credited to earnings proportionate to the premium
earned. Historical and current loss and loss adjustment expense experience and
anticipated investment income are considered in determining the recoverability
of deferred policy acquisition costs.
MANAGEMENT FEES AND COMMISSION INCOME
Management fees and commission income are recognized on the revenue
recognition date, which is the later of the effective date of the policy, the
date when the premium can be reasonably estimated, or the date when
substantially all required services relating to the insurance placement have
been rendered to the client. Management fees and commission income relating to
additional or return premiums or other policy adjustments are recognized when
the events occur and the amounts become known or can be estimated.
PREMIUM AND OTHER RECEIVABLES
The Company has adopted the gross method for reporting receivables and
payables on brokered transactions. Management reviews the collectibility of its
receivables on a current basis and provides an allowance for doubtful accounts
if it deems that there are accounts which are doubtful of collection. The amount
of the allowance at December 31, 1999 and 1998 is not material.
LOSS AND LOSS ADJUSTMENT EXPENSE PAYABLE OF INSURANCE COMPANY SUBSIDIARIES
Loss and loss adjustment expense payable is based on undiscounted estimates
of payments to be made for reported and incurred but not reported ("IBNR")
losses and anticipated salvage and subrogation
F-10
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
receipts. Estimates for reported losses are based on all available information,
including reports received from ceding companies on assumed business. Estimates
for IBNR are based both on the Company's and the industry's experience. While
management believes that amounts included in the accompanying financial
statements are adequate, such estimates may be more or less than the amounts
ultimately paid when the claims are settled. The estimates are continually
reviewed and any changes are reflected in current operations.
REINSURANCE
The Company records all reinsurance recoverables and ceded unearned premiums
as assets and deferred ceding commissions as a liability. All such amounts are
estimated and recorded in a manner consistent with the underlying reinsured
contracts. Management has also recorded a reserve for uncollectible reinsurance
based on current estimates of collectibility. These estimates could change and
affect the level of the reserve needed.
GOODWILL
In connection with the Company's acquisitions of subsidiaries accounted for
as purchases, the excess of cost over fair value of net assets acquired is being
amortized using the straight-line method over twenty years for acquired agency
operations which operate in existing lines of business and in the same country.
Goodwill related to acquired agency operations which represent the Company's
initial entry into new lines of business or new countries is amortized over
thirty years. Goodwill related to acquired insurance company operations is
amortized over forty years. Managements of the acquired businesses have
successfully operated in their markets for a number of years and, with the
additional capital provided by the Company, will be positioned to take advantage
of increased opportunities. Accumulated amortization of goodwill as of
December 31, 1999 and 1998, was $11.5 million and $5.2 million, respectively.
The Company's accounting policy regarding the assessment of the
recoverability of the carrying value of long-lived assets, including goodwill
and other intangibles and property, plant and equipment, is to review the
carrying value of the assets if the facts and circumstances suggest that they
may be impaired. If this review indicates that the carrying value will not be
recoverable, as determined based on the projected undiscounted future cash
flows, the carrying value is reduced to its estimated fair value. Amortization
of goodwill charged to income for the years ended December 31, 1999, 1998 and
1997 was $6.7 million, $3.0 million and $1.6 million, respectively.
CASH AND SHORT-TERM INVESTMENTS
Cash consists of cash in banks, generally in operating accounts. The Company
classifies certificates of deposit, corporate demand notes receivable,
commercial paper and money market funds as short-term investments. Short-term
investments are classified as investments in the consolidated balance sheets as
they relate principally to the Company's investment activities.
As of December 31, 1999 and 1998 the Company included $138.5 million and
$80.1 million, respectively, of certain fiduciary funds in short-term
investments. These are funds held by underwriting agency or intermediary
subsidiaries for the benefit of insurance or reinsurance clients. The Company
earns the interest on these funds.
F-11
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
The Company generally maintains its cash deposits in major banks and invests
its short-term investments with major banks and in investment grade commercial
paper and repurchase agreements. These securities typically mature within 90
days and, therefore, bear minimal risk. The Company has not experienced any
losses on its cash deposits or its short-term investments.
RESTRICTED CASH AND CASH INVESTMENTS
In conjunction with the management of reinsurance pools, the Company's
agency subsidiaries withhold premium funds for the payment of claims. These
funds are shown as restricted cash and cash investments in the consolidated
balance sheets. The corresponding liability is included within premium and
claims payable in the consolidated balance sheets. These amounts are considered
fiduciary funds, and interest earned on these funds accrues to the benefit of
the members of the reinsurance pools. Therefore, the Company does not include
these amounts as cash in the consolidated statements of cash flows.
FOREIGN CURRENCY
The functional currency of most foreign subsidiaries and branches is the
United States Dollar. Assets and liabilities recorded in foreign currencies are
translated into United States Dollars at exchange rates in effect at the balance
sheet date. Transactions in foreign currencies are translated at the rates of
exchange in effect on the date the transaction occurs. Translation gains and
losses are recorded in earnings and included in other operating expenses. The
Company's foreign currency transactions are principally denominated in British
Pound Sterling ("GBP") and other European currencies. For the years ended
December 31, 1999, 1998 and 1997, the gain (loss) from currency conversion was
$442,000, $219,000 and ($884,000), respectively.
Some foreign subsidiaries or branches have a functional currency of either
the GBP or the Canadian Dollar ("CAD"). The cumulative translation adjustment,
representing the effect of translating these subsidiaries' or branches' assets
and liabilities into United States Dollars, is included in the foreign currency
translation adjustment within accumulated other comprehensive income.
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
RML, purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. The foreign currency forward contracts are used to
convert currency at a known rate in an amount which approximates average monthly
expenses. Thus, the effect of these transactions is to limit the foreign
currency exchange risk of the recurring monthly expenses. In the future, the
Company may continue to limit its exposure to currency fluctuations through the
use of foreign currency forward contracts. The Company utilizes these foreign
currency forward contracts strictly as a hedge against existing exposure to
foreign currency fluctuations rather than as a form of speculative or trading
investment.
To the extent the fair value of the foreign exchange forward contracts
qualify for hedge accounting treatment the gain ($41,000 at December 31, 1999),
or loss due to changes in fair value is not recognized in the financial
statements until realized, at which time the gain or loss is recognized along
with the offsetting loss or gain on the hedged item. To the extent the fair
value of the foreign currency forward contracts do
F-12
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
not qualify for hedge accounting treatment, the gain or loss due to changes in
fair value is recognized in the consolidated statements of earnings, but is
generally offset by changes in value of the underlying exposure.
COMPUTER PRODUCTS AND SERVICES
Revenue from software contracts is recognized when delivery has occurred,
other remaining vendor obligations are no longer significant and collectibility
is probable or in accordance with contract accounting rules when material
modification or customization is required. Revenue from the sale of computer
hardware is recognized when delivery has occurred. Maintenance support is
recognized pro rata over the term of the maintenance agreement. Revenue from
such products and services is included in other operating income.
Software production costs are capitalized when the technological feasibility
of a new product has been established. The capitalized costs are amortized based
upon current and estimated future revenue for each product with a minimum of
straight-line amortization over the remaining estimated economic life of the
product. All other software development costs are expenses as incurred.
INCOME TAX
The companies file a consolidated Federal income tax return and include the
foreign subsidiaries' income to the extent required by law. Deferred income tax
is accounted for using the liability method, which reflects the tax impact of
temporary differences between the bases of assets and liabilities for financial
reporting purposes and such bases as measured by tax laws and regulations.
EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the year divided into net earnings. Diluted earnings
per share is based on the weighted average number of common shares outstanding
plus the potential common shares outstanding during the year divided into net
earnings. Outstanding common stock options, when dilutive, are considered to be
potential common stock for the purpose of the diluted calculation. The treasury
stock method is used to calculate potential common stock outstanding due to
options. Contingent shares to be issued are included in the earnings per share
computation when the underlying conditions for issuance have been met.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June, 1998 and is now effective for all fiscal quarters of fiscal years
beginning after June 15, 2000, with early adoption permitted. The Company has
utilized derivatives or hedging strategies only infrequently in the past and in
immaterial amounts, although it is currently using derivatives and hedging
strategies to a greater extent as it expands its foreign operations. The effects
of SFAS No. 133, as well as the timing of its adoption, are currently being
reviewed by management.
During December, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101 entitled "Revenue Recognition in Financial
Statements" which becomes effective for the
F-13
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(CONTINUED)
Company during the second quarter of 2000. The Company does not expect the
adoption of SAB No. 101 to have a material effect on the Company's financial
position, results of operations or shareholders' equity.
RECLASSIFICATIONS
Certain amounts in the 1998 and 1997 consolidated financial statements have
been reclassified to conform with the 1999 presentation. Such reclassifications
had no effect on the Company's shareholders' equity, net earnings or cash flows.
(2) ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
In 1999 and 1998, the Company acquired certain businesses in transactions
accounted for using the purchase method of accounting, as shown in the chart
below. The Company is still in the process of finalizing the purchase accounting
for The Centris Group, Inc. ("Centris") and the purchase price allocation may
change by amounts which are expected to be immaterial.
CONSIDERATION
-----------------------
SHARES OF GOODWILL
COMPANY'S AMORTIZATION
EFFECTIVE COMMON GOODWILL PERIOD
DATE STOCK CASH RECOGNIZED IN YEARS
--------- --------- ----------- ------------ ------------
1999
RML.................................... 01/01/99 414,207 $64,600,000 $ 70,800,000 30
Midwest Stop Loss Underwriting......... 01/28/99 110,330 3,000,000 4,800,000 20
Centris................................ 12/31/99 -- 149,500,000 101,900,000 20
1998
Guarantee Insurance Resources.......... 03/01/98 29,029 $21,400,000 $ 20,900,000 20
J.E. Stone and Associates, Inc......... 10/01/98 257,496 5,200,000 9,700,000 20
Sun Employer Services, Inc. ("Sun").... 11/01/98 500 17,600,000 21,300,000 30
North American Insurance
Management Corporation's occupational
accident operations................ 11/24/98 -- 4,000,000 4,000,000 20
On a combined basis, the fair value of assets acquired was $549.5 million in
1999 and $44.9 million in 1998. The fair value of liabilities assumed was
$499.8 million in 1999 and $46.2 million in 1998. The total consideration was
$227.4 million in 1999 and $50.0 million in 1998. The results of operations of
the businesses acquired in transactions accounted for using the purchase method
of accounting have been included in the consolidated financial statements
beginning on the effective date of each transaction.
In connection with the Sun acquisition, the Company may also issue up to
378,000 shares of its common stock on a contingent basis assuming certain future
financial benchmarks are met. Contingent shares issued will be recorded as
additional consideration at the current fair value if and when the financial
benchmarks are met and the shares are issued. Of these shares, 49,000 are
issuable in 2000 because the contingency had been partially met as of December
31, 1999.
F-14
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITIONS AND DISPOSITIONS (CONTINUED)
The following unaudited pro forma summary presents information as if the
1999 purchase acquisitions had occurred at the beginning of each year after
giving effect to certain adjustments including amortization of goodwill,
increased interest expense from debt issued to fund the acquisitions and Federal
income taxes. The pro forma summary is for information purposes only, does not
necessarily reflect the actual results that would have occurred, nor is it
necessarily indicative of future results of the combined companies. Centris,
whose results of operations are included in the pro forma financial information
below, in 1999 experienced both a loss from discontinued operations of $13.2
million and significant underwriting losses.
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
UNAUDITED PROFORMA INFORMATION
Revenue..................................................... $447,239,000 $493,551,000
Earnings (loss) from continuing operations.................. (2,062,000) 69,905,000
Net earnings (loss)......................................... (15,293,000) 46,637,000
Basic earnings (loss) per share from continuing
operations................................................ (0.04) 1.46
Diluted earnings (loss) per share from continuing
operations................................................ (0.04) 1.43
Basic earnings (loss) per share............................. (0.31) 0.97
Diluted earnings (loss) per share........................... (0.31) 0.95
In connection with the Centris acquisition, a plan was formulated, approved
and implemented prior to December 31, 1999 to eliminate Centris' corporate
staff, combine the Centris medical stop-loss operations with those of HCCB and
combine certain Centris and HCCB production and underwriting facilities. In
accordance with the plan, certain Centris employees were terminated with
severance benefits to be paid in accordance with Centris' employment contracts
for executives or the HCC severance plan for Centris employees who did not have
employment contracts. These severance obligations were accrued as of the
acquisition date, included in the purchase price allocation and will not be
included in expense in the Company's statements of earnings. Additionally,
accruals of $848,000 were made at that date for future lease costs of office
space made redundant by the plan. The following table provides a detailed
analysis of the accruals:
ACCRUED AT
PURCHASE PAID IN ACCRUED AT
DATE 1999 12/31/99
---------- -------- ----------
Contractual executive severance accruals................... $6,744,000 $878,000 $5,866,000
Other severance accruals................................... 397,000 -- 397,000
Lease obligation accruals.................................. 848,000 -- 848,000
---------- -------- ----------
Total.................................................. $7,989,000 $878,000 $7,111,000
========== ======== ==========
It is expected that the significant portion of the severance accruals will
be paid prior to April 30, 2000 in accordance with the contractual terms of the
severance agreements. Management is still evaluating what additional actions, if
any, are necessary to finalize the integration of the Centris operations. Any
additional accruals will be recorded as an adjustment to the purchase price
allocation.
F-15
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITIONS AND DISPOSITIONS (CONTINUED)
DISPOSITIONS
In January, 1999, the Company sold its 21% interest in Underwriters
Indemnity Holdings, the parent of Underwriters Indemnity Company, to RLI
Corporation for $8.2 million. The Company realized a pre-tax gain of $4.9
million, included in other operating income, in connection with the sale. The
Company's investment in Underwriters Indemnity Holdings, which was accounted for
by the equity method, was not material to the Company's financial position and
results of operations.
(3) INVESTMENTS
Substantially all of the Company's fixed income securities are investment
grade; most are A rated or better. No high-yield corporate bonds are owned or
contemplated. The cost or amortized cost, gross unrealized gain or loss and
estimated market value of investments in fixed income and marketable equity
securities, all of which are classified as available for sale, are as follows:
COST OR GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
------------- ----------- ----------- ------------
December 31, 1999:
Marketable equity securities........... $ 22,493,000 $ 8,000 $(2,531,000) $ 19,970,000
US Treasury securities................. 57,941,000 96,000 (532,000) 57,505,000
Obligations of states, municipalities
and political subdivisions........... 263,395,000 2,548,000 (2,839,000) 263,104,000
Other fixed income securities.......... 22,198,000 24,000 (190,000) 22,032,000
------------- ----------- ----------- ------------
Total securities................... $ 366,027,000 $ 2,676,000 $(6,092,000) $362,611,000
============= =========== =========== ============
December 31, 1998:
Marketable equity securities........... $ 1,750,000 $ 502,000 $ -- $ 2,252,000
Strategic operational investments...... 18,842,000 -- (2,900,000) 15,942,000
US Treasury securities................. 19,183,000 627,000 (37,000) 19,773,000
Obligations of states, municipalities
and political subdivisions........... 354,663,000 18,257,000 (767,000) 372,153,000
Other fixed income securities.......... 1,261,000 51,000 -- 1,312,000
------------- ----------- ----------- ------------
Total securities................... $ 395,699,000 $19,437,000 $(3,704,000) $411,432,000
============= =========== =========== ============
F-16
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENTS (CONTINUED)
The amortized cost and estimated market value of fixed income securities at
December 31, 1999, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
ESTIMATED
AMORTIZED MARKET
COST VALUE
------------ ------------
Due in 1 year or less....................................... $ 36,885,000 $ 37,052,000
Due after 1 year through 5 years............................ 107,135,000 107,647,000
Due after 5 years through 10 years.......................... 97,527,000 97,250,000
Due after 10 years through 15 years......................... 69,372,000 68,695,000
Due after 15 years.......................................... 32,615,000 31,997,000
------------ ------------
Total fixed income securities........................... $343,534,000 $342,641,000
============ ============
As of December 31, 1999, the Company's insurance company subsidiaries had
deposited fixed income securities with an amortized cost of approximately
$40.0 million (market: $40.1 million) to meet the deposit requirements of
various insurance departments.
All investments in fixed income securities and other investments were income
producing for the twelve months preceding December 31, 1999. The sources of net
investment income for the three years ended December 31, 1999, are detailed
below:
1999 1998 1997
----------- ----------- -----------
Fixed income securities............................... $20,098,000 $20,711,000 $20,937,000
Short-term investments................................ 10,915,000 8,079,000 5,680,000
Equity securities..................................... 36,000 35,000 572,000
Other................................................. -- 607,000 445,000
----------- ----------- -----------
Total investment income............................. 31,049,000 29,432,000 27,634,000
Investment expense.................................... (116,000) (97,000) (47,000)
----------- ----------- -----------
Net investment income............................... $30,933,000 $29,335,000 $27,587,000
=========== =========== ===========
F-17
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) INVESTMENTS (CONTINUED)
Realized pre-tax gain (loss) on the sale of investments is as follows:
GAIN LOSS NET
---------- ----------- -----------
For the year ended December 31, 1999:
Fixed income securities................................. $1,226,000 $(1,390,000) $ (164,000)
Marketable equity securities............................ 450,000 (4,391,000) (3,941,000)
Other investments....................................... 120,000 (179,000) (59,000)
---------- ----------- -----------
Realized gain (loss)................................ $1,796,000 $(5,960,000) $(4,164,000)
========== =========== ===========
For the year ended December 31, 1998:
Fixed income securities................................. $1,132,000 $ (121,000) $ 1,011,000
Marketable equity securities............................ 245,000 (411,000) (166,000)
---------- ----------- -----------
Realized gain (loss)................................ $1,377,000 $ (532,000) $ 845,000
========== =========== ===========
For the year ended December 31, 1997:
Fixed income securities................................. $ 68,000 $ (242,000) $ (174,000)
Marketable equity securities............................ 113,000 (267,000) (154,000)
---------- ----------- -----------
Realized gain (loss)................................ $ 181,000 $ (509,000) $ (328,000)
========== =========== ===========
Unrealized pre-tax net investment gains (losses) on investments for three
years ended December 31, 1999 is as follows:
1999 1998 1997
------------ ----------- -----------
Fixed income securities............................... $(19,024,000) $ 3,551,000 $ 8,869,000
Marketable equity securities.......................... (3,025,000) 888,000 (201,000)
Strategic operational investments..................... 2,900,000 (1,403,000) (1,497,000)
------------ ----------- -----------
Net unrealized investment gain (loss)............. $(19,149,000) $ 3,036,000 $ 7,171,000
============ =========== ===========
(4) PROPERTY AND EQUIPMENT
The following table summarizes property and equipment at December 31, 1999
and 1998:
ESTIMATED
1999 1998 USEFUL LIFE
------------ ------------ --------------
Buildings and improvements......................... $ 20,001,000 $ 18,995,000 30 to 45 years
Furniture, fixtures and equipment.................. 16,580,000 13,752,000 3 to 10 years
Management information systems..................... 27,769,000 20,615,000 3 to 7 years
------------ ------------
Total property and equipment................... 64,350,000 53,362,000
Less accumulated depreciation and amortization..... (26,546,000) (20,379,000)
------------ ------------
Property and equipment, net.................... $ 37,804,000 $ 32,983,000
============ ============
Depreciation and amortization expense on property and equipment was
approximately $6.7 million, $4.4 million, and $3.5 million for the years ended
December 31, 1999, 1998 and 1997, respectively.
F-18
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE
Notes payable as of December 31, 1999 and 1998 are shown in the table below.
The estimated fair value of the notes payable is based on current rates offered
to the Company for debt with similar terms and approximates the carrying value
at the balance sheet dates.
1999 1998
------------ ------------
Acquisition notes........................................... $ 7,546,000 $ 16,600,000
Facility.................................................... 235,000,000 105,000,000
------------ ------------
Total notes payable..................................... $242,546,000 $121,600,000
============ ============
Effective December 30, 1997, the Company executed a $120.0 million revolving
credit facility ("Previous Facility") with a group of banks. Borrowing under the
Previous Facility could be made by the Company until December 30, 1999, at which
time all principal was due. Outstanding advances under the Previous Facility
carried interest at the Company's option of either the prime rate or at the then
current London Interbank Offering Rate ("LIBOR") plus 1%.
On March 8, 1999, the Company entered into a Loan Agreement (the "Old
Facility") with a group of banks. The Old Facility included a $150.0 million
Revolving Loan Facility and $100.0 million Short Term Revolving Loan Facility.
Borrowings under the Old Facility could be made from time to time by the Company
for general corporate purposes through the Short Term Revolving Loan Facility
until it expired on March 7, 2000 and through the Revolving Loan Facility until
it expired on February 28, 2002. Outstanding loans under the Old Facility bore
interest at agreed upon rates.
On December 17, 1999, the Company entered into a Loan Agreement (the
"Facility") with a group of banks. The Facility includes a $300.0 million
Revolving Loan Facility. Borrowing under the Facility may be made from time to
time by the Company for general corporate purposes until the Facility's
expiration on December 18, 2004. Outstanding advances under the Facility bear
interest at agreed upon rates. The Facility is collateralized in part by the
pledge of the stock of HC, HCCL, AIC and USSIC and by the pledge of stock and
guarantees entered into by the Company's principal underwriting agency and
intermediary subsidiaries. The Facility agreement contains certain restrictive
covenants, including, without limitation, minimum net worth requirements for the
Company and certain subsidiaries, restrictions on certain extraordinary
corporate actions, notice requirements for certain material occurrences, and
required maintenance of specified financial ratios. Management believes that the
restrictive covenants and other obligations of the Company which are contained
in the Facility agreement are typical for financing arrangements comparable to
the Facility. The initial funding available under the Facility was used, among
other things, to refinance existing indebtedness under the Old Facility, and to
partially fund the Centris acquisition. As of December 31, 1999, total debt
outstanding under the Facility was $235.0 million and the weighted average
interest rate was 8.04%.
The acquisition note at December 31, 1998 was a note payable to the former
owner of Sun. The note carried interest at 6.4% and was due and paid January 5,
1999. The acquisition notes at December 31, 1999 are payable to former owners of
RML. The notes are payable in decreasing amounts in four annual installments
beginning January 31, 2000. The notes carry no stated interest, but were
discounted at 6.25% for financial reporting purposes when the acquisition of RML
was recorded. The interest rate used was based on current rates offered to the
Company as of RML's acquisition date.
F-19
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) NOTES PAYABLE (CONTINUED)
At December 31, 1999, several of the Company's subsidiaries maintained
revolving lines of credit with a bank in the combined maximum amount of
$40.0 million available through December 31, 2000. Advances under the lines of
credit are limited to amounts required to fund draws, if any, on letters of
credit issued by the bank on behalf of the subsidiaries and short-term direct
cash advances. The lines of credit are collateralized by securities having an
aggregate market value of up to $50.0 million, the actual amount of collateral
at any one time being 125% of the aggregate amount outstanding. Interest on the
lines is payable at the bank's prime rate of interest (8.5% at December 31,
1999). At December 31, 1999, letters of credit totaling $17.2 million had been
issued to insurance companies by the bank on behalf of the subsidiaries, with
total securities of $21.5 million collateralizing the line.
(6) INCOME TAX
As of December 31, 1999 and 1998, the Company had income taxes receivable of
$16.2 million and $2.9 million, respectively, included in other assets in the
consolidated balance sheets. In connection with the acquisition of Centris, the
Company acquired approximately $35.0 million in net operating loss carryforwards
for Federal income tax purposes which expire in varying amount through the year
2020. Future use of the net operating losses is subject to material statutory
limitations due to changes of ownership and entity. Therefore, a valuation
allowance was established to reduce the net deferred tax asset associated with
the carryforwards to zero. Any future tax benefit realized from the use of the
carryforwards will not be credited to future income but will reduce goodwill
recorded in connection with the purchase transaction. The components of the
income tax provision for the three years ended December 31, 1999, are as
follows:
1999 1998 1997
----------- ----------- -----------
Current............................................... $12,963,000 $32,498,000 $19,375,000
Deferred:
Change in net deferred tax at current enacted tax
rate................................................ (1,145,000) 2,758,000 4,074,000
Change in deferred tax valuation allowance.......... 453,000 (48,000) (144,000)
----------- ----------- -----------
Total deferred provision (benefit)................ (692,000) 2,710,000 3,930,000
----------- ----------- -----------
Total income tax provision........................ $12,271,000 $35,208,000 $23,305,000
=========== =========== ===========
F-20
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAX (CONTINUED)
The net deferred tax asset is included in other assets in the consolidated
balance sheets. The composition of deferred tax assets and liabilities as of
December 31, 1999 and 1998, is as follows:
1999 1998
------------ -----------
Tax net operating loss carryforwards........................ $ 12,155,000 $ 1,381,000
Excess of financial unearned premium over tax............... 2,512,000 4,408,000
Effect of loss reserve discounting and salvage and
subrogation accrual for tax............................... 9,585,000 5,187,000
Unrealizable loss on decrease in value of securities
available for sale (shareholders' equity)................. 1,611,000 --
Bad debt and accrued expenses, deducted for financial over
tax....................................................... 12,443,000 3,783,000
Valuation allowance......................................... (12,091,000) (50,000)
------------ -----------
Total assets............................................ 26,215,000 14,709,000
Unrealized gain on increase in value of securities available
for sale (shareholders' equity)........................... -- 5,522,000
Deferred policy acquisition costs, net of ceding
commissions, deductible for tax........................... 1,634,000 1,074,000
Amortizable goodwill........................................ 2,346,000 1,011,000
Property and equipment depreciation and other items......... 3,984,000 3,779,000
------------ -----------
Total liabilities....................................... 7,964,000 11,386,000
------------ -----------
Net deferred tax asset.................................. $ 18,251,000 $ 3,323,000
============ ===========
Changes in the valuation allowance account applicable to the net deferred
tax asset for the three years ended December 31, 1999 are as follows:
1999 1998 1997
----------- -------- ---------
Balance, beginning of year................................. $ 50,000 $ 98,000 $ 54,000
Increase (decrease) charged (credited) to income........... 453,000 (48,000) (144,000)
Valuation allowance acquired, which in 1999 relates to net
operating loss carryforwards............................. 11,588,000 -- 188,000
----------- -------- ---------
Balance, end of year................................... $12,091,000 $ 50,000 $ 98,000
=========== ======== =========
F-21
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAX (CONTINUED)
The following table summarizes the differences between the Company's
effective tax rate for financial statement purposes and the Federal statutory
rate for the three years ended December 31, 1999:
1999 1998 1997
----------- ----------- -----------
Statutory tax rate.................................... 35.0% 35.0% 35.0%
Federal tax at statutory rate......................... $13,088,000 $37,620,000 $25,572,000
Nontaxable municipal bond interest and dividends
received deduction.................................. (5,460,000) (5,753,000) (6,065,000)
Non deductible expenses............................... 1,097,000 450,000 2,198,000
State income taxes.................................... 3,011,000 3,521,000 2,242,000
Foreign income taxes.................................. 4,793,000 440,000 475,000
Foreign tax credit.................................... (4,354,000) (440,000) (475,000)
Other, net............................................ 96,000 (630,000) (642,000)
----------- ----------- -----------
Income tax provision.............................. $12,271,000 $35,208,000 $23,305,000
=========== =========== ===========
Effective tax rate................................ 32.8% 32.8% 31.9%
=========== =========== ===========
(7) SEGMENT AND GEOGRAPHIC DATA
The Company classifies its activities into four operating business segments
based upon services provided: 1) insurance company operations, 2) underwriting
agency operations, 3) intermediary operations, and 4) other operations. See
Note 1 for a description of the services provided by and the principal
subsidiaries included in the insurance company, underwriting agency and
intermediary segments. The other operations perform various insurance related
services for insurance company subsidiaries and unaffiliated insurance
companies. The subsidiaries currently operating in this segment provide
insurance claims adjusting services and the development and sale of insurance
industry related software. Also included in other operations is income from
strategic operational investments. Corporate includes general corporate
operations, and those minor operations not included in an operating segment.
Inter-segment revenue consists primarily of management fees of the underwriting
agency segment, commission income of the intermediary segment and service
revenue of the other operations charged to the insurance company segment on
business retained by the Company's insurance company subsidiaries. Inter-segment
pricing (either flat rate fees or as a percentage premium) approximates what is
charged to unrelated parties for similar services.
The performance of each segment is evaluated by management based upon net
earnings. Net earnings is calculated after tax and after all corporate expense
allocations, amortization of goodwill, interest expense on debt incurred at the
purchase date and intercompany eliminations have been charged or credited to the
individual segments.
F-22
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
The following tables show information by business segment and geographic
location. Geographic location is determined by physical location of the
Company's offices and does not represent the location of insureds or reinsureds
from whom the business was generated.
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------ ------------ ------------ ----------- ----------- ------------
For the year ended December 31, 1999:
Revenue:
Domestic................................ $151,044,000 $91,385,000 $31,778,000 $27,364,000 $ 681,000 $302,252,000
Foreign................................. 10,676,000 3,699,000 25,244,000 -- -- 39,619,000
Inter-segment........................... -- 3,170,000 594,000 1,133,000 -- 4,897,000
------------ ----------- ----------- ----------- ----------- ------------
TOTAL SEGMENT REVENUE................. $161,720,000 $98,254,000 $57,616,000 $28,497,000 $ 681,000 346,768,000
============ =========== =========== =========== ===========
Inter-segment revenue................... (4,897,000)
------------
CONSOLIDATED TOTAL REVENUE............ $341,871,000
============
Net earnings (loss):
Domestic................................ $ (8,631,000) $17,129,000 $ 9,042,000 $ 7,643,000 $(2,279,000) $ 22,904,000
Foreign................................. (2,078,000) 21,000 4,575,000 -- -- 2,518,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment net earnings (loss)..... $(10,709,000) $17,150,000 $13,617,000 $ 7,643,000 $(2,279,000) 25,422,000
============ =========== =========== =========== ===========
Inter-segment eliminations.............. (299,000)
------------
CONSOLIDATED NET EARNINGS............. $ 25,123,000
============
Other items:
Net investment income................... $ 23,400,000 $ 4,186,000 $ 2,491,000 $ 424,000 $ 432,000 $ 30,933,000
Depreciation and amortization........... 2,880,000 5,898,000 3,776,000 264,000 580,000 13,398,000
Interest expense........................ 19,000 3,809,000 4,640,000 -- 4,496,000 12,964,000
Restructuring expense................... 687,000 3,278,000 1,453,000 -- 71,000 5,489,000
Capital expenditures.................... 2,405,000 5,339,000 110,000 585,000 637,000 9,076,000
Income tax provision (benefit).......... (13,324,000) 13,969,000 8,608,000 4,454,000 (1,242,000) 12,465,000
Inter-segment eliminations.............. (194,000)
------------
Consolidated income tax provision..... $ 12,271,000
============
The insurance company segment incurred a provision for reinsurance totaling
$28.3 million, net of income tax, during 1999. Also during 1999, earnings before
income taxes was $32.3 million for domestic subsidiaries and $5.1 million for
foreign subsidiaries.
F-23
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------ ------------ ------------ ----------- ----------- ------------
For the year ended December 31, 1998:
Revenue:
Domestic................................ $156,715,000 $79,367,000 $33,086,000 $21,168,000 $ 2,121,000 $292,457,000
Foreign................................. 11,049,000 3,438,000 991,000 99,000 -- 15,577,000
Inter-segment........................... -- 1,975,000 1,876,000 1,252,000 -- 5,103,000
------------ ----------- ----------- ----------- ----------- ------------
TOTAL SEGMENT REVENUE................. $167,764,000 $84,780,000 $35,953,000 $22,519,000 $ 2,121,000 313,137,000
============ =========== =========== =========== ===========
Inter-segment revenue..................... (5,103,000)
------------
CONSOLIDATED TOTAL REVENUE............ $308,034,000
============
Net earnings (loss):
Domestic................................ $ 32,909,000 $19,283,000 $16,263,000 $ 5,210,000 $(2,676,000) $ 70,989,000
Foreign................................. 926,000 105,000 657,000 (399,000) -- 1,289,000
------------ ----------- ----------- ----------- ----------- ------------
NET EARNINGS (LOSS)................... $ 33,835,000 $19,388,000 $16,920,000 $ 4,811,000 $(2,676,000) $ 72,278,000
============ =========== =========== =========== =========== ============
Other items:
Net investment income................... $ 22,995,000 $ 3,949,000 $ 362,000 $ 536,000 $ 1,493,000 $ 29,335,000
Depreciation and amortization........... 2,011,000 4,094,000 406,000 422,000 455,000 7,388,000
Interest expense........................ (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000
Capital expenditures.................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000
Income tax provision (benefit).......... 9,485,000 13,025,000 10,702,000 2,885,000 (889,000) 35,208,000
For the year ended December 31, 1997:
Revenue:
Domestic................................ $170,943,000 $55,838,000 $18,335,000 $15,343,000 $ 1,188,000 $261,647,000
Foreign................................. 14,967,000 2,590,000 967,000 146,000 -- 18,670,000
Inter-segment........................... -- 3,067,000 1,213,000 1,812,000 1,271,000 7,363,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment revenue................. $185,910,000 $61,495,000 $20,515,000 $17,301,000 $ 2,459,000 287,680,000
============ =========== =========== =========== ===========
Inter-segment revenue..................... (7,363,000)
------------
CONSOLIDATED TOTAL REVENUE............ $280,317,000
============
Net earnings (loss):
Domestic................................ $ 34,274,000 $13,186,000 $ 6,104,000 $ 1,755,000 $(12,299,000) $ 43,020,000
Foreign................................. 6,333,000 90,000 987,000 (671,000) -- 6,739,000
------------ ----------- ----------- ----------- ----------- ------------
NET EARNINGS (LOSS)................... $ 40,607,000 $13,276,000 $ 7,091,000 $ 1,084,000 $(12,299,000) $ 49,759,000
============ =========== =========== =========== =========== ============
Other items:
Net investment income................... $ 23,379,000 $ 2,620,000 $ 322,000 $ 128,000 $ 1,138,000 $ 27,587,000
Depreciation and amortization........... 1,453,000 2,490,000 173,000 492,000 581,000 5,189,000
Interest expense........................ 3,000 33,000 -- -- 5,968,000 6,004,000
Capital expenditures.................... 2,838,000 3,416,000 76,000 168,000 296,000 6,794,000
Income tax provision (benefit).......... 13,172,000 9,818,000 4,128,000 436,000 (4,249,000) 23,305,000
The corporate net loss in 1997 included an after-tax charge of $7.2 million
with respect to merger expenses.
F-24
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
Assets by business segment and geographic location are shown in the
following table:
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
-------------- ------------ ------------ ----------- ----------- --------------
December 31, 1999:
Domestic............................ $1,567,855,000 $520,122,000 $114,818,000 $16,984,000 $28,001,000 $2,247,780,000
Foreign............................. 83,882,000 28,756,000 290,205,000 -- -- 402,843,000
-------------- ------------ ------------ ----------- ----------- --------------
Total assets...................... $1,651,737,000 $548,878,000 $405,023,000 $16,984,000 $28,001,000 $2,650,623,000
============== ============ ============ =========== =========== ==============
December 31, 1998:
Domestic............................ $1,074,738,000 $431,619,000 $52,940,000 $30,519,000 $25,823,000 $1,615,639,000
Foreign............................. 60,702,000 27,084,000 5,644,000 -- -- 93,430,000
-------------- ------------ ------------ ----------- ----------- --------------
Total assets...................... $1,135,440,000 $458,703,000 $58,584,000 $30,519,000 $25,823,000 $1,709,069,000
============== ============ ============ =========== =========== ==============
During the years ended December 31, 1998 and 1997, one broker in London,
England, produced gross written premium ("GWP") to the Company of approximately
$46.1 million and $42.8 million, respectively. This represents 10%, and 12% of
the Company's total GWP for those years. During 1999, no customer produced in
excess of 10% of the Company's total GWP.
(8) REINSURANCE
In the normal course of business the Company's insurance company
subsidiaries cede a substantial portion of their premium to non-affiliated
domestic and foreign reinsurers through quota share, surplus, excess of loss and
facultative reinsurance agreements. Although the ceding of reinsurance does not
discharge the primary insurer from liability to its policyholder, the
subsidiaries participate in such agreements for the purpose of limiting their
loss exposure, protect against catastrophic loss and diversifying their
business. Substantially all of the reinsurance assumed by the Company's
insurance company subsidiaries was underwritten directly by the Company but
issued by other non-affiliated companies in
F-25
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
order to satisfy local licensing or other requirements. The following table
represents the effect of such reinsurance transactions on net premium and loss
and loss adjustment expense:
LOSS AND LOSS
WRITTEN EARNED ADJUSTMENT
PREMIUM PREMIUM EXPENSE
------------- ------------- -------------
For the year ended December 31, 1999:
Direct business................................ $ 291,513,000 $ 294,130,000 $ 261,696,000
Reinsurance assumed............................ 276,818,000 294,103,000 423,763,000
Reinsurance ceded.............................. (428,407,000) (446,871,000) (575,809,000)
------------- ------------- -------------
Net amounts.................................. $ 139,924,000 $ 141,362,000 $ 109,650,000
============= ============= =============
For the year ended December 31, 1998:
Direct business................................ $ 228,629,000 $ 192,536,000 $ 202,858,000
Reinsurance assumed............................ 269,647,000 260,539,000 292,064,000
Reinsurance ceded.............................. (376,393,000) (309,975,000) (403,620,000)
------------- ------------- -------------
Net amounts.................................. $ 121,883,000 $ 143,100,000 $ 91,302,000
============= ============= =============
For the year ended December 31, 1997:
Direct business................................ $ 177,728,000 $ 174,533,000 $ 126,861,000
Reinsurance assumed............................ 168,671,000 180,339,000 165,831,000
Reinsurance ceded.............................. (203,546,000) (192,301,000) (196,178,000)
------------- ------------- -------------
Net amounts.................................. $ 142,853,000 $ 162,571,000 $ 96,514,000
============= ============= =============
Ceding commissions netted with policy acquisition costs in the consolidated
statements of earnings are $117.0 million, $59.1 million and $45.5 million for
the years ended December 31, 1999, 1998 and 1997, respectively.
The table below represents the composition of reinsurance recoverables in
the accompanying consolidated balance sheets:
1999 1998
------------ ------------
Reinsurance recoverable on paid losses........... $ 91,318,000 $ 33,572,000
Reinsurance recoverable on outstanding losses.... 382,565,000 279,086,000
Reinsurance recoverable on IBNR.................. 214,933,000 62,513,000
Reserve for uncollectible reinsurance............ (5,541,000) (2,499,000)
------------ ------------
Total reinsurance recoverables............... $683,275,000 $372,672,000
============ ============
The insurance company subsidiaries require reinsurers not authorized by the
subsidiaries' respective states of domicile to collateralize their reinsurance
obligations to the Company. The table below shows
F-26
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
amounts held by the Company as collateral plus other credits available for
potential offset as of December 31, 1999 and 1998:
1999 1998
------------ ------------
Payables to reinsurers........................... $212,962,000 $227,613,000
Letters of credit................................ 154,111,000 166,494,000
Cash deposits.................................... 19,882,000 8,077,000
------------ ------------
Total credits................................ $386,955,000 $402,184,000
============ ============
In order to minimize its exposure to reinsurance credit risk, the Company
evaluates the financial condition of its reinsurers and places its reinsurance
with a diverse group of financially sound companies. The following table shows
reinsurance balances relating to the reinsurers with a net recoverable balance
greater than $10.0 million as of December 31, 1999 and 1998. The total
recoverables column included paid loss recoverable, outstanding loss
recoverable, IBNR recoverable and ceded unearned premium.
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- --------- --------------- ------------ ------------------ ------------
December 31, 1999:
Underwriters at Lloyd's............. A United Kingdom $156,650,000 $22,805,000 $133,845,000
Underwriters Indemnity Company *.... A - Texas 50,451,000 4,201,000 46,250,000
SCOR Reinsurance Company............ A + New York 41,137,000 1,740,000 39,397,000
AXA Reinsurance Company............. A + Delaware 37,690,000 5,013,000 32,677,000
NAC Reinsurance Company **.......... A + New York 23,153,000 6,105,000 17,048,000
Transamerica Occidental Life Ins.
Co................................ A + California 22,481,000 6,102,000 16,379,000
St. Paul Fire and Marine Insurance
Co................................ A + Minnesota 17,577,000 1,721,000 15,856,000
Odyssey America Reinsurance Corp.... A Connecticut 19,114,000 5,891,000 13,223,000
Sun Life Assurance Company of
Canada............................ A ++ Canada 17,996,000 4,786,000 13,210,000
GE Reinsurance...................... A ++ Illinois 16,535,000 4,869,000 11,666,000
Chartwell Reinsurance Company ***... A Minnesota 12,736,000 2,074,000 10,662,000
December 31, 1998:
Underwriters at Lloyd's............. A United Kingdom $ 93,280,000 $37,040,000 $ 56,240,000
Underwriters Indemnity Company *.... A - Texas 51,576,000 11,039,000 40,537,000
SCOR Reinsurance Company............ A + New York 38,703,000 11,402,000 27,301,000
AXA Reinsurance Company............. A + Delaware 28,667,000 10,513,000 18,154,000
* Underwriters Indemnity Company was acquired by RLI Corporation in January,
1999.
** NAC Reinsurance Corporation was acquired by XL Capital, Ltd. in June, 1999.
*** Chartwell Reinsurance Company was acquired by Trenwick Group, Inc. in
October, 1999.
Prior to the acquisition of Centris, its life insurance subsidiary, now
HCCL, sold its entire block of life insurance and annuity business to Life
Reassurance Corporation of America in the form of an indemnity reinsurance
contract. Ceded life and annuity benefits amounted to $95.8 million as of
December 31, 1999.
F-27
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) REINSURANCE (CONTINUED)
In 1999, the Company recorded a $43.5 million provision for reinsurance to
reflect an estimated $29.5 million pre-tax loss for the insolvency of one of the
Company's reinsurers and an estimated $14.0 million pre-tax loss, the majority
of which represents the discount on ceded reserves, related to the commutation
of all liabilities with another reinsurer. This commutation, made at the
Company's request, was finalized and settled in February, 2000. In connection
with the commutation, the Company received cash and other amounts totaling
$56.5 million. Additionally, as of December 31, 1999 the Company has established
a reserve of $5.5 million which management believes is sufficient to absorb any
potential losses related to its reinsurance recoverables. However, the adverse
economic environment in the worldwide insurance industry has placed great
pressure on reinsurers and the results of their operations and these conditions
could, ultimately, affect reinsurers' solvency. Historically, there have been
insolvencies following a period of competitive pricing in the industry, such as
the marketplace has experienced for the last several years. Therefore, while
management believes that the reserve is adequate based upon current available
information, conditions may change or additional information might be obtained
that would affect management's estimate of the adequacy of the level of the
reserve and which may result in a future increase or decrease in the reserve.
Management continually reviews the Company's financial exposure to the
reinsurance market and will continue to take actions to protect shareholders'
equity.
(9) COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a party to numerous claims and lawsuits which arise in the
normal course of its business. Many of such claims or lawsuits involve claims
under policies underwritten or reinsured by the Company, the liabilities for
which management believes have been adequately included in its established loss
reserves. The Company believes the resolution of these lawsuits or claims will
not have a material adverse effect on its financial condition, results of
operations or cash flows.
FOREIGN CURRENCY FORWARD CONTRACTS
On a very limited basis in the past, the Company has entered into foreign
currency forward contracts as a hedge against foreign currency fluctuations.
There were no open foreign currency forward contracts at December 31, 1998. RML,
purchased by the Company during January, 1999, has a revenue stream in US
Dollars but incurs expenses in GBP. To mitigate the foreign exchange risk, the
Company entered into foreign currency forward contracts expiring at staggered
times through December, 2000. As of December 31, 1999, the Company had forward
contracts to sell US $12.0 million for GBP at an average rate of 1.00 GBP equals
US $1.60. The foreign currency forward contracts are used to convert currency at
a known rate in an amount which approximates average monthly expenses. Thus, the
effect of these transactions is to limit the foreign currency exchange risk of
the recurring monthly expenses. In the future, the Company may continue to limit
its exposure to currency fluctuations through the use of foreign currency
forward contracts. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than as a form of speculative or trading investment. The fair value of
foreign currency forward contracts December 31, 1999 was $164,000.
F-28
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES
The Company leases administrative office facilities under long-term
non-cancelable operating lease agreements expiring at various dates through
September, 2007. In addition to rent, the agreements generally require the
payment of utilities, real estate taxes, insurance and repairs. The Company has
recognized rent expense on a straight-line basis over the terms of these leases.
In addition, the Company leases computer equipment and automobiles under
operating leases expiring at various dates through the year 2004. Rent expense
under operating leases amounted to $5.7 million, $4.3 million, and $3.7 million
for the years ended December 31, 1999, 1998 and 1997, respectively.
At December 31, 1999, future minimum annual rental payments required under
long-term, non-cancelable operating leases, excluding certain expenses payable
by the Company, are as follows:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE
- -------------------------------- -----------
2000.............................................. $ 6,739,000
2001.............................................. 6,056,000
2002.............................................. 4,549,000
2003.............................................. 4,203,000
2004.............................................. 2,932,000
Thereafter........................................... 3,031,000
-----------
Total future minimum annual rental payments due............. $27,510,000
===========
CATASTROPHE EXPOSURE
The Company writes business in areas exposed to catastrophic losses and has
significant exposures to this type of loss in California, the Atlantic Coast of
United States, certain United States Gulf Coast states, particularly Florida and
Texas, the Caribbean and Mexico. The Company assesses its overall exposures to a
single catastrophic event and applies procedures that it believes are more
conservative than are typically used by the industry to ascertain the Company's
probable maximum loss ("PML") from any single event. The Company maintains
reinsurance protection which it believes is sufficient to cover any foreseeable
event.
LOAN GUARANTEE
During 1999, the Company guaranteed the construction financing debt of a
partnership in which the company is a limited partner. The total amount of the
loan commitment is $11.5 million, of which $8.7 million was funded as of
December 31, 1999.
F-29
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) RELATED PARTY TRANSACTIONS
Certain of the Company's Directors are officers, directors or owners of
business entities with which the Company transacts business. Balances with these
business entities and other related parties included in the accompanying
consolidated balance sheets are as follows:
1999 1998
----------- -----------
Marketable equity securities................................ $ 5,051,000 $ --
Other investments........................................... 3,017,000 1,072,000
Reinsurance recoverables.................................... -- 42,974,000
Premiums, claims and other receivables...................... 3,347,000 4,986,000
Ceded unearned premium...................................... -- 8,601,000
Strategic investments, included in other assets............. -- 11,453,000
Loss and loss adjustment expense payable.................... -- 3,863,000
Reinsurance balances payable................................ -- 6,337,000
Premium payable............................................. -- 560,000
Notes payable............................................... 7,546,000 16,600,000
Accounts payable and accrued liabilities.................... -- 159,000
Transactions with these business entities and other related parties included
in the accompanying consolidated statements of earnings are as follows:
1999 1998 1997
----------- ----------- -----------
Gross earned premium.................................. $ -- $ 1,716,000 $ 672,000
Ceded earned premium.................................. -- 14,543,000 16,041,000
Commission income..................................... -- 1,544,000 1,267,000
Investment income..................................... 206,000 64,000 397,000
Net realized investment gain (loss)................... (4,521,000) -- --
Other operating income................................ 5,221,000 968,000 8,000
Gross loss and loss adjustment expense................ -- 3,282,000 671,000
Ceded loss and loss adjustment expense................ -- 37,107,000 17,868,000
Other operating expense............................... 578,000 840,000 807,000
Interest expense...................................... 418,000 177,000 14,000
Substantially all of the insurance related amounts shown on the above tables
are due to balances and transactions with Underwriters Indemnity Company. Its
parent was majority owned by a Director and was 21% owned by the Company. Its
parent was sold to an unrelated party (RLI Corporation) in January, 1999.
During 1997, the Company committed to invest $5.0 million in an investment
partnership managed by a related party. At December 31, 1999, $2.3 million had
been invested under this commitment. In 1998, HC bought an office building to be
occupied by the Company from a partnership in which an officer and Director was
a partner. The purchase price of $6.0 million was based upon independent
appraisal.
(11) EMPLOYEE BENEFIT PLANS
The Company had various defined contribution retirement plans under Section
401(k) of the Internal Revenue Code which covered substantially all of the
employees residing in the United States who met
F-30
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) EMPLOYEE BENEFIT PLANS (CONTINUED)
specified service requirements. All of these plans were combined into one plan
during 1998. The contributions are discretionary and are determined by
management as of the beginning of each calendar year. The Company currently
matches each employee's contribution to the 401(k) plan up to 6% of the
employee's salary. Employees of the Company who reside outside the United States
receive comparable benefits under different plans. The Company contributed $3.1
million, $1.7 million and $858,000 to the plans for the years ended December 31,
1999, 1998 and 1997, respectively, which is included in compensation expense in
the accompanying consolidated statements of earnings.
(12) SHAREHOLDERS' EQUITY
Under the Texas Insurance Code, HC and USSIC must each maintain minimum
statutory capital of $1.0 million and minimum statutory surplus of $1.0 million,
and can only pay dividends out of statutory surplus funds. In addition, they are
limited in the amount of dividends which they may pay in any twelve month
period, without prior regulatory approval, to the greater of statutory net
income for the prior calendar year or ten percent (10%) of statutory capital and
surplus as of the prior calendar year end. During 2000, HC and USSIC's ordinary
dividend capacities is approximately $25.0 million and $10.4 million,
respectively.
AIC is limited by the State of Maryland in the amount of dividends which it
may pay in any twelve month period, without prior regulatory approval, to the
greater of statutory net income (under certain conditions) for the prior
calendar year or ten percent (10%) of statutory capital and surplus as of the
prior year end. Because AIC paid an extraordinary dividend of $45.0 million
during December, 1999, any dividends paid by AIC during 2000 will require prior
regulatory approval. No dividends from AIC are anticipated during 2000.
HCCL is limited by the State of Indiana in the amount of dividends it may
pay in any twelve month period, without prior regulatory approval, to the
greater of net gain from operations for the prior calendar year or ten percent
(10%) of statutory capital and surplus as of the prior year end. During 2000,
HCCL's ordinary dividend capacity will be approximately $7.0 million.
As of December 31, 1999, all of the domestic insurance company subsidiaries
total adjusted capital is significantly in excess of the NAIC authorized control
level risk-based capital.
The components of accumulated other comprehensive income (loss) are as
follows:
UNREALIZED ACCUMULATED OTHER
FOREIGN CURRENCY INVESTMENT COMPREHENSIVE
TRANSLATION GAIN (LOSS) INCOME (LOSS)
---------------- ----------- -----------------
Balance December 31, 1996........................ $ (91,000) $ 3,623,000 $ 3,532,000
Net change for year.............................. (215,000) 4,683,000 4,468,000
--------- ----------- -----------
Balance December 31, 1997........................ (306,000) 8,306,000 8,000,000
Net change for year.............................. (344,000) 2,049,000 1,705,000
--------- ----------- -----------
Balance December 31, 1998........................ (650,000) 10,355,000 9,705,000
Net change for year.............................. 167,000 (12,564,000) (12,397,000)
--------- ----------- -----------
Balance December 31, 1999........................ $(483,000) $(2,209,000) $(2,692,000)
========= =========== ===========
F-31
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS
The Company has five option plans, the 1994 Non-employee Director Stock
Option Plan, the 1996 Non-employee Director Stock Option Plan, the 1992
Incentive Stock Option Plan, the 1995 Flexible Incentive Plan, and the 1997
Flexible Incentive Plan. All plans are administered by the Compensation
Committee of the Board of Directors. Each option may be used to purchase one
share of Common Stock of the Company. As of December 31, 1999, 7,487,054 shares
of Common Stock were reserved for the exercise of options, of which 5,470,008
shares were reserved for options previously granted and 2,017,046 shares were
reserved for future issuances of options.
Options vest over a zero to five year period and expire four to ten years
after grant date. All options have been granted at fixed exercise prices,
generally at the market price of the Company's Common Stock on the grant date.
Any excess of the market price on the grant date over the exercise price is
recognized as compensation expense in the accompanying consolidated financial
statements. If the fair value method of valuing compensation related to options
would have been used, pro forma net earnings and pro forma diluted earnings per
share would have been $20.7 million, or $0.42 per share, for the year ended
December 31, 1999; $65.4 million, or $1.34 per share, for the year ended
December 31, 1998; and $43.8 million, or $0.91 per share, for the year ended
December 31, 1997. The fair value of each option grant was estimated on the
grant date using the Black-Scholes single option pricing model with the
following weighted average assumptions: a) risk free interest rate of 5.7% for
1999, 5.3% for 1998 and 6.2% for 1997, b) expected volatility factor of .3, c)
dividend yield of 1.52% for 1999, .91% for 1998 and .56% for 1997, and d)
expected option life of four years for 1999 and five years for 1998 and 1997.
The following table provides an analysis of stock option activity during the
three years ended December 31, 1999:
1999 1998 1997
-------------------------------- ------------------------------- -------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE FAIR NUMBER OF EXERCISE FAIR NUMBER OF EXERCISE FAIR
SHARES PRICE VALUE SHARES PRICE VALUE SHARES PRICE VALUE
---------- -------- -------- --------- -------- -------- --------- -------- --------
Outstanding, beginning
of year............... 5,459,766 $16.73 3,508,226 $16.22 3,124,793 $13.03
Granted at market
value................. 1,869,600 13.48 $4.16 2,779,500 17.01 $5.23 1,301,500 22.88 $ 7.98
Cancelled............... (1,327,243) 18.36 (192,462) 21.48 (125,075) 24.28
Exercised............... (532,115) 7.88 (635,498) 14.05 (792,992) 13.86
---------- ------ --------- ------ --------- ------
Outstanding, end of
year.................. 5,470,008 $16.08 5,459,766 $16.73 3,508,226 $16.22
========== ====== ========= ====== ========= ======
Exercisable, end of
year.................. 2,982,872 $16.84 2,792,707 $15.92 1,230,145 $11.60
========== ====== ========= ====== ========= ======
F-32
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) STOCK OPTIONS (CONTINUED)
Options outstanding and exerciseable as of December 31, 1999 are shown on
the following schedule:
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
--------------------------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF REMAINING EXERCISE NUMBER OF EXERCISE
RANGE OF EXERCISE PRICES SHARES CONTRACTUAL LIFE PRICE SHARES PRICE
- ------------------------ --------- ---------------- -------- --------- --------
Under $16.50................................... 2,712,041 5.08 years $12.36 1,184,515 $12.14
$16.50......................................... 1,063,000 4.06 16.50 607,849 16.50
$16.51 - $22.25................................ 675,600 5.23 19.42 406,348 18.91
Over $22.25.................................... 1,019,367 6.87 23.35 784,160 23.15
--------- ---------- ------ --------- ------
Total options................................ 5,470,008 5.23 years $16.08 2,982,872 $16.84
========= ========== ====== ========= ======
(14) EARNINGS PER SHARE
The following table provides reconciliation of the denominators used in the
earnings per share calculations for the three years ended December 31, 1999:
1999 1998 1997
----------- ----------- -----------
Net earnings.......................................... $25,123,000 $72,278,000 $49,759,000
=========== =========== ===========
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at year end........ 48,839,000 48,252,000 47,759,000
Changes in Common Stock due to issuance............... (241,000) (332,000) (764,000)
Contingent shares to be issued........................ 49,000 -- --
Common Stock contractually issuable in the future..... 414,000 -- --
----------- ----------- -----------
Weighted average Common Stock outstanding........... 49,061,000 47,920,000 46,995,000
Additional dilutive effect of outstanding options (as
determined by the application of the treasury stock
method)............................................. 588,000 1,016,000 1,214,000
----------- ----------- -----------
Weighted average Common Stock and potential common
stock outstanding................................. 49,649,000 48,936,000 48,209,000
=========== =========== ===========
As of December 31, 1999, there were approximately 2.0 million options that
were not included in the computation of diluted earnings per share because to do
so would have been antidilutive. As part of the Sun purchase agreement (See Note
2), up to 378,000 shares of the Company's Common Stock are to be issued if
certain conditions are met as of December 31, 1999 or in subsequent years. Of
these shares, 49,000 are included in the 1999 computation because the
contingency had been partially met. The remainder of the contingent shares were
not included in the earnings per share computation because the conditions for
issuance of the remaining shares have not yet been met.
(15) STATUTORY INFORMATION
The Company's insurance company subsidiaries file financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted by domestic or foreign insurance regulatory authorities. The
differences between statutory financial statements and financial statements
prepared in
F-33
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) STATUTORY INFORMATION (CONTINUED)
accordance with GAAP vary between domestic and foreign jurisdictions. The
principal differences are that for statutory financial statements deferred
policy acquisition costs are not recognized, deferred income taxes are not
recorded, bonds are generally carried at amortized cost and insurance assets and
liabilities are presented net of reinsurance. The Company's use of permitted
statutory accounting practices does not have a significant impact on statutory
surplus. Statutory policyholders' surplus as of December 31, 1999, 1998, and
1997, and net income for the three years ended December 31, 1999, of the
Company's insurance company subsidiaries included in those companies' respective
filings with regulatory authorities are as follows:
1999 1998 1997
------------ ------------ ------------
Statutory policyholders' surplus................... $315,474,000 $369,401,000 $331,922,000
Statutory net income (loss)........................ (8,707,000) 53,162,000 56,626,000
Statutory policyholders' surplus was adversely affected by adjustments for
reinsurance recoverables, which, although required statutorily, have no effect
on net earnings or shareholders' equity. Statutory net loss for 1999 includes a
$25.5 million loss, net of income tax, from the provision for reinsurance.
The National Association of Insurance Commissioners adopted Statements of
Statutory Accounting Principles ("SSAPs") in March, 1998 as a product of its
attempt to codify statutory accounting principles. While subject to adoption by
the individual states, the NAIC has established an effective date of January 1,
2001 for the SSAPs. Prior to the codification project, a comprehensive guide to
statutory accounting principles did not exist. Codification is new and will
evolve over time. Based upon the SSAPs as currently published, the Company does
not expect their adoption to have a material effect on the policyholders'
surplus of its individual insurance company subsidiaries. The only material
effect on statutory net income is that the statutory net income for HC will be
decreased or increased by a change in the method of recording equity in earnings
or losses of subsidiaries. Currently HC records the equity in earnings or losses
of its subsidiaries as a component of statutory net income. When codification
becomes effective, the equity in earnings or losses of subsidiaries will be
recorded as an unrealized gain or loss, which is a direct increase or decrease
to policyholders' surplus. Income will not be recognized until such time (if
any) that dividends are received from the subsidiaries and recorded in statutory
net income.
(16) OTHER INFORMATION
SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the three years ended December 31,
1999, is summarized below:
1999 1998 1997
----------- ----------- -----------
Interest paid......................................... $13,694,000 $ 5,409,000 $ 6,712,000
Income tax paid....................................... 23,116,000 30,662,000 24,132,000
Dividends declared but not paid at year end........... 2,442,000 1,930,000 1,386,000
The unrealized gain or loss on securities available for sale, deferred taxes
related thereto, and the issuance of the Company's Common Stock for the purchase
of subsidiaries are non-cash transactions which have been included as direct
increases or decreases in shareholders' equity.
F-34
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) OTHER INFORMATION (CONTINUED)
RESTRUCTURING
The Company recorded a restructuring charge and associated expenses of $5.5
million during the fourth quarter of 1999. Since its initial public offering in
1992, the Company has completed more than fifteen acquisitions for a total value
exceeding $750.0 million. During that time, total employees have grown from less
than 100 to more than 1,000. As a result of this rapid growth, management
believes certain operating inefficiencies occurred. At the beginning of the
fourth quarter of 1999, management made a review of its operations and
determined that they could be made more efficient, principally by reducing the
employee count in certain of its operations. The terminations that generated the
compensation savings took place in the fourth quarter.
A total of 92 employees were terminated in the fourth quarter as a result of
the Company's restructuring which affected all segments. The Company accrued
severance payments for 27 of these terminated employees at December 31, 1999,
substantially all of which was paid in January, 2000. The restructuring charge
also includes accruals of $911,000 related to future lease costs of office space
made redundant as a result of the restructuring plan and a write down of
$647,000, principally of leasehold improvements and other assets related to the
redundant space. The following table provides a detailed analysis of the charge:
PAID ACCRUED EXPENSED
IN 1999 AT 12/31/99 IN 1999
-------- ----------- ----------
Severance.................................................. $691,000 $3,115,000 $3,806,000
Other...................................................... 125,000 911,000 1,036,000
-------- ---------- ----------
$816,000 $4,026,000 4,842,000
======== ==========
Write down of assets..................................... 647,000
----------
Total restructuring expense.............................. $5,489,000
==========
F-35
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE
The following table provides a reconciliation of the liability of loss and
loss adjustment expense ("LAE"), for the three years ended December 31, 1999:
1999 1998 1997
------------ ------------ ------------
Reserves for loss and LAE at beginning of the
year............................................. $460,511,000 $275,008,000 $229,049,000
Less reinsurance recoverables...................... 341,599,000 155,374,000 111,766,000
------------ ------------ ------------
Net reserves at beginning of the year.............. 118,912,000 119,634,000 117,283,000
Net reserves acquired with purchase of
subsidiaries..................................... 55,523,000 3,877,000 1,919,000
Effect on loss reserves of write off of ceded
outstanding and IBNR reinsurance recoverables.... 82,343,000 -- --
Provision for loss and LAE for claims occurring in
the current year................................. 105,036,000 105,895,000 100,288,000
Increase (decrease) in estimated loss and LAE for
claims occurring in prior years.................. 4,614,000 (14,593,000) (3,774,000)
------------ ------------ ------------
Incurred loss and LAE, net of reinsurance........ 109,650,000 91,302,000 96,514,000
------------ ------------ ------------
Loss and LAE payments for claims occurring during:
Current year..................................... 36,770,000 47,126,000 48,208,000
Prior years...................................... 56,052,000 48,775,000 47,874,000
------------ ------------ ------------
Loss and LAE payments, net of reinsurance.......... 92,822,000 95,901,000 96,082,000
------------ ------------ ------------
Net reserves at end of the year.................... 273,606,000 118,912,000 119,634,000
Plus reinsurance recoverables...................... 597,498,000 341,599,000 155,374,000
------------ ------------ ------------
Reserves for loss and LAE at end of the year... $871,104,000 $460,511,000 $275,008,000
============ ============ ============
During 1999, the Company had net loss and LAE deficiency of $4.6 million
relating to prior year losses compared to redundancies of $14.6 million in 1998
and $3.7 million in 1997. The deficiencies and redundancies in the net reserves
result from the Company's and its actuaries' continued review of its loss
reserves and the increase or reduction of such reserves as losses are finally
settled and claims exposures are reduced. The Company believes it has provided
for all material net incurred losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by AIC and USSIC, because of the types of risks
incurred, principally general aviation, are not considered to have significant
environmental exposures. Therefore, the Company should not experience any
material development in reserves from environmental pollution claims.
F-36
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) QUARTERLY FINANCIAL DATA (UNAUDITED; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE
DATA)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER
------------------- ------------------- ------------------- -------------------
1999 1998 1999 1998 1999 1998 1999 1998
-------- -------- -------- -------- -------- -------- -------- --------
Total revenue......................... $84,308 $84,170 $83,093 $76,536 $82,483 $79,342 $91,987 $67,986
Net earnings (loss)................... (4,991) 15,482 9,118 22,075 287 17,634 20,709 17,087
Basic earnings (loss) per share data:
Earnings (loss) per share............. $ (0.10) $ 0.32 $ 0.19 $ 0.46 $ 0.01 $ 0.37 $ 0.42 $ 0.36
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares outstanding... 49,193 48,159 49,130 47,870 48,951 47,853 48,764 47,794
======= ======= ======= ======= ======= ======= ======= =======
Diluted earnings (loss) per share
data:
Earnings (loss) per share............. $ (0.10) $ 0.32 $ 0.18 $ 0.45 $ 0.01 $ 0.36 $ 0.42 $ 0.35
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares outstanding... 49,193 48,970 49,866 48,919 49,971 49,015 49,544 48,809
======= ======= ======= ======= ======= ======= ======= =======
During 1999, pre-tax provisions for reinsurance of $29.5 million and $14.0
million were recorded in the second quarter and fourth quarter, respectively.
Also, during the fourth quarter of 1999, the Company recorded a pre-tax
restructuring expense of $5.5 million and a $4.3 million writedown of one equity
investment to its estimated fair market value. The fourth quarter of 1998
includes a charge of $5.8 million (pre-tax) for catastrophe losses related to
hurricanes Georges and Mitch. The sum of the quarters earnings (loss) per share
may not equal the annual amounts due to rounding.
F-37
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULES
To the Board of Directors of
HCC Insurance Holdings, Inc.:
Our audits of the consolidated financial statements referred to in our report
dated March 30, 2000, included on page F-1 of this Form 10-K also included an
audit of the financial statement schedules listed in Item 14(b) of this Form
10-K. In our opinion, these financial statement schedules present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Houston, Texas
March 30, 2000
S-1
SCHEDULE 1
HCC INSURANCE HOLDINGS, INC.
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1999
COLUMN A COLUMN B COLUMN C COLUMN D
- --------------------------------------------------- ------------ ------------ ------------
AMOUNT AT
WHICH
SHOWN IN THE
BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- --------------------------------------------------- ------------ ------------ ------------
Fixed maturities:
Bonds--United States government and government
agencies and authorities....................... $ 57,941,000 $ 57,505,000 $ 57,505,000
Bonds--states, municipalities and political
subdivisions..................................... 99,360,000 99,459,000 99,459,000
Bonds--special revenue........................... 164,035,000 163,644,000 163,644,000
Bonds--Canadian government....................... 6,189,000 6,213,000 6,213,000
Bonds--corporate................................. 15,480,000 15,291,000 15,291,000
Mortgage backed securities....................... 529,000 529,000 529,000
------------ ------------ ------------
Total fixed maturities....................... 343,534,000 $342,641,000 342,641,000
------------ ============ ------------
Equity securities:
Common stocks--banks, trusts and insurance
companies...................................... 7,863,000 $ 5,787,000 5,787,000
Common stocks--industrial........................ 10,141,000 9,694,000 9,694,000
Non-redeemable preferred stocks.................. 4,489,000 4,489,000 4,489,000
------------ ------------ ------------
Total equity securities...................... 22,493,000 $ 19,970,000 19,970,000
------------ ============ ------------
Short-term investments........................... 215,694,000 215,694,000
Other investments................................ 3,017,000 3,017,000
------------ ------------
TOTAL INVESTMENTS............................ $584,738,000 $581,322,000
============ ============
S-2
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
ASSETS
Cash........................................................ $ 23,000 $ --
Short-term investments...................................... 395,000 4,539,000
Investment in subsidiaries.................................. 626,802,000 441,041,000
Intercompany loans to subsidiaries.......................... 76,260,000 103,426,000
Other assets................................................ 9,836,000 32,419,000
------------ ------------
TOTAL ASSETS............................................ $713,316,000 $581,425,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable............................................... $235,000,000 $105,000,000
Note payable to related party............................... 7,546,000 16,600,000
Payable to subsidiaries..................................... -- 14,558,000
Deferred Federal income tax................................. 948,000 261,000
Accounts payable and accrued liabilities.................... 12,394,000 5,143,000
------------ ------------
Total liabilities....................................... 255,888,000 141,562,000
Total shareholders' equity.............................. 457,428,000 439,863,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............. $713,316,000 $581,425,000
============ ============
See Note to Condensed Financial Information.
S-3
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
Equity in earnings of subsidiaries.................... $30,948,000 $75,228,000 $56,024,000
Interest income from subsidiaries..................... 4,165,000 2,052,000 --
Interest income....................................... 146,000 285,000 24,000
Net realized investment gain.......................... -- 840,000 --
Other income.......................................... 73,000 -- --
----------- ----------- -----------
Total revenue..................................... 35,332,000 78,405,000 56,048,000
Interest expense...................................... 12,907,000 6,036,000 1,904,000
Merger related expenses............................... -- 107,000 3,326,000
Other operating expense............................... 266,000 1,623,000 2,032,000
----------- ----------- -----------
Total expense..................................... 13,173,000 7,766,000 7,262,000
----------- ----------- -----------
Earnings before income tax benefit.............. 22,159,000 70,639,000 48,786,000
Income tax benefit.................................... 2,964,000 1,639,000 973,000
----------- ----------- -----------
NET EARNINGS.................................... $25,123,000 $72,278,000 $49,759,000
=========== =========== ===========
See Notes to Condensed Financial Information.
S-4
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
------------ ----------- -----------
Net earnings.......................................... $ 25,123,000 $72,278,000 $49,759,000
Other comprehensive income net of tax:
Foreign currency translation adjustment........... 167,000 (344,000) (215,000)
Investment gains (losses):
Investment gains during the year, net of
deferred tax charge of $294,000 in 1998..... -- 546,000 --
Consolidated subsidiaries' investment gains
(losses) during the year, net of deferred
tax charge (benefit) of $(8,042,000) in
1999, $1,205,000 in 1998 and $2,373,000 in
1997........................................ (15,271,000) 2,454,000 4,470,000
Less reclassification adjustment for gains
included in net earnings, net of deferred
tax charge of $294,000 in 1998.............. -- (546,000) --
Less consolidated subsidiaries'
reclassification adjustments for (gains)
losses included in net earnings, net of
deferred tax (charge) benefit of $1,457,000
in 1999, ($218,000) in 1998 and $115,000 in
1997........................................ 2,707,000 (405,000) 213,000
------------ ----------- -----------
Other comprehensive income (loss)........... (12,397,000) 1,705,000 4,468,000
------------ ----------- -----------
COMPREHENSIVE INCOME........................ $ 12,726,000 $73,983,000 $54,227,000
============ =========== ===========
See Notes to Condensed Financial Information.
S-5
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
1999 1998 1997
------------- ------------ ------------
Cash flows from operating activities:
Net earnings..................................... $ 25,123,000 $ 72,278,000 $ 49,759,000
Adjustment to reconcile net earnings to net cash
provided (used) by operating activities:
Undistributed net income of subsidiaries......... (30,948,000) (75,228,000) (56,024,000)
Change in deferred Federal income tax, net of tax
effect of unrealized gain or loss.............. 687,000 3,934,000 197,000
Changes in other assets and other................ 12,336,000 -- --
Depreciation..................................... 29,000 29,000 30,000
Change in intercompany loan to subsidiaries...... (4,035,000) (2,052,000) --
Change in payable to subsidiary and other
payables....................................... (7,819,000) (3,932,000) (533,000)
Net realized investment gain..................... -- (840,000) --
------------- ------------ ------------
Cash used by operating activities.............. (4,627,000) (5,811,000) (6,571,000)
Cash flows from investing activities:
Sales of fixed income securities................. -- 16,680,000 --
Cash contributions to subsidiaries............... (36,030,000) (62,000) (62,442,000)
Purchase of subsidiaries......................... (201,947,000) (30,355,000) (6,483,000)
Change in short-term investments................. 4,144,000 (3,339,000) 2,790,000
Cost of investment acquired...................... (2,898,000) (2,525,000) --
Intercompany loan to subsidiaries................ (27,404,000) (34,530,000) (41,250,000)
Payments on intercompany loan to subsidiaries.... 66,595,000 15,986,000 --
Cash dividends from subsidiaries................. 93,228,000 24,450,000 43,526,000
------------- ------------ ------------
Cash used by investing activities................ (104,312,000) (13,695,000) (63,859,000)
Cash flows from financing activities:
Proceeds from note payable....................... 547,000,000 74,200,000 97,500,000
Payments on notes payable........................ (433,600,000) (49,950,000) (33,000,000)
Sale of Common Stock............................. 4,783,000 2,203,000 10,470,000
Dividends paid................................... (9,221,000) (7,139,000) (4,550,000)
------------- ------------ ------------
Cash provided by financing activities.......... 108,962,000 19,314,000 70,420,000
------------- ------------ ------------
Net change in cash............................. 23,000 (192,000) (10,000)
Cash as of beginning of year................... -- 192,000 202,000
------------- ------------ ------------
Cash as of end of year......................... $ 23,000 $ -- $ 192,000
============= ============ ============
See Notes to Condensed Financial Information.
S-6
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTE TO CONDENSED FINANCIAL INFORMATION
(1) The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements and the related
notes thereto of HCC Insurance Holdings, Inc. and Subsidiaries. Investments
in subsidiaries are accounted for using the equity method.
(2) Intercompany loans to subsidiaries are demand notes issued primarily to
fund the cash portion of acquisitions. They bear interest at a rate set by
management, which approximates the interest rate charged to the Company for
similar debt. As of December 31, 1999, the interest rate on intercompany
loans was 7 1/4%.
S-7
SCHEDULE 3
HCC INSURANCE HOLDINGS, INC.
SUPPLEMENTARY INSURANCE INFORMATION
(DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H
-------- --------------- -------------- ----------- ----------- -------------- --------------
(1) (1) (2)
DECEMBER 31, FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------- ---------------------------------------------
FUTURE POLICY BENEFITS,
BENEFITS, CLAIMS, LOSSES
DEFERRED POLICY LOSSES, CLAIMS AND
ACQUISITION AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT
SEGMENTS COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES
-------------------------- --------------- -------------- ----------- ----------- -------------- --------------
1999 Insurance Company $ 658 $966,864 $188,524 $141,362 $23,400 $109,650
Underwriting Agency....... 4,186
Intermediary.............. 2,491
Other Operations 424
Corporate................. 432
-------- -------- -------- -------- ------- --------
Total $ 658 $966,864 $188,524 $141,362 $30,933 $109,650
======== ======== ======== ======== ======= ========
1998 Insurance Company......... $ (3,615) $460,511 $201,050 $143,100 $22,995 $ 91,302
Underwriting Agency....... 3,949
Intermediary.............. 362
Other Operations 536
Corporate................. 1,493
-------- -------- -------- -------- ------- --------
Total..................... $ (3,615) $460,511 $201,050 $143,100 $29,335 $ 91,302
======== ======== ======== ======== ======= ========
1997 Insurance Company......... $ 2,051 $275,008 $152,094 $162,571 $23,379 $ 96,514
Underwriting Agency....... 2,620
Intermediary.............. 322
Other Operations.......... 128
Corporate................. 1,138
-------- -------- -------- -------- ------- --------
Total..................... $ 2,051 $275,008 $152,094 $162,571 $27,587 $ 96,514
======== ======== ======== ======== ======= ========
COLUMN I COLUMN J COLUMN K
------------ --------------- ----------
(2)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
AMORTIZATION
OF DEFERRED
POLICY
ACQUISITION OTHER OPERATING PREMIUM
COSTS EXPENSES WRITTEN
------------ --------------- ----------
1999 $ 8,177 $ 63,963 $139,924
63,325
30,416
16,399
(417)
------- -------- --------
$ 8,177 $173,686 $139,924
======= ======== ========
1998 $10,978 $ 17,555 $121,883
50,325
8,241
14,936
1,190
------- -------- --------
$10,978 $ 92,247 $121,883
======= ======== ========
1997 $13,580 $ 17,588 $142,853
45,274
9,294
14,401
4,598
------- -------- --------
$13,580 $ 91,155 $142,853
======= ======== ========
- ------------------------
(1) Columns C and D are shown ignoring the effects of reinsurance.
(2) Net investment income was allocated to the company, and therefore the
segment, on which the related investment asset was recorded. Other operating
expenses were allocated to the company, and therefore the corresponding
segment, which actually incurred those expenses.
Note: Column E is omitted because the Company has no other policy claims and
benefits payable.
S-8
SCHEDULE 4
HCC INSURANCE HOLDINGS, INC.
REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
-------- ------------- -------------- ------------ ------------ --------------
(1)
ASSUMED FROM PERCENT OF
CEDED TO OTHER OTHER AMOUNT
DIRECT AMOUNT COMPANIES COMPANIES NET AMOUNT ASSUMED TO NET
------------- -------------- ------------ ------------ --------------
For the year ended December 31,
1999:
Life insurance in force............. $832,305,000 $799,573,000 $ 0 $ 32,732,000 0%
============ ============ ============ ============ =======
Earned premium:
Property and liability insurance.... $230,879,000 $277,089,000 $127,495,000 $ 81,285,000 157%
Accident and health insurance....... 63,251,000 169,782,000 166,608,000 60,077,000 277%
------------ ------------ ------------ ------------ -------
Total........................... $294,130,000 $446,871,000 $294,103,000 $141,362,000 208%
============ ============ ============ ============ =======
For the year ended December 31,
1998:
Earned premium:
Property and liability insurance.... $190,030,000 $233,549,000 $140,354,000 $ 96,835,000 145%
Accident and health insurance....... 2,506,000 76,426,000 120,185,000 46,265,000 260%
------------ ------------ ------------ ------------
Total........................... $192,536,000 $309,975,000 $260,539,000 $143,100,000 182%
============ ============ ============ ============ =======
For the year ended December 31,
1997:
Earned premium:
Property and liability insurance.... $173,032,000 $177,371,000 $140,423,000 $136,084,000 103%
Accident and health insurance....... 1,501,000 14,930,000 39,916,000 26,487,000 151%
------------ ------------ ------------ ------------
Total........................... $174,533,000 $192,301,000 $180,339,000 $162,571,000 111%
============ ============ ============ ============ =======
- ------------------------
(1) Substantially all of the reinsurance assumed by the Company's insurance
company subsidiaries was underwritten directly by the Company but issued by
other non-affiliated companies in order to satisfy local licensing or other
requirements.
S-9
SCHEDULE 5
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
VALUATION AND QUALIFYING ACCOUNTS
1999 1998 1997
----------- ---------- ----------
Reserve for uncollectible reinsurance:
Balance as of beginning of year....................... $ 2,499,000 $2,535,000 $2,415,000
Total provision charged to expense.................... 43,650,000 60,000 120,000
Total amounts written off............................. (40,608,000) (96,000) --
----------- ---------- ----------
Balance as of end of year............................. $ 5,541,000 $2,499,000 $2,535,000
=========== ========== ==========
S-10