SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-13135
HSB GROUP, INC.
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-1475343
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. BOX 5024, ONE STATE STREET,
HARTFORD, CONNECTICUT 06102-5024
(Address of principal executive offices) (Zip Code)
(860) 722-1866
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since the last report)
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
The number of shares outstanding of the registrant's common stock without par
value, as of March 31, 1998: 19,417,647
HSB GROUP, INC.
INDEX
PART I FINANCIAL INFORMATION PAGE
Consolidated Statements of Operations for the
Quarters Ended March 31, 1998 and 1997 (unaudited)........3
Statement of Comprehensive Income for the Quarters
Ended March 31, 1998 and 1997 (unaudited).................4
Consolidated Statements of Financial Position as
of March 31, 1998 (unaudited) and December 31, 1997 ......5
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1998 and 1997 (unaudited) ...6
Notes to Consolidated Financial Statements (unaudited)....7
Management's Discussion and Analysis of
Consolidated Financial Condition and Results
of Operations.............................................11
PART II OTHER INFORMATION
Item 1 - Legal Proceedings................................18
Item 6 - Exhibits and Reports on Form 8-K.................20
SIGNATURES.......................................................21
-2-
HSB GROUP, INC.
Consolidated Statements of Operations
(in millions, except per share data)
(Unaudited)
Quarter
Ended March 31
1998 1997
---------- ----------
Revenues:
Insurance premiums $ 101.5 $ 122.3
Engineering services 17.6 14.7
Net investment income 15.2 8.0
Realized investment gains 3.2 0.5
---------- ----------
Total revenues 137.5 145.5
---------- ----------
Expenses:
Claims and adjustment 44.6 51.5
Policy acquisition 12.6 23.5
Underwriting and inspection 33.5 35.3
Net engineering services 16.1 13.6
Interest 0.1 0.2
---------- ----------
Total expenses 106.9 124.1
---------- ----------
Income from continuing operations before
income taxes and distributions on capital
securities $ 30.6 $ 21.4
Gain on sale of IRI 39.0 -
Income taxes (benefit):
Current 27.6 6.5
Deferred (5.1) (1.0)
---------- ----------
Total income taxes $ 22.5 $ 5.5
Distribution on capital securities of
subsidiary trusts, net of income
tax benefits of $2.5 and $ --. 4.5 -
---------- ----------
Income from continuing operations $ 42.6 $ 15.9
Discontinued operations:
Loss from operations, net of
income tax benefits of (6.6) -
$3.2 and $--.
Gain on disposal, net of income
taxes of $23.7 and $--. 36.9 -
---------- ----------
Total discontinued operations $ 30.3 $ -
---------- ----------
Net income $ 72.9 $ 15.9
========== ==========
Per share data assuming stock split:
Net income per common share - basic:
Income from continuing operations $ 1.45 $ 0.52
Net income $ 2.49 $ 0.52
Net income per common share - assuming dilution
Income from continuing operations $ 1.31 $ 0.52
Net income $ 2.17 $ 0.52
Dividends declared per common share $ 0.40 $ 0.38
Average common shares outstanding and common
stock equivalents 35.2 30.7
See Notes to Consolidated Financial Statements.
-3-
HSB GROUP, INC.
Statement of Comprehensive Income
(in millions)
(Unaudited)
Quarter Ended
March
1998 1997
----------- ----------
Net income $ 72.9 $ 15.9
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising
during the period (net of taxes
of 9.6; 1.7) 17.2 1.9
Add: reclassification adjustment
for losses included in net income 0.2 0.2
----------- ----------
17.4 2.1
Foreign currency translation adjustments 0.3 (0.3)
----------- ----------
Other comprehensive income 17.7 1.8
Comprehensive income $ 90.6 $ 17.7
============ ==========
See Notes to Consolidated Financial Statements.
-4-
HSB GROUP, INC.
Consolidated Statements of Financial Position
(in millions, except per share data)
March 31, December 31,
1998 1997
(Unaudited)
-------------- -----------
Assets:
Cash $ 20.4 $ 45.3
Short-term investments, at cost 147.3 379.2
Fixed maturities, at fair value
(cost -$534.6; $241.1) 538.5 248.4
Equity securities, at fair value
(cost - $318.2; $231.3 ) 441.1 323.8
----------- -----------
Total cash and invested assets 1147.3 996.7
Reinsurance assets 307.1 124.5
Insurance premiums receivable 192.7 138
Engineering services receivable 14.4 12.2
Fixed assets 37.5 36.4
Prepaid acquisition costs 55.5 45.5
Capital lease 15.1 15.3
Investment in Radian - 83.4
Other assets 101.9 88.2
----------- ----------
Total assets $ 1871.5 $ 1540.2
=========== ==========
Liabilities:
Unearned insurance premiums $ 467.6 $ 290.3
Claims and adjustment expenses 296.7 276.7
Short-term borrowings 0.9 42.4
Long-term borrowings 25.1 25.1
Capital lease 27.9 27.9
Deferred income taxes 36.1 31.5
Accrued dividends and distributions
on capital securities 17.6 13.3
Other liabilities 179.4 78.8
----------- ----------
Total liabilities 1051.3 786.0
----------- ----------
Convertible redeemable preferred
stock- Series B (stated and
redemption value; shares authorized,
zero issued and outstanding) 0.0 0.0
Company obligated mandatorily redeemable
capital securities of subsidiary Trust
I holding solely junior subordinated
deferrable interest debentures of the
Company, net of unamortized discount of
$1.1 and $1.1 million, respectively 108.9 108.9
Company obligated mandatorily redeemable
convertible capital securities of
subsidiary Trust II holding solely junior
subordinated deferrable interest debentures
of the Company 300.0 300.0
Shareholders' equity:
Common stock (stated value; shares
authorized 50.0; shares issued 21.3;
shares outstanding 19.4; 19.6) 10.0 10.0
Additional paid-in capital 32.2 31.6
Unrealized investment gains, net of tax 77.5 59.8
Retained earnings 298.3 248.8
Benefit plans -6.7 -4.9
----------- -----------
Total shareholders' equity 411.3 345.3
----------- -----------
Total $ 1871.5 $ 1540.2
=========== ===========
Shareholders' equity per common share $ 14.12 $ 11.75
See Notes to Consolidated Financial Statements.
-5-
HSB Group, Inc.
Consolidated Statements of Cash Flows
(in millions)
(Unaudited)
Quarter Ended
March 31,
---------------------
1998 1997
--------- --------
Operating activities:
Net income $ 72.9 $ 15.9
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2.4 1.9
Deferred income taxes (benefit) (5.1) (1.0)
Realized investment gains (3.2) (0.5)
Realized gain from the disposition of
Radian (after tax) (30.3) --
Realized gain from the disposition of
IRI (after tax) (25.2) --
Change in:
Reinsurance assets (182.6) 26.4
Insurance premiums receivable (54.7) (2.2)
Engineering services receivable (2.2) 0.4
Prepaid acquisition costs (10.1) (3.3)
Unearned insurance premiums 177.3 11.7
Claims and adjustment expenses 20.0 (16.8)
Investment in Radian -- (0.8)
Other 56.2 (2.3)
------ -----
Cash provided by operating activities 15.4 29.4
------ -----
Investing activities:
Fixed asset additions, net (3.3) (1.3)
Investments:
Sale of short-term investments, net 231.9 6.6
Purchase of fixed maturities (307.1) (25.8)
Proceeds from the disposition of Radian 128.9 --
Proceeds from the disposition of IRI 49.1 --
Proceeds from sale of fixed maturities 11.6 2.1
Redemption of fixed maturities 2.3 1.5
Purchase of equity securities (132.0) (33.1)
Proceeds from sale of equity securities 47.3 37.4
------ -----
Cash provided by (used in) investment activities 28.7 (12.6)
------ -----
Financing Activities:
Increase (decrease) in short-term borrowings (14.4) (11.7)
Reacquisition of stock (19.7) --
Exercise of stock options 6.6 0.1
------ -----
Cash used in financing activities (69.0) (8.7)
------ -----
Net increase (decrease) in cash (24.9) 8.1
Cash at beginning of period 45.3 4.5
------ -----
Cash at end of period $ 20.4 $ 12.6
======== =======
Interest paid $ 0.1 $ 0.3
-------- -------
Federal income tax paid $ 0.8 $ 3.8
------ -------
See Notes to Consolidated Financial Statements.
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim consolidated financial statements in this report include
adjustments based on management's best estimates and judgments,
including estimates of future loss payments, which are necessary to
present a fair statement of the results for the interim periods
reported. These adjustments are of a normal, recurring nature. The
financial statements are prepared on the basis of generally accepted
accounting principles and should be read in conjunction with the
financial statements and related notes in the 1997 Annual Report.
Certain amounts for 1997 have been reclassified to conform with the
1998 presentation.
2. Discontinued Operations
On January 2, 1998, the Company exercised its option to put its 40
percent share in Radian International LLC (Radian LLC) to The Dow
Chemical Company, (Dow) for approximately $129 million, net of
expenses. Radian LLC was formed in January 1996 as a joint venture with
Dow to provide environmental, engineering, information technology,
remediation and strategic chemical management services to industries
and governments world-wide. In connection with the formation of the new
company, the Company contributed substantially all of the assets of its
wholly-owned subsidiary, Radian Corporation to Radian LLC. The results
of Radian LLC were classified as discontinued operations following
ratification in July 1997 by the Board of Directors of management's
decision to exercise its put. The Company's share of Radian LLC's
losses incurred subsequent to such decision of approximately $6.6
million after-tax was deferred until the closing of the sale on January
2, 1998. The after-tax gain of $30.3 million recognized in 1998 is net
of deferred losses noted above. In 1996 and prior to July 1997, the
Company's share of the joint venture's results were recorded as equity
in Radian.
3. Industrial Risk Insurers
On January 6, 1998, The Hartford Steam Boiler Inspection and Insurance
Company (HSBIIC) sold its 23.5 percent share in Industrial Risk
Insurers (IRI) to Employers Reinsurance Corporation (ERC), one of the
world's largest reinsurance companies, in accordance with a previously
announced purchase and sale agreement between ERC and IRI's
twenty-three member insurers. The gain on the sale of IRI was $39.0
million pre-tax and $25.2 million after-tax. IRI is a voluntary,
unincorporated joint underwriting association, which provides property
insurance for the class of business known as "highly protected risks"
(HPR) -- larger manufacturing, processing, and industrial businesses
which have invested in protection against loss through the use of
sprinklers and other means. Contemporaneous with the close of the sale,
IRI was reconstituted with ERC (with a 99.5 percent share) and HSBIIC
(with a .5 percent share) as the sole members. The new association has
been renamed HSB Industrial Risk Insurers. HSBIIC writes the business
for HSB Industrial Risk Insurers using its insurance licenses and
provides certain other management and technical services. In addition,
through various reinsurance agreements with ERC and HSB Industrial Risk
Insurers, HSBIIC transferred its manufacturing book of business to HSB
Industrial Risk Insurers and will retain 85% of the equipment breakdown
insurance and 15% of the property insurance of the combined insurance
portfolio.
-7-
4. Recent Accounting Developments
In June 1997 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130 " Reporting
Comprehensive Income" which requires items that comprise comprehensive
income be reported in a financial statement display with the same
prominence as other financial statements. This presentation will
include such items as market value adjustments of securities, foreign
currency translation, and certain adjustments made for benefit plans,
which are currently reported as components of the changes in
shareholders' equity. This statement is effective beginning in 1998
with retroactive restatement of prior periods required.
Also in June of 1997 the FASB issued SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information". This standard
requires companies to report financial and descriptive information
about reportable operating segments. It includes disclosure
requirements relating to products and services, geographic areas and
major customers. This statement will be effective beginning year end
1998.
5. Legal Proceedings
HSBIIC is involved in two arbitration or litigation proceedings
regarding the extent to which certain explosion events are insured
under boiler and machinery policies of HSBIIC or under the all-risk
property insurance policies issued by other companies. Management
believes HSBIIC's policies do not provide coverage for losses resulting
from the explosion events that are the subject of these proceedings.
HSBIIC has accrued $6.5 million with respect to these cases for
potential LAE, including legal costs to defend HSBIIC's position. One
case is in the process of pre-trial summary judgment motions and
appeals; the other case is involved in both arbitration and litigation
proceedings. A trial date has not been set for either case. In the
event that HSBIIC is held liable for one or both of the remaining
claims, amounts in excess of HSBIIC's net maximum aggregate retention
of $8.5 million is recoverable from reinsurers. Claim amounts
potentially recoverable from reinsurers in the event of a possible
adverse outcome in these cases could range, in the aggregate, from $40
million to $195 million.
The obligations of HSBIIC's reinsurers with respect to these cases are
not in dispute. Therefore, management believes that any adverse
outcomes in these cases will not, in the aggregate, have a material
effect on either the results of operations or financial condition of
the Company. HSBIIC's reinsurance contracts do not require HSBIIC to
reimburse its reinsurers for any losses such reinsurers might incur
should these cases not be decided in HSBIIC's favor. Nevertheless,
reinsurers often quote rates for future coverages based upon their or
other reinsurers' experience on a particular account. Therefore, in the
event HSBIIC's reinsurers pay significant sums pursuant to the
arbitration or litigation proceedings described above, it is likely
HSBIIC's reinsurance rates would increase in future periods. However,
given the insured capacity that exists in reinsurance markets
worldwide, coupled with HSBIIC's ability to negotiate a redesign or
restructuring of its reinsurance program, it does not necessarily mean
that such an increase would be material.
-8-
HSBIIC was involved in a third proceeding regarding coverage for loss
regarding an explosion event. A lower court ruling in that case held
that an explosion did occur, and that HSBIIC was not liable for losses
of the insured resulting from the explosion. In a further action, the
court denied HSBIIC's motion for summary judgment on certain issues,
thus leaving HSBIIC potentially liable for certain unqualified losses
resulting from events prior to the explosion. In the first quarter of
1997, HSBIIC and the property insurer jointly settled the case with the
insured. A final allocation of the loss in this case was reached in the
decision of a mediator dated February 2, 1998. The decision had no
material effect on HSB earnings.
The Company is also involved in various other legal proceedings as
defendant or co-defendant that have arisen in the normal course of its
business. In the judgment of management, after consultation with
counsel, it is improbable that any liabilities which may arise from
such litigation will have a material adverse impact on the results of
operations or the financial position of the Company.
6. Earnings per share
In February 1997, FASB issued SFAS No. 128, "Earnings per Share". This
statement established standards for computing and presenting earnings
per share (EPS). It replaced the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic
and diluted EPS on the face of the income statement and a
reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS
computation. The requirements of this statement became effective for
year end 1997 financial statements with prior restatement required.
Accordingly, comparative information presented in the Consolidated
Statements of Operation have been restated in compliance with SFAS No.
128. Previously, the company reported EPS of $ 0.78 per share for the
period ended March 31, 1997.
On April 21, 1998 the Board of Directors approved a three-for-two stock
split for shares held of record on May 1, 1998. Additional shares
resulting from the split will be distributed on or about May 22, 1998.
In accordance with SFAS No. 128, all earnings per share presentations
have been adjusted to reflect the impact of the stock split, including
retroactive restatement of prior periods.
Earnings per share on a pre-split basis are as follows:
Quarter Ended
March 31,
1998 1997
---- ----
Net income per share-basic $3.73 $0.78
Net income per share-assuming dilution $3.26 $0.78
-9-
Computation of Earnings Per Share:
(shares adjusted to reflect stock split)
Quarter Ended
March 31, 1998
Income Shares Per
Share
Net income $72.9
Basic EPS:
Income available to
common shareholders $72.9(A)
Weighted Average Common
Shares Outstanding 29.3(B)
Net income per common
share-basic: $2.49(A/B)*
Effect of dilutive securities:
After-tax interest on
convertible capital securities $ 3.4
Convertible capital securities 5.3
Stock options 0.6
Diluted EPS:
Income available to common
and assumed conversions: $76.3(C) 35.2(D)
Net income per common share-assuming dilution: $2.17 (C/D)*
Quarter Ended
March 31, 1997
Income Shares Per
Share
Net income $15.9
Less: convertible preferred
stock dividends 0.4
Basic EPS:
Income available to
common shareholders $15.5(A)
Weighted Average Common
Shares Outstanding 30.1(B)
Net income per common
share-basic: $0.52(A/B)*
Effect of dilutive securities:
Preferred stock dividends 0.4
Convertible preferred stock 0.6
Stock options -
Diluted EPS:
Income available to common
and assumed conversions: $15.9(C) 30.7(D)
Net income per common share-assuming dilution: $0.52 (C/D)
* Computation excludes rounding.
-10-
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
MARCH 31, 1998
RESULTS OF OPERATIONS
(dollar amounts in millions)
Consolidated Overview
Quarter Ended
March 31
1998 1997
---- ----
Gross Earned Premium $ 181.7 $ 155.7
Ceded Premium 80.2 33.4
-------- ---------
Insurance premium $ 101.5 $ 122.3
Net engineering services revenue 17.6 14.7
Net investment income 15.2 8.0
Realized investment gains 3.2 0.5
-------- ---------
Total revenues $ 137.5 $ 145.5
======== =========
Pre-tax Income from Continuing Operations:
Pre-tax income excluding sale of IRI $ 30.6 $ 21.4
Pre-tax Gain on Sale of IRI $ 39.0 --
-------- ---------
Pre-tax income $ 69.6 $ 21.4
Income taxes on Continuing Operations $ 22.5 $ 5.5
Distributions on Capital Securities $ 4.5 --
--------- ---------
Income From Continuing Operations $ 42.6 $ 15.9
After-tax Gain on Radian Disposal $ 30.3 --
-------- ---------
Net income $ 72.9 $ 15.9
======== =========
Net income per common share:
Basic $ 2.49 $ .52
Diluted $ 2.17 $ .52
Net income for the first quarter of 1998 included after-tax gains on the sale of
HSB's interests in Industrial Risk Insurers (IRI) of $ 25.2 million and Radian
International LLC of $ 30.3 million. The Radian International LLC gain is net of
after-tax operating losses of $6.6 million that were deferred in 1997 when the
decision was made to exercise HSB's option to put the Company's interest to The
Dow Chemical Company. As a result, HSB's interest in Radian International LLC
was classified as a discontinued operation. Absent these sales, HSB's after-tax
earnings increased 9.9 percent from the first quarter of 1997 due to improved
engineering margins and higher realized gains.
-11-
Gross earned premiums grew 16.7% percent compared to the prior year. Much of
this growth is attributable to HSB Industrial Risk Insurers. Contemporaneous
with the sale of IRI, the IRI association was reconstituted with Employers
Reinsurance Corporation (ERC) (with a 99.5 percent share) and The Hartford Steam
Boiler Inspection and Insurance Company (HSBIIC) (with a .5 percent share) as
sole members. The new association has been renamed HSB Industrial Risk Insurers.
HSBIIC writes the business for HSB Industrial Risk Insurers using its insurance
licenses and provides certain other services. HSBIIC transferred its highly
protected risk (HPR) manufacturing book of business to HSB Industrial Risk
Insurers and through various reinsurance arrangements with ERC, HSBIIC will
retain 85 percent of the equipment breakdown business and 15 percent of the
property business of the combined insurance portfolio. This arrangement is the
largest contributing factor in the growth of both the gross earned premium and
the ceded premium. As a result, both the Unearned insurance premium and the
Reinsurance assets reflected in the Consolidated Statements of Financial
Position have increased significantly. The first quarter combined ratio improved
to 89.0 percent in 1998 from 90.0 percent in 1997. Net engineering services
revenue increased 19.7 percent for the first quarter and margins in this
business grew to 8.4 percent from 7.1 percent in the first quarter of 1997.
The effective tax rate on income from continuing operations for the first
quarter was 32 percent compared to 26 percent for the comparable prior period.
Typically tax rate fluctuations occur as underwriting and engineering services
results and realized gains change the mix of pre-tax income between fully
taxable earnings and tax preferred earnings that can be obtained by investing in
certain instruments. In the first quarter of 1998 the taxes associated with the
sale of IRI contributed to the higher effective tax rate. The Company continues
to manage its use of tax advantageous investments to maximize after tax
earnings.
Recent Accounting Developments
In June of 1997 the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This standard requires companies to report
financial and descriptive information about reportable operating segments. It
includes disclosure requirements relating to products and services, geographic
areas and major customers. This statement will be effective with calendar year
1998, however application is not required for interim financial statements in
the initial year. It is possible that this standard may redefine our segment
information. However, the Company has not yet determined how SFAS No. 131 will
be applied.
-12-
Insurance Operations
Insurance operations include the insurance results of The Hartford Steam Boiler
Inspection and Insurance Company; HSB Engineering Insurance Limited (HSB-EIL);
The Boiler Inspection and Insurance Company of Canada (BI&I) and The Allen
Insurance Company, Ltd.
Quarter Ended
March 31
1998 1997
---- ----
Gross earned premium $ 181.7 $ 155.7
Ceded premium 80.2 33.4
--------- ---------
Insurance premium 101.5 122.3
Claims and adjustment expenses 44.6 51.5
Underwriting, acquisition
and other expenses 46.1 58.8
--------- ---------
Underwriting gain $ 10.8 $ 12.0
========= =========
Loss ratio 43.9% 42.1%
Expense ratio 45.1% 47.9%
----- -----
Combined ratio 89.0% 90.0%
===== =====
Gross earned premiums in the first quarter increased 16.7 percent from the
comparable period in 1997. This increase was primarily attributable to the new
arrangement with HSB Industrial Risk Insurers. Gross earned premiums from IRI
increased $24.6 million in 1998 compared to the comparable period in 1997. Gross
earned premiums representing coverage outside the U.S. for non HSB Industrial
Risk Insurers business increased 5 percent in the first quarter from the
comparable period in 1997. In certain areas of our direct domestic and foreign
business, the market is experiencing price erosion. HSB will not write business
at rates which would lessen our ability to maintain underwriting profit.
-13-
Increases in ceded premium of 140 percent in the current quarter were the result
of both the new HSB Industrial Risk Insurers arrangement previously discussed
and related reinsurance with ERC, and changes in the Company's reinsurance
programs which now utilize more quota share reinsurance on certain of our books
of business. We anticipate these new reinsurance contracts and the HSB
Industrial Risk Insurers arrangement will continue to result in high growth in
gross earned premium but lower growth in net earned premium.
The loss ratio increased from 42.1 percent in the first quarter of 1997 to 43.9
percent in the current quarter. First quarter 1998 results were impacted by
severe ice storms in Canada. These storms impacted the loss ratio by
approximately 6 percentage points. In the first quarter of 1997 flood related
losses impacted the loss ratio by 1.2 percentage points. Gross claims and
adjustment expenses for the first quarter 1998 and 1997 were $89.4 million and
$74.9 million, respectively.
The expense ratio improved to 45.1% in the first quarter of 1998 from 47.9% in
the first quarter of 1997. The new quota share reinsurance agreements and the
HSB Industrial Risk Insurers arrangement with ERC, both of which result in
ceding commissions to HSBIIC have positively impacted our expense ratio by
approximately 8 percentage points. Ceding commission should continue to
positively impact the expense ratio throughout 1998. A portion of such ceding
commission is intended to reimburse HSB for the additional costs of managing HSB
Industrial Risk Insurers.
Engineering Services Operations
Quarter Ended
March 31
1998 1997
---- ----
Net engineering services revenue $ 17.6 $ 14.7
Net engineering services expenses 16.1 13.6
-------- -------
Operating gain $ 1.5 $ 1.1
======== =======
Net margin 8.4% 7.1%
-14-
Engineering services operations include the results of HSB's and BI&I's
engineering services, HSB Reliability Technologies (HSBRT) and the Company's
other engineering services subsidiaries.
Net engineering services revenues increased $2.9 million in the first quarter
compared to the same period in 1997. The growth in revenues was primarily due to
increases generated by HSBRT as their revenues increased 17.7 percent, as well
as revenues generated by some recent small acquisitions which were made in the
latter part of 1997. The improvement in operating gain from the previous periods
reflects efforts to improve staff utilization and a refocus in certain areas on
pricing strategies. We are still incurring costs to develop new products which
have the objective of increasing growth rates.
The Company has been focusing on identifying acquisition candidates in the niche
engineering management consulting service business, primarily in process
industries, in order to grow the engineering service segment of the business. On
May 1, 1998 HSB and Solomon Associates, Inc. (SAI) announced an agreement for
HSB to acquire SAI. SAI provides comparative performance benchmarking to 80
percent of the worldwide petroleum refining industry and had gross sales of $13
million in 1997. The company also serves petro-chemical and power generation
customers and conducts performance improvement consulting, business valuation
assessments, performance monitoring and maintenance database services.
Investment Operations
Quarter Ended
March 31
1998 1997
Net investment income $ 15.2 $ 8.0
Realized investment gains 3.2 0.5
--------- ---------
Pretax income from
investment operations $ 18.4 $ 8.5
========== ==========
Net investment income for the first quarter increased significantly compared to
the first quarter of 1997 due to the investment of proceeds from capital
securities issued during the second half of 1997. In addition, proceeds from the
January sales of HSB's interests in IRI and Radian International LLC
significantly increased investable funds. Realized investment gains were largely
driven in 1998 by call premiums on fixed income investments. In 1997 realized
gains were reduced by $1.4 million to reflect the estimated fair value of three
"zero cost" collar contracts entered into at the end of 1996 which were used to
mitigate the effects of market risk on the U.S.
common stock portfolio.
-15-
The Company's investment strategy continues to be to maximize total return on
the investment portfolio through investment income and capital appreciation.
Investment strategies for any given year are developed based on many factors
including operational results, tax implications, regulatory requirements,
interest rates, dividends to stockholders and market conditions. The investment
portfolio includes a wide variety of high quality equity securities and both
domestic and foreign fixed maturities. The Company continues to manage its use
of tax advantageous investments to maximize after tax investment earnings.
Liquidity and Capital Resources
Balances at
March 31 December 31
1998 1997
------------ -------------
Total assets $ 1,871.5 $ 1,540.2
Short-term investments 147.3 379.2
Cash 20.4 45.3
All other invested assets 979.6 572.2
Short-term borrowing .9 42.4
Common shareholder's equity 411.3 345.3
Liquidity refers to the Company's ability to generate sufficient funds to meet
the cash requirements of its business operations. The Company receives a regular
inflow of cash from maturing investments and engineering services and insurance
operations. The mix of the investment portfolio is managed to respond to
expected claim pay-out patterns and other cash requirements. The Company also
maintains a highly liquid short-term portfolio to provide for immediate cash
needs and to offset a portion of interest rate risk relating to certain capital
securities.
Cash provided from operations was $ 15.4 million in the first three months of
1998 compared to $29.4 million for the same period in 1997. The reduction is
primarily the result of the timing of settlement of portfolio transfers related
to IRI in the first quarter of 1998 as compared to the first quarter of 1997.
Aside from IRI activity, premiums collected were essentially flat compared to
the first quarter of 1997 while claims paid declined approximately 36 percent.
Net settlements with reinsurers declined 41 percent in the same time period.
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Capital resources consist of shareholders' equity, capital securities and debt
outstanding and represent those funds deployed or available to be deployed to
support business operations and investment activities. Common shareholders'
equity of $411.3 million at March 31, 1998 increased by $66.0 million since
December 31, 1997. The increase primarily reflects net income of $72.9 million
for the quarter and an increase in unrealized gains, net of tax, of $17.7
million, offset by common dividends of $11.7 million and common stock
repurchases of $19.7 million.
At March 31, 1998, the Company had significant short-term and long-term
borrowing capacity. The Company is currently authorized to issue up to $75
million of commercial paper. Commercial paper outstanding at March 31, 1998 was
$.9 million
The Company is involved in two arbitration or litigation proceedings regarding
the extent to which certain explosion events are insured under boiler and
machinery policies of the Company or under the all-risk property insurance
policies issued by other companies. Management believes the Company's policies
do not provide coverage for losses resulting from the explosion events that are
the subject of these proceedings. In the opinion of management any adverse
outcomes in these cases will not, in the aggregate, have a material effect on
either the results of operations or financial condition of the Company. More
information pertaining to these legal proceedings may be found under note 5 of
the Notes to Consolidated Financial Statements herein.
The Company continues to evaluate the potential coverage exposures arising out
of the year 2000 and its impact on insured equipment. As has been well
publicized, many computer systems and date controlled equipment may cease to
function or may function in a different manner when the year 2000 arrives
because they are programmed to recognize only the last two digits of the year.
During the first quarter the Company filed with the various jurisdictions an
endorsement to its equipment breakdown forms which reiterates that coverage is
not provided for the inherent inability of computers and computerized equipment
to properly recognize a particular date or time, such as the year 2000.
Quantification of the Company's exposure to year 2000 losses is not possible at
this time as applicable policy wordings have not been legally tested in the
context of such losses. See discussion on other year 2000 uncertainties in the
Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations in the Company's 1997 Report on Form 10-K.
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Forward-Looking Statements
Certain statements contained in this report are forward-looking and are based on
management's current expectations. Actual results may differ materially from
such expectations depending on the outcome of certain factors described with
such forward-looking statements and other factors including: significant natural
disasters and severe weather conditions; changes in interest rates and the
performance of the financial markets; changes in the availability, cost and
collectibility of reinsurance; changes in domestic and foreign laws, regulations
and taxes; the entry of new or stronger competitors and the intensification of
pricing competition; the loss of current customers or the inability to obtain
new customers; changes in the coverage terms selected by insurance customers,
including higher deductibles and lower limits; adverse development on losses and
loss adjustment expenses related to claims arising in prior periods; new
insurance and reinsurance contract interpretations, including coverage issues
related to Year 2000 events; changes in asset valuations; consolidation and
restructuring in the financial services industry; changes in the Company's
participation in joint underwriting associations, and in particular IRI; changes
in the demand and customer base for engineering and inspection services offered
by the Company, whether resulting from changes in the law or otherwise, and
other general market conditions.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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HSBIIC is involved in two arbitration or litigation proceedings
regarding the extent to which certain explosion events are insured
under boiler and machinery policies of HSBIIC or under the all-risk
property insurance policies issued by other companies. Management
believes HSBIIC's policies do not provide coverage for losses
resulting from the explosion events that are the subject of these
proceedings.
HSBIIC has accrued $6.5 million with respect to these cases for
potential LAE, including legal costs to defend HSBIIC's position. One
case is in the process of pre-trial summary judgment motions and
appeals; the other case is involved in both arbitration and litigation
proceedings. A trial date has not been set for either case. In the
event that HSBIIC is held liable for one or both of the remaining
claims, amounts in excess of HSBIIC's net maximum aggregate retention
of $8.5 million is recoverable from reinsurers. Claim amounts
potentially recoverable from reinsurers in the event of a possible
adverse outcome in these cases could range, in the aggregate, from $40
million to $195 million.
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The obligations of HSBIIC's reinsurers with respect to these cases are
not in dispute. Therefore, management believes that any adverse
outcomes in these cases will not, in the aggregate, have a material
effect on either the results of operations or financial condition of
the Company. HSBIIC's reinsurance contracts do not require HSBIIC to
reimburse its reinsurers for any losses such reinsurers might incur
should these cases not be decided in HSBIIC's favor. Nevertheless,
reinsurers often quote rates for future coverages based upon their or
other reinsurers' experience on a particular account. Therefore, in
the event HSBIIC's reinsurers pay significant sums pursuant to the
arbitration or litigation proceedings described above, it is likely
HSBIIC's reinsurance rates would increase in future periods. However,
given the insured capacity that exists in reinsurance markets
worldwide, coupled with HSBIIC's ability to negotiate a redesign or
restructuring of its reinsurance program, it does not necessarily mean
that such an increase would be material.
HSBIIC was involved in a third proceeding regarding coverage for loss
regarding an explosion event. A lower court ruling in that case held
that an explosion did occur, and that HSBIIC was not liable for losses
of the insured resulting from the explosion. In a further action, the
court denied HSBIIC's motion for summary judgment on certain issues,
thus leaving HSBIIC potentially liable for certain unqualified losses
resulting from events prior to the explosion. In the first quarter of
1997, HSBIIC and the property insurer jointly settled the case with
the insured. A final allocation of the loss in this case was reached
in the decision of a mediator dated February 2, 1998. The decision had
no material effect on HSB earnings.
The Company is also involved in various other legal proceedings as
defendant or co-defendant that have arisen in the normal course of its
business. In the judgment of management, after consultation with
counsel, it is improbable that any liabilities which may arise from
such litigation will have a material adverse impact on the results of
operations or the financial position of the Company.
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Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 10(ii) - Operating agreement for HSB-IRI Property
Insurance Business by and among Employers Reinsurance
Corporation, HSB Industrial Risk Insurers L.L.C., Industrial Risk
Insurers, and The Hartford Steam Boiler Inspection and Insurance
Company, effective as of January 1, 1998
Exhibit 10(iii)(a) - HSB Group, Inc. Long-Term Incentive Plan, as
amended and restated effective January 1, 1998
Exhibit 10(iii)(b) - HSB Group, Inc. Short-Term Incentive Plan,
as amended and restated effective January 1, 1998
Exhibit 10(iii)(c) - The HSB Group, Inc. Directors Stock and
Deferred Compensation Plan, as amended and restated effective
January 1, 1998
Exhibit (27.1) - Financial Data Schedule
Exhibit (27.2) - Financial Data Schedule
(b) Reports on Form 8-K
(i) Form 8-K dated January 12, 1998 to report sale of interest in
Industrial Risk Insurers and $300 million of convertible capital
securities to Employers Reinsurance Corporation; and
(ii) Form 8-K dated January 28, 1998 to report Fourth Quarter
1997 Results of Registrant
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SIGNATURES
Pursuant to the requirements 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.
HSB GROUP, INC.
Date: May 15, 1998 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President, Treasurer
and Chief Financial Officer
Date: May 15, 1998 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President and
General Counsel
-21-
INDEX TO EXHIBITS
Exhibit No. Description
- ---------- -----------
10(ii) Operating agreement for HSB-IRI Property
Insurance Business by and among Employers Reinsurance
Corporation, HSB Industrial Risk Insurers L.L.C., Industrial Risk
Insurers, and The Hartford Steam Boiler Inspection and Insurance
Company, effective as of January 1, 1998
10(iii)(a) HSB Group, Inc. Long-Term Incentive Plan, as
amended and restated effective January 1, 1998
10(iii)(b) HSB Group, Inc. Short-Term Incentive Plan,
as amended and restated effective January 1, 1998
10(iii)(c) The HSB Group, Inc. Directors Stock and
Deferred Compensation Plan, as amended and restated effective
January 1, 1998
27.1 Financial Data Schedule
27.2 Financial Data Schedule