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 June 30, 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 June 30, 1998: 29,395,937
HSB GROUP, INC.
INDEX
PART I FINANCIAL INFORMATION PAGE
Consolidated Statements of Operations
for the Quarters Ended June 30, 1998 and
1997 and the Six Months ended
June 30, 1998 and 1997 (unaudited)..................3
Statement of Comprehensive Income
for the Quarters Ended June 30, 1998 and 1997
and the Six Months ended June 30,
1998 and 1997 (unaudited).............................4
Consolidated Statements of Financial Position as
of June 30, 1998 (unaudited) and December 31, 1997 ....5
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 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 4 - Submission of Matters to a Vote of
Security Holders.............................19
Item 5 - Other Information............................20
Item 6 - Exhibits and Reports on Form 8-K.............20
SIGNATURES......................................................21
2
HSB GROUP, INC.
Consolidated Statements of Operations
Unaudited
(in millions, except per share data)
Quarter Six Months
Ended June 30 Ended June 30
Revenues: 1998 1997 1998 1997
--------- --------- ---------- ---------
Insurance premiums $ 93.1 $ 117.2 $ 194.6 $ 239.5
Engineering services 19.9 15.0 37.5 29.7
Net investment income 16.0 8.8 31.2 16.7
Realized investment gains 7.3 3.4 10.5 4.0
--------- --------- ---------- ---------
Total revenues 136.3 144.4 273.8 289.9
--------- --------- ---------- --------
Expenses:
Claims and adjustment 40.4 51.4 85.0 102.9
Policy acquisition 10.7 20.4 23.3 43.9
Underwriting and inspection 31.9 36.0 65.4 71.3
Engineering services 18.3 14.1 34.4 27.7
Interest 0.2 0.4 0.3 0.6
--------- --------- --------- ----------
Total expenses 101.5 122.3 208.4 246.4
--------- --------- --------- ---------
Gain on sale of IRI - - 39.0 -
Income from continuing operations before income
taxes and distributions on capital securities $ 34.8 $ 22.1 $ 104.4 $ 43.5
Income taxes (benefit):
Current 1.7 6.1 29.3 12.7
Deferred 7.6 (0.4) 2.5 (1.4)
--------- --------- ---------- ------------
Total income taxes $ 9.3 $ 5.7 $ 31.8 $ 11.3
Distribution on capital securities
of subsidiary trust, net of income tax
benefits of $2.5 and $4.9. 4.7 - 9.2 -
------ --------- --------- -----------
Income from continuing operations $ 20.8 $ 16.4 $ 63.4 $ 32.2
Discontinued operations:
Loss from operations, net of income tax
benefits of $--; $--; $3.2; and $--. - - (6.6) -
Gain on disposal, net of income taxes
of $--; $--;$23.7; and $--. - - 36.9 -
--------- --------- ---------- ---------
Total discontinued operations $ - $ - $ 30.3 $ -
--------- --------- ---------- ---------
Net income $ 20.8 $ 16.4 $ 93.7 $ 32.2
--------- --------- ---------- ------------
Per share data:
Net income per common share-basic:
Income from continuing operations $ 0.71 $ 0.54 $ 2.16 $ 1.06
Net income $ 0.71 $ 0.54 $ 3.20 $ 1.06
Net income per common share-assuming dilution:
Income from continuing operations $ 0.68 $ 0.53 $ 1.99 $ 1.05
Net income $ 0.68 $ 0.53 $ 2.85 $ 1.05
Dividends declared per share $ 0.40 $ 0.38 $ 0.80 $ 0.76
Average shares outstanding and common stock
equivalents 35.4 30.7 35.3 30.7
See Notes to Consolidated Financial Statements.
3
HSB GROUP, INC.
Statements of Comprehensive Income
(in millions)
(Unaudited)
Quarter Ended Six Months
Ended June 30 Ended June 30
1998 1997 1998 1997
---- ---- ---- ----
Net income $ 20.8 $ 16.4 $ 93.7 $ 32.2
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during the period
(net of taxes of $5.4; $6.2; $14.7 and $7.2) 10.1 11.5 27.3 13.4
Add : reclassification adjustments for gains (7.0) (2.5) (6.8) (2.3)
included in net income 3.1 9.0 20.5 11.1
Foreign currency translation adjustments (1.0) 0.1 (0.7) (0.2)
Other comprehensive income 2.1 9.1 19.8 10.9
Comprehensive income $ 22.9 $ 25.5 $ 113.5 $ 43.1
See Notes to Consolidated Financial Statements
4
HSB GROUP, INC.
Consolidated Statements of Financial Position
(In millions, except per share data)
June 30, December 31,
1998 1997
(Unaudited)
------------- -------------
Assets:
Cash $ 17.5 $ 45.3
Short-term investments, at cost 104.4 379.2
Fixed maturities, at fair value
(cost -$542.3; $241.1) 554.2 248.4
Equity securities, at fair value
(cost - $340.9; $231.3 ) 461.3 323.8
------------------------------------
Total cash and invested assets 1,137.4 996.7
Reinsurance assets 403.0 124.5
Insurance premiums receivable 164.8 138.0
Engineering services receivable 25.1 12.2
Fixed assets 40.0 36.4
Prepaid acquisition costs 26.5 42.5
Capital lease 14.9 15.3
Investment in Radian - 83.4
Other assets 132.1 88.2
---------------- -----------------
Total assets $ 1,943.8 $ 1,537.2
================ =============
Liabilities:
Unearned insurance premiums $ 430.7 $ 287.3
Claims and adjustment expenses 337.1 276.7
Short-term borrowings 7.1 42.4
Long-term borrowings 25.1 25.1
Capital lease 27.9 27.9
Deferred income taxes 46.7 31.5
Dividends and distributions on capital
securities 23.2 13.3
Ceded reinsurance payable 98.6 3.9
Other liabilities 104.4 74.9
---------------- -----------------
Total liabilities 1,100.8 783.0
---------------- -----------------
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 75.0; shares issued 32.0;
shares outstanding 29.4; 29.4) 10.0 10.0
Additional paid-in capital 34.4 31.6
Accumulated other comprehensive income 79.6 59.8
Retained earnings 316.6 248.8
Benefit plans (6.5) (4.9)
---------------- -----------------
Total shareholders' equity 434.1 345.3
---------------- -----------------
Total $ 1,943.8 $ 1,537.2
================ =================
Shareholders' equity per common
share (restated for stock split) $ 14.77 $ 11.75
5
HSB Group, Inc.
Consolidated Statements of Cash Flows
Unaudited
(In Millions)
Six Months Ended
June 30,
------------------------
1998 1997
----------- ---------
Operating Activities:
Net income 93.7 32.2
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 4.4 3.3
Deferred income taxes (benefit) 2.5 (1.4)
Realized investment gains, including market
adjustment for derivative instruments (10.5) (4.0)
Gain from the disposition of Radian (after tax) (30.3) -
Gain from the disposition of IRI (after tax) (25.2) -
Change in balances net of effects from
purchases and sales of subsidiaries:
Insurance premiums receivable (26.8) (27.3)
Engineering services receivable (10.2) (0.2)
Prepaid acquisition costs 16.0 (3.5)
Reinsurance assets (278.5) 15.3
Unearned insurance premiums 143.4 25.4
Claims and adjustment expenses 60.4 (20.6)
Ceded reinsurance payable 94.7 4.9
Investment in Radian - (3.3)
Other (24.1) (7.7)
------------- -------
Cash provided by operating activities 9.5 13.1
------------- -------
Investing Activities:
Fixed asset additions, net (7.6) (2.0)
Investments:
Sale (purchase) of short-term
investments, net 274.8 (0.6)
Purchase of fixed maturities (342.4) (28.0)
Proceeds from sale of fixed maturities 23.5 7.4
Redemption of fixed maturities 17.9 8.7
Purchase of equity securities (209.5) (90.1)
Proceeds from disposition of Radian 128.9 -
Proceeds from disposition of IRI 49.1 -
Proceeds from sale of equity securities 109.0 107.3
Purchase of Solomon Associates, net
of cash acquired (2.1) -
------------- -------
Cash provided by (used in) investment
activities 41.6 2.7
------------- -------
Financing Activities
Increase (decrease) in short-term borrowings (35.3) 23.2
Dividends and distributions on capital securities (27.9) (23.5)
Reacquisition of stock (24.1) (16.6)
Exercise of stock options 8.4 1.3
------------- -------
Cash used in financing activities (78.9) (15.6)
------------- -------
Net increase (decrease) in cash (27.8) 0.2
Cash at beginning of period 45.3 4.5
------------- -------
Cash at end of period 17.5 4.7
============= =======
Interest paid $ 1.1 $ 0.6
------------- -------
Federal income tax paid $ 25.5 $ 13.1
------------- -------
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 or restated 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 June 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 quota share 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 loss adjustment expenses, including legal costs, to defend
HSBIIC's position. One case is on appeal; the other case is involved
in both arbitration and litigation proceedings. The arbitration has
been set for a final hearing in the third quarter 1998. 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
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 Operations have been restated in compliance with SFAS No.
128. 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 were distributed on 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. Previously, the company
reported EPS of $ 0.80 and $1.58 per share for the quarter and six
months ended June 30,1997, respectively.
9
Computation of Earnings per share
Quarter Ended Six Months Ended
June 30, 1998 June 30, 1998
---------------------------------------- -------------------------------------
Income Shares Per Share Income Shares Per Share
Income from continuing operations $20.8 $63.4
Basic EPS:
Income available to common shareholders 20.8(A) 63.4(E)
Weighted Average Common Shares Outstanding 29.3(B) 29.3(F)
Income from continuing operations
per common share-basic: $0.71(A/B) $2.16(E/F)
Effect of dilutive securities:
After-tax interest on convertible
capital securities $ 3.4 $ 6.8
Convertible capital securities 5.3 5.3
Stock options 0.8 0.7
Diluted EPS:
Income available to common and
assumed conversions: $24.2(C) 35.4(D) $70.2(G) 35.3(H)
Income from continuing operations per common
share-assuming dilution: $0.68(C/D) $1.99(G/H)
Quarter Ended Six Months Ended
June 30, 1997 June 30, 1997
------------------------------------------ ---------------------------------------
Income Shares Per Share Income Shares Per Share
Income from continuing operations $16.4 $32.2
Less: convertible preferred stock dividends $ 0.3 $0.6
Basic EPS:
Income available to common shareholders 16.1(A) 31.6(E)
Weighted Average Common Shares Outstanding 29.9(B) 30.0(F)
Income from continuing operations per
common share-basic: $0.54(A/B) $1.06(E/F)*
Effect of dilutive securities:
Preferred stock dividends $ 0.3 $0.6
Convertible preferred stock 0.4 0.4
Stock options 0.4 0.3
Diluted EPS:
Income available to common and
assumed conversions: $16.4(C) 30.7(D) $32.2(G) 30.7(H)
Income from continuing operations per common
share-assuming dilution: $0.53(C/D) $1.05(G/H)
* Computation excludes rounding.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
JUNE 30, 1998
RESULTS OF OPERATIONS
(dollar amounts in millions)
Consolidated Overview
Quarter Ended Six Months Ended
June 30 June 30
--------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
Gross Earned Premium .......................... $ 178.5 $ 149.2 $ 360.2 $ 305.0
Ceded Premium ................................. 85.4 32.0 165.6 65.5
------- ------- ------- ------
Insurance premium ............................. $ 93.1 $ 117.2 $ 194.6 $ 239.5
Engineering services revenue .................. 19.9 15.0 37.5 29.7
Net investment income ......................... 16.0 8.8 31.2 16.7
Realized investment gains ..................... 7.3 3.4 10.5 4.0
------ ------- ------- ------
Total revenues ............................ $ 136.3 $ 144.4 $ 273.8 $ 289.9
======= ======= ======= ======
Pre-tax Income from Continuing Operations:
Pre-tax income excluding sale of IRI ........ $ 34.8 $ 22.1 $ 65.4 $ 43.5
Pre-tax Gain on Sale of IRI ................. $ -- -- 39.0 --
------- ------- ------- ------
Pre-tax income .............................. $ 34.8 $ 22.1 104.4 43.5
Income taxes on Continuing Operations ......... $ 9.3 $ 5.7 $ 31.8 $ 11.3
Distributions on Capital Securities, net of tax $ 4.7 -- 9.2 --
------- ------- ------- ------
Income From Continuing Operations ............. $ 20.8 $ 16.4 $ 63.4 $ 32.2
After-tax Gain on Radian Disposal ............. $ -- -- $ 30.3 $ --
------- ------- ------- --------
Net income .................................... $ 20.8 $ 16.4 $ 93.7 $ 32.2
======= ======= ======= ======
Net income per common share:
Basic ....................................... $ .71 $ .54 $ 3.20 $ 1.06
Diluted ..................................... $ .68 $ .53 $ 2.85 $ 1.05
Net income for the six months ended June 30, 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
11
International LLC was classified as a discontinued operation. Absent these
sales, HSB's after-tax earnings increased 26.8 percent from the second quarter
of 1997 and increased 18.6 percent in the first six months of 1998 compared to
1997 due to improved engineering margins and higher net realized gains.
Gross earned premiums grew 19.6 percent in the quarter and 18.1 percent year to
date 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 quota share
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, the Unearned insurance premium, the Reinsurance assets, and the Ceded
reinsurance payable reflected in the Consolidated Statements of Financial
Position have increased significantly. The second quarter combined ratio
improved to 88.9 percent in 1998 from 91.8 percent in 1997 and the year to date
combined ratio improved to 88.9 percent in 1998 from 90.9 percent in 1997.
Engineering services revenue increased 32.7 percent for the second quarter and
26.4 percent year to date and margins in this business grew to 8.1 percent from
6.1 percent in the second quarter of 1997 and to 8.2 percent from 6.6 percent
year to date.
The effective tax rate on income from continuing operations for the second
quarter and year to date were 27 percent and 30 percent compared to 26 percent
for both periods in 1997. 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 1998 the taxes associated with
the sale of IRI contributed to the higher first quarter and year to date
effective tax rates. 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 HSBIIC; HSB Engineering
Insurance Limited (HSB-EIL); The Boiler Inspection and Insurance Company of
Canada (BI&I) and The Allen Insurance Company, Ltd.
Quarter Ended Six Months Ended
June 30 June 30
------------------ ---------------------
1998 1997 1998 1997
---- ---- ---- ----
Gross earned premium $ 178.5 $ 149.2 $ 360.2 $ 305.0
Ceded premium 85.4 32.0 165.6 65.5
------- ------- -------- ---------
Insurance premium 93.1 117.2 194.6 239.5
Claims and adjustment expenses 40.4 51.4 85.0 102.9
Underwriting, acquisition
and other expenses 42.6 56.4 88.7 115.2
------- ------- --------- --------
Underwriting gain $ 10.1 $ 9.4 $ 20.9 $ 21.4
======= ======= ======== ========
Loss ratio 43.4% 43.9% 43.7% 43.0%
Expense ratio (Excluding Goodwill
Amortization) 45.5% 47.9% 45.2% 47.9%
----- ----- ----- -----
Combined ratio 88.9% 91.8% 88.9% 90.9%
===== ===== ===== =====
Gross earned premiums in the second quarter and year to date increased 19.6
percent and 18.1 percent from the comparable periods in 1997. This increase was
primarily attributable to the new arrangement with HSB Industrial Risk Insurers.
Gross earned premiums from IRI increased $ 32.5 million in the second quarter of
1998 and $ 66.7 million year to date 1998 compared to the comparable periods in
1997. Gross earned premiums representing coverage outside the U.S. for non HSB
Industrial Risk Insurers business increased 18.8 percent in the second quarter
and 11.4 percent year to date from the comparable periods 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 166.9 percent in the second quarter and 152.8
percent year to date 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 declined from 43.9 percent in the second quarter of 1997 to 43.4
percent in the current quarter and increased from 43.0 percent in the first six
months of 1997 to 43.7 percent in the first six months of 1998. Year to date
1998 results were impacted by severe ice storms in Canada. In 1997 flood related
losses impacted the loss ratio. Gross claims and adjustment expenses for the
first six months of 1998 and 1997 were $ 220.7 million and $ 142.5 million,
respectively.
The expense ratio improved to 45.5 percent in the second quarter of 1998 from
47.9 percent in the second quarter of 1997 and to 45.2 percent year to date 1998
from 47.9 percent year to date 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 10 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.
HSBIIC completed an acquisition of the monoline boiler and machinery business of
Kemper Insurance Companies, effective July 1, 1998. The two companies also
completed an arrangement for HSBIIC to reinsure boiler and machinery coverage
written as part of Kemper's commercial package policies. Kemper's total
estimated boiler and machinery premiums were $80 million in 1997.
Engineering Services Operations
Quarter Ended Six Months Ended
June 30 June 30
------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
Net engineering services revenue $ 19.9 $ 15.0 $ 37.5 $ 29.7
Net engineering services expenses 18.3 14.1 34.4 27.7
------- ------- ------- -------
Operating gain $ 1.6 $ .9 $ 3.1 $ 2.0
======= ======== ======= =======
Net margin 8.1% 6.1% 8.2% 6.6%
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.
In April 1998 HSB acquired Solomon Associates, Inc. (SAI), based in Dallas,
Texas. SAI is an engineering management consulting firm that provides
comparative performance benchmarking consulting to the refining, petro-chemical
and power generation industries. In 1997, SAI had gross sales of $13,000,000.
SAI establishes efficiency and productivity benchmarks for 80 percent of the
worldwide petroleum refining industry. This acquisition expands HSB's
engineering management consulting services and benchmarking capability.
Engineering services revenues increased $ 4.9 million in the second quarter and
$ 7.8 million year to date compared to the same periods in 1997. The growth in
revenues was primarily due to increases generated by HSBRT as their revenues
increased 20.5 percent, SAI revenues of $1.4 million, as well as revenues
generated by some recent small acquisitions. 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.
On July 1, 1998 HSB purchased Kemper's ASME inspection services business that
certifies boiler and pressure vessel compliance with the codes and standards of
the American Society of Mechanical Engineers. Total estimated 1997 revenues were
approximately $7.5 million.
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.
Investment Operations
Quarter Ended Six Months Ended
June 30 June 30
---------------- -------------------
1998 1997 1998 1997
----- ------ ----- ------
Net investment income $ 16.0 $ 8.8 $ 31.2 $ 16.7
Realized investment gains 7.3 3.4 10.5 4.0
------- ------- ------- -------
Pretax income from
investment operations $ 23.3 $ 12.2 $ 41.7 $ 20.7
======= ======= ======= =======
15
Net investment income for the second quarter and year to date increased
significantly compared to the same periods in 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 significantly impacted in 1998 by call premiums on fixed income
investments. In the second quarter of 1997 realized gains were reduced by $18.0
million and year to date 1997 by $19.4 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. These collars were closed out by year end 1997.
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 shareholders 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
June 30 December 31
1998 1997
------------ ----------
Total assets $ 1,943.8 $ 1,537.2
Short-term investments 104.4 379.2
Cash 17.5 45.3
All other invested assets 1,015.5 572.2
Short-term borrowing 7.1 42.4
Common shareholder's equity 434.1 345.3
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 $9.5 million in the first six months of 1998
compared to $13.1 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 six months of 1997 while claims paid declined.
16
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 $ 434.1 million at June 30, 1998 increased by $ 88.8 million since
December 31, 1997. The increase primarily reflects net income of $ 93.7 million
for the year to date and an increase in unrealized gains, net of tax, of $ 19.8
million, offset by common dividends of $ 23.4 million and common stock
repurchases of $24.1 million offset by issuances of $22.4 million.
At June 30, 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 June 30, 1998 was $6 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 HSBIIC 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.
The Company writes business in European markets primarily through its U.K.
subsidiary, HSB Engineering Insurance Limited. The adoption of a common currency
(the euro) by eleven of the fifteen member countries of the European Union on
January 1, 1999 is not expected to result in a substantial change in the
business or a significant increase in costs in the short term. In part, this is
due to the fact that much of the business is U.S. dollar denominated. Over time,
as and if the U.K. adopts the euro as its currency there may be more of an
impact. The Company will continue to monitor developments and assess impacts on
markets, pricing, etc.
17
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
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 loss adjustment expenses, including legal costs to defend
HSBIIC's position. One case is on appeal; the other case is involved in
both arbitration and litigation proceedings. The arbitration has been
set for a final hearing in the third quarter 1998. 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
18
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.
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.
Item 4 - Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders was held on April 21, 1998.
(b) Three directors were nominated for election at the Annual
Meeting. Proxies for such meeting were solicited by Registrant's
management pursuant to Regulation 14A under the Securities
Exchange Act of 1934; there was no solicitation in opposition to
management's nominees as listed in the proxy statement; and all
of such nominees were elected for a three-year term.
(c) The following matters were voted upon at the Annual Meeting with
the voting results indicated.
1. Election of directors
Nominee Votes for Votes Withheld
------- --------- --------------
Richard H. Booth 16,220,588 201,029
Colin G. Campbell 16,219,532 202,085
Simon W. Leathes 16,230,814 190,803
2. Proposal to amend and restate the Short-Term Incentive Plan
Votes for Against Abstain
--------- ------- -------
15,139,437 1,042,442 239,736
3. Proposal to amend and restate the Long-Term Incentive Plan
Votes for Against Abstain
--------- ------- -------
15,164,414 1,028,033 229,168
19
4. Appointment of Coopers & Lybrand as Independent Public
Accountants
Votes for Against Abstain
--------- ------- -------
16,280,619 79,445 61,553
Item 5. Other Information
The deadline for submission of shareholder proposals pursuant to Rule 14a-8
under the Securities Exchange Act of 1934, as amended, for inclusion in the
Company's proxy statement for its 1999 Annual Meeting of Shareholders is
November 6, 1998. Additionally, if the Company receives notice of a shareholder
proposal after February 20, 1998, the persons named in the proxies solicited by
the Board of Directors of the Company for its 1999 Annual Meeting of
Shareholders may exercise discretionary voting power with respect to such
proposal.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule
Exhibit 27.2 - Financial Data Schedule
(b) Reports on Form 8-K
(i) Form 8-K dated April 22, 1998 to report first quarter results, a
three-for-two stock split, the declaration of a quarterly dividend payable
June 30, 1998, and a summary of the Company's annual meeting held on April
21, 1998.
(ii) Form 8-K dated May 18, 1998 to report the signing of a letter of
intent for The Hartford Steam Boiler Inspection and Insurance Company, the
Company's subsidiary, to acquire Kemper Insurance Companies' monoline
boiler and machinery business and to reinsure boiler and machinery coverage
written as part of Kemper's commercial package policies and to acquire ASME
code business.
20
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: August 14, 1998 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President,
Treasurer and Chief Financial
Officer
Date: August 14, 1998 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President and
General Counsel
21