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, 1999
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, 1999: 29,000,782
HSB GROUP, INC.
INDEX
PART I FINANCIAL STATEMENTS PAGE
Item 1 - Financial Statements
Consolidated Statements of Operations for the Quarters
ended March 31, 1999 and 1998 (unaudited).............................. 3
Consolidated Statements of Comprehensive Income for the
Quarters ended March 31, 1999 and 1998 (unaudited)..................... 4
Consolidated Statements of Financial Position
as of March 31, 1999 (unaudited) and December 31, 1998............. 5
Consolidated Statements of Cash Flows for the Three
Months ended March 31, 1999 and 1998 (unaudited) ...................... 6
Notes to Consolidated Financial Statements (unaudited)................. 7
Item 2 - Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations........... 12
PART II OTHER INFORMATION
Item 1 - Legal Proceedings............................................ 21
Item 6 - Exhibits and Reports on Form 8-K............................. 21
SIGNATURES................................................................. 22
2
Item 1. Financial Statements
HSB GROUP, INC.
Consolidated Statements of Operations
Unaudited
(in millions, except per share data)
Quarter
Ended March 31
1999 1998
----------------------------------
Revenues:
Gross earned premium $ 208.9 $ 179.7
Ceded premiums 112.4 80.3
----------------------------------
Insurance premiums 96.5 99.4
Engineering services 27.6 19.7
Net investment income 15.7 15.2
Realized investment gains 7.1 3.2
----------------------------------
Total revenues 146.9 137.5
----------------------------------
Expenses:
Claims and adjustment 38.3 44.6
Policy acquisition 22.6 14.6
Underwriting and inspection 24.0 29.7
Engineering services 25.2 17.9
Interest 0.4 0.1
----------------------------------
Total expenses 110.5 106.9
----------------------------------
Gain on sale of IRI - 39.0
Income from continuing operations
before income taxes and distributions
on capital securities $ 36.4 $ 69.6
Income taxes (benefit):
Current 8.2 27.6
Deferred 2.7 (5.1)
----------------------------------
Total income taxes $ 10.9 $ 22.5
Distribution on capital securities of
subsidiary trust, net of income
tax benefits of $2.4 and $2.5 4.5 4.5
----------------------------------
Income from continuing operations $ 21.0 $ 42.6
Discontinued operations:
Loss from operations, net of income
tax benefits of $ - and $3.2 - (6.6)
Gain on disposal, net of income
taxes of $ - and $23.7 - 36.9
----------------------------------
Total discontinued operations $ - $ 30.3
----------------------------------
Net income $ 21.0 $ 72.9
==================================
Per share data:
Net income per common share-basic:
Income from continuing operations $ 0.72 $ 1.45
Discontinued operations - 1.04
==================================
Net income $ 0.72 $ 2.49
==================================
Net income per common
share-assuming dilution:
Income from continuing operations $ 0.71 $ 1.31
Discontinued operations - 0.86
==================================
Net income $ 0.71 $ 2.17
==================================
Dividends declared per share $ 0.42 $ 0.40
Average shares outstanding and common
stock equivalents 34.5 35.2
See Notes to Consolidated Financial Statements.
3
HSB GROUP, INC.
Consolidated Statements of Comprehensive Income
Unaudited
(in millions)
Quarter
Ended March 31,
1999 1998
------------------------------
Net income $ 21.0 $ 72.9
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period, net of taxes
(benefits) of ($4.2) and $10.9 (8.0) 18.2
Add : reclassification adjustments for
gains included in net income (4.6) (0.7)
------------------------------
Total unrealized gains on securities (12.6) 17.5
Foreign currency translation adjustments,
net of income taxes 0.3 0.1
------------------------------
Other comprehensive income (12.3) 17.6
------------------------------
Comprehensive income $ 8.7 $ 90.5
==============================
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,
1999 1998
(Unaudited)
--------------------------
Assets:
Cash and cash equivalents $ 3.7 $ 18.3
Short-term investments, at cost 90.6 62.3
Fixed maturities, at fair value
(cost -$562.7; $568.5) 559.1 577.1
Equity securities, at fair value
(cost - $322.8; $326.3) 426.7 437.1
--------------------------
Total cash and invested assets 1,080.1 1,094.8
Reinsurance assets 637.3 630.4
Insurance premiums receivable 109.7 146.7
Engineering services receivable 32.6 26.1
Fixed assets 54.7 54.9
Prepaid acquisition costs 50.5 46.6
Capital lease 14.4 14.6
Other assets 133.7 129.9
==========================
Total assets $ 2,113.0 $ 2,144.0
==========================
Liabilities:
Unearned insurance premiums $ 454.6 $ 477.9
Claims and adjustment expenses 558.0 550.3
Short-term borrowings 26.2 21.0
Long-term borrowings 25.1 25.1
Capital lease 27.8 27.9
Deferred income taxes 38.6 42.7
Dividends and distributions on capital
securities 17.9 23.2
Ceded reinsurance payable 56.9 64.1
Other liabilities 84.8 83.6
--------------------------
Total liabilities 1,289.9 1,315.8
--------------------------
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 in 1999 and 1998 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 and
outstanding 29.0; 28.9) 10.0 10.0
Additional paid-in capital 35.2 33.5
Accumulated other comprehensive income 54.5 66.8
Retained earnings 321.4 311.2
Benefit plans (6.9) (2.2)
--------------------------
Total shareholders' equity 414.2 419.3
--------------------------
Total $ 2,113.0 $ 2,144.0
==========================
Common shareholders' equity per common share $ 14.28 $ 14.53
See Notes to Consolidated Financial Statements.
5
HSB GROUP, INC.
Consolidated Statements of Cash Flows
Unaudited
(In Millions)
Quarter
Ended March 31,
1999 1998
------------------------------
Operating Activities:
Net income $ 21.0 $ 72.9
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 5.1 2.9
Deferred income taxes (benefit) 2.7 (5.1)
Realized investment gains (7.1) (3.2)
Distributions on capital securities 6.9 7.0
Gain from the disposition of Radian,
net of income taxes - (30.3)
Gain from the disposition of IRI,
net of income taxes - (25.2)
Change in balances, net of effects from
purchases and sales of subsidiaries:
Insurance premiums receivable 37.0 (54.7)
Engineering services receivable (6.3) (2.2)
Prepaid acquisition costs (3.9) 26.7
Reinsurance assets (6.9) (182.6)
Unearned insurance premiums (23.3) 140.6
Claims and adjustment expenses 7.7 20.0
Ceded reinsurance payable (7.2) 46.8
Other (3.3) 1.8
------------------------------
Cash provided by operating activities 22.4 15.4
------------------------------
Investing Activities:
Fixed asset additions, net (3.3) (3.3)
Investments:
Sale (purchase) of short-term
investments, net (28.3) 54.5
Purchase of fixed maturities (13.6) (307.1)
Proceeds from sale of fixed maturities 16.0 11.6
Redemption of fixed maturities 2.7 2.3
Purchase of equity securities (56.6) (132.0)
Proceeds from disposition of Radian - 128.9
Proceeds from disposition of IRI - 49.1
Proceeds from sale of equity securities 68.1 47.3
------------------------------
Cash used in investment activities (15.0) (148.7)
------------------------------
Financing Activities:
Increase (decrease) in short-term
borrowings 4.4 (41.5)
Dividends and distributions on
capital securities (24.4) (14.4)
Reacquisition of stock (2.2) (19.7)
Exercise of stock options 0.2 6.6
------------------------------
Cash used in financing activities (22.0) (69.0)
------------------------------
Net decrease in cash and cash equivalents (14.6) (202.3)
Cash and cash equivalents at beginning of period 18.3 293.2
------------------------------
Cash and cash equivalents at end of period $ 3.7 $ 90.9
==============================
Interest paid $ 1.3 $ 0.1
------------------------------
Federal income tax paid $ 1.8 $ 0.8
------------------------------
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 1998 Annual Report.
Certain amounts for 1998 have been reclassified to conform with the
1999 presentation.
2. Discontinued Operations
On January 2, 1998, The Hartford Steam Boiler Inspection and Insurance
Company (HSBIIC) 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, HSBIIC
contributed substantially all of the assets and liabilities of its
wholly-owned subsidiary, Radian Corporation at historical cost to
Radian LLC. No gain was recognized on the transfer. The results of
Radian LLC were classified as discontinued operations following
ratification on July 28, 1997 by HSB's 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 and recognized at the
time the gain was recognized in 1998. This transaction resulted in an
after-tax gain of $36.9 million which was recorded in the first quarter
of 1998.
3. Industrial Risk Insurers
On January 6, 1998, 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 $36.6
million pre-tax and $23.8 million after-tax, of which $39.0 million
pre-tax and $25.2 million after-tax was recognized in the first quarter
of 1998. In the fourth quarter of 1998, adjustments were made to the
costs associated with the sale. 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. HSBIIC received gross proceeds of $49.1 million, prior to
transaction costs, for its 23.5 percent share in IRI. Because the sale
was structured in part as a reinsurance transaction, a portion of
HSBIIC's gross proceeds was utilized to reinsure in-force policies with
ERC.
Contemporaneous with the close of the sale, IRI was reconstituted with
ERC (with a 99.5 percent share) and HSBIIC (with a 0.5 percent share)
as the sole members. The new association was 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 retains 85 percent of the equipment breakdown
insurance and 15 percent of the property insurance of the combined
insurance portfolio. The agreements are of indefinite
7
duration, but ERC has an option to purchase HSB's interest in the
business in the event of a 50 percent or more change in the control of
HSB.
4. Recent Accounting Developments
The Accounting Standards Executive Committee of the American Institute
of Certified Public Accountants (AcSEC) recently issued three
Statements of Position (SOP) which became effective for fiscal years
beginning after December 15, 1998; SOP 97-3, "Accounting by Insurance
and Other Enterprises for Insurance-Related Assessments", SOP 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use", and SOP 98-5, "Reporting on the Costs of Start-Up
Activities". Because the Company's accounting policies were in
compliance with the provisions of the SOP's, the implementation of the
SOP's had no impact upon the results of operations, financial condition
or cash flows.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting
for Derivative Instruments and Hedging Activities". This statement
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that all derivatives
be recognized as either assets or liabilities in the statement of
financial position and that such instruments be measured at fair value.
In addition, all hedging relationships must be designated, reassessed
and documented pursuant to the provisions of SFAS No. 133. This
statement is effective for fiscal years beginning after June 15, 1999.
The Company anticipates that the adoption of the provisions of SFAS No.
133 will not have a material impact on results of operations, financial
condition or cash flows.
In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance
Risk." The SOP identifies several methods of deposit accounting and
provides guidance on the application of each method. This SOP is
effective for financial statements for fiscal years beginning after
June 15, 1999. Currently the Company is not party to any contracts
which do not comply with the risk transfer provisions of SFAS No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts," and, therefore, does not anticipate the
adoption of SOP 98-7 will have a material impact on results of
operations, financial condition or cash flows.
5. Legal Proceedings
HSBIIC has been involved in three significant claim-related disputes
concerning the extent to which certain explosion events were insured
under boiler and machinery coverages of HSBIIC. Information regarding
these disputes has been provided in previous 10-K and 10-Q reports.
Current rulings in all three cases confirm HSBIIC's long-standing
position that HSBIIC policies do not cover the explosion events that
occurred in those cases. In one case the parties settled their dispute
following Summary Judgment rulings of the Federal District Court for
the State of Illinois; in a second case, a decision of an arbitration
panel has been confirmed by the Superior Court of the State of
Connecticut; and in a third case, the Federal Court of Appeals for the
Seventh Circuit has remanded the matter for entry of a judgment in
HSBIIC's favor.
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 material adverse impact on the results of
operations or the financial position of the Company.
8
6. Earnings per share
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, earnings per share presentations for
March 1998 have been adjusted to reflect the impact of the stock split.
9
Computation of Earnings Per Share:
Quarter Ended
March 31, 1999
--------------
Income Shares Per Share
------ ------ ---------
Net income $ 21.0
Basic EPS:
Income available to common shareholders $ 21.0 (A)
Weighted Average Common Shares Outstanding 28.9 (B)
Net income per common share-basic: $0.72 (A/B)*
Effect of dilutive securities:
After-tax interest on convertible capital
securities $ 3.4
Convertible capital securities 5.3
Stock options 0.3
Diluted EPS:
Income available to common and assumed
conversions: $ 24.4 (C) 34.5 (D)
Net income per common share-assuming dilution: $0.71 (C/D)*
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)*
* Computation excludes rounding.
10
7. Segment Information
In 1998, HSB implemented the provisions of Statement of Financial
Accounting Standards (SFAS) 131, "Disclosures about Segments of an
Enterprise and Related Information". This standard requires companies
to report financial and descriptive information about reportable
operating segments utilizing the management approach to defining
operating segments. It includes disclosure requirements relating to
products and services, geographic areas and major customers. The
adoption of SFAS 131 did not affect consolidated results of operations
or financial position but did affect the disclosure of segment
information.
HSB has four reportable segments--Commercial insurance, Global Special
Risk insurance, Engineering services and Investments. HSB is a
multi-national company operating primarily in North American, European,
and Asian markets. Through its Commercial segment operations, HSB
provides risk modification services, equipment breakdown insurance and
loss recovery services to commercial businesses. The Global Special
Risk operating segment focuses on the needs of equipment-intensive
industries by offering all risk coverage with customized engineering
consulting and risk management. HSB's Engineering services operations
offers professional scientific and technical consulting for industry
and government on a worldwide basis. The Company's investment assets
are managed by its Investment operating segment.
The accounting policies of the segments are consistent with generally
accepted accounting principles except for certain benefit charges which
comprise the Corporate Account. HSB evaluates the performance of its
segments and allocates resources to them based on net income (loss).
Segment assets are not included in this evaluation process. Interest
income and expense are included in the results of Investment
operations.
The following presents revenue and net income from the Company's
reportable segments and reconciles these amounts to the corresponding
consolidated totals:
For the quarters ended March 31, 1999 1998
---------------------------------------- ----------------------------
Revenues from continuing operations
Insurance premiums:
Commercial $ 80.3 $ 68.1
Global Special Risks 15.7 30.0
Engineering services 27.6 19.7
Net investment income and realized
investment gains 22.8 18.4
------------ ------------
Total revenues from reportable
segments 146.4 136.2
Other segments .5 1.3
------------ ------------
Total revenues $ 146.9 $ 137.5
============ ============
Net income (loss):
Commercial $ 1.4 $ 1.3
Global Special Risks 5.2 4.2
Engineering services 1.3 1.0
Investment 16.0 13.4
------------ ------------
Total net income from reportable
segments 23.9 19.9
Other segments 0.0 .7
Corporate account 1.6 1.3
Distributions on capital securities (4.5) (4.5)
Discontinued operations 0.0 30.3
Gain on sale of IRI, net of
income taxes 0.0 25.2
------------ ------------
Net income $ 21.0 $ 72.9
============ ============
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - MARCH 31, 1999
RESULTS OF OPERATIONS
- ---------------------
(dollar amounts in millions)
Consolidated Overview
- ---------------------
Quarter Ended
March 31
--------
1999 1998
---- ----
Revenues:
Gross earned premiums $ 208.9 $ 179.7
Ceded premiums 112.4 80.3
---------------- --------------
Insurance premiums 96.5 99.4
Engineering services 27.6 19.7
Net investment income 15.7 15.2
Realized investment gains 7.1 3.2
---------------- --------------
Total revenues $146.9 $ 137.5
================ ==============
Pre-tax Income from Continuing Operations:
Pre-tax income excluding sale of IRI $36.4 $30.6
Pre-tax gain on sale of IRI 0.0 39.0
---------------- --------------
Pre-tax income 36.4 69.6
Income taxes on continuing operations 10.9 22.5
Distributions on capital securities 4.5 4.5
---------------- --------------
Income from continuing operations 21.0 42.6
Discontinued operations 0.0 30.3
---------------- --------------
Net income $21.0 $72.9
================ ==============
Net income per common share:
Basic $0.72 $2.49
Assuming dilution $0.71 $2.17
12
Absent the sales of Industrial Risk Insurers (IRI) and Radian International LLC
(Radian LLC) discussed below, the Company's 1999 after-tax earnings increased
20.7 percent from the first quarter of 1998 due to higher realized gains,
improved underwriting results and higher engineering gains. Net income for the
first quarter of 1998 included after-tax gains on the sale of HSB's interest in
IRI of $25.2 million and Radian LLC of $30.3 million. The Radian 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 (Dow). As a result, HSB's interest in Radian LLC was
classified as a discontinued operation in 1997.
The effective tax rate on income from continuing operations for the first
quarter was 30 percent compared to 32 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
- ------------------------------
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants (AcSEC) recently issued three Statements of
Position (SOP) which became effective for fiscal years beginning after December
15, 1998; SOP 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use", and SOP 98-5, "Reporting on
the Costs of Start-Up Activities". Because the Company's accounting policies
were in compliance with the provisions of the SOP's, the implementation of the
SOP's had no impact upon the results of operations, financial condition or cash
flows.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that all derivatives be recognized as either assets or liabilities in the
statement of financial position and that such instruments be measured at fair
value. In addition, all hedging relationships must be designated, reassessed and
documented pursuant to the provisions of SFAS No. 133. This statement is
effective for fiscal years beginning after June 15, 1999. The Company
anticipates that the adoption of the provisions of SFAS No. 133 will not have a
material impact on results of operations, financial condition or cash flows.
In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The
SOP identifies several methods of deposit accounting and provides guidance on
the application of each method. This SOP is effective for financial statements
for fiscal years beginning after June 15, 1999. Currently the Company is not
party to any contracts which do not comply with the risk transfer provisions of
SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts," and, therefore, does not anticipate the adoption of
SOP 98-7 will have a material impact on results of operations, financial
condition or cash flows.
13
Insurance Operations
- --------------------
Insurance operations include the insurance results of The Hartford Steam Boiler
Inspection and Insurance Company (HSBIIC), HSB Engineering Insurance Limited
(EIL), The Boiler Inspection and Insurance Company of Canada (BI&I), The Allen
Insurance Company, Ltd., HSB of Connecticut, HSB of Texas, and HSBIIC's
participation in HSB Industrial Risk Insurers and various other pools.
Quarter Ended
March 31
--------
1999 1998
---------------- ---------------
Gross earned premiums $ 208.9 $ 179.7
Ceded premiums 112.4 80.3
---------------- ---------------
Insurance premiums 96.5 99.4
Claims and adjustment expenses 38.3 44.6
Underwriting, acquisition and other expenses 46.6 44.3
---------------- ---------------
Underwriting gain $ 11.6 $ 10.5
================ ===============
Loss ratio 39.7% 44.9%
Expense ratio 48.0% 44.3%
---------------- ---------------
Combined ratio 87.7% 89.2%
================ ===============
Gross earned premiums increased 16.2 percent from the comparable period in 1998.
This was primarily attributable to an increase in premiums from HSB Industrial
Risk Insurers of $13.0 million reflecting the Company's role as direct writer of
that business. Other growth includes the impact of certain commercial books of
business acquired in mid 1998. Gross earned premiums representing coverage
outside the U.S. for non HSB Industrial Risk Insurers business decreased 4
percent in the first quarter from the comparable period in 1998. In certain
areas of the Company's direct domestic and international businesses, the market
is experiencing price erosion. HSB will not write business at rates which would
lessen our ability to maintain underwriting profit.
Increases in ceded premium of 40 percent in the current quarter were the result
of both the HSB Industrial Risk Insurers arrangement and related reinsurance
with ERC, and 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, along
with growth in our commercial business, will continue to result in growth in
gross earned premium but lower growth in net earned premium.
The loss ratio decreased from 44.9 percent in the first quarter of 1998 to 39.7
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. Gross claims and adjustment expenses for the
first quarter 1999 and 1998 were $117.6 million and $87.7 million, respectively.
The increase over 1998 was primarily the result of three large losses in our
international business which were largely reinsured.
14
The expense ratio increased from 44.3 percent in the first quarter of 1998 to
48.0 percent in the current quarter as the company purchased more reinsurance.
The following information summarizes net earned premiums and net income by
reportable insurance segment:
Quarter Ended
March 31
--------
1999 1998
---- ----
Commercial:
Net earned premiums $ 80.3 $ 68.1
Net income 1.4 1.3
Global Special Risks:
Net earned premiums $ 15.7 $ 30.0
Net income 5.2 4.2
Net earned premiums in the Commercial segment rose $12.2 million in 1999 from
the comparable period in 1998 due to strong growth in client company billings
and integration of the Kemper portfolio. Net income was depressed by an
adjustment to commission expense, higher system costs related to Year 2000 and
increased frequency of small claims.
Global Special Risks net earned premiums declined $14.3 million in 1999 from the
comparable period in 1998 due to price erosion and the maintenance of strict
underwriting standards, coupled with changes in reinsurance programs. Net income
increased, however, due to favorable claims experience in comparison to 1998.
Engineering Services Operations
- -------------------------------
Quarter Ended
March 31
--------
1999 1998
---- ----
Engineering services revenues $ 27.6 $ 19.7
Engineering services expenses 25.2 17.9
------------------- ------------------
Operating gain $ 2.4 $ 1.8
=================== ==================
Net margin 8.4% 8.9%
Engineering services operations include the results of HSBIIC's, EIL's and
BI&I's engineering services, HSB Reliability Technologies (HSBRT), HSB
Professional Loss Control, HSB International, Solomon Associates, Inc. (SAI) and
the Company's interest in Integrated Process Technologies, LLC.
Engineering services revenues increased $7.9 million in the first quarter
compared to the same period in 1998. The growth in revenues was primarily due to
SAI which was acquired in April 1998 and EIL's revenues generated through recent
acquisitions. The decline in operating margin from the previous periods reflects
operating costs incurred to develop new products and in new start up operations.
15
The company continues to focus on identifying and evaluating acquisition
candidates in the niche engineering management consulting service business,
primarily in process industries, in order to expand or complement its
engineering service capabilities.
Investment Operations
- ---------------------
Quarter Ended
March 31
--------
1999 1998
--------------------- -----------------
Net investment income $15.7 $15.2
Realized investment gains 7.1 3.2
--------------------- -----------------
Pretax income from
investment operations $22.8 $18.4
===================== =================
Income from investment operations for the first quarter increased $4.4 million
primarily due to realized investment gains resulting from repositioning the
investment portfolio due to market fluctuations.
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. The
Company does not engage in cash flow underwriting; it seeks to have underwriting
profit each year.
Statements of Comprehensive Income
- ----------------------------------
In addition to the impact of HSB's results of operations, the Consolidated
Statements of Comprehensive Income displays the effects of price movements on
HSB's invested assets. As a result of the market corrections and subsequent
rebounds, cumulative holding gains, net of taxes, for the first quarter of 1999
decreased $12.3 million as compared to the increase of $17.6 million in the same
period in 1998.
Liquidity and Capital Resources
- -------------------------------
Balances at
March 31 December 31
1999 1998
----------------- -----------------
Total assets $ 2,113.0 $ 2,144.0
Short-term investments 90.6 62.3
Cash and cash equivalents 3.7 18.3
Short-term borrowings 26.2 21.0
Capital securities of subsidiary Trust I 108.9 108.9
Capital securities of subsidiary Trust II 300.0 300.0
Common shareholder's equity 414.2 419.3
Liquidity refers to the Company's ability to generate sufficient funds to meet
the cash requirements of its business operations. HSB is a holding company whose
principal subsidiary is HSBIIC. HSB relies on investment income, primarily in
the form of dividends from HSBIIC, in order to meet its short and long-term
liquidity requirements including the service requirements for its capital
securities. The Company receives a regular inflow of cash from maturing
investments, engineering services and insurance operations. The mix of the
investment portfolio is managed to respond to expected claim pay-out patterns
16
and the service requirements of the Company's capital securities. HSB 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 the Capital
Securities of subsidiary Trust I.
Cash provided from operations was $22.4 million in the first three months of
1999 compared to $15.4 million for the same period in 1998. Overall cash flows
in 1998 were significantly impacted by the investment of proceeds from the
convertible capital securities issued in late December 1997 and the sales of
Radian and IRI in 1998.
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. Common shareholders' equity of $414.2 million at
March 31, 1999, decreased by $5.1 million since December 31, 1998. The decrease
primarily reflects comprehensive income of $8.7 million less dividends of $12.1
million and share repurchases of $2.2 million.
At March 31, 1999, HSBIIC had significant short-term and long-term borrowing
capacity. HSBIIC is currently authorized to issue up to $75 million of
commercial paper. Commercial paper outstanding at March 31, 1999 was $25
million.
HSBIIC has been involved in three significant claim-related disputes concerning
the extent to which certain explosion events were insured under boiler and
machinery coverages of HSBIIC. Information regarding these disputes has been
provided in previous 10-K and 10-Q reports. Current rulings in all three cases
confirm HSBIIC's long-standing position that HSBIIC policies do not cover the
explosion events that occurred in those cases. In one case the parties settled
their dispute following Summary Judgment rulings of the Federal District Court
for the State of Illinois; in a second case, a decision of an arbitration panel
has been confirmed by the Superior Court of the State of Connecticut; and in a
third case, the Federal Court of Appeals for the Seventh Circuit has remanded
the matter for entry of a judgment in HSBIIC's favor.
The Company writes business in European markets primarily through its U.K.
subsidiary, EIL. 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. The U.K. is not a first wave euro
country and as such the primary impact will be in Spain and the Irish Republic.
Over time, if the U.K. adopts the euro as its currency, there may be more of an
impact, however, the number of affected transactions are such that a manual
backup system is practicable. The Company will continue to monitor developments
and assess impacts on markets, pricing, and reporting.
Year 2000
- ---------
The following Year 2000 statements constitute a Year 2000 Readiness Disclosure
within the meaning of the Year 2000 Information and Readiness Disclosure Act of
1998.
Year 2000 Plan and State of Readiness
- -------------------------------------
In 1996, the Company began a comprehensive effort to assess and address issues
affecting the Company, which related to the inability of computer equipment and
embedded computer chips to distinguish between the year 1900 and the year 2000.
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.
17
As a part of this effort, the Company established a Year 2000 Program to address
four key areas: (i) applications software, primarily consisting of the Company's
policy management, claims, financial recording and reporting, human resource
systems, and engineering databases and systems; (ii) infrastructures, such as
mainframe and corporate servers, workstations and networking components; (iii)
embedded technology in facilities in which the Company conducts its operations
and in testing equipment used by the Company's engineering staff; and (iv) key
business partners and suppliers. In addition, the Company is evaluating
potential coverage exposures arising out of the Year 2000 and its impact on
insured equipment. The Company's Year 2000 Program consists of six partially
overlapping stages for the key areas listed above: (i) assessment and analysis;
(ii) development, renovation and replacement; (iii) implementation; (iv) testing
and certification; (v) contingency planning; and (vi) audit and review. The
Company is using members of its internal information technology staff as well as
external consultants and programmers to complete various tasks in connection
with its Year 2000 Program and is currently on schedule.
The Company has completed the assessment and analysis phase for its policy
management, claims, and financial recording and reporting, and human resource
systems and engineering databases and systems. The Company has largely completed
the development, renovation, replacement and implementation phases as of
December 31, 1998 with the exception of human resource and certain non-critical
financial reporting and engineering systems, which are expected to be compliant
by mid-1999. We have substantially completed Year 2000 testing for our current
policy management, financial application and engineering systems. We will
continue to Year 2000 test our claims, human resource systems and other
supporting applications throughout the second quarter of 1999.
The Company has completed the assessment and analysis phase with respect to
infrastructure items. The mainframe is Year 2000 compliant and the Company
expects to complete the migration to Year 2000 compliant servers and supporting
hardware and software by September 1999. Replacement of the various components
of non-compliant workstations and peripheral equipment also is expected to be
completed by September 1999. Many of the third-party software applications
utilized by the Company in its desktop environment are already Year 2000
compliant. The Company expects to complete the installation of such compliant
programs on virtually all of its workstations by September 1999.
In the area of embedded chip technology, the Company's principal exposure
relates to the prevalence of such technology in office buildings in which the
Company leases space for conducting its business operations. The Company has
sent questionnaires to the leasing vendors for all of its principal facilities
with respect to Year 2000 readiness and has received assurances of readiness
from most of its vendors.
The Company has identified and is currently in the process of contacting key
suppliers of services and business partners, such as client companies, agents
and brokers, with whom the Company has significant business relations and who
may either electronically provide to, or receive from, the Company certain
financial and other information. As the Company receives responses from its
suppliers and business partners, it will update its assessment of the potential
impact on the Company of such parties' Year 2000 state of readiness and
remediation plans and conduct renovations and/or replacement and compliance
testing, as appropriate.
The Company is relying upon Year 2000 readiness statements of other entities and
has not independently verified the accuracy of such statements.
Costs
- -----
It is currently estimated that the Company's aggregate spending in connection
with the Year 2000 Program will be in the range of $27 million of which
approximately $22.7 million has been expended through March 31, 1999. Certain of
these costs are being expensed as they are incurred and are being funded through
operating cash flow. The Company has expensed $5.1 million, $1.5 million and
$0.2 million in 1998, 1997 and 1996, respectively, and $2.5 million for the
first three months of 1999. It is estimated that
18
expenditures of $3.6 million for the remainder of 1999 will be expensed as
incurred. The remainder of the $27 million estimate relates to systems that the
Company anticipated replacing in the normal course of information technology
development but the timetable for which was accelerated in contemplation of the
Year 2000 event. Costs of replacement and renovation of information systems and
infrastructure that would have occurred in the normal course of business without
the advent of the Year 2000 event are excluded from these amounts. The current
estimate also does not include any costs associated with the implementation of
contingency plans that are in the process of being developed.
The Company does not expect the costs relating to its Year 2000 Program to have
a material effect on its results of operations, liquidity or financial
condition. However, the Year 2000 Program is an ongoing process and the
estimated costs, as well as the estimated completion dates for various phases of
the program, are subject to change.
Risks
- -----
The failure of one or more critical software applications or components of the
Company's infrastructure to be Year 2000 compliant could cause a material
disruption in the normal business operations of the Company. Such disruptions
could include the inability to process policies, register and collect premiums
and engineering receivables, process claims or schedule inspections and
engineering services. Due to the difficulty in estimating the scope and duration
of such failures, the Company is unable to determine at this time whether the
consequences of such failures would have a material impact on the Company's
results of operations, liquidity, or financial condition. Moreover, the
Company's operations are interdependent with systems of business partners and
service providers, such as financial institutions, communication service
providers and utilities, over which the Company has no control. The failure of
one or more of such business partners or service providers to be Year 2000
compliant could have a material adverse impact on the Company. However, the
Company believes that with the implementation of its Year 2000 Program as
scheduled, including the contingency plans discussed below, the risk of material
disruptions to its normal business operations should be significantly reduced.
As an insurance company, the Company maintains a significant portfolio of
investments in cash, short-term fixed income, and equity securities. Inasmuch as
the advent of the Year 2000 may cause events, business interruptions and altered
economic facts and circumstances, the value of the Company's investments may be
affected favorably or unfavorably. The Company is selectively monitoring the
Year 2000 compliant status of the corporate issuers of the securities in its
investment portfolio primarily through reviewing public disclosure documents.
State government and municipal bonds held by the Company are general obligations
and/or are credit-enhanced and therefore the Company does not perceive there to
be a significant credit risk with these securities in the absence of a severe
Year 2000 disruption affecting governments and businesses generally. An
immaterial portion of the Company's portfolio is invested in non-public issues
where public disclosure documents are unavailable. Due to the difficulty in
estimating the scope and duration of such events, the Company is unable to
determine at this time whether the consequences of such developments will have a
material impact on the Company's investment portfolio and therefore, on the
Company's results of operations, liquidity or financial condition.
Contingency Plans
- -----------------
As a component of the Year 2000 Program, the Company is concurrently developing
contingency plans intended to mitigate the possible disruption of business
operations arising out of the Year 2000 event. These plans will be continuously
refined during 1999 as the Company completes compliance testing on its internal
applications software and infrastructure and further assesses the Year 2000
readiness status of its business partners. Contingency plans may include
securing back-up power for the Company's data center, manual processing,
short-term fixes to non-compliant programs or business partner interfaces and
modifying the Company's asset selection criteria for its investment activities.
19
Insurance Coverage Issues
- -------------------------
The Company continues to evaluate the potential coverage exposures arising out
of the Year 2000 event and its impact on insured equipment. The Company has
prepared 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. The endorsement is being included on all equipment breakdown
policies. In addition, a notice reiterating the Company's coverage intent with
respect to Year 2000 exposures is being sent to policyholders. The Company has
filed a similar endorsement for use with its all-risk policy and expects to
receive approvals for use in all jurisdictions. Most of the insurers that the
Company reinsures for equipment breakdown coverage are issuing similar
endorsements to their policies. The Company is conducting an on-going
communications program with its client company insurers and agents to
disseminate to the ultimate policyholders its Year 2000 loss control suggestions
and policy coverage position.
Quantification of the Company's exposure to Year 2000 losses and loss adjustment
expenses are not reasonably estimable at this time as applicable policy and
reinsurance contract wordings have not been legally tested in the context of
such losses.
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; the adequacy of loss reserves;
changes in asset valuations; consolidation and restructuring in the insurance
industry; changes in the Company's participation in joint underwriting
associations, and in particular its arrangement with HSB Industrial Risk
Insurers; 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.
20
PART II OTHER INFORMATION
Item 1 - Legal Proceedings
See Note 5 to Consolidated Financial Statements, Part I, Item 1
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 January 25, 1999 reporting the fourth quarter 1998
earnings.
(ii) Form 8-K dated January 26, 1999 announcing the declaration of a
dividend of 42 cents per share payable on April 29, 1999.
21
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 17, 1999 By: /s/ Saul L. Basch
Saul L. Basch
Senior Vice President, Treasurer
and Chief Financial Officer
Date: May 17, 1999 By: /s/ Robert C. Walker
Robert C. Walker
Senior Vice President and
General Counsel
22