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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
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 0-20766
HCC INSURANCE HOLDINGS, INC.
(Exact name of Registrant as Specified in Its Charter)
DELAWARE 76-0336636
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
13403 NORTHWEST FREEWAY
HOUSTON, TEXAS 77040-6094
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code
(713) 690-7300
Securities Registered Pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK, $1.00 PAR VALUE New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (sec.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value on March 16, 2001, of the voting stock held by
non-affiliates of the registrant was approximately $1.3 billion. For purposes of
the determination of the above stated amount, only directors and executive
officers are presumed to be affiliates, but neither the registrant nor any such
person concede that they are affiliates of the registrant.
The number of shares outstanding of the registrant's Common Stock, $1.00
par value, as of March 16, 2001 was 58,697,666.
DOCUMENTS INCORPORATED BY REFERENCE
Information called for in Part III of this Form 10-K is incorporated by
reference to the Registrant's definitive Proxy Statement to be filed within 120
days of the close of the Registrant's fiscal year in connection with the
Registrant's annual meeting of shareholders.
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TABLE OF CONTENTS
HCC INSURANCE HOLDINGS, INC.
PAGE
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PART I.
ITEM 1. Business.................................................... 2
ITEM 2. Properties.................................................. 26
ITEM 3. Legal Proceedings........................................... 26
ITEM 4. Submission of Matters to a Vote of Security Holders......... 26
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters......................................... 27
ITEM 6. Selected Financial Data..................................... 28
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 30
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk... 41
ITEM 8. Financial Statements and Supplementary Data................. 42
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................... 42
PART III.
ITEM 10. Directors and Executive Officers of the Registrant.......... 43
ITEM 11. Executive Compensation...................................... 43
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 43
ITEM 13. Certain Relationships and Related Transactions.............. 43
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 43
SIGNATURES............................................................ 44
This report on Form 10-K contains certain "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, and Section 21E
of the Securities Exchange Act of 1934, which are intended to be covered by the
safe harbors created by those laws. Forward-looking statements include
information about possible or assumed future results of our operations. All
statements, other than statements of historical facts, included or incorporated
by reference in this report that address activities, events or developments that
we expect or anticipate may occur in the future, including such things as future
capital expenditures, business strategies, competitive strengths, goals, growth
of our businesses and operations, plans and references to future successes may
be considered forward-looking statements. Also, when we use words such as
"anticipate," "believe," "estimate," "expect," "intend," "plan," "probably" or
similar expressions, we are making forward-looking statements.
Many risks and uncertainties may impact the matters addressed in
forward-looking statements. Many possible events or factors could affect our
future financial results and performance. These could cause our results or
performance to differ materially from those we express in our forward-looking
statements. Although we believe that the assumptions underlying our
forward-looking statements are reasonable, any of these assumptions, and
therefore also the forward-looking statements based on these assumptions, could
themselves prove to be inaccurate. In light of the significant uncertainties
inherent in the forward-looking statements which are included in this report,
our inclusion of this information is not a representation by us or any other
person that our objectives and plans will be achieved.
Our forward-looking statements speak only as of the date made and we will
not update these forward-looking statements unless the securities laws require
us to do so. In light of these risks, uncertainties and assumptions, any
forward-looking events discussed in this report may not occur.
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PART I
ITEM 1. BUSINESS
TERMINOLOGY
As used in this report, unless otherwise required by the context, the terms
"we," "us," "our" and the "Company," refer to HCC Insurance Holdings, Inc. and
its consolidated subsidiaries, and the term "HCC" refers only to HCC Insurance
Holdings, Inc. All trade names or trademarks appearing in this report are the
property of their respective holders.
OVERVIEW
Our company, HCC Insurance Holdings, Inc., is a Delaware corporation formed
in 1991 as a holding company for insurance companies, underwriting agencies and
intermediary operations. It's predecessor company was formed in 1974. Our
principal and executive offices are located at 13403 Northwest Freeway, Houston,
Texas 77040 and our telephone number is (713) 690-7300. We maintain an internet
website at www.hcch.com. The reference to our website address does not
constitute the incorporation by reference of the information contained at that
site in this report.
We provide specialized property and casualty, and accident and health
insurance coverages, underwriting agency and intermediary services and other
insurance related services both to commercial customers and individuals. We
operate primarily in the United States and in the United Kingdom, although some
of our operations have a broader international scope. We underwrite insurance on
both a direct basis, where we insure a risk in exchange for a premium, and
reinsurance basis, where we insure all or a portion of another insurance
company's risk in exchange for all or portion of the premium. We market our
products both directly to customers and through a network of independent and
affiliated agents and brokers.
Since our founding, we have been consistently profitable, generally
reporting annual increases in gross written premium and total revenue. During
the period 1996 through 2000, we had an average statutory combined ratio of
94.7% versus the less favorable 105.2% (1996-1999) recorded by the U.S. property
and casualty insurance industry overall. During the same period, our gross
written premium increased from $337.3 million to $967.5 million, an increase of
187% while net written premium increased 55% from $183.0 million to $283.8
million. During this period, our revenues increased from $270.8 million to
$466.2 million, an increase of 72%.
During the period December 31, 1996 through December 31, 2000, our
shareholders' equity increased from $296.5 million to $529.4 million, a 79%
increase. After giving effect to the March, 2001 public offering of our Common
Stock, our pro forma shareholders' equity as of December 31, 2000 would have
been $682.3 million. During the same four-year period, our assets increased from
$965.8 million to $2.7 billion, a 184% increase.
Our insurance companies are risk-bearing and focus their underwriting
activities on providing insurance and/or reinsurance in the following lines of
business:
- accident and health;
- general aviation;
- marine and offshore energy;
- medical stop-loss;
- property; and
- workers' compensation.
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Our principal insurance company subsidiaries are Houston Casualty Company
in Houston, Texas and London, England; HCC Life Insurance Company in Houston,
Texas; U.S. Specialty Insurance Company in Houston, Texas; and Avemco Insurance
Company in Frederick, Maryland. In the United States, certain of our insurance
companies operate on an admitted, or licensed, basis. Our other insurance
companies operate in some states on a surplus lines basis as a non-admitted, or
unlicensed, insurer offering insurance coverage not otherwise available from an
admitted insurer in the relevant state.
Our operating property and casualty insurance companies are rated "A+
(Superior)" by A.M. Best Company and "AA (Very Strong)" by Standard and Poor's,
two nationally recognized independent rating agencies. These ratings are
intended to provide an independent opinion of an insurer's ability to meet its
obligations to policyholders and are not evaluations directed at investors.
Our underwriting agencies are fee-based, non-risk bearing and underwrite on
behalf of our insurance companies and other insurance companies. Our
underwriting agencies generate revenues based entirely on management fees and
profit commissions and specialize in medical stop-loss insurance and a variety
of accident and health related insurance and reinsurance products.
Our principal underwriting agency subsidiaries are LDG Reinsurance
Corporation in Wakefield, Massachusetts and New York City, New York; and HCC
Benefits Corporation in Atlanta, Georgia; Costa Mesa, California; Wakefield,
Massachusetts; Minneapolis, Minnesota; and Dallas, Texas. We have recently
consolidated the operations of certain of our agencies with certain of our
insurance companies to improve operational efficiencies.
Our combined gross written premium in 2000 was over $1.4 billion, after
intercompany eliminations. Our insurance company operations wrote $967.5 million
of gross written premium and our underwriting agencies wrote $1.1 billion of
written premium, before intercompany eliminations.
Our intermediary subsidiaries are fee based and non-risk bearing and
provide insurance and reinsurance brokerage services for our insurance companies
and our clients. They earn commission income and to a lesser extent, fees for
certain services, generally paid by the insurance and reinsurance companies with
whom the business is placed. These operations consist of:
- consulting on risks;
- marketing risks;
- placing risks; and
- servicing risks.
Our intermediaries specialize in developing and marketing employee benefit
plans on a retail basis and in placing reinsurance for both accident and health,
and property and casualty lines of business. Our principal intermediary
subsidiaries are HCC Intermediaries, Inc. in Houston, Texas; HCC Employee
Benefits, Inc. in Houston, Texas and Atlanta, Georgia; and Rattner Mackenzie
Limited in London, England.
We also operate insurance claims adjusting and other service operations
which support our operations as well as provide services for other clients. In
addition, we make strategic investments, usually in businesses that complement
our operations. Our revenues from these investments are comprised of dividends
from, or equity in earnings of, the company in which we invested and gains or
losses on the sale of such investments.
OUR STRATEGY
Our business philosophy as an insurer is to maximize underwriting profits
while limiting risk in order to preserve shareholders' equity and maximize
earnings. We concentrate our insurance writings in selected, narrowly defined
lines of business where we believe we can achieve an underwriting profit. We
focus on lines of business that have relatively short lead times between the
occurrence of an insured event and the
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reporting of claims. We market our insurance products both directly to customers
and through independent or affiliated agents and brokers.
The property and casualty insurance industry is cyclical, and individual
lines of business experience their own cycles within that overall industry
cycle. In our insurance company operations, we believe our operational
flexibility, experienced underwriting personnel and access to, and expertise in,
the reinsurance marketplace allow us to implement a strategy of emphasizing more
profitable lines of business during periods of increased premium rates and
de-emphasizing less profitable lines of business during periods of severe
competition. In addition, we believe that our underwriting agencies and
intermediary subsidiaries complement our insurance underwriting activities. Our
ability to utilize affiliated insurers, underwriting agencies, intermediaries
and service providers permits us to retain a greater portion of the gross
revenue derived from written premium.
We purchase reinsurance by transferring part of the risk we have assumed
(known as ceding) to a reinsurance company in exchange for part of the premium
we receive in connection with the risk. We purchase reinsurance to limit the net
loss from both individual and catastrophic risks to our insurance companies. The
amount of reinsurance we purchase varies by, among other things, the particular
risks inherent in the policies underwritten, the pricing of reinsurance and the
competitive conditions within the relevant line of business. In 2000, due to a
hardening of the respective markets, premium rates in the accident and health,
general aviation and medical stop-loss lines of business increased. We
anticipate continued improvements in these markets in 2001. In response to these
changing market conditions, we plan to continue to expand the underwriting
activities in our insurance company operations.
As part of this expansion, we have recently consolidated certain of our
underwriting agencies with certain of our insurance companies for the purpose of
streamlining our business. We have consolidated the operations of our domestic
general aviation underwriting agency, HCC Aviation, and our occupational
accident and workers' compensation underwriting agency, HCC Employer Services
into those U.S. Specialty, and the operations of our London-based accident and
health underwriting agency, LDG Re (London) with those of the London branch of
Houston Casualty. We believe that the consolidation of these operations will
result in greater efficiency in these businesses. We expect that this
consolidation will result in a reduction in our management fee revenues and the
net earnings of our underwriting agencies, but that any such reduction will be
more than offset over time by increases in the net earnings of our insurance
companies. The cost of this restructuring was $1.0 million (after-tax) and was
taken in the fourth quarter of 2000. As market conditions warrant, we anticipate
reviewing other agency operations to determine if similar consolidation
activities will provide greater operating efficiencies.
We also acquire or make strategic investments in companies that present an
opportunity for future profits or for enhancement of our business. We expect to
continue to seek to acquire complementary businesses with established
managements and established reputations in the insurance industry. We believe
that we can enhance acquired businesses through the synergies created by our
underwriting capabilities and our other operations. However, our business plan
is shaped by our underlying business philosophy, which is to maximize
underwriting profit, while preserving shareholders' equity. As a result, our
primary objective is to increase net earnings rather than market share or gross
written premium.
In our ongoing operations, we will continue to:
- emphasize the underwriting of lines of business in which premium rates,
the availability and cost of reinsurance, and market conditions warrant;
- limit our net loss exposure to our insurance company subsidiaries from a
catastrophe loss through the use of reinsurance; and
- review the potential acquisition of specialty insurance operations and
other strategic investments.
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INDUSTRY SEGMENT INFORMATION
Financial information concerning the Company's operations by industry
segment is set forth in the Consolidated Financial Statements and the Notes
thereto.
MAJOR ACQUISITIONS
We have made a series of strategic acquisitions that have furthered our
overall business strategy. Our recent larger transactions are described below:
On January 31, 1999, we acquired PEPYS Holdings Limited. PEPYS is a holding
company for Rattner Mackenzie. The total initial consideration was $54.8 million
in cash and deferred payments of $8.3 million in cash and 414,207 shares of our
common stock. We may pay additional amounts in the future based upon the
attainment of certain earnings benchmarks over the ensuing four years. Rattner
Mackenzie provides intermediary services for reinsurance business placed by our
insurance company subsidiaries as well as other insurance and reinsurance
companies and underwriting agencies, primarily in the accident and health area.
On December 20, 1999, we acquired all of the outstanding shares of the
publicly traded The Centris Group, Inc. following a tender offer at a price of
$12.50 per share in cash. We paid a total of $149.5 million for the Centris
acquisition. Centris was the parent corporation of a group of insurance
companies and underwriting agencies principally operating in the medical
stop-loss line of business. Centris' primary insurance company subsidiary was
the entity now known as HCC Life Insurance Company. HCC Life's operations were
relocated to Houston, and it has become a subsidiary of Houston Casualty. The
medical stop-loss underwriting agency operations of Centris have been combined
with HCC Benefits' operations.
On January 19, 2001, we issued 996,805 shares of our common stock to
acquire the Schanen Consulting Corporation and its operating subsidiary, Schanen
Consulting Group, L.L.C. Schanen provides employee benefit consulting and retail
insurance intermediary services and has been consolidated with HCC Employee
Benefits' operations.
We continue to evaluate possible acquisition candidates and we may complete
additional acquisitions during 2001. Any future acquisitions will be designed to
expand and strengthen our existing lines of business and perhaps provide access
to additional specialty sectors, which we expect to contribute to our overall
growth.
DISPOSITIONS
In March, 2000, we sold Trafalgar Insurance Company, an Oklahoma domiciled
surplus lines insurance company subsidiary, for a price which approximated its
shareholders' equity in accordance with generally accepted accounting principles
in the United States, or GAAP.
In September, 2000, we sold a substantial portion of the assets of The
Wheatley Group, Ltd., a subsidiary of Avemco Corporation.
Neither of these operations were material to our financial condition,
results of operations or cash flows.
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INSURANCE COMPANY OPERATIONS
Lines of Business
This table shows our insurance companies' total premium written, otherwise
known as gross written premium, by line of business and the percentage of each
line to total gross written premium for the years indicated (dollars in
thousands):
2000 1999 1998
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Accident and health reinsurance..... $193,714 20% $158,264 28% $114,787 23%
Aviation............................ 191,089 20 210,029 37 203,573 41
Marine and offshore energy.......... 26,102 3 18,694 3 34,941 7
Medical stop-loss................... 368,450 38 69,258 12 7,046 1
Property............................ 53,275 5 63,309 11 106,515 21
Workers' compensation and
alternative workers'
compensation...................... 49,872 5 27,202 5 8,958 2
Other............................... 84,955 9 21,575 4 22,456 5
-------- --- -------- --- -------- ---
Total gross written
premium................. $967,457 100% $568,331 100% $498,276 100%
======== === ======== === ======== ===
This table shows our insurance companies' actual premium retained,
otherwise known as the net written premium, by line of business and the
percentage of each line to total net written premium for the years indicated
(dollars in thousands):
2000 1999 1998
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Accident and health reinsurance..... $ 61,855 22% $ 37,725 27% $ 39,949 33%
Aviation............................ 79,794 28 68,513 49 53,030 44
Marine and offshore energy.......... 8,435 3 6,616 5 7,978 6
Medical stop-loss................... 100,353 35 20,332 15 3,415 3
Property............................ 10,015 4 2,945 2 8,356 7
Workers' compensation and
alternative workers'
compensation...................... 8,697 3 673 -- 1,059 1
Other............................... 14,639 5 3,120 2 8,096 6
-------- --- -------- --- -------- ---
Total net written
premium................. $283,788 100% $139,924 100% $121,883 100%
======== === ======== === ======== ===
Underwriting
DIRECT
We underwrite direct business produced through independent agents and
brokers, affiliated intermediaries, and by direct marketing efforts. Our direct
underwriting includes general aviation, medical stop-loss and workers'
compensation business.
Reinsurance
Our insurance companies participate in certain insurance and reinsurance
underwriting pools managed by our underwriting agency subsidiary, LDG Re, in the
accident and health line of business. Our insurance company subsidiaries also
write facultative, or individual account, reinsurance, particularly in the
aviation, marine and offshore energy and property lines of business. Our
facultative underwriting is typically on international business in order to
comply with local licensing requirements or as reinsurance of captive insurance
companies controlled by others, and can be considered direct business for most
purposes, since we maintain underwriting and claims control. However, we record
all of this business under the caption of "Reinsurance Assumed" in our financial
statements.
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Aviation
Aviation underwriting was one of our largest lines of business in 2000 and
in recent years we have grown into a market leader in the aviation insurance
industry. We insure general aviation risks, both domestically and
internationally, including:
- antique and vintage military aircraft;
- cargo operations;
- commuter airlines;
- corporate aircraft;
- fixed base operations;
- military and law enforcement aircraft;
- private aircraft owners and pilots; and
- rotor wing aircraft.
We offer coverages that include hulls, engines, avionics and other systems,
liabilities, war, cargo and other ancillary coverages. At this time, we do not
generally insure major airlines, major manufacturers or satellites. Insurance
claims related to general aviation business tend to be seasonal, with the
majority of the claims being incurred during the spring and summer months.
We have been underwriting aviation risks through Houston Casualty, our
largest and most important insurance company subsidiary, since 1981. Avemco
Insurance has been insuring aviation risks since 1959. Our gross written premium
has remained relatively flat during the period 1998 to 2000. During this period
we have successfully re-underwritten our book of business, removing
under-performing types of business where the premium rates were insufficient,
and focusing on areas where increasing rates were able to generate profitable
business. Our aviation net written premium increased during the period because
we increased our retentions, i.e., the portion of risk that we retain for our
own account.
We maintain reinsurance on both a proportional basis, where we share a
proportional part of the original premium and losses with reinsurers, and an
excess of loss basis, where we transfer liability, premium and loss on a
non-proportional basis above our net retention of risk to reinsurers, to protect
us against severe losses on individual risks and catastrophe exposures. We
believe that the aviation risks we underwrite carry a relatively low level of
catastrophe exposures.
Marine and Offshore Energy
We underwrite marine risks for ocean going vessels as well as inland,
coastal trading and fishing vessels. The marine risks we write include:
- hull and machinery;
- liabilities, including protection and indemnity;
- marine cargo; and
- various ancillary coverages.
We have underwritten marine risks since 1984, primarily in Houston
Casualty. Competition has created downward pressure on premium rates since 1996,
causing a reduction in our gross written premium since 1997 and a corresponding
decrease in net written premium.
We maintain marine reinsurance on both a proportional and an excess of loss
basis. We believe that the marine risks we underwrite carry a relatively low
level of catastrophe exposure.
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We have been underwriting offshore energy risks since 1988, primarily in
Houston Casualty. The offshore energy risks we write include drilling rigs,
production and gathering platforms, and pipelines. We underwrite physical
damage, liabilities, business interruption and various ancillary coverages.
Rates have declined significantly during the past few years to levels where
underwriting profitability is difficult to obtain. As a result, we have
underwritten offshore energy risks on a very selective basis, striving for
quality rather than quantity.
We maintain offshore energy reinsurance on both a proportional basis and an
excess of loss basis to protect us against severe losses on individual risks and
the catastrophe exposure that exists, for example, from a hurricane or a major
platform explosion.
Property
We specialize in writing risks of large, often multinational, corporations,
covering a variety of commercial risks including:
- factories;
- hotels;
- industrial plants;
- natural gas facilities;
- office buildings;
- petrochemical plants;
- refineries;
- retail locations; and
- utilities.
The insurance we offer includes business interruption, physical damage and
catastrophe risks including flood and earthquake.
We have written property business since 1986, primarily through Houston
Casualty. Gross written premium declined from $106.5 million in 1998 to $53.3
million in 2000 as premium rates were soft due in a large part to excess
capacity and the absence of significant catastrophe losses. Net written premium
increased slightly from $8.4 million to $10.0 million in the same period. Our
property gross written premium exceeds our net written premium by a substantial
amount due to the amount of facultative reinsurance, which is the separately
negotiated reinsurance of all or part of the coverage provided by a single
policy, and other reinsurance purchased in order to protect us from catastrophe
losses.
We maintain reinsurance on both a proportional basis and an excess of loss
basis to ensure adequate reinsurance protection, particularly against
catastrophe exposures. We estimate our aggregate probable maximum loss in any
individual catastrophe zone and maintain catastrophe reinsurance to cover such
exposure to any one occurrence.
Accident and Health Reinsurance
We began writing accident and health reinsurance risks through Houston
Casualty during 1996. LDG Re is the primary producer and underwriter of this
business. Our gross written premium increased from $114.8 million in 1998 to
$193.7 million in 2000. This growth reflects Houston Casualty's increased
participation in, and the growth of, the business written by LDG Re. Net written
premium in this area increased because Houston Casualty retained a larger
percentage of the increased gross premium.
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Medical Stop-loss
We write medical stop-loss business for employer sponsored self-insured
health plans. When measured on a gross written premium basis, medical stop-loss
was our largest single line of business in 2000. Our underwriting agency
subsidiary, HCC Benefits, produces and underwrites this business on behalf of
our insurance companies. We first began writing this business in our insurance
companies in 1997 and gross written premium and net written premium have
increased as a result of greater participation by our insurance company
subsidiaries, primarily HCC Life and Avemco Insurance. HCC Benefits' business
has grown both internally and through acquisitions, most notably of Centris. HCC
Benefits began underwriting this business in 1980. The 2000 gross written
premium underwritten in our insurance company subsidiaries was $368.5 million
and net written premium was $100.4 million. We maintain reinsurance on a
proportional basis and believe that these risks carry a relatively low level of
catastrophe exposure.
Workers' Compensation and Alternative Workers' Compensation
We began writing statutory workers' compensation business in 1998,
primarily through U.S. Specialty. We also underwrite alternative workers'
compensation and occupational accident insurance to independent truckers. As
market conditions warrant, it is our intent to grow this line of business in the
future, both internally and through acquisition. Losses in this line of business
generally take longer to develop than in our other lines of business.
We maintain reinsurance on both a proportional and excess of loss basis.
There is a relatively low level of catastrophe exposure in our workers'
compensation line of business because we do not write significant amounts of
business in states with high potential claim concentrations such as California.
Other Business
Our other lines of business principally consist of discontinued operations
or disposed of lines of business including provider excess, lender's single
interest and small property and casualty business.
Principal Insurance Company Subsidiaries
HOUSTON CASUALTY COMPANY
Houston Casualty is our principal insurance company subsidiary. It is rated
"A+ (Superior), IX" by A.M. Best and "AA" by Standard & Poor's. Houston Casualty
operates worldwide and is licensed in Texas and operates on a surplus lines
basis in 46 states. Houston Casualty receives business through independent
agents and brokers, our underwriting agency and intermediary subsidiaries, and
other insurance and reinsurance companies. Houston Casualty has a highly
experienced staff of underwriters trained to deal with the high value,
complicated exposures prevailing in many of the lines of business in which we
specialize. As of December 31, 2000, Houston Casualty's policyholders' surplus
was $231.2 million, which is its total admitted assets less total liabilities
determined in accordance with statutory accounting principles, or SAP. Houston
Casualty's GAAP shareholder's equity was $317.4 million as of December 31, 2000.
HOUSTON CASUALTY COMPANY -- LONDON
Houston Casualty operates a full branch office in the United Kingdom.
Houston Casualty established its London branch operation in order to more
closely align its underwriting operations with the London market, a historical
focal point for much of the business that Houston Casualty underwrites. Houston
Casualty London underwrites accident and health reinsurance, marine and offshore
energy and property business.
HCC LIFE INSURANCE COMPANY
HCC Life is an Indiana domiciled life insurance company which became a
direct subsidiary of Houston Casualty in December, 1999 following the Centris
acquisition. HCC Life is rated
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"A - (Excellent), VII" by A.M. Best and operates as an accident, health and life
insurer on an admitted basis in 41 states and the District of Columbia. As of
December 31, 2000, HCC Life had statutory policyholders' surplus of $63.3
million and GAAP shareholder's equity of $80.3 million.
U.S. SPECIALTY INSURANCE COMPANY
U.S. Specialty is a Texas domiciled property and casualty insurance
company. It is a direct subsidiary of Houston Casualty. U.S. Specialty is rated
"A+ (Superior), VIII" by A.M. Best and "AA" by Standard & Poor's. U.S. Specialty
operates on an admitted basis throughout the United States, primarily writing
general aviation, workers' compensation and alternative workers' compensation
insurance. As of December 31, 2000, U.S. Specialty had statutory policyholders'
surplus of $106.1 million and GAAP shareholder's equity of $116.9 million.
AVEMCO INSURANCE COMPANY
Avemco Insurance is a Maryland domiciled property and casualty insurer, is
rated "A+ (Superior), VII" by A.M. Best and "AA" by Standard & Poor's, and is
operating as a direct market underwriter of general aviation business on an
admitted basis throughout the United States and Canada (except Quebec). In
addition, Avemco Insurance has become the primary insurer of medical stop-loss
products produced and underwritten by HCC Benefits. As of December 31, 2000,
Avemco Insurance had statutory policyholders' surplus of $85.9 million and GAAP
shareholder's equity of $98.7 million.
UNDERWRITING AGENCY OPERATIONS
Our underwriting agencies act on behalf of our insurance companies and
those of other firms, and provide insurance underwriting management and claims
administration services. Our underwriting agencies do not assume any insurance
or reinsurance risk themselves and generate revenues based entirely on
management fees and profit commissions. These subsidiaries are in a position to
direct and control business that they produce. Our insurance companies serve as
policy issuing companies for most of the business written by our underwriting
agencies. Our insurance companies may retain a portion of the risk and reinsure
the remainder with unaffiliated insurance companies or reinsure all of the risk.
In instances where our insurance companies are not the policy issuing company,
our insurance companies may reinsure the business written by the underwriting
agencies. Management fees generated by our underwriting agencies in 2000
amounted to $96.1 million.
Lines of Business
This table shows our underwriting agencies' written premium by lines of
business for the periods indicated (dollars in thousands):
2000 1999 1998
---------------- -------------- --------------
Accident and health reinsurance... $ 443,041 41% $452,017 53% $356,530 50%
Aviation.......................... 92,412 9 91,156 11 92,668 13
Medical stop-loss................. 402,908 38 184,302 22 182,528 26
Workers' compensation and
alternative workers'
compensation.................... 97,877 9 106,758 12 52,529 8
Other............................. 37,313 3 13,883 2 21,932 3
---------- --- -------- --- -------- ---
Total premium........... $1,073,551 100% $848,116 100% $706,187 100%
========== === ======== === ======== ===
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Underwriting Agency Subsidiaries
LDG REINSURANCE CORPORATION
LDG Re, with operations in Wakefield, Massachusetts and New York, New York,
acts as an underwriting manager writing accident and health special risks,
workers' compensation and alternative workers' compensation reinsurance. LDG Re
generated approximately $355.6 million of written premium in 2000, the majority
of which was written on behalf of non-affiliated insurance companies.
HCC BENEFITS CORPORATION
HCC Benefits, with its home office in Atlanta, Georgia and regional offices
in Costa Mesa, California; Wakefield, Massachusetts; Minneapolis, Minnesota; and
Dallas, Texas, acts as an underwriting manager writing medical stop-loss
products for employer sponsored self-insured health plans. In 2000, HCC Benefits
generated approximately $402.9 million of medical stop-loss written premium and
$32.5 million of other written premium, the majority of which was underwritten
on behalf of HCC Life and Avemco Insurance.
OTHER AGENCY OPERATIONS
We have recently consolidated certain of our underwriting agencies with
certain of our insurance companies for the purpose of streamlining our business.
We have consolidated the operations of our domestic general aviation
underwriting agency, HCC Aviation, and our occupational accident and workers'
compensation underwriting agency, HCC Employer Services, into U.S. Specialty and
the operations of our London-based accident and health underwriting agency, LDG
Re (London) with those of the London branch of Houston Casualty.
INTERMEDIARY OPERATIONS
Our intermediary subsidiaries provide a variety of services, including
marketing, placing, consulting on and servicing insurance risks for their
clients, which include medium to large corporations, insurance and reinsurance
companies and other risk taking entities. The intermediary subsidiaries earn
commission income and to a lesser extent fees for certain services, generally
paid by the underwriters with whom the business is placed. Some of these risks
may be initially underwritten by our insurance company subsidiaries, which may
retain a portion of the risk. Commission income generated by our intermediary
subsidiaries in 2000 amounted to $42.5 million.
HCC Employee Benefits, Inc.
HCC Employee Benefits, based in Houston, Texas, is a retail insurance
agency and consulting firm specializing in life, accident and health insurance
for employee benefit plans of medium and large commercial customers throughout
the United States. We acquired Schanen Consulting Corporation of Atlanta,
Georgia in January 2001 and consolidated its operations with those of HCC
Employee Benefits.
HCC Intermediaries, Inc.
HCC Intermediaries, based in Houston, Texas, is an intermediary
specializing in marketing and servicing large, complicated insurance and
reinsurance programs placed on behalf of multinational clients operating in our
lines of business. This business is placed with domestic and international
insurance companies, including our insurance companies, on a direct basis and
through other intermediaries. In addition, HCC Intermediaries acts as a
reinsurance intermediary on behalf of affiliated and non-affiliated insurance
companies.
Rattner Mackenzie Limited
Rattner Mackenzie is an intermediary based in London, England. Rattner
Mackenzie is a Lloyd's broker specializing in accident and health reinsurance
and some specialty property and casualty lines of business. Rattner Mackenzie is
considered a market leader in its core businesses. Rattner Mackenzie
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serves as an intermediary for reinsurance business placed by unaffiliated
insurance and reinsurance companies and underwriting agencies as well as our
insurance company subsidiaries.
OTHER OPERATIONS
Our other operations provide insurance related services to our
subsidiaries, our reinsurers and unaffiliated entities. The revenue earned from
these services primarily consists of fees or commissions. The primary operating
entities in this segment provide insurance claims adjusting services.
Additionally, this revenue may be in the form of equity in the earnings of a
company in which we invest, or dividends or gains or losses from the disposition
of these investments. Other operating income was $25.5 million in 2000. Revenue
and earnings can vary considerably from period to period depending on investment
or disposition activity.
REINSURANCE CEDED
We purchase reinsurance to reduce our net liability on individual risks, to
protect against catastrophe losses and to achieve a desired ratio of net written
premium to policyholders' surplus. We purchase reinsurance on both a
proportional and an excess of loss basis. We believe that we reinsure our risks
to a greater extent than most of our competitors and most other insurance
companies. We use this strategy to protect our shareholders' equity. Under our
current reinsurance protections, we have limited our net retained loss, or the
amount we keep for our own account, across any single line of business to a
maximum of approximately $1.8 million for any one risk and $3.0 million for any
one event, but significantly less on most risks.
The type, cost and limits of reinsurance we purchase can vary from year to
year based upon our desired retention levels and the availability of quality
reinsurance at an acceptable price. Our reinsurance programs renew throughout
the year and during 2001 some of those renewed contained price increases which
are not material to our underwriting results. Additionally, we retained higher
percentages of our business in connection with certain lines of business which
are reinsured on a proportional basis. We plan to continue to increase our
retentions as underwriting conditions improve.
We consider the maintenance of reinsurance protection to be an important
part of our business plan, protecting shareholders' equity from catastrophe
losses and fluctuations in the insurance market cycles of the insurance
industry. We have built important relationships over the years with many core
reinsurers. We intend to continue to share our business with these partners as
underwriting profitability returns in an improving market in order to build even
stronger relationships for the future. We believe that increased retentions
during profitable periods are made possible not at the sacrifice of core
reinsurers but through reduction of facultative reinsurance and the natural
attrition of certain reinsurers who exit lines of business or curtail their
writings for other reasons. This reduction in reinsurance market capacity causes
rates to rise but the increased rates historically have been passed on to the
original insureds.
We structure a specific reinsurance program for each line of business we
underwrite. We place this reinsurance in order to protect our insurance
companies from exposure to foreseeable events. We place reinsurance
proportionally to cover loss frequency and catastrophe exposure. We obtain
additional reinsurance on an excess of loss basis to cover individual risk
severity of loss and on a catastrophe basis to cover exposure from occurrences
involving multiple risks, such as those resulting from a hurricane or an
earthquake. Additionally, we may also obtain facultative reinsurance protection
on an excess of loss or proportionate basis on any single risk. We do not intend
to expose our assets to any net loss in excess of our reinsurance protection.
We write business in areas exposed to catastrophe losses and have exposures
to this type of loss in California, the United States Atlantic Coast, certain
United States Gulf Coast states, particularly Florida and Texas, the Caribbean,
Mexico and the North Sea. We carefully assess our overall exposure to a single
catastrophic event and apply procedures that are more conservative than are
typically used by the industry to ascertain our probable maximum loss from any
single event. We maintain reinsurance protection which we believe is sufficient
to cover any foreseeable event.
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14
In general, we receive an overriding (ceding) commission on the premium
ceded to reinsurers. This compensates our insurance company for the direct costs
associated with the production of the business, the servicing of the business
during the term of the policies ceded and the costs associated with the
placement of the related reinsurance. In addition, certain of our reinsurance
treaties allow us to share with the reinsurers in any net profits generated
under such treaties.
Various intermediaries, including HCC Intermediaries and Rattner Mackenzie,
arrange for the placement of this reinsurance coverage on our behalf and are
compensated, directly or indirectly, by the reinsurers.
The table below shows property and casualty reinsurance balances relating
to the reinsurers with net recoverable balances greater than $10.0 million as of
December 31, 2000. The total recoverables column includes paid loss recoverable,
outstanding loss recoverable, incurred but not reported recoverables and ceded
unearned premium (dollars in thousands).
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- --------- -------------- ------------ ------------------ --------
December 31, 2000
Underwriters at Lloyd's............... A United Kingdom $220,849 $28,602 $192,247
GE Reinsurance Corporation............ A++ Illinois 38,152 4,881 33,271
AXA Reinsurance Company............... A+ Delaware 40,886 9,131 31,755
Underwriters Indemnity Company........ A- Texas 33,912 2,416 31,496
SCOR Reinsurance Company.............. A+ New York 28,419 734 27,685
American Re-Insurance Company......... A++ Delaware 23,487 2,249 21,238
Transamerica Occidental Life Ins.
Co. ................................ A+ California 17,056 151 16,905
Federal Insurance Company............. A++ Indiana 21,185 6,708 14,477
St. Paul Fire and Marine Insurance
Co. ................................ A+ Minnesota 14,290 -- 14,290
Odyssey America Reinsurance Corp. .... A Connecticut 24,602 11,741 12,861
American Fidelity Assurance Corp. .... A+ Oklahoma 21,745 10,680 11,065
NAC Reinsurance Company............... A+ New York 10,972 94 10,878
Chartwell Insurance Company........... A Minnesota 11,308 677 10,631
Lloyds of London is an insurance and reinsurance marketplace composed of
many independent underwriting syndicates financially supported by a central
trust fund. As of December 31, 2000, the net recoverable due from Underwriters
at Lloyd's, aggregating $192.2 million, represented balances due from over 140
different syndicates; five of which each had a net recoverable balance in excess
of $10.0 million. The largest net recoverable balance from an individual Lloyd's
syndicate as of December 31, 2000 was $26.5 million.
HCC Life previously sold its entire block of life insurance and annuity
business to Life Reassurance Corporation of America (rated A++ by A.M. Best) in
the form of an indemnity reinsurance contract. Ceded life and annuity benefits
amounted to $86.8 million as of December 31, 2000.
During 2000, a number of reinsurers have delayed or suspended the payment
of amounts recoverable under certain reinsurance contracts to which we are a
party. Such delays have affected, though not materially to date, the investment
income of our insurance companies, but not to any extent their liquidity. We
limit our liquidity exposure by holding funds, letters of credit or other
security such that net balances due are significantly less than the gross
balances shown in our consolidated balance sheets. In addition, a number of
reinsurers have claimed they are not liable for payment to us and, in one or
more cases, have sought arbitration of these matters. We believe these claims
are without merit and expect to collect the full amount recoverable. We are
currently in negotiations with most of these parties. If such negotiations do
not result in a satisfactory resolution of the matters in question, we will seek
a judicial or arbitral determination of these matters.
During 1999, we recorded a provision for reinsurance totaling $29.5 million
in connection with the insolvency of a reinsurer. We expect this provision to be
sufficient. We also recorded a $14.0 million provision following a commutation
(the contractual settlement of outstanding and future liabilities) with
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15
another reinsurer, the majority of which represents the present value discount
of ceded losses. Commutations are typical in the reinsurance community and
should not be construed negatively. Commutations can be used to bring finality
to an open contract or, as in this case, to negate any exposure to a reinsurer's
financial condition. A discount is given for cash settlement of future losses
and such discount is usually recovered by future investment income. However,
GAAP requires that the discount be recorded at the time of the commutation.
OPERATING RATIOS
Premium to Surplus Ratio
This table shows, for the years indicated, the ratio of statutory gross
written premium and net written premium to statutory policyholders' surplus for
our property and casualty insurance company subsidiaries (dollars in thousands):
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
GWP............................. $972,154 $576,184 $500,962 $346,094 $340,367
NWP............................. 283,947 150,261 123,315 143,068 189,022
Policyholders' surplus.......... 326,249 315,474 369,401 331,922 288,863
GWP ratio....................... 298.0% 182.6% 135.6% 104.3% 117.8%
GWP industry average(1)......... * 154.1% 147.9% 154.7% 179.9%
NWP ratio....................... 87.0% 47.6% 33.4% 43.1% 65.4%
NWP industry average(1)......... * 85.5% 84.3% 89.7% 105.2%
- ---------------
(1) Source: A.M. Best.
* Not available
While there is no statutory requirement regarding a permissible premium to
policyholders' surplus ratio, guidelines established by the National Association
of Insurance Commissioners, or NAIC, provide that a property and casualty
insurer's annual statutory gross written premium should not exceed 900% and net
written premium should not exceed 300% of its policyholders' surplus. However,
industry standards and rating agency criteria place these ratios at 300% and
200%, respectively. In the past, our property and casualty insurance companies
have maintained premium to surplus ratios significantly lower than such
guidelines and generally below industry norms. The gross written premium ratio
has increased during 2000 with the acquisition of Centris' book of medical
stop-loss business and the increasing use of our insurance company subsidiaries
as the issuing company for business written by our underwriting agencies. This
ratio is expected to stabilize at or decrease from its 2000 level as statutory
policyholders' surplus increases due to the retention of earnings and other
increases in policyholders' surplus.
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Statutory Combined Ratio
The underwriting experience of a property and casualty insurance company is
indicated by its SAP combined ratio, which is a combination of the loss ratio,
or the ratio of insured losses and loss adjustment expenses to net earned
premium, and the expense ratio, which is the ratio of policy acquisition costs
and other underwriting expenses, net of ceding commissions, to net written
premium. Our insurance subsidiaries' loss ratio, expense ratio and combined
ratio are shown in the following table for the years indicated:
2000 1999 1998 1997 1996
---- ----- ----- ----- -----
Loss ratio..................................... 71.1% 107.1% 67.2% 61.6% 64.4%
Expense ratio.................................. 27.0 22.8 15.7 17.2 19.2
---- ----- ----- ----- -----
Combined ratio................................. 98.1% 129.9% 82.9% 78.8% 83.6%
==== ===== ===== ===== =====
Combined ratio excluding the effects of the
provision for reinsurance in 1999............ 104.1%
=====
Industry average(1)............................ * 107.8% 105.6% 101.6% 105.7%
- ---------------
(1) Source: A.M. Best.
* Not available
The SAP basis ratio data is not intended to be a substitute for results of
operations on the basis of GAAP. The differences between SAP and GAAP are
described in Note (15) of our consolidated financial statements included in this
report. Including this information on a SAP basis is meaningful and useful to
allow a comparison of our operating results with those of other companies in the
insurance industry. The source of the industry average is A.M. Best. A.M. Best
reports on insurer performance on a SAP basis to provide for more standardized
comparisons among individual companies, as well as overall industry performance.
RESERVES
Applicable insurance laws require us to maintain reserves to cover our
estimated ultimate liability for reported and incurred but not reported, or
IBNR, losses under insurance and reinsurance policies that we wrote and for loss
adjustment expenses relating to the investigation and settlement of policy
claims. In most cases, we estimate such losses and claims costs through an
evaluation of individual claims. However, for some types of claims, we use an
average reserving method until more information becomes available to permit an
evaluation of individual claims.
We establish loss reserves for individual claims by evaluating reported
claims on the basis of:
- jurisdiction of the occurrence;
- our experience with the insured and the line of business and policy
provisions relating to the particular type of claim;
- our knowledge of the circumstances surrounding the claim;
- the information and reports received from ceding insurance companies
where applicable;
- the potential for ultimate exposure;
- the severity of injury or damage; and
- the type of loss.
We establish loss reserves for incurred but not reported losses based in
part on statistical information and in part on industry experience with respect
to the probable number and nature of claims arising from occurrences that have
not been reported. We also establish our reserves based on predictions of future
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events, our estimates of future trends in claims severity, and other subjective
factors. Currently all reserves are recorded on an undiscounted basis. The net
GAAP and SAP reserves of each of our insurance companies are established in
conjunction with and reviewed by our in-house actuarial staff, and our SAP
reserves are certified annually by our independent actuaries. In 2000,
PricewaterhouseCoopers LLP certified the SAP reserves of our insurance companies
with the exception of one acquired with the Centris Group. This former Centris
subsidiary's SAP reserves were certified by another independent actuary.
With respect to some classes of risks, the period of time between the
occurrence of an insured event and the final settlement of a claim may be many
years, and during this period it often becomes necessary to adjust the claim
estimates either upward or downward. Certain classes of marine and offshore
energy and workers' compensation insurance underwritten by our insurance
companies have historically had longer lead times between the occurrence of an
insured event, reporting of the claim, and final settlement. In such cases, we
are forced to estimate reserves over long periods of time with the possibility
of several adjustments to reserves. Other classes of insurance that we
underwrite, such as most aviation, property and medical stop-loss, historically
have shorter lead times between the occurrence of an insured event, reporting of
the claim and final settlement. The reserves with respect to these classes are,
therefore, less likely to be adjusted. The majority of the risks currently
underwritten by our insurance companies tend to have shorter lead times.
The reserving process is intended to reflect the impact of inflation and
other factors affecting loss payments by taking into account changes in
historical payment patterns and perceived trends. However, there is no precise
method for the subsequent evaluation of the adequacy of the consideration given
to inflation, or to any other specific factor, or to the way one factor may
impact another.
We underwrite, directly and through reinsurance, risks which are
denominated in a number of foreign currencies, and therefore maintain loss
reserves with respect to these policies in the respective currencies. These
reserves are subject to exchange rate fluctuations, which may have an effect on
our earnings. We may attempt to limit our exposure to future currency
fluctuations through the use of foreign currency forward contracts.
The loss development triangles below show changes in our GAAP reserves in
subsequent years from the prior loss estimates based on experience as of the end
of each succeeding year on the basis of generally accepted accounting
principles. The estimate is increased or decreased as more information becomes
known about the frequency and severity of losses for individual years. A
redundancy means the original estimate was higher than the current estimate; a
deficiency means that the current estimate is higher than the original estimate.
The first line of each loss development triangle presents, for the years
indicated, the gross or net reserve liability including the reserve for incurred
but not reported losses. The first section of each table shows, by year, the
cumulative amounts of loss and loss adjustment expense paid as of the end of
each succeeding year. The second section sets forth the re-estimates in later
years of incurred losses, including payments, for the years indicated. The
"cumulative redundancy (deficiency)" represents, as of the date indicated, the
difference between the latest re-estimated liability and the reserves as
originally estimated.
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This loss development triangle shows development in loss reserves on a
gross basis (dollars in thousands):
2000 1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- -------- ---------
Balance sheet reserves:..... $944,117 $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $ 129,503
Reserve adjustments from
acquisition and
disposition of
subsidiaries.............. -- 989 (136) -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- -------- ---------
Adjusted reserves....... 944,117 872,093 460,375 275,008 229,049 200,756 170,957 144,178 129,503
Cumulative paid as of:
One year later............ 424,379 229,746 160,324 119,453 118,656 97,580 82,538 83,574
Two years later........... 367,512 209,724 179,117 167,459 143,114 126,290 130,379
Three years later......... 241,523 193,872 207,191 166,541 157,509 158,973
Four years later.......... 212,097 214,046 192,540 176,472 182,193
Five years later.......... 226,762 195,930 195,269 192,512
Six years later........... 202,844 197,147 213,052
Seven years later......... 203,075 215,280
Eight years later......... 221,403
Re-estimated liability as
of:
End of year............... 944,117 872,093 460,375 275,008 229,049 200,756 170,957 144,178 129,503
One year later............ 870,201 550,409 308,501 252,236 243,259 186,898 163,967 162,827
Two years later........... 545,955 316,250 249,013 248,372 207,511 183,015 176,817
Three years later......... 304,281 250,817 247,053 214,738 203,137 194,419
Four years later.......... 247,245 248,687 220,695 211,546 215,531
Five years later.......... 248,559 217,892 218,182 222,746
Six years later........... 219,196 214,498 234,115
Seven years later......... 216,820 231,269
Eight years later......... 233,995
Cumulative redundancy
(deficiency).............. $ 1,892 $(85,580) $(29,273) $(18,196) $(47,803) $(48,239) $(72,640) $(104,492)
The gross deficiencies reflected in the table for the years prior to 1999
result from three principal conditions:
- The development of large claims on individual policies which were either
reported late or for which reserves were increased as subsequent
information became available. However, as these policies were
substantially reinsured, there was no material effect to our net
earnings.
- During 1999, in connection with the insolvency of one of our reinsurers
and the commutation of all liabilities with another, we re-evaluated all
loss reserves and incurred but not reported loss reserves related to
business placed with these reinsurers to determine the ultimate losses we
might conservatively expect. These reserves were then used as the basis
for the determination of the provision for reinsurance recorded in 1999.
- For the years prior to 1997, the runoff of the retrocessional excess of
loss business, which we underwrote between 1988 and 1991, experienced
gross development. This development was due primarily to the delay in
reporting of losses by the London insurance market, coupled with the
unprecedented number of catastrophe losses during that period. This
business was substantially reinsured and there was no material effect to
our net earnings.
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This loss development triangle shows development in loss reserves on a net
basis (dollars in thousands):
2000 1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- -------- -------- --------
Gross reserves.................. $944,117 $871,104 $460,511 $275,008 $229,049 $200,756 $170,957 $144,178 $129,503
Less reinsurance recoverables... 694,245 597,498 341,599 155,374 111,766 101,497 95,279 82,289 81,075
-------- -------- -------- -------- -------- -------- -------- -------- --------
Reserves, net of reinsurance.... 249,872 273,606 118,912 119,634 117,283 99,259 75,678 61,889 48,428
Reserve adjustments from
acquisition and disposition of
subsidiaries.................. -- 440 (410) -- -- -- -- -- --
Effect on loss reserves of 1999
write off of reinsurance
recoverables.................. -- -- 63,851 15,008 2,636 1,442 51 -- --
-------- -------- -------- -------- -------- -------- -------- -------- --------
Adjusted reserves, net of
reinsurance................... 249,872 274,046 182,353 134,642 119,919 100,701 75,729 61,889 48,428
Cumulative paid, net of
reinsurance, as of:
One year later................ 145,993 56,052 48,775 47,874 41,947 36,500 29,258 18,978
Two years later............... 103,580 64,213 66,030 56,803 49,283 41,207 32,733
Three years later............. 80,227 72,863 64,798 56,919 46,576 36,536
Four years later.............. 81,620 67,355 60,441 51,536 38,480
Five years later.............. 72,627 61,781 53,110 40,327
Six years later............... 66,591 53,879 40,550
Seven years later............. 58,353 41,133
Eight years later............. 45,552
Nine years later..............
Ten years later...............
Re-estimated liability, net of
reinsurance, as of:
End of year................... 249,872 274,046 182,353 134,642 119,919 100,701 75,729 61,889 48,428
One year later................ 264,461 186,967 120,049 116,145 95,764 72,963 59,659 45,812
Two years later............... 175,339 116,745 101,595 94,992 74,887 60,079 44,964
Three years later............. 110,673 97,353 85,484 76,474 62,224 46,129
Four years later.............. 95,118 80,890 73,660 64,377 48,993
Five years later.............. 79,626 69,528 64,103 50,785
Six years later............... 70,642 59,408 50,585
Seven years later............. 60,960 46,071
Eight years later............. 47,629
Nine years later..............
Ten years later...............
Cumulative redundancy
(deficiency).................. $ 9,585 $ 7,014 $ 23,969 $ 24,801 $ 21,075 $ 5,087 $ 929 $ 799
1991 1990
-------- --------
Gross reserves.................. $123,248 $108,027
Less reinsurance recoverables... 83,727 60,194
-------- --------
Reserves, net of reinsurance.... 39,521 47,833
Reserve adjustments from
acquisition and disposition of
subsidiaries.................. -- --
Effect on loss reserves of 1999
write off of reinsurance
recoverables.................. -- --
-------- --------
Adjusted reserves, net of
reinsurance................... 39,521 47,833
Cumulative paid, net of
reinsurance, as of:
One year later................ 18,416 23,450
Two years later............... 23,057 33,815
Three years later............. 31,903 35,912
Four years later.............. 33,875 42,465
Five years later.............. 34,970 43,422
Six years later............... 36,203 43,690
Seven years later............. 35,413 44,611
Eight years later............. 35,960 43,715
Nine years later.............. 39,770 44,203
Ten years later............... 45,358
Re-estimated liability, net of
reinsurance, as of:
End of year................... 39,521 47,833
One year later................ 38,575 44,887
Two years later............... 38,656 45,435
Three years later............. 39,176 44,689
Four years later.............. 40,407 45,507
Five years later.............. 43,418 46,805
Six years later............... 45,142 48,932
Seven years later............. 43,924 50,190
Eight years later............. 39,858 49,732
Nine years later.............. 41,513 47,422
Ten years later............... 46,818
Cumulative redundancy
(deficiency).................. $ (1,992) $ 1,015
We believe that our loss reserves are adequate to provide for all material
net incurred losses.
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The following table provides a reconciliation of the gross liability of
loss and loss adjustment expenses, or LAE, on a GAAP basis for the three years
ended December 31, 2000 (dollars in thousands):
2000 1999 1998
-------- -------- --------
Reserves for loss and LAE at beginning of year....... $871,104 $460,511 $275,008
Reserve adjustments from acquisition and disposition
of subsidiaries.................................... 1,709 146,233 3,877
Provision for loss and LAE for claims occurring In
the current year................................... 775,538 595,425 461,429
Increase in estimated loss and LAE for claims
occurring in prior years(1)........................ (1,892) 90,034 33,493
-------- -------- --------
Incurred loss and LAE................................ 773,646 685,459 494,922
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year....................................... 277,963 191,353 152,972
Prior years........................................ 424,379 229,746 160,324
-------- -------- --------
Loss and LAE payments................................ 702,342 421,099 313,296
-------- -------- --------
Reserves for loss and LAE at end of the year......... $944,117 $871,104 $460,511
======== ======== ========
- ---------------
(1) Changes in loss and loss adjustment expense reserves on a GAAP basis, for
losses occurring in prior years, reflect the gross effect of the resolution
of losses for other than the reserve value and the subsequent adjustments of
loss reserves.
This table provides a reconciliation of the liability for loss and loss
adjustment expense, net of reinsurance ceded, on a GAAP basis for the periods
indicated (dollars in thousands):
2000 1999 1998
-------- -------- --------
Reserves for loss and LAE at beginning of year....... $273,606 $118,912 $119,634
Reserve adjustments from acquisition and disposition
of subsidiaries.................................... 514 55,523 3,877
Effect on loss reserves of write off of ceded
outstanding and IBNR reinsurance recoverables...... -- 82,343 --
Provision for loss and LAE for claims occurring In
the current year................................... 208,055 105,036 105,895
Increase (decrease) in estimated loss and LAE for
claims occurring in prior years(2)................. (9,585) 4,614 (14,593)
-------- -------- --------
Incurred loss and LAE................................ 198,470 109,650 91,302
-------- -------- --------
Loss and LAE payments for claims occurring during:
Current year....................................... 76,725 36,770 47,126
Prior years........................................ 145,993 56,052 48,775
-------- -------- --------
Loss and LAE payments................................ 222,718 92,822 95,901
-------- -------- --------
Reserves for loss and LAE at end of the year......... $249,872 $273,606 $118,912
======== ======== ========
- ---------------
(2) Changes in loss and loss adjustment expense reserves on a GAAP basis, for
losses occurring in prior years, reflect the net effect of the resolution of
losses for other than the reserve value and the subsequent adjustments of
loss reserves.
Although we experienced a gross loss deficiency during 1999 and 1998, the
business was substantially reinsured and, therefore, there was no material
effect to our insurance companies on a net loss basis.
During 2000, we had net loss and loss adjustment expense redundancy of $9.6
million relating to prior year losses compared to a deficiency of $4.6 million
in 1999 and a redundancy of $14.6 million in 1998.
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The deficiencies and redundancies in the net reserves result from our continued
review with our actuaries of loss reserves and the increase or reduction of
reserves as losses are finally settled and claims exposures are reduced. We
believe we have provided for all material net incurred losses.
We have no material exposure to environmental pollution losses, because
Houston Casualty only began writing business in 1981 and its policies normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by HCC Life, Avemco Insurance and U.S. Specialty,
because of the types of risks insured, are not considered to have significant
environmental exposures. We do not expect to experience any material development
in reserves for environmental pollution claims.
INVESTMENTS
Insurance company investments must comply with applicable regulations which
prescribe the type, quality and concentration of investments. These regulations
permit investments, within specified limits and subject to certain
qualifications, in federal, state and municipal obligations, corporate bonds,
and preferred and common equity securities. As of December 31, 2000, we had
$710.3 million of investment assets. The majority of our investment assets are
held by our insurance companies. All of our securities are classified as
available for sale and are recorded at market value.
Our investment policy is determined by our Board of Directors and our
Investment Committee and is reviewed on a regular basis. In January, 2000, we
engaged a nationally prominent investment advisor, New England Asset Management,
a subsidiary of Berkshire Hathaway, Inc., to oversee our investments and to make
recommendations to our Board's Investment Committee. Although we generally
intend to hold fixed income securities to maturity, we regularly re-evaluate our
position based upon market conditions. Beginning in the second quarter of 2000,
our purchases have been focused on taxable fixed income investments. These
purchases have had no significant effect on the average credit rating of our
investments, but have shortened the duration of our investment portfolio. Prior
to that time our investments were concentrated in obligations of states,
municipalities and political subdivisions. As of December 31, 2000, our fixed
income securities have a weighted average maturity of five years and a weighted
average duration of four years. Our financial statements reflect an unrealized
gain on fixed income securities available for sale as of December 31, 2000, of
$11.0 million.
We have maintained a substantial level of cash and liquid short-term
instruments in our insurance company subsidiaries in order to maintain the
ability to fund losses of our insureds. Our underwriting agencies and
intermediaries typically have short-term investments, which are fiduciary funds
held on behalf of others. As of December 31, 2000, we had cash and short-term
investments of approximately $263.3 million, of which $181.5 million were in our
agency and intermediary subsidiaries.
This table shows a profile of our investments. The table shows the average
amount of investments, income earned, and the yield thereon for the periods
indicated (dollars in thousands):
2000 1999 1998
-------- -------- --------
Average investments.................................. $618,478 $545,876 $505,796
Net investment income................................ 39,794 30,933 29,335
Average yield(1)..................................... 6.4% 5.7% 5.8%
Average tax equivalent yield(1)...................... 7.3% 7.2% 7.6%
- ---------------
(1) Excluding realized and unrealized capital gains and losses.
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This table summarizes, by type, the estimated market value of our
investments as of December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL
-------- ----------------
Short-term investments...................................... $262,982 37%
U.S. Treasury securities.................................... 72,612 10
Obligations of states, municipalities and political
subdivisions.............................................. 62,506 9
Special revenue fixed income securities..................... 146,809 21
Corporate fixed income securities........................... 103,700 14
Mortgage-backed securities.................................. 40,792 6
Foreign government securities............................... 7,425 1
Marketable equity securities................................ 6,282 1
Other investments........................................... 7,182 1
-------- ---
Total investments................................. $710,290 100%
======== ===
This table summarizes, by rating, the market value of our investments in
fixed income securities as of December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL
-------- ----------------
AAA......................................................... $207,021 48%
AA.......................................................... 108,448 25
A........................................................... 115,377 26
BBB......................................................... 2,998 1
-------- ---
Total fixed income securities..................... $433,844 100%
======== ===
The table set forth below indicates the expected maturity distribution of
the estimated market value of the Company's fixed income securities as of
December 31, 2000 (dollars in thousands):
AMOUNT PERCENT OF TOTAL
-------- ----------------
One year or less............................................ $ 28,366 7%
One year to five years...................................... 166,001 38
Five years to ten years..................................... 85,391 20
Ten years to fifteen years.................................. 60,987 14
More than fifteen years..................................... 52,307 12
-------- ---
Securities with fixed maturities.................. 393,052 91
Mortgage-backed securities.................................. 40,792 9
-------- ---
Total fixed income securities..................... $433,844 100%
======== ===
The weighted average life of our mortgage-backed securities is four years.
The value of our portfolio of fixed income securities is inversely correlated to
changes in market interest rates. In addition, some of our fixed income
securities have call or prepayment options. This could subject us to a
reinvestment risk should interest rates fall or issuers call their securities
and we are forced to invest the proceeds at lower interest rates. We mitigate
this risk by investing in securities with varied maturity dates, so that only a
portion of the portfolio will mature at any point in time.
BANK LOAN
On December 17, 1999, we entered into a $300.0 million Revolving Loan
Facility with a group of banks. We can borrow up to $300.0 million under the
facility on a revolving basis until it expires on December 18, 2004. Outstanding
advances bear interest at agreed upon rates. The facility is collateralized in
part by the pledge of the stock of Houston Casualty and Avemco Insurance and by
the stock of and guarantees entered into by our principal underwriting agency
and intermediary subsidiaries. The facility
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agreement contains certain restrictive covenants, including minimum net worth
requirements for us and certain of our subsidiaries, restrictions on certain
extraordinary corporate actions, notice requirements for certain material
occurrences, and required maintenance of specified financial ratios. We believe
that the restrictive covenants and our obligations that are contained in the
facility agreement are typical for financing arrangements comparable to our
facility. As of December 31, 2000, total debt outstanding under the facility was
$207.5 million and the weighted average interest rate was 8.18%. During March
2001, we reduced debt outstanding under the facility to $55.0 million using the
proceeds from our recent public stock offering.
REGULATION
The business of insurance is extensively regulated by the government. At
this time, the insurance business in the United States is regulated primarily by
the individual states. However, a form of federal financial services
modernization legislation enacted in 1999 is expected to result in additional
federal regulation of the insurance industry. In addition, some insurance
industry trade groups are actively lobbying for legislation that would allow an
option for a separate federal charter for insurance companies. The full extent
to which the federal government will determine to directly regulate the business
of insurance has not been determined by lawmakers. Also, various foreign
governments regulate our international operations.
Our business depends on our compliance with applicable laws and regulations
and our ability to maintain valid licenses and approvals for our operations. We
devote a significant effort toward obtaining and maintaining our licenses and
compliance with a diverse and complex regulatory structure. In all
jurisdictions, the applicable laws and regulations are subject to amendment or
interpretation by regulatory authorities. Generally, regulatory authorities are
vested with broad discretion to grant, renew and revoke licenses and approvals
and to implement regulations governing the business and operations of insurers
and insurance agents.
Insurance Companies
Our insurance companies, in common with other insurers, are subject to
regulation and supervision by the states and by other jurisdictions in which
they do business. Regulation by the states varies, but generally involves
regulatory and supervisory powers of a state insurance official. The regulation
and supervision of our insurance operations relates primarily to:
- approval of policy forms and premium rates;
- licensing of insurers and their agents;
- periodic examinations of our operations and finances;
- prescribing the form and content of records of financial condition
required to be filed;
- requiring deposits for the benefit of policyholders;
- requiring certain methods of accounting;
- requiring reserves for unearned premium, losses and other purposes;
- restrictions on the ability of our insurance companies to pay dividends
to us;
- restrictions on the nature, quality and concentration of investments;
- restrictions on transactions between insurance companies and their
affiliates;
- restrictions on the size of risks insurable under a single policy; and
- standards of solvency, including risk-based capital measurements.
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In general, state insurance regulations are intended primarily for the
protection of policyholders rather than shareholders. The state insurance
departments monitor compliance with regulations through periodic reporting
procedures and examinations. The quarterly and annual financial reports to the
state insurance regulators utilize accounting principles which are different
from the generally accepted accounting principles we use in our reports to
shareholders. Statutory accounting principles, in keeping with the intent to
assure the protection of policyholders, are generally based on a liquidation
concept while generally accepted accounting principles are based on a
going-concern concept.
Houston Casualty is domiciled in Texas. It operates on an admitted basis in
Texas and may write reinsurance on all lines of business that it may write on a
direct basis. Houston Casualty is an accredited reinsurer in 35 states and an
approved surplus lines insurer or is otherwise permitted to write surplus lines
insurance in 46 states, three United States territories and the District of
Columbia. When a reinsurer obtains accreditation from a particular state,
insurers within that state are permitted to obtain statutory credit for risks
ceded to the reinsurer. Surplus lines insurance is offered by non-admitted
companies on risks which are not insured by admitted companies. All surplus
lines insurance is required to be written through licensed surplus lines
insurance brokers, who are required to be knowledgeable of and follow specific
state laws prior to placing a risk with a surplus lines insurer.
Houston Casualty operates a branch office in London, England which is
subject to regulation by regulatory authorities in the United Kingdom. Avemco
Insurance is domiciled in Maryland and operates as a licensed admitted insurer
in all states, the District of Columbia, and all Canadian provinces except
Quebec. U.S. Specialty is domiciled in Texas and operates as a licensed admitted
insurer in all states and the District of Columbia. HCC Life is domiciled in
Indiana, and operates as a licensed admitted insurer in 41 states and the
District of Columbia.
State insurance regulations also affect the payment of dividends and other
distributions by insurance companies to their shareholders. Generally, insurance
companies are limited by these regulations to the payment of dividends above a
specified level. Dividends in excess of those thresholds are "extraordinary
dividends" and subject to prior regulatory approval.
Underwriting Agencies and Intermediaries
In addition to the regulation of insurance companies, the states impose
licensing and other requirements on the insurance agency and service operations
of our other subsidiaries. These regulations relate primarily to:
- advertising and business practice rules;
- contractual requirements;
- financial security
- licensing as agents, brokers, intermediaries, managing general agents or
third party administrators;
- limitations on authority; and
- recordkeeping requirements..
The manner of operating our underwriting agency and intermediary activities
in particular states may vary according to the licensing requirements of the
particular state, which may require, among other things, that we operate in the
state through a local corporation. In a few states, licenses are issued only to
individual residents or locally-owned business entities. In such cases, we may
have arrangements with residents or business entities licensed to act in the
state.
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Statutory Accounting Principles
The principal differences between statutory accounting principles, or SAP,
and generally accepted accounting principles, or GAAP, the method by which we
report our financial results to our shareholders in accordance with SEC
requirements, are:
- a liability is recorded for certain reinsurance recoverables under SAP,
whereas under GAAP there is no such provision unless the recoverables are
deemed to be not collectible.
- certain assets which are considered "non-admitted assets" are eliminated
from a balance sheet prepared in accordance with SAP but are included in
a balance sheet prepared in accordance with GAAP;
- certain reserves are recognized under SAP but not under GAAP;
- deferred taxes are not provided under SAP;
- fixed-income investments classified as available for sale are recorded at
market value for GAAP and at amortized cost under SAP;
- reinsurance balances are recorded on a gross basis under GAAP and on a
net basis under SAP; and
- under SAP, policy acquisition costs are expensed as incurred and under
GAAP such costs are deferred and amortized to expense as the related
premium is earned.
The NAIC adopted Statements of Statutory Accounting Principles in March,
1998 as a product of its attempt to codify statutory accounting principles.
Although subject to adoption by the individual states, an effective date of
January 1, 2001 was established for implementation of the statements. Prior to
the codification project, a comprehensive guide to statutory accounting
principles did not exist. Codification is new and will evolve over time. The
cumulative effect of codification is expected to increase statutory
policyholders' surplus of our insurance company subsidiaries by approximately
$6.0 million. We expect that the statutory surplus of our insurance companies
after adoption will continue to be in excess of their regulatory risk-based
capital requirements.
Insurance Holding Company Acts
Because we are an insurance holding company, we are subject to the
insurance holding company system regulatory requirements of the states of
Arkansas, California, Indiana, Maryland, Pennsylvania and Texas. Under these
regulations, we are required to report information regarding our capital
structure, financial condition and management. We are also required to provide
prior notice to, or seek the prior approval of insurance regulatory authorities
of certain agreements and transactions between our affiliated companies. These
agreements and transactions must satisfy certain regulatory requirements.
Risk-Based Capital
The NAIC has developed a formula for analyzing insurance companies called
risk-based capital. The risk-based capital formula is intended to establish
"minimum" capital thresholds that vary with the size and mix of a company's
business and assets. It is designed to identify companies with the capital
levels that may require regulatory attention. As of December 31, 2000, each of
our domestic insurance company subsidiaries' total adjusted capital is
significantly in excess of the NAIC authorized control level risk-based capital.
Insurance Regulatory Information System
The NAIC has also developed a rating system, the Insurance Regulatory
Information System, primarily intended to assist state insurance departments in
overseeing the financial condition of all insurance companies operating within
their respective states. The Insurance Regulatory Information System consists of
eleven key financial ratios that address various aspects of each insurer's
financial
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condition and stability. Our insurance company subsidiaries Insurance Regulatory
Information System ratios generally fall within the usual prescribed ranges
except in satisfactorily explainable circumstances such as when there is a large
reinsurance transaction, capital change, merger or planned growth.
Pending or Proposed Legislation
In recent years, state legislatures have considered or enacted laws that
modify and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. State insurance regulators are
members of the NAIC, which seeks to promote uniformity of, and to enhance the
state regulation of, insurance. In addition, the NAIC and state insurance
regulators, as part of the NAIC's state insurance department accreditation
program and in response to new federal laws, have re-examined existing state
laws and regulations, specifically focusing on insurance company investments,
issues relating to the solvency of insurance companies, licensing and market
conduct issues, streamlining agent licensing and policy form approvals, adoption
of privacy rules for handling policyholder information, interpretations of
existing laws, the development of new laws, and the definition of extraordinary
dividends.
In recent years, a variety of measures have been proposed at the federal
level to reform the current process of federal and state regulation of the
financial services industries in the United States, which include the banking,
insurance and securities industries. These measures, which are often referred to
as financial services modernization, have as a principal objective the
elimination or modification of current regulatory barriers to cross-industry
combinations involving banks, securities firms and insurance companies. A form
of financial services modernization legislation was enacted at the federal level
in 1999 through the Gramm-Leach-Bliley Act. That federal legislation will have
significant implications on the banking, insurance and securities industries and
could result in more cross-industry consolidations among banks, insurance
companies and securities firms and increased competition in many of the areas of
our operations. It also mandated the adoption of laws allowing reciprocity among
the states in the licensing of agents and the adoption of laws and regulations
dealing with the protection of the privacy of policyholder information. Also,
the federal government has conducted investigations of the current condition of
the insurance industry in the United States to determine whether to impose
overall federal regulation of insurers. In the past several years there have
been a number of recommendations that the industry's anti-trust exemption be
removed and the industry placed under federal regulation. If so, we believe
state regulation of the insurance business would likely continue. This could
result in an additional layer of federal regulation.
We do not know at this time the full extent to which these federal or state
legislative or regulatory initiatives will or may affect our operations, and no
assurance can be given that they would not, if adopted, have a material adverse
effect on our business or its results of operations.
EMPLOYEES
As of December 31, 2000, we had 958 employees. The employees include five
executive officers, 19 senior management, 78 management and 856 other personnel.
Of this number, 168 are employed by our insurance company subsidiaries, 521 are
employed by our underwriting agency subsidiaries, 116 are employed by our
intermediary subsidiaries, 69 are employed by our insurance services
subsidiaries and 84 are employed at the corporate headquarters and elsewhere.
With the restructuring of certain agency operations, 214 employees will move
from the agency segment to the insurance company segment in 2001. We are not a
party to any collective bargaining agreement and have not experienced work
stoppages or strikes as a result of labor disputes. We consider our employee
relations to be good.
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ITEM 2. PROPERTIES
Our principal and executive offices are located in Houston, Texas, in an
approximately 51,000 square foot building owned by Houston Casualty. Houston
Casualty also owns a 77,000 square foot building adjacent to its home office
building. We also maintain offices in over 30 locations elsewhere in the United
States and England. The majority of these additional locations are in leased
facilities.
Besides our home office, our principal office facilities are as follows:
SUBSIDIARY LOCATION SQ. FT. LEASE TERMINATION DATE
- ---------- -------- ------- ----------------------
Avemco Insurance Frederick, Maryland 40,000 Owned
U.S. Specialty Aviation
Division Dallas, Texas 40,000 March 31, 2004
HCC Benefits Costa Mesa, California 22,000 March 31, 2007
Atlanta, Georgia 21,000 January 31, 2006
HCC Employee Benefits Houston, Texas 20,000 August 31, 2001
U.S. Specialty Workers'
Compensation Division Northbrook, Illinois 19,000 April 1, 2005
LDG Re Wakefield, Massachusetts 34,000 October 31, 2001
Rattner Mackenzie London, England 15,000 September 29, 2003
ITEM 3. LEGAL PROCEEDINGS
We are party to numerous lawsuits and other proceedings that arise in the
normal course of our business. Many of such lawsuits and other proceedings
involve claims under policies that we underwrite as an insurer or reinsurer, the
liabilities for which, we believe have been adequately included in our loss
reserves. Also, from time to time, we are a party to lawsuits and other
proceedings which relate to disputes over contractual relationships with third
parties, or which involve alleged errors and omissions on the part of our
subsidiaries. We believe the resolution of any such lawsuits will not have a
material adverse effect on our financial condition, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 2000.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock trades on the New York Stock Exchange under the ticker
symbol "HCC".
The intra-day high and low sales prices for quarterly periods during the
period January 1, 1999 through December 31, 2000, as reported by the New York
Stock Exchange were as follows:
2000 1999
--------------- ---------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First quarter...................................... $15.00 $11.50 $21.44 $16.00
Second quarter..................................... 19.69 10.94 22.69 17.94
Third quarter...................................... 22.94 18.69 25.13 13.88
Fourth quarter..................................... 27.19 17.63 16.69 8.00
On March 16, 2001, the last reported sales price of our common stock as
reported by the New York Stock Exchange was $24.55.
SHAREHOLDERS
We have one class of authorized capital stock: 250,000,000 shares of common
stock, par value $1.00 per share. As of March 16, 2001, there were 58,697,666
shares of issued and outstanding common stock held by 1,028 shareholders of
record; however, we believe there are in excess of 15,000 beneficial owners.
DIVIDEND POLICY
Beginning in June, 1996, we announced a planned quarterly program of paying
cash dividends to shareholders. We paid a cash dividend of $0.02 per share in
July, 1996 and in each succeeding quarter through the first quarter of 1997. We
have increased the quarterly cash dividend in each year and beginning in
October, 2000, our quarterly dividend was $0.06 per share. Our Board of
Directors may review our dividend policy from time to time, and any
determination with respect to future dividends will be made in light of
regulatory and other conditions at that time, including our earnings, financial
condition, capital requirements, loan covenants, and other related factors.
Under the terms of our bank loan, we are prohibited from paying dividends in
excess of an agreed upon maximum amount in any fiscal year. That limitation
should not affect our ability to pay dividends in a manner consistent with our
past practice and current expectations.
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ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below has been derived
from the Consolidated Financial Statements. All information contained herein
should be read in conjunction with the Consolidated Financial Statements, the
related notes thereto and Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Report.
FOR THE YEARS ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (1)
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
STATEMENT OF EARNINGS DATA
Revenue
Net earned premium.................... $267,647 $141,362 $143,100 $162,571 $170,068
Management fees....................... 96,058 90,713 74,045 51,039 28,651
Commission income..................... 42,492 54,552 38,441 24,209 21,477
Net investment income................. 39,794 30,933 29,335 27,587 23,593
Net realized investment gain (loss)... (5,321) (4,164) 845 (328) 8,341
Other operating income................ 25,497 28,475 22,268 15,239 18,656
-------- -------- -------- -------- --------
Total revenue................. 466,167 341,871 308,034 280,317 270,786
Expense
Loss and LAE.......................... 198,470 109,650 91,302 96,514 114,464
Operating expense
Policy acquisition costs, net...... 23,743 8,177 10,978 13,580 8,218
Compensation expense............... 78,446 77,488 56,077 51,458 42,102
Provision for reinsurance.......... -- 43,462 -- -- --
Other operating expense............ 52,515 52,736 36,063 31,628 26,382
Merger expense..................... -- -- 107 8,069 26,160
-------- -------- -------- -------- --------
Total operating expense....... 154,704 181,863 103,225 104,735 102,862
Interest expense...................... 20,347 12,964 6,021 6,004 4,993
-------- -------- -------- -------- --------
Total expense................. 373,521 304,477 200,548 207,253 222,319
-------- -------- -------- -------- --------
Earnings before income tax
provision.......................... 92,646 37,394 107,486 73,064 48,467
Income tax provision.................. 37,202 12,271 35,208 23,305 9,885
-------- -------- -------- -------- --------
Net earnings before accounting
change........................... 55,444 25,123 72,278 49,759 38,582
Cumulative effect of accounting
change................................ (2,013) -- -- -- --
-------- -------- -------- -------- --------
Net Earnings....................... $ 53,431 $ 25,123 $ 72,278 $ 49,759 $ 38,582
======== ======== ======== ======== ========
BASIC EARNINGS PER SHARE DATA:
Earnings before accounting change..... $ 1.11 $ 0.51 $ 1.51 $ 1.06 $ 0.86
Cumulative effect of accounting
change............................. (0.04) -- -- -- --
-------- -------- -------- -------- --------
Net Earnings.......................... $ 1.07 $ 0.51 $ 1.51 $ 1.06 $ 0.86
======== ======== ======== ======== ========
Weighted average shares outstanding... 49,745 49,061 47,920 46,995 44,795
======== ======== ======== ======== ========
DILUTED EARNINGS PER SHARE DATA:
Earnings before accounting change..... $ 1.10 $ 0.51 $ 1.48 $ 1.03 $ 0.84
Cumulative effect of accounting
change............................. (0.04) -- -- -- --
-------- -------- -------- -------- --------
Net Earnings.......................... $ 1.06 $ 0.51 $ 1.48 $ 1.03 $ 0.84
======== ======== ======== ======== ========
Weighted average shares outstanding... 50,622 49,649 48,936 48,209 46,043
======== ======== ======== ======== ========
Cash dividends declared, per share...... $ 0.22 $ 0.20 $ 0.16 $ 0.12 $ 0.06
======== ======== ======== ======== ========
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DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
---------------------------------------------------------------------------
PRO FORMA(3)
2000 2000 1999 1998 1997 1996
------------ ---------- ---------- ---------- ---------- --------
(UNAUDITED)
BALANCE SHEET DATA:
Total investments......... $ 710,626 $ 710,290 $ 581,322 $ 525,646 $ 518,772 $468,725
Premium, claims and other
receivables............. 562,868 562,868 622,087 382,630 252,618 168,300
Reinsurance
recoverables............ 789,412 789,412 736,485 372,672 176,965 132,328
Ceded unearned premium.... 114,469 114,469 133,657 149,568 84,610 71,758
Goodwill.................. 266,015 266,015 263,687 88,043 34,758 10,922
Total assets......... 2,743,312 2,742,976 2,664,724 1,709,069 1,198,132 965,793
Loss and LAE payable...... 944,117 944,117 871,104 460,511 275,008 229,049
Unearned premium.......... 190,550 190,550 188,524 201,050 152,094 156,268
Notes payable............. 59,633 212,133 242,546 121,600 80,750 72,917
Shareholders' equity...... 682,271 529,435 457,428 439,863 365,601 296,524
Book value per share(2)... 11.86 10.46 9.29 9.12 7.66 6.49
- ---------------
(1) Certain amounts in the 1999, 1998, 1997, and 1996 selected consolidated
financial data have been reclassified to conform to the 2000 presentation.
Such reclassifications had no effect on the Company's net earnings,
shareholders' equity, or cash flows.
(2) Book value per share is calculated by dividing the sum of shares outstanding
plus contractually issuable shares into total shareholders' equity.
(3) During March 2001, we sold 6.9 million shares of our Common Stock in a
public offering at a price of $23.35 per share. Most of the net proceeds of
approximately $152.8 million was used to pay down our notes payable. The
unaudited pro forma balance sheet data shows the effect of the transactions
as if they had occurred December 31, 2000.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We primarily receive our revenue from earned premium from derived from our
insurance company operations, management fees generated by our underwriting
agency operations, commission income produced by our intermediary operations,
investment income from all of our operations and capital and other operating
income. Our core underwriting activities involve providing accident and health
reinsurance and aviation, marine and offshore energy, medical stop-loss,
property and workers' compensation insurance, each of which is marketed either
directly to customers or through a network of independent or affiliated agents
and brokers.
During the past several years, we have substantially increased our
shareholders' equity through the issuance of equity securities and through our
retained earnings, thereby enabling us to increase the underwriting capacity of
our insurance companies. With this additional equity, we increased underwriting
activity across many of our core lines of business, emphasizing lines of
business and individual opportunities with the most favorable underwriting
characteristics at a particular point in the insurance cycle. As an insurer, we
also purchase reinsurance for each of our lines of business. We purchase
different types of reinsurance in amounts we consider appropriate for each of
our lines of business based upon market conditions and the level of risk we wish
to retain.
During 1999 and 2000, our underwriting agencies underwrote aviation,
medical stop-loss, occupational accident and workers' compensation insurance and
a variety of accident and health related insurance and reinsurance products on
behalf of our insurance companies and unaffiliated insurance companies. Our
underwriting agency activities are fee based and non-risk bearing.
Effective January 1, 2001, in conjunction with the expansion of
underwriting activities by our insurance companies and in an effort to
streamline certain of our operations, we consolidated the operations of certain
of our agency operations, with those of certain of our insurance companies. We
have consolidated the operations of our domestic general aviation underwriting
agency, HCC Aviation, and our occupational accident and workers' compensation
underwriting agency, HCC Employer Services, with those of U.S. Specialty, and
the operations of our London-based accident and health reinsurance underwriting
agency subsidiary, LDG Re (London), with those of the London branch of Houston
Casualty. These consolidations will result in a reduction in management fee
income and the net earnings from our underwriting agency segment, but such
reduction will be more than offset over time by increases in net earnings of our
insurance company segment. The cost of this restructuring was $1.0 million
(after-tax) and was recorded in the fourth quarter of 2000. A total of 26
employees were or will be terminated as a result of this consolidation. As
market conditions warrant, we anticipate reviewing our other agency operations
to determine if similar consolidation activities will provide greater operating
efficiencies.
Our intermediaries are fee based, non-risk bearing and place reinsurance
for our insurance companies and underwriting agencies and for other
non-affiliated insurance companies and risk taking entities, as well as
insurance on behalf of medium and large corporate clients.
Other operating income is generated through our insurance services
operations, which support our own operations as well as provide services for
other clients. Additionally, other operating income may include the equity in
the earnings of a company in which we invest, dividends or gains or losses from
the disposition of these investments.
From 1998 through 2000, in response to adverse market conditions, we
focused our acquisition activities on expanding our underwriting agency and
intermediary operations for three principal reasons:
- to increase the management fees and commission income components of our
total revenue, which we believed were a more predictable and stable
source of revenue than the potential underwriting gain from insurance
company operations during periods of overly competitive pricing;
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- to insulate our Company from a decline in our revenue growth rate as
insurance premium rates became more competitive in our specialty lines of
business and we became more selective in our underwriting, resulting in
reduced earned premium;
- to provide a future source of premium revenue to our insurance companies
and greater control of premium distribution channels.
In 1999, due to a reduction in reinsurance capacity, rates began to
increase, particularly in the accident and health reinsurance, general aviation
and medical stop-loss lines of business. Market conditions continued to improve
in 2000 and we anticipate further improvement in 2001. In response to these
changing market conditions, we plan to continue to expand these underwriting
activities in our insurance companies and in our other lines of business as they
also improve.
During December, 1999, we acquired all of the outstanding shares of The
Centris Group, Inc. in a transaction accounted for using the purchase method of
accounting. Therefore, the results of operations and cash flows of Centris are
included in the condensed consolidated statements of earnings and cash flows for
the twelve months ended December 31, 2000, but are not included in the condensed
consolidated statement of earnings and cash flows for the twelve months ended
December 31, 1999 and earlier periods.
Centris was the parent corporation of a group of insurance companies and
underwriting agencies principally operating in the medical stop-loss line of
business. Centris' primary insurance company subsidiary was the entity now known
as HCC Life Insurance Company. Following the acquisition, HCC Life's operations
were relocated to Houston, and it became a subsidiary of Houston Casualty.
Centris' medical stop-loss underwriting agency operations have been combined
with HCC Benefits' operations. Since the date of the acquisition, the premium
rates for medical stop-loss have increased substantially and the loss ratio has
greatly improved for the 2000 business underwritten by the combined operations.
In connection with the integration of Centris' operations with our own, we took
a restructuring charge, which was accrued at the date of acquisition.
From 1992 through 1999, our employee count had grown from less than 100 to
more than 1,000. In the fourth quarter of 1999, we determined, based upon a
review of our operations, that our operating efficiency and profitability could
be enhanced principally by reducing the employee count in certain operations. We
therefore implemented a restructuring plan which resulted in the termination of
92 of our employees during 1999. This restructuring resulted in a decreased
level of operating expenses in 2000 for the operating entities affected.
RESULTS OF OPERATIONS
The following table sets forth certain premium revenue information for the
three years ended December 31, 2000 (dollars in thousands):
2000 1999 1998
--------- --------- ---------
Direct............................................ $ 676,730 $ 291,513 $ 228,629
Reinsurance assumed............................... 290,727 276,818 269,647
--------- --------- ---------
Gross written premium........................... 967,457 568,331 498,276
Reinsurance ceded................................. (683,669) (428,407) (376,393)
--------- --------- ---------
Net written premium............................. 283,788 139,924 121,883
Change in unearned premium........................ (16,141) 1,438 21,217
--------- --------- ---------
Net earned premium.............................. $ 267,647 $ 141,362 $ 143,100
========= ========= =========
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The following table sets forth the relationships of certain income
statement items as a percent of total revenue for the three years ended December
31, 2000:
2000 1999 1998
----- ----- -----
Net earned premium.......................................... 57.4% 41.4% 46.5%
Management fees............................................. 20.6 26.5 24.0
Commission income........................................... 9.1 16.0 12.5
Net investment income....................................... 8.5 9.0 9.5
Net realized investment gain (loss)......................... (1.1) (1.2) 0.3
Other operating income...................................... 5.5 8.3 7.2
----- ----- -----
Total revenue..................................... 100.0 100.0 100.0
Loss and LAE................................................ 42.6 32.1 29.6
Net operating expense *..................................... 33.2 53.2 33.5
Interest expense............................................ 4.3 3.8 2.0
----- ----- -----
Earnings before income tax provision.............. 19.9 10.9 34.9
Income tax provision........................................ 8.0 3.6 11.4
----- ----- -----
Net earnings before accounting change............. 11.9% 7.3% 23.5%
===== ===== =====
- ---------------
* Includes provision for reinsurance in 1999.
Year Ended December 31, 2000 Versus Year Ended December 31, 1999
Our total revenue increased 36% to $466.2 million in 2000 compared to 1999.
This revenue increase resulted from the higher retention of premium underwritten
by our insurance companies, particularly in the medical stop-loss line of
business, and increased investment income. We expect the upward trend in revenue
to continue.
Our net investment income increased 29% to $39.8 million in 2000 compared
to 1999. This increase was primarily due to a higher level of invested assets
which resulted from the greater retentions of premium underwritten by our
insurance companies, the investment of cash received during the first quarter of
2000 from our commutation with a reinsurer and cash flow from operations. We
expect cash flow to continue to improve, thereby increasing net investment
income, which could be substantially offset by falling interest rates.
In 2000, we engaged General Re New England Asset Management, a subsidiary
of Berkshire Hathaway, Inc. and a nationally prominent investment advisor,
particularly to insurance companies, and undertook an in-depth review and
restructuring of our investment portfolio. As a part of this restructuring, we
have shortened our investment portfolio's duration but have not significantly
changed the average credit rating. Our net realized investment losses from sales
or write downs of equity securities was $5.6 million in 2000, compared to losses
of $3.9 million in 1999. In 2000, we recognized a $5.1 million realized loss
from the write down of an equity investment to its estimated fair market value
based upon market quotations compared to a similar write down of $4.3 million in
1999. Our net realized investment gains from the disposition of fixed income
securities were $203,000 in 2000, compared to losses of $164,000 in 1999.
Our compensation expense increased to $78.4 million during 2000 from $77.5
million in 1999. This increase reflects a normal progressional increase due to
business growth plus the increase due to the Centris acquisition, offset by the
savings resulting from the 1999 fourth quarter restructuring and the sale of
non-core subsidiaries. Other than the restructuring expenses discussed below,
other operating expenses increased to $51.8 million from $47.2 million for
similar reasons. Included in other operating expense are restructuring expenses
of $761,000 in 2000 and $5.5 million in 1999. Currency conversion losses
amounted to $330,000 in 2000, compared to gains of $442,000 in 1999.
Our interest expense was $20.3 million in 2000 compared to $13.0 million in
1999. This increase is a result of higher interest rates and increased debt
outstanding, principally as a result of funding the Centris
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acquisition. Interest expense will be down substantially in 2001 as a result of
our reduced level of debt following our equity offering in March, 2001.
Our income tax expense was $35.9 million in 2000 compared to $12.3 million
in 1999. Our effective tax rate was 40% in the 2000 period compared to 33% in
1999. Most of the increase in the effective tax rate was due to non-deductible
goodwill amortization relating to the Centris acquisition, a shift of fixed
income investments to taxable instruments from tax exempt instruments and
increased underwriting agency income which is subject to state income taxes.
Our net earnings in 2000 increased 113% to $53.4 million or $1.06 per
diluted share from $25.1 million or $0.51 per diluted share in 1999. These
increases result principally from improved underwriting results, an increase in
investment income and the effects of the provision for reinsurance and a larger
restructuring expense recorded during 1999. In 2000, we incurred a $2.0 million
after-tax charge for a change in accounting principles to conform our agency and
intermediary revenue recognition principles to those required by the guidance in
SEC Staff Accounting Bulletin Number 101 entitled "Revenue Recognition in
Financial Statements." The change was not material to earnings before cumulative
effect of accounting change for 2000.
Our book value per share was $10.46 as of December 31, 2000, up from $9.29
as of December 31, 1999. During March 2001, we sold 6.9 million shares of our
common stock at a price of $23.25 per share. If this transaction had occurred on
December 31, 2000, our pro forma book value per share would have increased to
$11.86.
SEGMENTS
Insurance Companies
Gross written premium generated by our insurance companies increased 70% to
$967.5 million in 2000 compared to 1999 due to new business, rate increases,
increased participation by our insurance companies in the business underwritten
by our underwriting agencies and the acquisition of Centris. Net written premium
generated by our insurance companies in 2000 increased 103% to $283.8 million
compared to 1999, as our insurance companies have increased retentions in many
of their lines of business as underwriting results showed improvement. Net
earned premium increased 89% to $267.6 million during 2000 for the same reasons.
We expect net premium increases to continue in 2001.
Loss and loss adjustment expense incurred by our insurance companies
increased to $198.5 million in 2000 from $109.7 million in 1999. The increase in
net loss and loss adjustment expense is due to the higher level of net retained
premium, net of the effect of improved underwriting results. The GAAP net loss
ratio decreased to 74.2% in 2000 from 77.6% in 1999. In 2000, we also recorded a
$4.4 million increase in reserves for discontinued lines of business acquired
with our 1999 acquisition of Centris. This increase represents 1.6% of the 2000
net loss ratio. The GAAP gross loss ratio decreased to 79.4% in 2000 from 116.5%
in 1999. The general improvement in our loss ratios result from the effects of
increased premium rates in certain lines of business, reduced writings in other
unprofitable lines of business and a general improvement in market conditions,
particularly in the domestic aviation and medical stop-loss lines of business.
The statutory net combined ratio of our insurance companies was 98.1% for 2000
compared to 129.9% (104.1% excluding effects of the provision for reinsurance)
in 1999.
During 2000, we had net loss and LAE redundancy of $9.6 million relating to
prior year losses compared to a deficiency of $4.6 million in 1999 and we had
gross loss and LAE redundancy of $1.9 million compared to a deficiency of $90.0
million in 1999. The 1999 gross deficiency results from two principal
conditions. The first is the development of large claims on individual policies
which were either reported late or for which reserves were increased as
subsequent information became available. However, as these policies were
substantially reinsured, there was no material effect to our net earnings.
Secondly, during 1999 in connection with the insolvency of one of our reinsurers
and with the commutation, finalized subsequent to year end, of all liabilities
with another, we re-evaluated all loss reserves and incurred but not reported
loss reserves related to business placed with these reinsurers to determine the
ultimate losses we
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might conservatively expect. These reserves were then used as the basis for the
determination of the provision for reinsurance recorded in 1999. The other
deficiencies and redundancies in the reserves result from our continued review
with our actuaries of loss reserves and the increase or reduction of such
reserves as losses are finally settled and claims exposures are reduced. We
continue to believe we have provided for all material net incurred losses.
Policy acquisition costs, which are net of commissions on ceded
reinsurance, increased to $23.7 million during 2000 from $8.2 million for 1999.
This increase in costs results from higher retained premium and the resulting
reduced ceding commissions.
Net earnings of our insurance companies increased to $24.2 million in 2000
from a loss of $10.7 million in 1999, primarily as a result of improved
underwriting results, the effect of the provision for reinsurance recorded in
1999 and the increase in investment income.
UNDERWRITING AGENCIES
Premiums underwritten by our underwriting agencies increased 27% to $1.1
billion for 2000 compared to 1999. Management fees generated by our underwriting
agencies increased 6% to $96.1 million in 2000 compared to 1999. These increases
resulted primarily from the increased premium volume in the medical stop-loss
line of business, which was due to rate increases and the Centris acquisition.
The increase in management fees was disproportionate to the increase in written
premium as a result of higher policy issuance fees and increased retentions by
our insurance companies which reduced management fees earned by our underwriting
agencies. These reductions are offset by an equal reduction in net policy
acquisition costs of our insurance companies. Net earnings of our underwriting
agencies increased 13% to $19.4 million in 2000 from $17.2 million in 1999 due
to increased revenue, a smaller restructuring charge in 2000 than in 1999 and
higher pretax margins primarily as a result of the successful integration of the
Centris acquisition.
INTERMEDIARIES
Commission income decreased to $42.5 million in 2000 from $54.6 million in
1999. Net earnings of our intermediary subsidiaries decreased to $9.2 million in
2000 from $13.6 million in 1999. These decreases were due to a significant
reduction in the amount of ceded reinsurance placed on behalf of our insurance
companies as a result of their planned increase in retentions.
In January 2001, we acquired all of the outstanding shares of Schanen
Consulting for 996,805 shares of our common stock. This transaction will be
recorded using the pooling-of-interests method of accounting. Schanen
Consulting's operations have been consolidated with those of HCC Employee
Benefits, our specialty retail employee benefits agency.
OTHER OPERATIONS
Other operating revenue decreased to $25.5 million during 2000 from $28.5
million for the same period in 1999. Net earnings of our other operations
decreased to $6.0 million in 2000 from $7.6 million in 1999. Revenue and
earnings can vary considerably from period to period depending on investment or
disposition activity.
RESTRUCTURING
As of December 31, 1999, we accrued a restructuring liability of $4.0
million related to our ongoing operations. As of December 31, 2000, all
restructuring costs had been paid or adjusted with the exception of a remaining
liability of $105,000. During 2000, we determined that one of the leased offices
scheduled to be closed would be retained. Therefore, we reversed $789,000
(included as a credit in other operating expenses in the consolidated financial
statements) of the restructuring expense recorded during the fourth quarter of
1999, of which $514,000 was the reversal of the accrual for future lease
payments and $275,000 was the reversal of the write-off of certain assets.
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As of December 31, 1999, we had also accrued a restructuring liability
related to our acquisition of Centris. Changes in the accrual between December
31, 1999 and December 31, 2000 are shown in the table below:
ACCRUED PAID 2000 ACCRUED
AT 12/31/99 IN 2000 ADJUSTMENTS AT 12/31/00
----------- ---------- ----------- -----------
Contractual executive severance
accruals........................... $5,866,000 $6,027,000 $ 166,000 $ 5,000
Other severance accruals............. 397,000 541,000 258,000 114,000
Lease obligation accruals............ 848,000 1,004,000 1,196,000 1,040,000
---------- ---------- ---------- ----------
Total...................... $7,111,000 $7,572,000 $1,620,000 $1,159,000
========== ========== ========== ==========
The adjustments in 2000 were recorded as management decided to take
additional steps to integrate parts of the Centris operations.
During the fourth quarter of 2000, we also recorded a restructuring charge
and associated expenses of $1.5 million. A total of 26 employees were or will be
terminated as a result of our restructuring of certain underwriting agency
operations and their integration into our insurance company operations. The
charges affected both segments and consisted of $557,000 accrued severance pay
to be paid at various times throughout 2001 and $992,000 for the write down or
write off of various impaired assets, primarily redundant computer software.
Year Ended December 31, 1999 Versus Year Ended December 31, 1998
Our revenue increased 11% to $341.9 million in 1999, from $308.0 million in
1998. The revenue increase was principally a result of increases in non-risk
bearing management fees and commission income. This growth is from new business
and acquisitions.
Our net investment income increased 5% to $30.9 million in 1999 from $29.3
million in 1998, reflecting a slightly higher level of investment assets and
increased interest rates earned on short-term investments.
Our net realized investment losses from sales or write downs of equity
securities were $3.9 million in 1999, compared to losses of $166,000 in 1998. In
1999, we recognized a $4.3 million realized loss from the write down of one
equity investment to its estimated fair market value based upon market
quotations. Our net realized investment losses from the disposition of fixed
income securities were $164,000 in 1999, compared to gains of $1.0 million in
1998. The losses in 1999 resulted from the sale of bonds in connection with the
funding of the Centris acquisition.
Our compensation expense increased to $77.5 million in 1999, from $56.1
million in 1998. This increase reflects a normal progressional increase due to
business growth as well as the effect of acquisitions. Other operating expenses
increased $11.1 million to $47.2 million, before restructuring expenses of $5.5
million, during the same period for similar reasons. Our currency conversion
gains amounted to $442,000 in 1999, compared to gains of $219,000 in 1998.
We recorded a restructuring charge and associated expenses of $5.5 million
during the fourth quarter of 1999. Since our initial public offering in 1992, we
have completed more than fifteen acquisitions. During that time, total employees
had grown from less than 100 to more than 1,000. As a result of this rapid
growth, we believe certain operating inefficiencies occurred. At the beginning
of the fourth quarter of 1999, we made a review of our operations and determined
that they could be made more efficient, principally by reducing the employee
count in certain operations. We believe that this restructuring will strengthen
our corporate and management structure and enhance future earnings by improving
operating efficiency and therefore profitability. The charge included severance
pay of $3.8 million for 92 employees, $1.0 million related to lease costs of
office space made redundant as a result of the restructuring plan and an asset
write down of $647,000, principally of leasehold improvements, and other assets
related to the redundant space.
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Our interest expense was $13.0 million for 1999, an increase of $6.9
million from 1998. The increase is a result of increased debt outstanding as a
result of funding for acquisitions.
Our income tax expense was $12.3 million in 1999 compared to $35.2 million
in 1998. The decrease was due to the reduction in earnings before income tax.
Our effective tax rate for both years was approximately the same.
Our net earnings in 1999 decreased to $25.1 million from $72.3 million in
1998, due to the provision for reinsurance, which equated to $28.3 million after
income taxes, or $0.57 per diluted share, the higher net loss ratio and the
restructuring expense, which, after income taxes, amounted to $0.07 per diluted
share. Diluted earnings per share decreased to $0.51 per share from $1.48 per
share during the same period.
Our book value per share was $9.29 as of December 31, 1999, up from $9.12
as of December 31, 1998.
SEGMENTS
Insurance Companies
Gross written premium for our insurance companies increased 14% to $568.3
million in 1999, from $498.3 million in 1998. Our accident and health
reinsurance, medical stop-loss and workers' compensation lines of business
showed strong growth because our insurance companies continued to participate in
more of the business written by our underwriting agencies. This growth was
partially offset by reductions in offshore energy and property premium as a
result of the continuing extremely soft conditions in these markets. Net written
premium for our insurance companies increased 15% in 1999 to $139.9 million from
$121.9 million in 1998, as a result of increases in retained aviation and
medical stop-loss premium. Net earned premium decreased slightly in 1999 to
$141.4 million from $143.1 million in 1998 as changes in earned premium lag
behind changes in written premium.
Loss and loss adjustment expense incurred by our insurance companies
increased to $109.7 million in 1999, from $91.3 million in 1998, and the GAAP
net loss ratio increased to 77.6% in 1999, from 63.8% in 1998. The GAAP gross
loss ratio was 116.5% in 1999 compared to 109.2% in 1998. The deterioration is
primarily from poor results in the aviation, medical stop-loss and property
lines of business. We have taken steps to reduce these gross loss ratios,
primarily by increasing premium rates and more selective underwriting. The
statutory net combined ratio was 129.9% (104.1% excluding the effects of the
provision for reinsurance) in 1999 compared to 82.9% in 1998.
During 1999, we had a net loss and loss adjustment expense deficiency of
$4.6 million relating to prior year losses compared to a redundancy of $14.6
million in 1998. During 1999, we had a gross loss and loss adjustment expense
deficiency of $90.0 million compared to a deficiency of $33.5 million in 1998.
The 1999 gross deficiency results from two principal conditions. The first is
the development of large claims on individual policies which were either
reported late or for which reserves were increased as subsequent information
became available. However, because these policies were substantially reinsured,
there was no material effect to our net earnings. Secondly, during 1999, in
connection with the insolvency of one of our reinsurers and with the commutation
of all liabilities of another, we re-evaluated all loss reserves and incurred
but not reported loss reserves related to business placed with these reinsurers
to determine the ultimate losses we might conservatively expect. These reserves
were then used as the basis for the determination of the provision for
reinsurance we recorded in 1999. The other deficiencies and redundancies in the
reserves result from our continued review with our actuaries of loss reserves
and the increase or reduction of those reserves as losses are finally settled
and claims exposures are reduced.
In 1999, our insurance companies recorded a $43.5 million provision for
reinsurance to reflect an estimated $29.5 million pre-tax loss for the
insolvency of a reinsurer and an estimated $14.0 million pre-tax loss, the
majority of which represents the discount on ceded reserves related to the
commutation we initiated of all liabilities with another reinsurer. The
commutation was settled for cash and other assets totaling $56.5 million in
February, 2000.
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Our insurance companies' policy acquisition costs, which are net of ceding
commissions on reinsurance ceded, decreased $2.8 million to $8.2 million in
1999, from $11.0 million in 1998. This decrease reflects a greater amount of
gross premium ceded and, therefore, a higher level of ceding commissions.
Net earnings of our insurance companies decreased to a loss of $10.7
million in 1999, from a profit of $33.8 million in 1998, as a result of the
provision for reinsurance, the effect of restructuring and the higher net loss
ratio.
Underwriting Agencies
Management fees generated by our underwriting agencies increased 23% to
$90.7 million in 1999, from $74.0 million in 1998. Premium underwritten on
behalf of both our insurance companies and other insurance companies increased
to $848.1 million in 1999, an increase of 20% from $706.2 million in 1998. Both
increases resulted from acquisitions and internal growth of existing operations.
The underwriting agency segment also incurred a $1.9 million, net of income tax,
restructuring expense in 1999. In addition to its impact on the agency segment,
growth in underwriting agency premium has a positive impact on both the
insurance company segment and the intermediary segment.
Net earnings of our underwriting agencies decreased to $17.2 million in
1999, from $19.4 million in 1998. Acquisitions made during 1998 and 1999 had not
yet had a positive impact on net earnings due to licensing and other regulatory
requirements, which were still in process.
Intermediaries
Commission income generated by our intermediaries increased 42% to $54.6
million in 1999, from $38.4 million in 1998, primarily as a result of the
January 1, 1999 acquisition of Rattner Mackenzie. Net earnings of the
intermediaries decreased to $13.6 million in 1999 from $16.9 million in 1998.
The increase in net earnings generated by Rattner Mackenzie was offset by fewer
large brokerage transactions in 1999 and other reductions, including a $902,000
(net of income tax) restructuring expense in 1999.
Other Operations
Our other operating revenue increased 28% to $28.5 million in 1999, from
$22.3 million in 1998. There was a general increase in revenue of the service
operations, net of the decrease in revenue related to operations disposed of in
late 1998. Other operating net earnings increased to $7.6 million in 1999, from
$4.8 million in 1998 due principally to the higher earnings of the service
operations. Revenue and earnings can vary considerably from period to period
depending on investment or disposition activity.
LIQUIDITY AND CAPITAL RESOURCES
We receive substantial cash from premiums, reinsurance recoverables, and
management fee and commission income and, to a lesser extent, investment income,
and proceeds from sales and redemptions of investments and other assets. Our
principal cash outflows are for the payment of claims and loss adjustment
expenses, payment of premiums to reinsurers, purchase of investments, debt
service, and repayment policy acquisition costs, operating expenses, income and
other taxes and dividends. Variations in operating cash flows can occur due to
timing differences in either the payment of claims and the collection of related
recoverables or the collection of receivables and the payment of related payable
amounts. We limit our liquidity exposure by holding funds, letters of credit and
other security such that net balances due to us are less than the gross balances
shown in our condensed consolidated balance sheets.
We maintain a substantial level of cash and liquid short-term investments
which are used to meet anticipated payment obligations. Our consolidated cash
and investment portfolio increased $116.5 million, or 19% since December 31,
1999, and totaled $724.3 million as of December 31, 2000, of which $277.0
million was cash and short-term investments. The increase in investments
resulted from increased
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operating cash flows and from the collection of a commutation receivable. Total
assets increased slightly to $2.7 billion as of December 31, 2000.
Our investment portfolio includes a high percentage of liquid investments
and generates a significant amount of investment income, which serves as a
source of cash flow. The average tax equivalent yield on investments was 7.3% in
2000, compared to 7.2% in 1999. The weighted average duration of the portfolio
was four years as of December 31, 2000. Over 99% of our fixed income securities
were rated A or better by Standard & Poor's. The value of our portfolio of fixed
income securities is inversely correlated to changes in market interest rates.
In addition, some of our fixed income securities have call or prepayment
options. This could subject us to reinvestment risk should interest rates fall
or issuers call their securities and we reinvest the proceeds at lower interest
rates. We mitigate this risk by investing in securities with varied maturity
dates, so that only a portion of our portfolio will mature at any point in time.
As of December 31, 2000, certain of our subsidiaries maintained revolving
lines of credit with a bank in the combined maximum amount of $55.0 million
available through December 31, 2001. Advances under the lines of credit are
limited to amounts required to fund draws, if any, on letters of credit issued
by the bank on behalf of the subsidiaries and short-term direct cash advances.
The lines of credit are collateralized by securities having an aggregate market
value of up to $68.8 million, the actual amount of collateral at any one time
being 125% of the aggregate amount outstanding. Interest on the lines is payable
at the bank's prime rate of interest less 1% (8.5% at December 31, 2000). At
December 31, 2000, letters of credit totaling $26.4 million had been issued to
insurance companies by the bank on behalf of the subsidiaries, with total
securities of $33.1 million collateralizing the lines.
During March 2001, we sold 6.9 million shares of our common stock in a
public offering at a price of $23.35 per share. Net proceeds from the offering
amounted to approximately $152.8 million after deducting underwriting discounts
and commissions and estimated offering expenses. Most of the proceeds, $152.5
million, were used to pay down our bank facility.
On December 17, 1999, we entered into a $300.0 million Revolving Loan
Facility with a group of banks. We can borrow up to $300.0 million under the
facility on a revolving basis until it expires on December 18, 2004. Outstanding
advances under the facility bear interest at agreed upon rates. The facility is
collateralized in part by the pledge of the stock of Houston Casualty and Avemco
Insurance and by the stock of and guarantees entered into by our principal
underwriting agency and intermediary subsidiaries. The facility agreement
contains certain restrictive covenants, including minimum net worth requirements
for us and certain of our subsidiaries, restrictions on certain extraordinary
corporate actions, notice requirements for certain material occurrences, and
required maintenance of specified financial ratios. We believe that the
restrictive covenants and our obligations that are contained in the facility
agreement are typical for financing arrangements comparable to our facility. As
of December 31, 2000, total debt outstanding under the facility was $207.5
million and the weighted average interest rate was 8.18%. During March 2001, we
reduced debt outstanding under the facility to $55.0 million using the proceeds
from our recent public stock offering.
Property and casualty insurance companies domiciled in the State of Texas
are limited in the payment of dividends to their shareholders in any
twelve-month period, without the prior written consent of the Commissioner of
Insurance, to the greater of statutory net income for the prior calendar year or
10% of its statutory policyholders' surplus as of the prior year end. Houston
Casualty and U.S. Specialty, both Texas domiciled companies, paid no dividends
in 1999 or 2000. During 2001, Houston Casualty's ordinary dividend capacity will
be approximately $23.1 million and U.S. Specialty's ordinary dividend capacity
will be approximately $10.6 million.
Under the laws of the State of Maryland, Avemco Insurance may only pay
dividends out of statutory earned surplus. The maximum amount of dividends that
Avemco Insurance may pay without prior regulatory approval in any twelve-month
period is the greater of its statutory net income (under certain conditions) for
the prior calendar year or 10% of its statutory policyholders' surplus as of the
prior year end. Avemco Insurance paid an extraordinary dividend of $45.0 million
during December, 1999, but paid
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no dividends during 2000. During 2001, Avemco Insurance will have an ordinary
dividend capacity of approximately $18.2 million.
HCC Life Insurance Company is limited by the laws of the State of Indiana
in the amount of dividends it may pay in any twelve-month period, without prior
regulatory approval, to the greater of its statutory net gain from operations
for the prior calendar year or 10% of its policyholders' surplus as of the prior
year end. HCC Life paid no dividends in 2000. During 2001, HCC Life's ordinary
dividend capacity will be approximately $6.3 million.
As of December 31, 2000, we had a net deferred tax asset of $6.7 million
compared to $18.3 million as of December 31, 1999. Due to our history of
consistent earnings and expectations for future earnings and to the ability to
carry losses back to profitable years for tax purposes, we expect to be able to
fully realize the benefit of our net deferred tax asset.
The overall increase in underwriting activity by our insurance companies
and the Centris acquisition in December, 1999 resulted in increases in gross
loss reserves, life and annuity policy benefits and gross unearned premiums.
Related amounts of reinsurance recoverables, ceded life and policy benefits and
ceded unearned premium also increased.
We continue to collect our receivables and recoverables generally in the
ordinary course of business and we have not incurred and do not expect to incur
any significant liquidity difficulties as a result of the substantial growth in
gross amounts due. However, during 2000, a number of reinsurers have delayed or
suspended the payment of amounts recoverable under certain reinsurance contracts
to which we are a party. Such delays have affected, though not materially to
date, the investment income of our insurance companies, but not to any extent
their liquidity. We limit our liquidity exposure by holding funds, letters of
credit or other security such that net balances due are significantly less than
the gross balances shown in our consolidated balance sheets. In addition, a
number of reinsurers have claimed they are not liable for payment to us and, in
one or more cases, have sought arbitration of these matters. We believe these
claims are without merit and expect to collect the full amount recoverable. We
are currently in negotiations with most of these parties. If such negotiations
do not result in a satisfactory resolution of the matters in question, we will
seek a judicial or arbitral determination of these matters.
As of December 31, 2000, each of our domestic insurance companies' total
adjusted capital was significantly in excess of the authorized control level
risk-based capital level prescribed by the National Association of Insurance
Commissioners.
Regulatory guidelines suggest that a property and casualty insurer's annual
statutory gross written premium should not exceed 900% of its statutory
policyholders' surplus and net written premium should not exceed 300% of its
statutory policyholders' surplus. However, industry standards and rating agency
criteria place these ratios at 300% and 200%, respectively. In the past, our
property and casualty insurance companies have maintained premium to surplus
ratios significantly lower than such guidelines and generally below industry
norms. For the year ended December 31, 2000, our statutory gross written premium
to policyholders' surplus was 298.0% compared to 182.6% for the year ended
December 31, 1999. For the year ended December 31, 2000, our statutory net
written premium to policyholders' surplus was 87.0% compared to 47.6% for the
year ended December 31, 1999. The gross written premium ratio has increased
during 2000 with the acquisition of Centris' book of medical stop-loss business
and the increasing use of our insurance companies as the issuing company for
business written by our underwriting agencies. This ratio is expected to
stabilize at or decrease from its 2000 level as statutory policyholders' surplus
increases due to the retention of earnings and other increases in policyholders'
surplus.
IMPACT OF INFLATION
Our operations, like those of other property and casualty insurers, are
susceptible to the effects of inflation, as premiums are established before the
ultimate amounts of loss and loss adjustment expense are known. Although we
consider the potential effects of inflation when setting premium rates, for
competitive reasons, such premiums may not fully offset the effects of
inflation. However, because the majority of our
39
41
business is comprised of lines which have relatively short lead times between
the occurrence of an insured event, reporting of the claims to us and the final
settlement of the claims, the effects of inflation are minimized.
A significant portion of our revenue is related to healthcare insurance and
reinsurance products that are subject to the effects of the underlying inflation
of healthcare costs. Such inflation in the costs of healthcare tends to generate
increases in premiums for medical stop-loss coverage, resulting in greater
revenue, but also higher claim payments. Inflation may have a negative impact on
insurance and reinsurance operations by causing higher claim settlements than
may originally have been estimated without an immediate increase in premiums to
a level necessary to maintain profit margins. We do not specifically provide for
inflation when setting underwriting terms and claim reserves, although we do
consider trends. We continually review claim reserves to assess their adequacy
and make necessary adjustments. Also, the market value of our investments vary
depending on economic and market conditions and interest rates. Any significant
increase in interest rates could have a material adverse effect on the market
value of our investments. In addition, the interest rate payable under our
$300.0 million bank loan floats with that of the market. Any significant
increase in interest rates could have a material adverse effect on our earnings,
depending on the amount borrowed on our bank facility.
FOREIGN EXCHANGE RATE FLUCTUATIONS
We underwrite risks which are denominated in a number of foreign
currencies. As a result, we have receivables and payables in foreign currencies
and we establish and maintain loss reserves with respect to our insurance
policies in their respective currencies. Our net earnings could be impacted by
exchange rate fluctuations affecting these balances. Our principal area of
exposure is with respect to fluctuations in the exchange rate between the major
European currencies and the U.S. Dollar. For the year ended December 31, 2000,
our loss from currency conversion was $(330,000) compared to gains of $442,000
in 1999 and $219,000 in 1998.
On a limited basis, we enter into foreign currency forward contracts as a
hedge against foreign currency fluctuations. Rattner Mackenzie has revenue
streams in U.S. Dollars and Canadian Dollars ("CAD") but its expenses are paid
in British Pound Sterling ("GBP"). To mitigate our foreign exchange risk, we
entered into foreign currency forward contracts expiring at staggered times
through December 31, 2001. As of December 31, 2000 we had forward contracts to
sell U.S. $7.5 million for GBP at an average rate of 1.00 GBP equals U.S. $1.50
and to sell CAD $600,000 for GBP at an average exchange rate of 1.00 GBP equals
CAD $2.18. This compares with December 31,1999 when we had forward contracts to
sell U.S. $12.0 million for GBP at an average rate of 1.00 GBP equals U.S.
$1.60. The foreign currency forward contracts are used to convert currency at a
known rate in an amount which approximates average monthly expenses. This
permits us to limit the foreign currency exchange risk of the recurring monthly
expenses. In the future, we may continue to limit our exposure to currency
fluctuations through the use of foreign currency forward contracts. We utilize
these foreign currency forward contracts strictly as a hedge against existing
exposure to foreign currency fluctuations rather than as a form of speculation
or trading investment.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June 1998, and became effective for us January 1, 2001. We utilize derivatives
or hedging strategies on a limited basis. The cumulative effect adjustment due
to this change in accounting has been calculated by us and is not material to
our financial position, results of operations or cash flows nor do we expect the
adoption of SFAS No. 133 to be material on an ongoing basis due to our limited
use of derivatives.
The National Association of Insurance Commissioners adopted Statements of
Statutory Accounting Principles in March, 1998 as a product of its attempt to
codify statutory accounting principles. Although subject to adoption by the
individual states, an effective date of January 1, 2001 was established for
40
42
implementation of the statements. Prior to the codification project, a
comprehensive guide to statutory accounting principles did not exist.
Codification is new and will evolve over time. The cumulative effect of
codification is expected to increase statutory policyholders' surplus of our
insurance company subsidiaries by approximately $6.0 million. We expect that the
statutory surplus of our insurance company subsidiaries after adoption will
continue to be in excess of their regulatory risk-based capital requirements.
In addition, the Financial Accounting Standards Board has recently
announced that it proposes to change the accounting for certain acquisitions and
goodwill. This pronouncement, if finally adopted, could affect the way we
account for and the structure of future acquisitions. Final rules implementing
the announced standards are not expected until the second quarter of 2001 and no
date has been established for adopting the final standards.
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union
irrevocably fixed the conversion rates between their national currencies and a
common currency, the Euro, which became the common legal currency of those
countries on that date. The participating countries' former national currencies
will continue to serve as legal tender and as denominations of the Euro until
January 1, 2002. The conversion to the Euro is scheduled to be completed on July
1, 2002, when the national currencies will cease to exist. We do not expect the
introduction of the Euro to have a material effect on our business, financial
condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our principal assets and liabilities are financial instruments which are
subject to the market risk of potential losses from adverse changes in market
rates and prices. Our primary market risk exposures are: interest rate risk on
fixed income securities and interest expense on variable rate debt, equity risk
on marketable equity securities, credit risk on reinsurance recoverables and
foreign currency exchange rate risk.
To manage the exposures of our investment risks, we generally invest in
investment grade securities with characteristics of duration and liquidity to
reflect the underlying characteristics of the insurance liabilities of our
insurance companies. We have not historically used derivatives to manage any of
our investment related market risks.
Caution should be used in evaluating overall market risk from the
information below. Actual results could differ materially from estimates below
for a variety of reasons, including, among other things:
- amounts and balances on which the estimates are based are likely to
change over time;
- assumptions used in the models may prove to be inaccurate;
- market changes could be different from market changes assumed below; and
- not all factors and balances are taken into account.
Interest Rate Risk
The value of our portfolio of fixed income securities is inversely
correlated to changes in the market interest rates. In addition, some of our
fixed income securities have call or prepayment options. This could subject us
to reinvestment risk should interest rates fall or issuers call their securities
and we reinvest the proceeds at lower interest rates. We attempt to mitigate
this risk by investing in securities with varied maturity dates, so that only a
portion of the portfolio will mature at any point in time. The fair value of our
fixed income securities as of December 31, 2000 was $433.8 million and was
$342.6 million, as of December 31, 1999. If market interest rates were to change
1%, (e.g. from 6% to 5%) the fair value of our fixed income securities would
change approximately $17.9 million as of December 31, 2000. This compares to
change in value of $17.2 million as of December 31, 1999 for the same 1% change
in market interest rates. The change in fair value was determined using duration
modeling assuming no prepayments.
41
43
Our $300 million bank loan is subject to variable interest rates. Thus, our
interest expense is directly correlated to market interest rates. As of December
31, 2000, we had $207.5 million in debt outstanding under the bank loan. At this
debt level, a 1% change in market interest rates (e.g. from 8.0% to 7.0%) would
change our annual interest expense by $2.1 million. As of December 31, 1999, we
had $235.0 million in debt outstanding under the bank loan. At that debt level,
the 1% change in market interest rates would have changed interest expense by
$2.4 million. During March 2001, we reduced our debt under the bank loan to
$55.0 million. At that debt level, a 1% change in market interest rates would
change our annual interest expense $550,000.
Equity Risk
Our portfolio of marketable equity securities is subject to equity price
risk due to market changes. The fair value of our marketable equity securities
as of December 31, 2000 was $6.3 million, compared to $20.0 million as of
December 31, 1999. If the market price of all marketable equity securities were
to change by 10% as of these dates, the fair value of our equity portfolio would
have changed $628,000 as of December 31, 2000 and $2.0 million as of December
31, 1999.
Credit Risk
See Reinsurance Ceded section contained in Item 1., Business, and Footnote
(8) in the Notes to Consolidated Financial Statements.
Foreign Exchange Risk
The table below shows the net amounts of significant foreign currency
balances at December 31, 2000 and 1999 converted to U.S. Dollars. It also shows
the expected dollar change in fair value that would occur if exchange rates
changed 10% from exchange rates in effect at those times:
2000 1999
--------------------------- ---------------------------
HYPOTHETICAL HYPOTHETICAL
U.S. DOLLAR 10% CHANGE IN U.S. DOLLAR 10% CHANGE IN
EQUIVALENT FAIR VALUE EQUIVALENT FAIR VALUE
----------- ------------- ----------- -------------
British Pound Sterling............ $7,486,000 $749,000 $5,974,000 $597,000
Euro and 11 national currencies... 1,345,000 135,000 1,054,000 105,000
Cape Verde Escudo................. 1,685,000 169,000 38,000 4,000
See Foreign Exchange Rate Fluctuations section contained in Item 7,
Management's Discussion and Analysis, and Footnotes (1) and (9) in the Notes to
Consolidated Financial Statements for additional information.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedules listed in the
accompanying index are filed as part of this Report.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
None.
42
44
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding Directors and Executive Officers of the
Registrant, reference is made to the Registrant's definitive proxy statement for
its Annual Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission within 120 days after December 31, 2000, and which is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information regarding Executive Compensation, reference is made to the
Registrant's definitive proxy statement for its Annual Meeting of Shareholders,
which will be filed with the Securities and Exchange Commission within 120 days
after December 31, 2000, and which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information regarding Security Ownership of Certain Beneficial Owners
and Management, reference is made to the Registrant's definitive proxy statement
for its Annual Meeting of Shareholders, which will be filed with the Securities
and Exchange Commission within 120 days after December 31, 2000, and which is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information regarding Certain Relationships and Related Transactions,
reference is made to the Registrant's definitive proxy statement for its Annual
Meeting of Shareholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 2000, and which is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) EXHIBITS
The exhibits listed on the accompanying Index to Exhibits are filed as part
of this Report.
(b) FINANCIAL STATEMENT SCHEDULES
The financial statements and financial statement schedules listed in the
accompanying index are filed as part of this Report.
(c) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by us during the fourth quarter of 2000.
43
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HCC Insurance Holdings, Inc.
--------------------
(Registrant)
By: /s/ STEPHEN L. WAY
----------------------------------
Stephen L. Way
Chairman of the Board and Chief
Executive Officer
Dated: March 30, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ STEPHEN L. WAY Chairman of the Board of March 30, 2001
- ----------------------------------------------------- Directors and Chief Executive
(Stephen L. Way) Officer (Principal Executive
Officer)
/s/ MARVIN P. BUSH* Director March 30, 2001
- -----------------------------------------------------
(Marvin P. Bush)
/s/ FRANK J. BRAMANTI* Director and Executive Vice March 30, 2001
- ----------------------------------------------------- President
(Frank J. Bramanti)
/s/ PATRICK B. COLLINS* Director March 30, 2001
- -----------------------------------------------------
(Patrick B. Collins)
/s/ JAMES R. CRANE* Director March 30, 2001
- -----------------------------------------------------
(James R. Crane)
/s/ J. ROBERT DICKERSON* Director March 30, 2001
- -----------------------------------------------------
(J. Robert Dickerson)
/s/ EDWARD H. ELLIS, JR. Senior Vice President and Chief March 30, 2001
- ----------------------------------------------------- Financial Officer (Chief
(Edward H. Ellis, Jr.) Accounting Officer)
/s/ EDWIN H. FRANK, III* Director March 30, 2001
- -----------------------------------------------------
(Edwin H. Frank, III)
/s/ ALAN W. FULKERSON* Director March 30, 2001
- -----------------------------------------------------
(Alan W. Fulkerson)
44
46
NAME TITLE DATE
---- ----- ----
/s/ WALTER J. LACK* Director March 30, 2001
- -----------------------------------------------------
(Walter J. Lack)
/s/ STEPHEN J. LOCKWOOD* Director and Vice Chairman March 30, 2001
- -----------------------------------------------------
(Stephen J. Lockwood)
/s/ JOHN N. MOLBECK, JR. Director, President and Chief March 30, 2001
- ----------------------------------------------------- Operating Officer
(John N. Molbeck, Jr.)
*By: /s/ JOHN N. MOLBECK, JR. March 30, 2001
------------------------------------------------
John N. Molbeck, Jr., Attorney-in-fact
45
47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Report of Independent Accountants........................... F-1
Consolidated Balance Sheets at December 31, 2000 and 1999... F-2
Consolidated Statements of Earnings for the three years
ended December 31, 2000................................... F-3
Consolidated Statements of Comprehensive Income for the
three years ended December 31, 2000....................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the three years ended December 31, 2000............... F-5
Consolidated Statements of Cash Flows for the three years
ended December 31, 2000................................... F-6
Notes to Consolidated Financial Statements.................. F-7
SCHEDULES:
Report of Independent Accountants on Financial
Statement Schedules....................................... S-1
Schedule 1 Summary of Investments other than Investments in
Related Parties........................................... S-2
Schedule 2 Condensed Financial Information of Registrant... S-3
Schedule 3 Supplementary Insurance Information............. S-8
Schedule 4 Reinsurance..................................... S-9
Schedule 5 Valuation and Qualifying Accounts............... S-10
Schedules other than those listed above have been omitted because they are
either not required, not applicable, or the required information is shown in the
Consolidated Financial Statements and related notes thereto or other Schedules.
46
48
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
HCC Insurance Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of earnings, comprehensive income, changes in
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of HCC Insurance Holdings, Inc. and its subsidiaries at
December 31, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1, effective January 1, 2000 the Company changed its
method of revenue recognition for certain contracts as prescribed by the
Securities and Exchange Commission's Staff Accounting Bulletin No. 101 entitled
"Revenue Recognition in Financial Statements".
/s/ PricewaterhouseCoopers LLP
Houston, Texas
March 21, 2001
F-1
49
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
PRO FORMA -------------------------------
DECEMBER 31, 2000 2000 1999
----------------- -------------- --------------
(UNAUDITED,
SEE NOTE 2)
ASSETS
Investments:
Fixed income securities, at market (cost: 2000
$422,821,000; 1999 $343,534,000)................ $ 433,844,000 $ 433,844,000 $ 342,641,000
Marketable equity securities, at market (cost: 2000
$8,896,000; 1999 $22,493,000)................... 6,282,000 6,282,000 19,970,000
Short-term investments, at cost, which approximates
market.......................................... 263,318,000 262,982,000 215,694,000
Other investments, at cost, which approximates fair
value........................................... 7,182,000 7,182,000 3,017,000
-------------- -------------- --------------
Total investments.......................... 710,626,000 710,290,000 581,322,000
Cash................................................. 14,038,000 14,038,000 26,533,000
Restricted cash and cash investments................. 101,738,000 101,738,000 84,112,000
Premium, claims and other receivables................ 562,868,000 562,868,000 622,087,000
Reinsurance recoverables............................. 789,412,000 789,412,000 736,485,000
Ceded unearned premium............................... 114,469,000 114,469,000 133,657,000
Ceded life and annuity benefits...................... 86,760,000 86,760,000 95,760,000
Deferred policy acquisition costs.................... 39,108,000 39,108,000 40,450,000
Property and equipment, net.......................... 39,289,000 39,289,000 37,804,000
Goodwill............................................. 266,015,000 266,015,000 263,687,000
Other assets......................................... 18,989,000 18,989,000 42,827,000
-------------- -------------- --------------
Total assets............................... $2,743,312,000 $2,742,976,000 $2,664,724,000
============== ============== ==============
LIABILITIES
Loss and loss adjustment expense payable............. $ 944,117,000 $ 944,117,000 $ 871,104,000
Life and annuity policy benefits..................... 86,760,000 86,760,000 95,760,000
Reinsurance balances payable......................... 113,346,000 113,346,000 113,373,000
Unearned premium..................................... 190,550,000 190,550,000 188,524,000
Deferred ceding commissions.......................... 30,013,000 30,013,000 39,792,000
Premium and claims payable........................... 589,830,000 589,830,000 598,638,000
Notes payable........................................ 59,633,000 212,133,000 242,546,000
Accounts payable and accrued liabilities............. 46,792,000 46,792,000 57,559,000
-------------- -------------- --------------
Total liabilities.......................... 2,061,041,000 2,213,541,000 2,207,296,000
SHAREHOLDERS' EQUITY
Common Stock, $1.00 par value; 250,000,000 shares
authorized; (shares issued and outstanding: pro
forma 57,245,201; 2000 50,345,201; 1999
48,839,027)........................................ 57,245,000 50,345,000 48,839,000
Additional paid-in capital........................... 342,891,000 196,955,000 176,359,000
Retained earnings.................................... 277,422,000 277,422,000 234,922,000
Accumulated other comprehensive income (loss)........ 4,713,000 4,713,000 (2,692,000)
-------------- -------------- --------------
Total shareholders' equity................. 682,271,000 529,435,000 457,428,000
-------------- -------------- --------------
Total liabilities and shareholders'
equity................................... $2,743,312,000 $2,742,976,000 $2,664,724,000
============== ============== ==============
See Notes to Consolidated Financial Statements.
F-2
50
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
------------ ------------ ------------
REVENUE
Net earned premium................................. $267,647,000 $141,362,000 $143,100,000
Management fees.................................... 96,058,000 90,713,000 74,045,000
Commission income.................................. 42,492,000 54,552,000 38,441,000
Net investment income.............................. 39,794,000 30,933,000 29,335,000
Net realized investment gain (loss)................ (5,321,000) (4,164,000) 845,000
Other operating income............................. 25,497,000 28,475,000 22,268,000
------------ ------------ ------------
Total revenue............................ 466,167,000 341,871,000 308,034,000
EXPENSE
Loss and loss adjustment expense................... 198,470,000 109,650,000 91,302,000
Operating expense:
Policy acquisition costs, net.................... 23,743,000 8,177,000 10,978,000
Compensation expense............................. 78,446,000 77,488,000 56,077,000
Provision for reinsurance........................ -- 43,462,000 --
Other operating expense.......................... 52,515,000 52,736,000 36,170,000
------------ ------------ ------------
Total operating expense.................. 154,704,000 181,863,000 103,225,000
Interest expense................................... 20,347,000 12,964,000 6,021,000
------------ ------------ ------------
Total expense............................ 373,521,000 304,477,000 200,548,000
------------ ------------ ------------
Earnings before income tax provision............... 92,646,000 37,394,000 107,486,000
Income tax provision............................... 37,202,000 12,271,000 35,208,000
------------ ------------ ------------
Earnings before cumulative effect of accounting
change........................................... 55,444,000 25,123,000 72,278,000
Cumulative effect of accounting change, net of
deferred tax effect of $1,335,000................ (2,013,000) -- --
------------ ------------ ------------
Net Earnings............................. $ 53,431,000 $ 25,123,000 $ 72,278,000
============ ============ ============
Basic earnings per share data:
Earnings before accounting change................ $ 1.11 $ 0.51 $ 1.51
Cumulative effect of accounting change........... (0.04) -- --
------------ ------------ ------------
Net Earnings..................................... $ 1.07 $ 0.51 $ 1.51
============ ============ ============
Weighted average shares outstanding.............. 49,745,000 49,061,000 47,920,000
============ ============ ============
Diluted earnings per share data:
Earnings before accounting change................ $ 1.10 $ 0.51 $ 1.48
Cumulative effect of accounting change........... (0.04) -- --
------------ ------------ ------------
Net Earnings..................................... $ 1.06 $ 0.51 $ 1.48
============ ============ ============
Weighted average shares outstanding.............. 50,622,000 49,649,000 48,936,000
============ ============ ============
See Notes to Consolidated Financial Statements.
F-3
51
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
Net earnings.......................................... $53,431,000 $25,123,000 $72,278,000
Other comprehensive income net of tax:
Foreign currency translation adjustment............. (172,000) 167,000 (344,000)
Investment gains (losses):
Investment gains (losses) during the year, net of
income tax charge (benefit) of $2,386,000 in
2000, ($8,042,000) in 1999 and $1,283,000 in
1998........................................... 4,118,000 (15,271,000) 2,598,000
Less reclassification adjustment for (gains)
losses included in net earnings, net of income
tax (charge) benefit of $1,862,000 in 2000,
$1,457,000 in 1999 and ($296,000) in 1998...... 3,459,000 2,707,000 (549,000)
----------- ----------- -----------
Other comprehensive income (loss)................... 7,405,000 (12,397,000) 1,705,000
----------- ----------- -----------
Comprehensive income............................. $60,836,000 $12,726,000 $73,983,000
=========== =========== ===========
See Notes to Consolidated Financial Statements.
F-4
52
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ------------ ------------ ------------- -------------
Balance as of December 31, 1997....... $47,759,000 $154,633,000 $155,209,000 $ 8,000,000 $365,601,000
Net earnings.......................... -- -- 72,278,000 -- 72,278,000
Other comprehensive income............ -- -- -- 1,705,000 1,705,000
206,504 shares of Common Stock issued
for exercise of options, including
tax benefit of $925,000............. 206,000 1,997,000 -- -- 2,203,000
287,025 shares of Common Stock issued
for purchased companies............. 287,000 5,472,000 -- -- 5,759,000
Cash dividends declared, $0.16 per
share............................... -- -- (7,683,000) -- (7,683,000)
----------- ------------ ------------ ------------ ------------
Balance as of December 31,
1998........................... 48,252,000 162,102,000 219,804,000 9,705,000 439,863,000
Net earnings.......................... -- -- 25,123,000 -- 25,123,000
Other comprehensive income (loss)..... -- -- -- (12,397,000) (12,397,000)
505,555 shares of Common Stock issued
for exercise of options, including
tax benefit of $1,156,000........... 506,000 4,277,000 -- -- 4,783,000
101,330 shares of Common Stock issued
for purchased companies............. 101,000 1,899,000 -- -- 2,000,000
414,207 shares of Common Stock
contractually issuable in the
future.............................. -- 8,271,000 -- -- 8,271,000
Cash dividends declared, $0.20 per
share............................... -- -- (9,733,000) -- (9,733,000)
Contractual adjustments to previous
acquisitions........................ (20,000) (190,000) (272,000) -- (482,000)
----------- ------------ ------------ ------------ ------------
Balance as of December 31,
1999........................... 48,839,000 176,359,000 234,922,000 (2,692,000) 457,428,000
Net earnings.......................... -- -- 53,431,000 -- 53,431,000
Other comprehensive income............ -- -- -- 7,405,000 7,405,000
1,266,701 shares of Common Stock
issued for exercise of options,
including tax benefit of
$3,627,000.......................... 1,266,000 19,596,000 -- -- 20,862,000
Issuance of 144,973 shares of
contractually issuable Common
Stock............................... 145,000 (145,000) -- -- --
Issuance of 94,500 shares of
contingently issuable Common
Stock............................... 95,000 1,145,000 -- -- 1,240,000
Cash dividends declared, $0.22 per
share............................... -- -- (10,931,000) -- (10,931,000)
----------- ------------ ------------ ------------ ------------
Balance as of December 31,
2000........................... $50,345,000 $196,955,000 $277,422,000 $ 4,713,000 $529,435,000
=========== ============ ============ ============ ============
See Notes to Consolidated Financial Statements.
F-5
53
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------
2000 1999 1998
------------- ------------- -------------
Cash flows from operating activities:
Net earnings...................................... $ 53,431,000 $ 25,123,000 $ 72,278,000
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Change in premium, claims and other
receivables.................................. 52,923,000 (92,206,000) (102,804,000)
Change in reinsurance recoverables............. (52,007,000) (284,504,000) (195,707,000)
Change in ceded unearned premium............... 19,188,000 31,408,000 (64,958,000)
Change in deferred policy acquisition costs,
net.......................................... (8,664,000) (4,659,000) 5,666,000
Change in other assets......................... 13,362,000 (12,081,000) 410,000
Change in loss and loss adjustment expense
payable...................................... 72,311,000 264,360,000 181,626,000
Change in reinsurance balances payable......... (348,000) (15,098,000) 47,069,000
Change in unearned premium..................... 2,689,000 (31,138,000) 46,074,000
Change in premium and claims payable, net of
restricted cash.............................. (25,749,000) 102,114,000 64,364,000
Change in accounts payable and accrued
liabilities.................................. (12,229,000) 4,707,000 (9,205,000)
Net realized investment (gain) loss............ 5,321,000 4,164,000 (845,000)
Gains on sales of other operating
investments.................................. (5,739,000) (5,523,000) (4,694,000)
Provision for reinsurance...................... -- 43,462,000 --
Depreciation and amortization expense.......... 19,876,000 13,398,000 7,388,000
Other, net..................................... (2,772,000) (2,630,000) 3,382,000
------------- ------------- -------------
Cash provided by operating activities........ 131,593,000 40,897,000 50,044,000
Cash flows from investing activities:
Sales of fixed income securities.................. 137,175,000 131,485,000 18,212,000
Maturity or call of fixed income securities....... 34,341,000 17,050,000 30,202,000
Sales of equity securities........................ 7,969,000 2,886,000 4,160,000
Dispositions of other operating investments....... 27,803,000 15,905,000 3,324,000
Change in short-term investments.................. (68,577,000) (14,935,000) (24,667,000)
Cash paid for companies acquired, net of cash
received....................................... (8,909,000) (186,923,000) (33,011,000)
Cost of investments acquired...................... (244,586,000) (70,736,000) (43,968,000)
Purchase of property and equipment and other...... (9,474,000) (9,076,000) (15,320,000)
------------- ------------- -------------
Cash used by investing activities............ (124,258,000) (114,344,000) (61,068,000)
Cash flows from financing activities:
Proceeds from notes payable....................... 26,700,000 547,000,000 74,200,000
Sale of Common Stock.............................. 20,862,000 4,783,000 2,203,000
Payments on notes payable......................... (57,042,000) (458,600,000) (49,950,000)
Dividends paid.................................... (10,350,000) (9,221,000) (7,139,000)
------------- ------------- -------------
Cash provided (used) by financing
activities................................ (19,830,000) 83,962,000 19,314,000
------------- ------------- -------------
Net change in cash........................... (12,495,000) 10,515,000 8,290,000
Cash as of beginning of year................. 26,533,000 16,018,000 7,728,000
------------- ------------- -------------
Cash as of end of year....................... $ 14,038,000 $ 26,533,000 $ 16,018,000
============= ============= =============
See Notes to Consolidated Financial Statements.
F-6
54
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
HCC Insurance Holdings, Inc. ("the Company" or "HCC") and its subsidiaries,
include domestic and foreign property and casualty and life insurance companies,
underwriting agencies, intermediaries and service companies. HCC, through its
subsidiaries, provides specialized property and casualty and life and health
insurance to commercial customers in the areas of accident and health
reinsurance and aviation, marine and offshore energy, medical stop-loss,
property and workers' compensation insurance. The principal insurance company
subsidiaries are Houston Casualty Company ("HC") in Houston, Texas, and London,
England; HCC Life Insurance Company ("HCCL") in Houston, Texas; U.S. Specialty
Insurance Company ("USSIC") in Houston, Texas; and Avemco Insurance Company
("AIC") in Frederick, Maryland. The underwriting agency subsidiaries provide
underwriting management and claims servicing for insurance and reinsurance
companies, specializing in aviation, medical stop-loss, occupational accident
and workers' compensation insurance and a variety of accident and health related
reinsurance products. The principal agency subsidiaries are LDG Reinsurance
Corporation ("LDG Re") in Wakefield, Massachusetts and New York City, New York;
and HCC Benefits Corporation ("HCCB") in Atlanta, Georgia, Costa Mesa,
California, Wakefield, Massachusetts, Minneapolis, Minnesota and Dallas, Texas.
We have recently consolidated the operations of other of the Company's agencies
with certain of the Company's insurance companies. The intermediary subsidiaries
provide brokerage, consulting and other intermediary services to insurance and
reinsurance companies, commercial customers and individuals in the same lines of
business as the insurance companies operate. The Company's principal
intermediary subsidiaries are HCC Intermediaries, Inc. ("HCCI") in Houston,
Texas; HCC Employee Benefits, Inc. ("HCCEB") in Houston, Texas and Atlanta,
Georgia; and Rattner Mackenzie Limited ("RML") in London, England. The service
company subsidiaries perform various insurance related services for insurance
companies.
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States ("GAAP") requires management
to make estimates and assumptions. This affects amounts reported in the
financial statements and the disclosure of contingent assets and liabilities.
Actual results could differ from those estimates.
A description of the significant accounting and reporting policies utilized
by the Company in preparing the consolidated financial statements is as follows:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Investments
Fixed income securities and marketable equity securities are classified as
available for sale and are carried at quoted market value, if readily
marketable, or at management's estimated fair value, if not readily marketable.
The change in unrealized gain or loss with respect to these securities is
recorded as a component of other comprehensive income, net of the related
deferred income tax effects, if any. Fixed income securities available for sale
are purchased with the original intent to hold to maturity, but they may be
available for sale if market conditions warrant, or if the Company's investment
policies dictate, in order to maximize the Company's investment yield.
Short-term investments and restricted short-term investments are carried at
cost, which approximates market value.
For the mortgage-backed securities portion of the fixed income portfolio,
the Company recognizes income using a constant effective yield based on
anticipated prepayments and the estimated economic life of the securities. When
actual prepayments differ significantly from anticipated prepayments, the
estimated
F-7
55
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
economic life is recalculated and the remaining unamortized premium or discount
is amortized prospectively over the remaining economic life.
The realized gain or loss on investment transactions is determined on an
average cost basis and included in earnings on the trade date. When impairment
of the value of an investment is considered other than temporary, the decrease
in value is reported in earnings as a realized investment loss and a new cost
basis is established.
Property and Equipment
Property and equipment are carried at cost, net of accumulated
depreciation. Depreciation expense is provided using the straight-line method
over the estimated useful lives of the related assets. Amortization of leasehold
improvements is provided using the straight-line method over the shorter of the
estimated useful life or the term of the respective lease. Upon disposal of
assets, the cost and related accumulated depreciation are removed from the
accounts and the resulting gain or loss is included in earnings.
Costs incurred in developing or purchasing management information systems
are capitalized and included in property and equipment. These costs are
amortized over their estimated useful lives from the dates the systems are
placed in service.
Earned Premium, Deferred Policy Acquisition Costs and Ceding Commissions of
Insurance Company Subsidiaries
Written premium, net of reinsurance, is primarily included in earnings on a
pro rata basis over the lives of the related policies. However, for certain
types of business, it is recognized over the period of risk in proportion to the
amount of insurance risk provided. Policy acquisition costs, including
commissions, taxes, fees and other direct costs of underwriting policies, less
ceding commissions allowed by reinsurers, including expense allowances, are
deferred and charged or credited to earnings proportionate to the premium
earned. Historical and current loss and loss adjustment expense experience and
anticipated investment income are considered in determining the recoverability
of deferred policy acquisition costs.
Management Fees and Commission Income
When there is no future servicing obligation, management fees and
commission income are recognized on the revenue recognition date, which is the
later of the effective date of policy, the date when the premium can be
reasonably established, or the date when substantially all the services relating
to the insurance placement have been rendered to the client. When additional
services are required, the service revenue is deferred and recognized over the
service period. The Company also records an allowance for estimated return
commissions which the Company may be required to pay upon the early termination
of policies.
The Company changed certain of its revenue recognition methods for its
agencies and intermediaries to agree with guidance contained in SEC Staff
Accounting Bulletin Number 101 ("SAB 101") entitled "Revenue Recognition in
Financial Statements." Previously, the Company's agencies and intermediaries
recognized revenue in conformity with principles that historically had been
considered generally accepted accounting principles for insurance agents and
brokers. The Company had recognized return commissions when the event occurred
that caused the return and accrued a liability for future servicing costs, when
significant, instead of deferring revenue.
The after-tax cumulative non-cash charge resulting from the adoption of SAB
101 was $2.0 million. As required by this new accounting guidance, the Company
has restated the 2000 first quarter results for the cumulative effect of the
change in accounting. The change was not material to earnings before cumulative
effect of accounting change for the year ended December 31, 2000 or to net
earnings for any prior year presented.
F-8
56
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other Operating Revenue
The Company has two primary sources of other operating revenue, which are
included in the Company's other operations segment. The first source is a
variety of insurance related services, principally claims adjusting services.
These revenues are recorded when the service is performed. The second source is
income from and gains or losses from the disposition of investments made in this
segment. The income is recognized as earned and the gains or losses from the
sale of investments are recognized upon consummation of the transaction or upon
other-than-temporary impairment.
Premium and Other Receivables
The Company uses the gross method for reporting receivables and payables on
brokered transactions. Management reviews the collectibility of its receivables
on a current basis and provides an allowance for doubtful accounts if it deems
that there are accounts which are doubtful of collection. The amount of the
allowance as of December 31, 2000 and 1999 was $3.2 million and $1.7 million,
respectively. Management's estimate of the level of the allowance could change
as conditions change in the future.
Loss and Loss Adjustment Expense Payable of Insurance Company Subsidiaries
Loss and loss adjustment expense payable is based on estimates of payments
to be made for reported and incurred but not reported ("IBNR") losses and
anticipated salvage and subrogation receipts. Currently all reserves are
recorded on an undiscounted basis. Estimates for reported losses are based on
all available information, including reports received from ceding companies on
business. Estimates for IBNR are based both on the Company's and the industry's
experience. While management believes that amounts included in the accompanying
financial statements are adequate, such estimates may be more or less than the
amounts ultimately paid when the claims are settled. The estimates are
continually reviewed and any changes are reflected in current operations.
Reinsurance
The Company records all reinsurance recoverables and ceded unearned
premiums as assets and deferred ceding commissions as a liability. All such
amounts are recorded in a manner consistent with the underlying reinsured
contracts. Management has also recorded a reserve for uncollectible reinsurance
based on current estimates of collectibility. These estimates could change and
affect the level of the reserve needed.
Goodwill
In connection with the Company's acquisitions of subsidiaries accounted for
as purchases, the excess of cost over fair value of net assets acquired is being
amortized using the straight-line method over twenty years for acquired agency
operations which operate in existing lines of business and in the same country.
Goodwill related to acquired agency operations which represent the Company's
initial entry into new lines of business or new countries is amortized over
thirty years. Goodwill related to acquired insurance company operations is
amortized over forty years. Managements of the acquired businesses have
successfully operated in their markets for a number of years and, with the
additional capital provided by the Company, will be positioned to take advantage
of increased opportunities. Accumulated amortization of goodwill as of December
31, 2000 and 1999, was $24.9 million and $11.9 million, respectively.
The Company's accounting policy regarding the assessment of the
recoverability of the carrying value of long-lived assets, including goodwill
and other intangibles and property and equipment, is to review the carrying
value of the assets if the facts and circumstances suggest that they may be
impaired. If this review indicates that the carrying value will not be
recoverable, as determined based on projected undiscounted future cash flows,
the carrying value is reduced to its estimated fair value. Amortization of
goodwill charged to
F-9
57
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
income for the years ended December 31, 2000, 1999 and 1998 was $13.0 million,
$6.7 million and $3.0 million, respectively.
Cash and Short-term Investments
Cash consists of cash in banks, generally in operating accounts. The
Company classifies certificates of deposit, corporate demand notes receivable,
commercial paper and money market funds as short-term investments. Short-term
investments are classified as investments in the consolidated balance sheets as
they relate principally to the Company's investment activities.
As of December 31, 2000 and 1999 the Company included $158.3 million and
$138.5 million, respectively, of certain fiduciary funds in short-term
investments. These are funds held by underwriting agency or intermediary
subsidiaries for the benefit of insurance or reinsurance clients. The Company
earns the interest on these funds.
The Company generally maintains its cash deposits in major banks and
invests its short-term investments with major banks and in investment grade
commercial paper and repurchase agreements. These securities typically mature
within 90 days and, therefore, bear minimal risk. The Company has not
experienced any losses on its cash deposits or its short-term investments.
Restricted Cash and Cash Investments
In conjunction with the management of reinsurance pools, the Company's
agency subsidiaries withhold premium funds for the payment of claims. These
funds are shown as restricted cash and cash investments in the consolidated
balance sheets. The corresponding liability is included within premium and
claims payable in the consolidated balance sheets. These amounts are considered
fiduciary funds, and interest earned on these funds accrues to the benefit of
the members of the reinsurance pools. Therefore, the Company does not include
these amounts as cash in the consolidated statements of cash flows.
Foreign Currency
The functional currency of most foreign subsidiaries and branches is the
U.S. Dollar. Assets and liabilities recorded in foreign currencies are
translated into U.S. Dollars at exchange rates in effect at the balance sheet
date. Transactions in foreign currencies are translated at the rates of exchange
in effect on the date the transaction occurs. Translation gains and losses are
recorded in earnings and included in other operating expenses. The Company's
foreign currency transactions are principally denominated in British Pound
Sterling ("GBP") and other European currencies. For the years ended December 31,
2000, 1999 and 1998, the gain (loss) from currency conversion was $(330,000),
$442,000 and $219,000, respectively.
Some foreign subsidiaries or branches have a functional currency of either
the GBP or the Canadian Dollar ("CAD"). The cumulative translation adjustment,
representing the effect of translating these subsidiaries' or branches' assets
and liabilities into U.S. Dollars, is included in the foreign currency
translation adjustment within accumulated other comprehensive income.
On a limited basis, the Company enters into foreign currency forward
contracts as a hedge against foreign currency fluctuations. RML has revenue
streams in U.S. Dollars and Canadian Dollars but its expenses are paid in GBP.
To mitigate the foreign exchange risk, the Company entered into foreign currency
forward contracts expiring at staggered times through December, 2001. The
foreign currency forward contracts are used to convert currency at a known rate
in an amount which approximates average monthly expenses. Thus, the effect of
these transactions is to limit the foreign currency exchange risk of the
recurring monthly expenses. The Company utilizes these foreign currency forward
contracts strictly as a hedge against existing exposure to foreign currency
fluctuations rather than as a form of speculative or trading investment.
F-10
58
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
To the extent the foreign exchange forward contracts qualify for hedge
accounting treatment, the gain ($4,000 as of December 31, 2000), or loss due to
changes in fair value is not recognized in the financial statements until
realized, at which time the gain or loss is recognized along with the offsetting
loss or gain on the hedged item. To the extent the foreign currency forward
contracts do not qualify for hedge accounting treatment, the gain or loss due to
changes in fair value is recognized in the consolidated statements of earnings,
but is generally offset by changes in value of the underlying exposure.
Income Tax
The companies file a consolidated Federal income tax return and include the
foreign subsidiaries' income to the extent required by law. Deferred income tax
is accounted for using the liability method, which reflects the tax impact of
temporary differences between the bases of assets and liabilities for financial
reporting purposes and such bases as measured by tax laws and regulations.
Earnings Per Share
Basic earnings per share is based on the weighted average number of common
shares outstanding during the year divided into net earnings. Diluted earnings
per share is based on the weighted average number of common shares outstanding
plus the potential common shares outstanding during the year divided into net
earnings. Outstanding common stock options, when dilutive, are considered to be
potential common stock for the purpose of the diluted calculation. The treasury
stock method is used to calculate potential common stock outstanding due to
options.
Contingent shares to be issued are included in the earnings per share
computation when the underlying conditions for issuance have been met.
Effects of Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 133 entitled
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June, 1998 and is effective for the Company January 1, 2001. The Company has
utilized derivatives or hedging strategies on a limited basis. After adoption,
hedge effectiveness will be measured by comparing RML's actual GBP expenses with
proceeds from the forward currency forward contracts. The cumulative effect
adjustment due to this change in accounting has been calculated by the Company
and is not material to its financial position, results of operations or cash
flows nor does the Company expect the adoption of SFAS No. 133 to be material on
an ongoing basis due to its limited use of derivatives.
In addition, the Financial Accounting Standards Board has recently
announced that it proposes to change the accounting for certain acquisitions and
goodwill. This pronouncement, if finally adopted, could affect the way the
Company accounts for and the structure of future acquisitions. Final rules
implementing the announced standards are not expected until the second quarter
of 2001 and no date has been established for adopting the final standards.
Reclassifications
Certain amounts in the 1999 and 1998 consolidated financial statements have
been reclassified to conform with the 2000 presentation. Such reclassifications
had no effect on the Company's shareholders' equity, net earnings or cash flows.
F-11
59
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) ACQUISITIONS AND SUBSEQUENT EVENTS
Public Offering of Common Stock
During March 2001, the Company sold 6.9 million shares of the Company's
Common Stock in a public offering at a price of $23.35 per share. Net proceeds
from the offering amounted to approximately $152.8 million after deducting
underwriting discounts and commissions and estimated offering expenses. Most of
the proceeds, $152.5 million, were used to pay down the bank Facility. The
unaudited pro forma consolidated balance sheet gives effect to the proceeds of
the public offering as if it had occurred at December 31, 2000.
Schanen Acquisition
On January 19, 2001, the Company acquired all of the outstanding shares of
Schanen Consulting Corporation and its operating subsidiary, Schanen Consulting
Group, L.L.C. (collectively "Schanen") in exchange for 996,805 shares of the
Company's Common Stock. This business combination will be recorded using the
pooling-of-interests method of accounting. The table below shows the pro forma
effects on revenue, net earnings and net earnings per share as if the two
entities had been combined for the three years ended December 31, 2000:
2000 1999 1998
------------ ------------ ------------
Revenue:
HCC...................................... $466,167,000 $341,871,000 $308,034,000
Schanen.................................. 7,436,000 3,694,000 2,370,000
------------ ------------ ------------
Combined total revenue........... $473,603,000 $345,565,000 $310,404,000
============ ============ ============
Net earnings:
HCC...................................... $ 53,431,000 $ 25,123,000 $ 72,278,000
Schanen.................................. 2,037,000 1,449,000 832,000
------------ ------------ ------------
Combined net earnings............ $ 55,468,000 $ 26,572,000 $ 73,110,000
============ ============ ============
Combined net earnings per share data:
Basic.................................... $ 1.09 $ 0.53 $ 1.49
============ ============ ============
Diluted.................................. $ 1.07 $ 0.52 $ 1.46
============ ============ ============
F-12
60
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Purchase Acquisitions
In 1999 and 1998, the Company acquired certain businesses in transactions
accounted for using the purchase method of accounting. On a combined basis, the
fair value of assets acquired was $549.5 million in 1999 and $44.9 million in
1998. The fair value of liabilities assumed was $499.8 million in 1999 and $46.2
million in 1998. The total consideration was $227.4 million in 1999 and $50.0
million in 1998. The results of operations of these businesses have been
included in the consolidated financial statements beginning on the effective
date of each transaction. The following table lists these transactions:
CONSIDERATION
------------------------
SHARES OF GOODWILL
COMPANY'S AMORTIZATION
EFFECTIVE COMMON GOODWILL PERIOD
DATE STOCK CASH RECOGNIZED IN YEARS
--------- --------- ------------ ------------ ------------
1999
RML............................... 01/01/99 414,207 $ 64,600,000 $ 70,800,000 30
Midwest Stop Loss Underwriting.... 01/28/99 101,330 3,000,000 4,800,000 20
Centris........................... 12/31/99 -- 149,500,000 101,900,000 20
1998
Guarantee Insurance Resources..... 03/01/98 29,029 $ 21,400,000 $ 20,900,000 20
J.E. Stone and Associates, Inc.... 10/01/98 257,496 5,200,000 9,700,000 20
Sun Employer Services, Inc. ...... 11/01/98 500 17,600,000 21,300,000 30
North American Insurance
Management Corporation's
occupational accident
operations..................... 11/24/98 -- 4,000,000 4,000,000 20
The following unaudited pro forma summary presents information as if the
1999 purchase acquisitions had occurred at the beginning of each year after
giving effect to certain adjustments including amortization of goodwill,
increased interest expense from debt issued to fund the acquisitions and Federal
income taxes. Similar information for the 1998 acquisitions is not included in
this presentation as it is immaterial to the 1998 consolidated financial
statements. The pro forma summary is for information purposes only, does not
necessarily reflect the actual results that would have occurred, nor is it
necessarily indicative of future results of the combined companies. Centris,
whose results are included in the pro forma financial information below, in 1999
experienced both a loss from discontinued operations of $13.2 million and
significant underwriting losses.
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
UNAUDITED PROFORMA INFORMATION 1999 1998
- ------------------------------ --------------- ---------------
Revenue.................................................. $447,239,000 $493,551,000
Earnings (loss) from continuing operations............... (2,062,000) 69,905,000
Net earnings (loss)...................................... (15,293,000) 46,637,000
Basic earnings (loss) per share from continuing
operations............................................. (0.04) 1.46
Diluted earnings (loss) per share from continuing
operations............................................. (0.04) 1.43
Basic earnings (loss) per share.......................... (0.31) 0.97
Diluted earnings (loss) per share........................ (0.31) 0.95
F-13
61
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) INVESTMENTS
Substantially all of the Company's fixed income securities are investment
grade; most are A rated or better. The cost or amortized cost, gross unrealized
gain or loss and estimated market value of investments in fixed income and
marketable equity securities, all of which are classified as available for sale,
are as follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS MARKET VALUE
------------ ----------- ----------- ------------
December 31, 2000:
Marketable equity securities...... $ 8,896,000 $ 264,000 $(2,878,000) $ 6,282,000
US Treasury securities............ 71,155,000 1,482,000 (25,000) 72,612,000
Obligations of states,
municipalities and political
subdivisions.................... 203,768,000 5,961,000 (414,000) 209,315,000
Corporate fixed income
securities...................... 100,881,000 3,008,000 (189,000) 103,700,000
Mortgage-backed securities........ 39,722,000 1,183,000 (113,000) 40,792,000
Foreign government securities..... 7,295,000 132,000 (2,000) 7,425,000
------------ ----------- ----------- ------------
Total securities......... $431,717,000 $12,030,000 $(3,621,000) 440,126,000
============ =========== =========== ============
December 31, 1999:
Marketable equity securities...... $ 22,493,000 $ 8,000 $(2,531,000) $ 19,970,000
US Treasury securities............ 57,941,000 96,000 (532,000) 57,505,000
Obligations of states,
municipalities and political
subdivisions.................... 263,395,000 2,548,000 (2,839,000) 263,104,000
Corporate fixed income
securities...................... 14,459,000 -- (190,000) 14,269,000
Mortgage-backed securities........ 529,000 -- -- 529,000
Foreign government securities..... 7,210,000 24,000 -- 7,234,000
------------ ----------- ----------- ------------
Total securities......... $366,027,000 $ 2,676,000 $(6,092,000) $362,611,000
============ =========== =========== ============
The amortized cost and estimated market value of fixed income securities at
December 31, 2000, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties. The
weighted average life of the Company's mortgage-backed securities is four years.
ESTIMATED
AMORTIZED COST MARKET VALUE
-------------- ------------
Due in 1 year or less....................................... $ 28,258,000 $ 28,366,000
Due after 1 year through 5 years............................ 162,899,000 166,001,000
Due after 5 years through 10 years.......................... 82,861,000 85,391,000
Due after 10 years through 15 years......................... 59,201,000 60,987,000
Due after 15 years.......................................... 49,880,000 52,307,000
------------ ------------
Securities with fixed maturities.......................... 383,099,000 393,052,000
Mortgage-backed securities.................................. 39,722,000 40,792,000
------------ ------------
Total fixed income securities..................... $422,821,000 $433,844,000
============ ============
As of December 31, 2000, the Company's insurance company subsidiaries had
deposited fixed income securities with an amortized cost of approximately $32.8
million (market: $33.5 million) to meet the deposit requirements of various
insurance departments.
F-14
62
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All investments in fixed income securities and other investments were
income producing for the twelve months preceding December 31, 2000. The sources
of net investment income for the three years ended December 31, 2000, are
detailed below:
2000 1999 1998
----------- ----------- -----------
Fixed income securities....................... $22,074,000 $20,098,000 $20,711,000
Short-term investments........................ 18,043,000 10,915,000 8,079,000
Equity securities............................. 59,000 36,000 35,000
Other......................................... 4,000 -- 607,000
----------- ----------- -----------
Total investment income............. 40,180,000 31,049,000 29,432,000
Investment expense............................ (386,000) (116,000) (97,000)
----------- ----------- -----------
Net investment income............... $39,794,000 $30,933,000 $29,335,000
=========== =========== ===========
Realized pre-tax gain (loss) on the sale or write down of investments is as
follows:
GAIN LOSS NET
---------- ----------- -----------
For the year ended December 31, 2000:
Fixed income securities........................ $1,173,000 $ (970,000) $ 203,000
Marketable equity securities................... 567,000 (6,195,000) (5,628,000)
Other investments.............................. 104,000 -- 104,000
---------- ----------- -----------
Realized gain (loss)................. $1,844,000 $(7,165,000) $(5,321,000)
========== =========== ===========
For the year ended December 31, 1999:
Fixed income securities........................ $1,226,000 $(1,390,000) $ (164,000)
Marketable equity securities................... 450,000 (4,391,000) (3,941,000)
Other investments.............................. 120,000 (179,000) (59,000)
---------- ----------- -----------
Realized gain (loss)................. $1,796,000 $(5,960,000) $(4,164,000)
========== =========== ===========
For the year ended December 31, 1998:
Fixed income securities........................ $1,132,000 $ (121,000) $ 1,011,000
Marketable equity securities................... 245,000 (411,000) (166,000)
---------- ----------- -----------
Realized gain (loss)................. $1,377,000 $ (532,000) $ 845,000
========== =========== ===========
Unrealized pre-tax net investment gains (losses) on investments for three
years ended December 31, 2000 are as follows:
2000 1999 1998
----------- ------------ -----------
Fixed income securities...................... $11,916,000 $(19,024,000) $ 3,551,000
Marketable equity securities................. (91,000) (3,025,000) 888,000
Strategic operational investments............ -- 2,900,000 (1,403,000)
----------- ------------ -----------
Net unrealized investment gain
(loss)........................... $11,825,000 $(19,149,000) $ 3,036,000
=========== ============ ===========
F-15
63
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) PROPERTY AND EQUIPMENT
The following table summarizes property and equipment at December 31, 2000
and 1999:
ESTIMATED
2000 1999 USEFUL LIFE
----------- ----------- --------------
Buildings and improvements.................. $19,332,000 $20,001,000 30 to 45 years
Furniture, fixtures and equipment........... 17,286,000 16,580,000 3 to 10 years
Management information systems.............. 34,078,000 27,769,000 3 to 10 years
----------- -----------
Total property and equipment...... 70,696,000 64,350,000
Less accumulated depreciation and
amortization.............................. (31,407,000) (26,546,000)
----------- -----------
Property and equipment, net....... $39,289,000 $37,804,000
=========== ===========
Depreciation and amortization expense on property and equipment was
approximately $6.9 million, $6.7 million and $4.4 million for the years ended
December 31, 2000, 1999 and 1998, respectively.
(5) NOTES PAYABLE
Notes payable as of December 31, 2000 and 1999 are shown in the table
below. The estimated fair value of the notes payable is based on current rates
offered to the Company for debt with similar terms and approximates the carrying
value at the balance sheet dates.
PRO FORMA
DECEMBER 31, 2000 2000 1999
----------------- ------------ ------------
(UNAUDITED,
SEE NOTE 2)
Acquisition notes................................ $ 4,633,000 $ 4,633,000 $ 7,546,000
Facility......................................... 55,000,000 207,500,000 235,000,000
----------- ------------ ------------
Total notes payable.................... $59,633,000 $212,133,000 $242,546,000
=========== ============ ============
On December 17, 1999, the Company entered into a $300.0 million Revolving
Loan Facility (the "Facility") with a group of banks. Borrowing under the
Facility may be made from time to time on a revolving basis until the Facility's
expiration on December 18, 2004. Outstanding advances under the Facility bear
interest at agreed upon rates. The Facility is collateralized in part by the
stock of HC and AIC and by the stock and guarantees entered into by the
Company's principal underwriting agency and intermediary subsidiaries. The
Facility agreement contains certain restrictive covenants, including minimum net
worth requirements for the Company and certain subsidiaries, restrictions on
certain extraordinary corporate actions, notice requirements for certain
material occurrences, and required maintenance of specified financial ratios.
Management believes that the restrictive covenants and other obligations of the
Company which are contained in the Facility agreement are typical for financing
arrangements comparable to the Facility. As of December 31, 2000, total debt
outstanding under the Facility was $207.5 million and the weighted average
interest rate was 8.18%. During March 2001, the Company reduced the debt
outstanding under the Facility to $55.0 million using the proceeds from its
recent public stock offering (see Note 2).
The acquisition notes are payable to former owners of RML. The notes are
payable in decreasing amounts in four annual installments beginning January 31,
2000. The notes carry no stated interest, but were discounted at 6.25% for
financial reporting purposes when the acquisition of RML was recorded. The
interest rate used was based on current rates offered to the Company as of RML's
acquisition date.
At December 31, 2000, certain of the Company's subsidiaries maintained
revolving lines of credit with a bank in the combined maximum amount of $55.0
million available through December 31, 2001. Advances under the lines of credit
are limited to amounts required to fund draws, if any, on letters of credit
issued by the
F-16
64
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bank on behalf of the subsidiaries and short-term direct cash advances. The
lines of credit are collateralized by securities having an aggregate market
value of up to $68.8 million, the actual amount of collateral at any one time
being 125% of the aggregate amount outstanding. Interest on the lines is payable
at the bank's prime rate of interest less 1% (8.5% at December 31, 2000). At
December 31, 2000, letters of credit totaling $26.4 million had been issued to
insurance companies by the bank on behalf of the subsidiaries, with total
securities of $33.1 million collateralizing the lines.
(6) INCOME TAX
As of December 31, 2000 and 1999, the Company had income taxes receivable
of $13.2 million and $34.0 million, respectively, included in other assets in
the consolidated balance sheets. The components of the income tax provision for
the three years ended December 31, 2000 are as follows:
2000 1999 1998
----------- ----------- -----------
Current....................................... $26,948,000 $12,963,000 $32,498,000
Deferred...................................... 8,919,000 (692,000) 2,710,000
----------- ----------- -----------
Total income tax provision.......... $35,867,000 $12,271,000 $35,208,000
=========== =========== ===========
The net deferred tax asset is included in other assets in the consolidated
balance sheets. The composition of deferred tax assets and liabilities as of
December 31, 2000 and 1999, is as follows:
2000 1999
----------- ------------
Tax net operating loss carryforwards...................... $ 9,698,000 $ 11,692,000
Excess of financial unearned premium over tax............. 4,919,000 2,512,000
Effect of loss reserve discounting and salvage and
subrogation accrual for tax............................. 7,434,000 9,585,000
Unrealized loss on decrease in value of securities
available for sale (shareholders' equity)............... -- 1,611,000
Excess of financial accrued expenses over tax............. 5,520,000 10,063,000
Allowance for bad debts, not deductible for tax........... 2,484,000 2,380,000
Foreign branch net operating loss carryforwards........... 1,912,000 463,000
Valuation allowance....................................... (9,666,000) (12,091,000)
----------- ------------
Total assets.................................... 22,301,000 26,215,000
Unrealized gain on increase in value of securities
available for sale (shareholders' equity)............... 2,400,000 --
Deferred policy acquisition costs, net of ceding
commissions, deductible for tax......................... 5,237,000 1,634,000
Amortizable goodwill...................................... 3,816,000 2,346,000
Property and equipment depreciation and other items....... 4,183,000 3,984,000
----------- ------------
Total liabilities............................... 15,636,000 7,964,000
----------- ------------
Net deferred tax asset.......................... $ 6,665,000 $ 18,251,000
=========== ============
F-17
65
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in the valuation allowance account applicable to the net deferred
tax asset for the three years ended December 31, 2000 are as follows:
2000 1999 1998
----------- ----------- --------
Balance, beginning of year...................... $12,091,000 $ 50,000 $ 98,000
Increase (decrease) charged (credited) to
income........................................ -- 453,000 (48,000)
Valuation allowance related to acquired net
operating loss carryforwards.................. 3,262,000 11,588,000 --
Reduction in valuation allowance resulting from
waiver of previously acquired net operating
loss carryforwards............................ (5,687,000) -- --
----------- ----------- --------
Balance, end of year.................. $ 9,666,000 $12,091,000 $ 50,000
=========== =========== ========
In connection with the acquisition of Centris in 1999, the Company acquired
approximately $35.0 million in net operating losses for Federal income tax
purposes. As of December 31, 1999 a valuation allowance was established to
reduce the acquired net operating loss deferred tax asset to zero. During 2000,
under applicable Treasury regulations, the Company irrevocably waived (reduced)
the level of the carryforwards to approximately $16.0 million. As a consequence
of this waiver, the deferred tax asset and the related deferred tax valuation
allowance applicable to the waived net operating losses were reduced by the same
amount ($5.7 million) resulting in no change in net deferred tax assets. As of
December 31, 2000, the Company has Federal net operating loss carryforwards of
approximately $16.0 million which will expire in varying amounts through the
year 2020. Future use of the carryforwards is subject to material statutory
limitations due to prior changes of ownership. Any future tax benefit realized
from the pre-acquisition loss carryforwards will not be credited to future
income but will reduce goodwill recorded in connection with the applicable
purchase transaction. As of December 31, 2000, the Company also has
approximately $5.0 million of losses from foreign branches which are limited to
use against future income of the respective foreign branches.
The following table summarizes the differences between the Company's
effective tax rate for financial statement purposes and the Federal statutory
rate for the three years ended December 31, 2000:
2000 1999 1998
----------- ----------- -----------
Statutory tax rate.......................... 35.0% 35.0% 35.0%
Federal tax at statutory rate............... $31,255,000 $13,088,000 $37,620,000
Nontaxable municipal bond interest and
dividends received deduction.............. (3,545,000) (5,460,000) (5,753,000)
Other non deductible expenses............... 620,000 622,000 312,000
Non deductible goodwill amortization........ 2,497,000 475,000 138,000
State income taxes.......................... 4,202,000 3,011,000 3,521,000
Foreign income taxes........................ 1,537,000 4,793,000 440,000
Foreign tax credit.......................... (1,826,000) (4,354,000) (440,000)
Other, net.................................. 1,127,000 96,000 (630,000)
----------- ----------- -----------
Income tax provision........................ $35,867,000 $12,271,000 $35,208,000
=========== =========== ===========
Effective tax rate.......................... 40.2% 32.8% 32.8%
=========== =========== ===========
(7) SEGMENT AND GEOGRAPHIC DATA
The Company classifies its activities into four operating business segments
based upon services provided: 1) insurance company operations, 2) underwriting
agency operations, 3) intermediary operations, and 4) other operations. See Note
1 for a description of the services provided by and the principal subsidiaries
included in
F-18
66
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the insurance company, underwriting agency and intermediary segments. The other
operations segment performs various insurance related services and contains
insurance related investments made from time to time. The primary operating
entities in this segment principally provide insurance claims adjusting
services. Also included in other operations is income from gains or losses from
the disposition of the investments. Corporate includes general corporate
operations, and those minor operations not included in an operating segment.
Inter-segment revenue consists primarily of management fees of the underwriting
agency segment, commission income of the intermediary segment and service
revenue of the other operations charged to the insurance company segment on
business retained by the Company's insurance company subsidiaries. Inter-
segment pricing (either flat rate fees or as a percentage premium) approximates
what is charged to unrelated parties for similar services.
The performance of each segment is evaluated by management based upon net
earnings. Net earnings is calculated after tax and after all corporate expense
allocations, amortization of goodwill, interest expense on debt incurred at the
purchase date and intercompany eliminations have been charged or credited to the
individual segments.
The following tables show information by business segment and geographic
location. Geographic location is determined by physical location of the
Company's offices and does not represent the location of insureds or reinsureds
from whom the business was generated.
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------ ------------ ------------ ----------- ----------- ------------
For the year ended December 31, 2000:
Revenue:
Domestic............................. $276,240,000 $ 99,808,000 $24,089,000 $23,826,000 $ 1,035,000 $424,998,000
Foreign.............................. 15,054,000 4,446,000 21,669,000 -- -- 41,169,000
Inter-segment........................ -- 16,404,000 345,000 1,468,000 -- 18,217,000
------------ ------------ ----------- ----------- ----------- ------------
Total segment revenue.......... $291,294,000 $120,658,000 $46,103,000 $25,294,000 $ 1,035,000 484,384,000
============ ============ =========== =========== ===========
Inter-segment revenue.................. (18,217,000)
------------
Consolidated total revenue..... $466,167,000
============
Net earnings (loss):
Domestic............................. $ 27,289,000 $ 18,758,000 $ 7,809,000 $ 5,960,000 $(4,710,000) $ 55,106,000
Foreign.............................. (3,094,000) 672,000 1,366,000 -- -- (1,056,000)
------------ ------------ ----------- ----------- ----------- ------------
Total segment net earnings
(loss)....................... $ 24,195,000 $ 19,430,000 $ 9,175,000 $ 5,960,000 $(4,710,000) 54,050,000
============ ============ =========== =========== ===========
Inter-segment eliminations........... (619,000)
------------
Consolidated net earnings...... $ 53,431,000
============
Other items:
Net investment income................ $ 27,948,000 $ 7,547,000 $ 3,293,000 $ 476,000 $ 530,000 $ 39,794,000
Depreciation and amortization........ 3,662,000 11,926,000 3,535,000 385,000 368,000 19,876,000
Interest expense..................... 103,000 9,222,000 4,846,000 2,000 6,174,000 20,347,000
Restructuring expense................ 749,000 798,000 (789,000) 3,000 -- 761,000
Capital expenditures................. 3,124,000 4,651,000 1,021,000 219,000 1,074,000 10,089,000
Income tax provision (benefit)....... 8,308,000 19,565,000 6,402,000 3,578,000 (1,604,000) 36,249,000
Inter-segment eliminations........... (382,000)
------------
Consolidated income tax
provision........................ $ 35,867,000
============
F-19
67
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The agency segment incurred the $2.0 million reduction in net income
resulting from the cumulative effect of the Company's adoption of SAB 101
effective January 1, 2000. For 2000, earnings before income taxes were $90.7
million for domestic subsidiaries and a loss before income taxes of $1.4 million
for foreign subsidiaries. The insurance company subsidiaries increased their
policy issuance fees on certain 2000 contracts to reflect current market
conditions, which had the effect of reducing the underwriting agencies'
management fees $11.4 million for the year ended December 31, 2000, but as the
insurance company segment reduced its net policy acquisition costs by a like
amount, there was no effect to consolidated net income.
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------ ------------ ------------ ----------- ----------- ------------
For the year ended December 31, 1999:
Revenue:
Domestic............................... $151,044,000 $91,385,000 $31,778,000 $27,364,000 $ 681,000 $302,252,000
Foreign................................ 10,676,000 3,699,000 25,244,000 -- -- 39,619,000
Inter-segment.......................... -- 3,170,000 594,000 1,133,000 -- 4,897,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment revenue............ $161,720,000 $98,254,000 $57,616,000 $28,497,000 $ 681,000 346,768,000
============ =========== =========== =========== ===========
Inter-segment revenue.................. (4,897,000)
------------
Consolidated total revenue....... $341,871,000
============
Net earnings (loss):
Domestic............................... $ (8,631,000) $17,129,000 $ 9,042,000 $ 7,643,000 $(2,279,000) $ 22,904,000
Foreign................................ (2,078,000) 21,000 4,575,000 -- -- 2,518,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment net earnings
(loss)......................... $(10,709,000) $17,150,000 $13,617,000 $ 7,643,000 $(2,279,000) 25,422,000
============ =========== =========== =========== ===========
Inter-segment eliminations............. (299,000)
------------
Consolidated net earnings........ $ 25,123,000
============
Other items:
Net investment income.................. $ 23,400,000 $ 4,186,000 $ 2,491,000 $ 424,000 $ 432,000 $ 30,933,000
Depreciation and amortization.......... 2,880,000 5,898,000 3,776,000 264,000 580,000 13,398,000
Interest expense....................... 19,000 3,809,000 4,640,000 -- 4,496,000 12,964,000
Restructuring expense.................. 687,000 3,278,000 1,453,000 -- 71,000 5,489,000
Capital expenditures................... 2,405,000 5,339,000 110,000 585,000 637,000 9,076,000
Income tax provision (benefit)......... (13,324,000) 13,969,000 8,608,000 4,454,000 (1,242,000) 12,465,000
Inter-segment eliminations............. (194,000)
------------
Consolidated income tax provision.... $ 12,271,000
============
The insurance company segment incurred a provision for reinsurance totaling
$28.3 million, net of income tax, during 1999. Also during 1999, earnings before
income taxes was $32.3 million for domestic subsidiaries and $5.1 million for
foreign subsidiaries.
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
------------ ------------ ------------ ----------- ----------- ------------
For the year ended December 31, 1998:
Revenue:
Domestic............................... $156,715,000 $79,367,000 $33,086,000 $21,168,000 $ 2,121,000 $292,457,000
Foreign................................ 11,049,000 3,438,000 991,000 99,000 -- 15,577,000
Inter-segment.......................... -- 1,975,000 1,876,000 1,252,000 -- 5,103,000
------------ ----------- ----------- ----------- ----------- ------------
Total segment revenue............ $167,764,000 $84,780,000 $35,953,000 $22,519,000 $ 2,121,000 313,137,000
============ =========== =========== =========== ===========
Inter-segment revenue.................... (5,103,000)
------------
Consolidated total revenue....... $308,034,000
============
Net earnings (loss):
Domestic............................... $ 32,909,000 $19,283,000 $16,263,000 $ 5,210,000 $(2,676,000) $ 70,989,000
Foreign................................ 926,000 105,000 657,000 (399,000) -- 1,289,000
------------ ----------- ----------- ----------- ----------- ------------
Net earnings (loss).............. $ 33,835,000 $19,388,000 $16,920,000 $ 4,811,000 $(2,676,000) $ 72,278,000
============ =========== =========== =========== =========== ============
Other items:
Net investment income.................. $ 22,995,000 $ 3,949,000 $ 362,000 $ 536,000 $ 1,493,000 $ 29,335,000
Depreciation and amortization.......... 2,011,000 4,094,000 406,000 422,000 455,000 7,388,000
Interest expense....................... (58,000) 1,963,000 91,000 -- 4,025,000 6,021,000
Capital expenditures................... 10,405,000 2,685,000 660,000 205,000 1,365,000 15,320,000
Income tax provision (benefit)......... 9,485,000 13,025,000 10,702,000 2,885,000 (889,000) 35,208,000
F-20
68
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Assets by business segment and geographic location are shown in the
following table:
INSURANCE UNDERWRITING OTHER
COMPANY AGENCY INTERMEDIARY OPERATIONS CORPORATE TOTAL
-------------- ------------ ------------ ----------- ----------- --------------
December 31, 2000:
Domestic.............. $1,596,012,000 $559,649,000 $ 87,474,000 $ 6,908,000 $34,299,000 $2,284,342,000
Foreign............... 146,825,000 37,729,000 274,080,000 -- -- 458,634,000
-------------- ------------ ------------ ----------- ----------- --------------
Total
assets...... $1,742,837,000 $597,378,000 $361,554,000 $ 6,908,000 $34,299,000 $2,742,976,000
============== ============ ============ =========== =========== ==============
December 31, 1999:
Domestic.............. $1,567,855,000 $520,122,000 $114,818,000 $16,984,000 $42,102,000 $2,261,881,000
Foreign............... 83,882,000 28,756,000 290,205,000 -- -- 402,843,000
-------------- ------------ ------------ ----------- ----------- --------------
Total
assets...... $1,651,737,000 $548,878,000 $405,023,000 $16,984,000 $42,102,000 $2,664,724,000
============== ============ ============ =========== =========== ==============
During the year ended December 31, 1998, one broker in London, England,
produced gross written premium ("GWP") to the Company of approximately $46.1
million. This represents 10% of the Company's total GWP for that year. During
2000 and 1999, no customer produced in excess of 10% of the Company's total GWP.
(8) REINSURANCE
In the normal course of business, the Company's insurance company
subsidiaries cede a substantial portion of their premium to non-affiliated
domestic and foreign reinsurers through quota share, surplus, excess of loss and
facultative reinsurance agreements. Although the ceding of reinsurance does not
discharge the primary insurer from liability to its policyholder, the
subsidiaries participate in such agreements for the purpose of limiting their
loss exposure, protect against catastrophic loss and diversifying their
business. Most of the reinsurance assumed by the Company's insurance company
subsidiaries was underwritten directly by one of the Company's underwriting
agency subsidiaries, but issued by other non-affiliated companies in order to
satisfy local licensing, contractual or other requirements. The following table
represents the effect of such reinsurance transactions on net premium and loss
and loss adjustment expense:
LOSS AND LOSS
WRITTEN ADJUSTMENT
PREMIUM EARNED PREMIUM EXPENSE
------------- -------------- -------------
For the year ended December 31, 2000:
Direct business......................... $ 676,730,000 $ 663,458,000 $ 493,647,000
Reinsurance assumed..................... 290,727,000 311,137,000 279,999,000
Reinsurance ceded....................... (683,669,000) (706,948,000) (575,176,000)
------------- ------------- -------------
Net amounts................... $ 283,788,000 $ 267,647,000 $ 198,470,000
============= ============= =============
For the year ended December 31, 1999:
Direct business......................... $ 291,513,000 $ 294,130,000 $ 261,696,000
Reinsurance assumed..................... 276,818,000 294,103,000 423,763,000
Reinsurance ceded....................... (428,407,000) (446,871,000) (575,809,000)
------------- ------------- -------------
Net amounts................... $ 139,924,000 $ 141,362,000 $ 109,650,000
============= ============= =============
For the year ended December 31, 1998:
Direct business......................... $ 228,629,000 $ 192,536,000 $ 202,858,000
Reinsurance assumed..................... 269,647,000 260,539,000 292,064,000
Reinsurance ceded....................... (376,393,000) (309,975,000) (403,620,000)
------------- ------------- -------------
Net amounts................... $ 121,883,000 $ 143,100,000 $ 91,302,000
============= ============= =============
F-21
69
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Ceding commissions netted with policy acquisition costs in the consolidated
statements of earnings are $214.7 million, $117.0 million and $59.1 million for
the years ended December 31, 2000, 1999 and 1998, respectively.
The table below represents the composition of reinsurance recoverables in
the accompanying consolidated balance sheets:
2000 1999
------------ ------------
Reinsurance recoverable on paid losses................... $ 99,224,000 $ 91,318,000
Commuted receivable...................................... -- 53,210,000
Reinsurance recoverable on outstanding losses............ 376,778,000 382,565,000
Reinsurance recoverable on IBNR.......................... 317,467,000 214,933,000
Reserve for uncollectible reinsurance.................... (4,057,000) (5,541,000)
------------ ------------
Total reinsurance recoverables................. $789,412,000 $736,485,000
============ ============
The insurance company subsidiaries require reinsurers not authorized by the
subsidiaries' respective states of domicile to collateralize their reinsurance
obligations to the Company. The table below shows amounts held by the Company as
collateral plus other credits available for potential offset as of December 31,
2000 and 1999:
2000 1999
------------ ------------
Payables to reinsurers................................... $200,591,000 $212,962,000
Letters of credit........................................ 142,494,000 154,111,000
Cash deposits............................................ 23,813,000 19,882,000
------------ ------------
Total credits.................................. $366,898,000 $386,955,000
============ ============
In order to minimize its exposure to reinsurance credit risk, the Company
evaluates the financial condition of its reinsurers and places its reinsurance
with a diverse group of financially sound companies. The following table shows
reinsurance balances relating to the reinsurers with a net recoverable balance
greater than $10.0 million as of December 31, 2000 and 1999. The total
recoverables column includes paid loss recoverable, outstanding loss
recoverable, IBNR recoverable and ceded unearned premium.
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- --------- -------------- ------------ ------------------ ------------
December 31, 2000:
Underwriters at Lloyd's................ A United Kingdom $220,849,000 $28,602,000 $192,247,000
GE Reinsurance Corporation............. A++ Illinois 38,152,000 4,881,000 33,271,000
AXA Reinsurance Company................ A+ Delaware 40,886,000 9,131,000 31,755,000
Underwriters Indemnity Company......... A- Texas 33,912,000 2,416,000 31,496,000
SCOR Reinsurance Company............... A+ New York 28,419,000 734,000 27,685,000
American Re-Insurance Company.......... A++ Delaware 23,487,000 2,249,000 21,238,000
Transamerica Occidental Life Ins.
Co................................... A+ California 17,056,000 151,000 16,905,000
Federal Insurance Company.............. A++ Indiana 21,185,000 6,708,000 14,477,000
St. Paul Fire and Marine Insurance
Co................................... A+ Minnesota 14,290,000 -- 14,290,000
Odyssey America Reinsurance Corp....... A Connecticut 24,602,000 11,741,000 12,861,000
American Fidelity Assurance Corp....... A+ Oklahoma 21,745,000 10,680,000 11,065,000
NAC Reinsurance Corporation............ A+ New York 10,972,000 94,000 10,878,000
Chartwell Insurance Company............ A Minnesota 11,308,000 677,000 10,631,000
F-22
70
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LETTERS OF CREDIT,
A.M. BEST TOTAL CASH DEPOSITS AND
REINSURER RATING LOCATION RECOVERABLES OTHER PAYABLES NET
- --------- --------- -------------- ------------ ------------------ ------------
December 31, 1999:
Underwriters at Lloyd's................ A United Kingdom $156,650,000 $22,805,000 $133,845,000
Underwriters Indemnity Company......... A- Texas 50,451,000 4,201,000 46,250,000
SCOR Reinsurance Company............... A+ New York 41,137,000 1,740,000 39,397,000
AXA Reinsurance Company................ A+ Delaware 37,690,000 5,013,000 32,677,000
NAC Reinsurance Company................ A+ New York 23,153,000 6,105,000 17,048,000
Transamerica Occidental Life Ins.
Co................................... A+ California 22,481,000 6,102,000 16,379,000
St. Paul Fire and Marine Insurance
Co................................... A+ Minnesota 17,577,000 1,721,000 15,856,000
Odyssey America Reinsurance Corp....... A Connecticut 19,114,000 5,891,000 13,223,000
Sun Life Assurance Company of Canada... A++ Canada 17,996,000 4,786,000 13,210,000
GE Reinsurance......................... A++ Illinois 16,535,000 4,869,000 11,666,000
Chartwell Insurance Company............ A Minnesota 12,736,000 2,074,000 10,662,000
Lloyds of London is an insurance and reinsurance marketplace composed of
many independent underwriting syndicates financially supported by a central
trust fund. As of December 31, 2000, the net recoverable due from Underwriters
at Lloyd's, aggregating $192.2 million, represented balances due from over 140
different syndicates, five of which each had a net recoverable balance in excess
of $10.0 million. The largest net recoverable balance from an individual Lloyd's
syndicate as of December 31, 2000 was $26.5 million.
HCCL previously sold its entire block of life insurance and annuity
business to Life Reassurance Corporation of America (rated A++ by A.M. Best) in
the form of an indemnity reinsurance contract. Ceded life and annuity benefits
amounted to $86.8 million and $95.8 million as of December 31, 2000 and 1999,
respectively.
The Company has a reserve of $4.1 million as of December 31, 2000 for
potential collectibility issues related to reinsurance recoverables. The adverse
economic environment in the worldwide insurance industry has placed great
pressure on reinsurers and the results of their operations. Ultimately, these
conditions could affect reinsurers' solvency. Historically, there have been
insolvencies following a period of competitive pricing in the industry, such as
the marketplace has experienced for the last several years. Therefore, while
management believes that the reserve is adequate based on current available
information, conditions may change or additional information might be obtained
that would affect management's estimate of the adequacy of the level of the
reserve and which may result in a future increase or decrease in the reserve.
Management continually reviews the Company's financial exposure to the
reinsurance market and continues to take actions to protect shareholders'
equity.
During 2000, a number of reinsurers have delayed or suspended the payment
of amounts recoverable under certain reinsurance contracts to which the Company
is a party. Such delays have affected, though not materially to date, the
investment income of the Company's insurance company subsidiaries, but not to
any extent their liquidity. The Company limits its liquidity exposure by holding
funds, letters of credit or other security such that net balances due are
significantly less than the gross balances shown on the Company's consolidated
balance sheets. In addition, a number of reinsurers have claimed they are not
liable for payments to us and, in one or more cases, have sought arbitration of
these matters. The Company believes these claims are without merit and expects
to collect the full amount recoverable. The Company is currently in negotiations
with most of these parties. If such negotiations do not result in a satisfactory
resolution of the matters in question, the Company will seek a judicial or
arbitral determination of these matters.
During 1999, the Company recorded a provision for reinsurance totaling
$29.5 million in connection with the insolvency of a reinsurer. The Company
expects this provision to be sufficient. The Company also recorded a $14.0
million provision following a commutation (the contractual settlement of
outstanding and future liabilities) with another reinsurer, the majority of
which represents the present value discount of ceded losses.
F-23
71
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES
Litigation
The Company is party to numerous lawsuits and other proceedings that arise
in the normal course of its business. Many of such lawsuits and other
proceedings involve claims under policies that the Company's insurance company
subsidiaries underwrite as an insurer or reinsurer, the liabilities for which
management believes have been adequately included in the Company's loss
reserves. Also, from time to time, the Company is a party to lawsuits and other
proceedings which relate to disputes over contractual relationships with third
parties, or which involve alleged errors and omissions on the part of its
subsidiaries. Management believes the resolution of any such lawsuits will not
have a material adverse effect on the Company's financial condition, results of
operations or cash flows.
Foreign Currency Forward Contracts
On a limited basis, the Company enters into foreign currency forward
contracts as a hedge against foreign currency fluctuations. RML has revenue
streams in U.S. Dollars and Canadian Dollars but incurs expenses in GBP. To
mitigate the foreign exchange risk, the Company entered into foreign currency
forward contracts expiring at staggered times through December, 2001. As of
December 31, 2000, the Company had forward contracts to sell US $7.5 million for
GBP at an average rate of 1.00 GBP equals US $1.50 and to sell CAD $600,000 for
GBP at an average rate of 1.00 GBP equals CAD $2.18. The foreign currency
forward contracts are used to convert currency at a known rate in an amount
which approximates average monthly expenses. Thus, the effect of these
transactions is to limit the foreign currency exchange risk of the recurring
monthly expenses. The Company utilizes these foreign currency forward contracts
strictly as a hedge against existing exposure to foreign currency fluctuations
rather than as a form of speculative or trading investment. The fair value of
foreign currency forward contracts December 31, 2000 was $14,000.
Leases
The Company leases administrative office facilities under long-term
non-cancelable operating lease agreements expiring at various dates through
September, 2007. In addition to rent, the agreements generally require the
payment of utilities, real estate taxes, insurance and repairs. The Company has
recognized rent expense on a straight-line basis over the terms of these leases.
In addition, the Company leases computer equipment and automobiles under
operating leases expiring at various dates through the year 2004. Rent expense
under operating leases amounted to $7.1 million, $5.7 million, and $4.3 million,
for the years ended December 31, 2000, 1999 and 1998, respectively.
At December 31, 2000, future minimum annual rental payments required under
long-term, non-cancelable operating leases, excluding certain expenses payable
by the Company, are as follows:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE
- -------------------------------- -----------
2001................................................... $ 5,999,000
2002................................................... 4,957,000
2003................................................... 4,543,000
2004................................................... 3,163,000
2005................................................... 2,172,000
Thereafter............................................. 2,059,000
-----------
Total future minimum annual rental payments
due........................................ $22,893,000
===========
F-24
72
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Catastrophe Exposure
The Company writes business in areas exposed to catastrophic losses and has
significant exposures to this type of loss in California, the Atlantic Coast of
United States, certain United States Gulf Coast states, particularly Florida and
Texas, the Caribbean and Mexico. The Company assesses its overall exposures to a
single catastrophic event and applies procedures that it believes are more
conservative than are typically used by the industry to ascertain the Company's
probable maximum loss ("PML") from any single event. The Company maintains
reinsurance protection which it believes is sufficient to cover any foreseeable
event.
Loan Guarantee
During 1999, the Company guaranteed the construction financing debt of a
partnership in which the company is a limited partner. The total amount of the
loan commitment is $11.5 million, of which $11.1 million was funded as of
December 31, 2000.
(10) RELATED PARTY TRANSACTIONS
Certain of the Company's Directors are officers, directors or owners of
business entities with which the Company transacts business. Balances with these
business entities and other related parties included in the accompanying
consolidated balance sheets are as follows:
2000 1999
---------- ----------
Marketable equity securities................................ $2,725,000 $5,051,000
Other investments........................................... 7,182,000 3,017,000
Premiums, claims and other receivables...................... 435,000 3,347,000
Notes payable............................................... 4,633,000 7,546,000
Transactions with these business entities and other related parties
included in the accompanying consolidated statements of earnings are as follows:
2000 1999 1998
----------- ----------- -----------
Gross earned premium.......................... $ -- $ -- $ 1,716,000
Ceded earned premium.......................... -- -- 14,543,000
Commission income............................. -- -- 1,544,000
Investment income............................. 112,000 206,000 64,000
Net realized investment loss.................. (5,067,000) (4,521,000) --
Other operating income........................ 89,000 5,221,000 968,000
Gross loss and loss adjustment expense........ -- -- 3,282,000
Ceded loss and loss adjustment expense........ -- -- 37,107,000
Other operating expense....................... 757,000 578,000 840,000
Interest expense.............................. 74,000 418,000 177,000
The Company has committed to invest $5.0 million in an investment
partnership managed by a related party. As of December 31, 2000, $3.4 million
had been invested under this commitment. In 1998, HC bought an office building
to be occupied by the Company from a partnership in which an officer and
Director was a partner. The purchase price of $6.0 million was based upon
independent appraisal.
(11) EMPLOYEE BENEFIT PLANS
The Company has a defined contribution retirement plan under Section 401(k)
of the Internal Revenue Code which covers substantially all of the employees
residing in the United States who meet specified service requirements. The
contributions are discretionary and are determined by management as of the
beginning of
F-25
73
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
each calendar year. The Company currently matches each employee's contribution
to the 401(k) plan up to 6% of the employee's salary. Employees of the Company
who reside outside the United States receive comparable benefits under different
plans. The Company contributed $3.2 million, $3.1 million, and $1.7 million to
the plans for the years ended December 31, 2000, 1999 and 1998, respectively,
which is included in compensation expense in the accompanying consolidated
statements of earnings.
(12) SHAREHOLDERS' EQUITY
Under the Texas Insurance Code, HC and USSIC must each maintain minimum
statutory capital of $1.0 million and minimum statutory surplus of $1.0 million,
and can only pay dividends out of statutory surplus funds. In addition, they are
limited in the amount of dividends which they may pay in any twelve-month
period, without prior regulatory approval, to the greater of statutory net
income for the prior calendar year or ten percent (10%) of statutory
policyholders' surplus as of the prior calendar year end. During 2001, HC's and
USSIC's ordinary dividend capacities will be approximately $23.1 million and
$10.6 million, respectively.
AIC is limited by the State of Maryland in the amount of dividends which it
may pay in any twelve-month period, without prior regulatory approval, to the
greater of statutory net income (under certain conditions) for the prior
calendar year or ten percent (10%) of statutory policyholders' surplus as of the
prior year end. During 2001, AIC's ordinary dividend capacity will be
approximately $18.2 million.
HCCL is limited by the laws of the State of Indiana in the amount of
dividends it may pay in any twelve-month period, without prior regulatory
approval, to the greater of net gain from operations for the prior calendar year
or ten percent (10%) of statutory capital and surplus as of the prior year end.
During 2001, HCCL's ordinary dividend capacity will be approximately $6.3
million.
As of December 31, 2000, all of the domestic insurance company subsidiaries
total adjusted capital is significantly in excess of the NAIC authorized control
level risk-based capital.
The components of accumulated other comprehensive income (loss) are as
follows:
ACCUMULATED
UNREALIZED OTHER
FOREIGN CURRENCY INVESTMENT COMPREHENSIVE
TRANSLATION GAIN (LOSS) INCOME (LOSS)
---------------- ------------ -------------
Balance December 31, 1997................. $(306,000) $ 8,306,000 $ 8,000,000
Net change for year....................... (344,000) 2,049,000 1,705,000
--------- ------------ ------------
Balance December 31, 1998................. (650,000) 10,355,000 9,705,000
Net change for year....................... 167,000 (12,564,000) (12,397,000)
--------- ------------ ------------
Balance December 31, 1999................. (483,000) (2,209,000) (2,692,000)
Net change for year....................... (172,000) 7,577,000 7,405,000
--------- ------------ ------------
Balance December 31, 2000................. $(655,000) $ 5,368,000 $ 4,713,000
========= ============ ============
(13) >STOCK OPTIONS
The Company has five option plans, the 1994 Non-employee Director Stock
Option Plan, the 1996 Non-employee Director Stock Option Plan, the 1992
Incentive Stock Option Plan, the 1995 Flexible Incentive Plan, and the 1997
Flexible Incentive Plan. All plans are administered by the Compensation
Committee of the Board of Directors. Each option may be used to purchase one
share of Common Stock of the Company. As of December 31, 2000, 6,149,243 shares
of Common Stock were reserved for the exercise of options, of which 5,494,229
shares were reserved for options previously granted and 655,014 shares were
reserved for future issuances of options.
F-26
74
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options vest over a zero to five year period and expire four to ten years
after grant date. All options have been granted at fixed exercise prices,
generally at the market price of the Company's Common Stock on the grant date.
Any excess of the market price on the grant date over the exercise price is
recognized as compensation expense in the accompanying consolidated financial
statements. If the fair value method of valuing compensation related to options
would have been used, pro forma net earnings and pro forma diluted earnings per
share would have been $48.7 million, or $0.96 per share, for the year ended
December 31, 2000; $20.7 million, or $0.42 per share, for the year ended
December 31, 1999; and $65.4 million, or $1.34 per share, for the year ended
December 31, 1998. The fair value of each option grant was estimated on the
grant date using the Black-Scholes single option pricing model with the
following weighted average assumptions: a) risk free interest rate of 6.4% for
2000, 5.7% for 1999 and 5.3% for 1998, b) expected volatility factor of .3, c)
dividend yield of 0.89% for 2000, 1.52% for 1999 and 0.91% for 1998, and d)
expected option life of four years for 2000 and 1999, and five years for 1998.
The average fair value of options granted during the years ended December 31,
2000, 1999 and 1998 was $4.51, $4.16 and $5.23, respectively.
The following table provides an analysis of stock option activity during
the three years ended December 31, 2000:
2000 1999 1998
--------------------- --------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
---------- -------- ---------- -------- --------- --------
Outstanding, beginning of
year....................... 5,470,008 $16.08 5,459,766 $16.73 3,508,226 $16.22
Granted at market value...... 1,745,000 13.59 1,869,600 13.48 2,779,500 17.01
Forfeitures and
expirations................ (434,242) 18.32 (1,327,243) 18.36 (192,462) 21.48
Exercised.................... (1,286,537) 14.34 (532,115) 7.88 (635,498) 14.05
---------- ------ ---------- ------ --------- ------
Outstanding, end of year..... 5,494,229 $15.54 5,470,008 $16.08 5,459,766 $16.73
========== ====== ========== ====== ========= ======
Exercisable, end of year..... 2,716,705 $16.59 2,982,872 $16.84 2,792,707 $15.92
========== ====== ========== ====== ========= ======
Options outstanding and exerciseable as of December 31, 2000 are shown on
the following schedule:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- --------------------
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OF SHARES CONTRACTUAL LIFE PRICE OF SHARES PRICE
- --------------- --------- ---------------- -------- --------- --------
Under $16.00................... 2,614,400 4.80 years $11.53 952,454 $11.41
$16.00-$16.99.................. 1,434,546 3.51 16.45 821,319 16.46
Over $16.99.................... 1,445,283 5.30 21.88 942,932 21.94
--------- ---------- ------ --------- ------
Total options........ 5,494,229 4.59 years $15.54 2,716,705 $16.59
========= ========== ====== ========= ======
F-27
75
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) EARNINGS PER SHARE
The following table provides reconciliation of the denominators used in the
earnings per share calculations for the three years ended December 31, 2000:
2000 1999 1998
----------- ----------- -----------
Net earnings................................... $53,431,000 $25,123,000 $72,278,000
=========== =========== ===========
Reconciliation of number of shares outstanding:
Shares of Common Stock outstanding at year
end.......................................... 50,345,000 48,839,000 48,252,000
Changes in Common Stock due to issuance........ (908,000) (241,000) (332,000)
Contingent shares to be issued................. 39,000 49,000 --
Common Stock contractually issuable in the
future....................................... 269,000 414,000 --
----------- ----------- -----------
Weighted average Common Stock
outstanding........................ 49,745,000 49,061,000 47,920,000
Additional dilutive effect of outstanding
options (as determined by the application of
the treasury stock method)................... 877,000 588,000 1,016,000
----------- ----------- -----------
Weighted average Common Stock and
potential common stock
outstanding........................ 50,622,000 49,649,000 48,936,000
=========== =========== ===========
As of December 31, 2000, there were approximately 1.5 million options that
were not included in the computation of diluted earnings per share because to do
so would have been antidilutive. As part of a 1999 purchase agreement, up to
378,000 shares of the Company's Common Stock are to be issued if certain
conditions are met. Of these shares, 94,500 have been issued and 39,000 are
included in the 2000 computation because the contingency had been partially met.
The remainder of the contingent shares were not included in the earnings per
share computation because the conditions for issuance of the remaining shares
have not yet been met.
(15) STATUTORY INFORMATION
The Company's insurance company subsidiaries file financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted by domestic or foreign insurance regulatory authorities. The
differences between statutory financial statements and financial statements
prepared in accordance with GAAP vary between domestic and foreign
jurisdictions. The principal differences are that for statutory financial
statements deferred policy acquisition costs are not recognized, deferred income
taxes are not recorded, bonds are generally carried at amortized cost, certain
assets are non-admitted and charged directly to surplus, a liability for a
provision for reinsurance is recorded and charged directly to surplus and
insurance assets and liabilities are presented net of reinsurance. The Company's
use of permitted statutory accounting practices does not have a significant
impact on statutory surplus. Statutory policyholders' surplus, and net income
for the three years ended December 31, 2000, after intercompany eliminations, of
the Company's insurance company subsidiaries included in those companies'
respective filings with regulatory authorities are as follows:
2000 1999 1998
------------ ------------ ------------
Statutory policyholders' surplus........... $326,249,000 $315,474,000 $369,401,000
Statutory net income (loss)................ 13,749,000 (8,707,000) 53,162,000
F-28
76
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Statutory policyholders' surplus has been adversely affected by statutory
adjustments for reinsurance recoverables which, although required statutorily,
have no effect on net earnings or shareholders' equity. The statutory net loss
for 1999 includes a $25.5 million loss, net of income tax, from the provision
for reinsurance.
The National Association of Insurance Commissioners adopted Statements of
Statutory Accounting Principles in March, 1998 as a product of its attempt to
codify statutory accounting principles. Although subject to adoption by the
individual states, an effective date of January 1, 2001 was established for
implementation of the statements. Prior to the codification project, a
comprehensive guide to statutory accounting principles did not exist.
Codification is new and will evolve over time. The cumulative effect of
codification is expected to increase statutory policyholders' surplus of the
Company's insurance company subsidiaries by approximately $6.0 million. The
Company expects that the statutory surplus of its insurance company subsidiaries
after adoption will continue to be in excess of their regulatory risk-based
capital requirements.
(16) OTHER INFORMATION
Supplemental Cash Flow Information
Supplemental cash flow information for the three years ended December 31,
2000, is summarized below:
2000 1999 1998
----------- ----------- -----------
Interest paid................................. $17,418,000 $13,694,000 $ 5,409,000
Income tax paid............................... 11,859,000 23,116,000 30,662,000
Dividends declared but not paid at year end... 3,023,000 2,442,000 1,930,000
The unrealized gain or loss on securities available for sale, deferred
taxes related thereto and the issuance of the Company's Common Stock for the
purchase of subsidiaries are non-cash transactions which have been included as
direct increases or decreases in shareholders' equity. The cumulative effect of
accounting change due to the Company's adoption of SAB 101 is a non-cash charge
to earnings.
Restructuring
As of December 31, 1999, the Company had accrued two separate restructuring
liabilities, one relating to HCC's ongoing operations ("HCC Internal") and
another relating to HCC's acquisition of Centris. Changes in the accruals
between December 31, 1999 and December 31, 2000 are shown in the tables below:
ACCRUED AT 2000 ACCRUED AT
12/31/99 PAID IN 2000 ADJUSTMENTS 12/31/00
----------- ------------ ----------- -----------
HCC Internal Restructuring
Severance........................... $3,115,000 $3,115,000 $ -- $ --
Other............................... 911,000 292,000 (514,000) 105,000
---------- ---------- --------- --------
Total....................... $4,026,000 $3,407,000 $(514,000) $105,000
========== ========== ========= ========
During 2000, the Company determined that one of the leased offices
scheduled to be closed would be retained. Therefore, the Company reversed
$789,000 (included as a credit in other operating expenses) of the restructuring
expense recorded during the fourth quarter of 1999, of which $514,000 was the
reversal of the accrual for the future lease payments and $275,000 was the
reversal of the write down of certain assets.
F-29
77
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ACCRUED AT 2000 ACCRUED AT
12/31/99 PAID IN 2000 ADJUSTMENTS 12/31/00
----------- ------------ ----------- -----------
Centris Restructuring
Contractual executive severance
accruals........................ $5,866,000 $6,027,000 $ 166,000 $ 5,000
Other severance accruals........... 397,000 541,000 258,000 114,000
Lease obligation accruals.......... 848,000 1,004,000 1,196,000 1,040,000
---------- ---------- ---------- ----------
Total...................... $7,111,000 $7,572,000 $1,620,000 $1,159,000
========== ========== ========== ==========
The adjustments in 2000 were recorded as management decided to take
additional steps to integrate parts of the Centris operations.
During the fourth quarter of 2000, the Company also recorded a
restructuring charge and associated expenses of $1.5 million. A total of 26
employees were or will be terminated as a result of the Company's restructuring
of certain underwriting agency operations and their integration into the
Company's insurance company operations. The charges affected both segments and
consisted of $557,000 accrued severance pay to be paid at various times
throughout 2001 and $992,000 for the write down or write off of various impaired
assets, primarily redundant computer software.
Restructuring charges of $761,000 in 2000 and $5.5 million in 1999 are
included in other operating expenses in the consolidated statements of earnings.
(17) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE
The following table provides a reconciliation of the liability of loss and
loss adjustment expense ("LAE"), for the three years ended December 31, 2000:
2000 1999 1998
------------ ------------ ------------
Reserves for loss and LAE at beginning of the
year............................................. $871,104,000 $460,511,000 $275,008,000
Less reinsurance recoverables...................... 597,498,000 341,599,000 155,374,000
------------ ------------ ------------
Net reserves at beginning of the year............ 273,606,000 118,912,000 119,634,000
Net reserve adjustments from acquisition and
disposition of subsidiaries...................... 514,000 55,523,000 3,877,000
Effect on loss reserves of write off of ceded
outstanding and IBNR reinsurance recoverables.... -- 82,343,000 --
Provision for loss and LAE for claims occurring in
the current year................................. 208,055,000 105,036,000 105,895,000
Increase (decrease) in estimated loss and LAE for
claims occurring in prior years.................. (9,585,000) 4,614,000 (14,593,000)
------------ ------------ ------------
Incurred loss and LAE, net of reinsurance........ 198,470,000 109,650,000 91,302,000
------------ ------------ ------------
Loss and LAE payments for claims occurring during:
Current year....................................... 76,725,000 36,770,000 47,126,000
Prior years........................................ 145,993,000 56,052,000 48,775,000
------------ ------------ ------------
Loss and LAE payments, net of reinsurance........ 222,718,000 92,822,000 95,901,000
------------ ------------ ------------
Net reserves at end of the year.................... 249,872,000 273,606,000 118,912,000
Plus reinsurance recoverables...................... 694,245,000 597,498,000 341,599,000
------------ ------------ ------------
Reserves for loss and LAE at end of the
year.................................... $944,117,000 $871,104,000 $460,511,000
============ ============ ============
F-30
78
HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 2000, the Company had net loss and LAE redundancy of $9.6 million
relating to prior year losses compared to a deficiency of $4.6 million in 1999
and a redundancy of $14.6 million in 1998. The deficiencies and redundancies in
the reserves result from the Company's and its actuaries' continued review of
its loss reserves and the increase or reduction of such reserves as losses are
finally settled and claims exposures are reduced. The Company believes it has
provided for all material net incurred losses.
The Company has no material exposure to environmental pollution losses, as
HC only began writing business in 1981 and policies issued by HC normally
contain pollution exclusion clauses which limit pollution coverage to "sudden
and accidental" losses only, thus excluding intentional (dumping) and seepage
claims. Policies issued by AIC and USSIC, because of the types of risks
incurred, principally general aviation, are not considered to have significant
environmental exposures. Therefore, the Company should not experience any
material development in reserves from environmental pollution claims.
(18) QUARTERLY FINANCIAL DATA (UNAUDITED; AMOUNTS IN THOUSANDS, EXCEPT PER SHARE
DATA)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER
------------------ ------------------ ------------------ ------------------
2000 1999 2000 1999 2000 1999 2000 1999
-------- ------- -------- ------- -------- ------- -------- -------
Total revenue...................... $108,308 $84,308 $118,681 $83,093 $119,089 $82,483 $120,089 $91,987
Earnings (loss) before accounting
change........................... 13,404 (4,991) 16,994 9,118 12,411 287 12,635 20,709
Cumulative effect of accounting
change........................... -- -- -- -- -- -- (2,013) --
-------- ------- -------- ------- -------- ------- -------- -------
Net earnings (loss)................ $ 13,404 $(4,991) $ 16,994 $ 9,118 $ 12,411 $ 287 $ 10,622 $20,709
======== ======= ======== ======= ======== ======= ======== =======
Basic earnings (loss) per share
data:
Earnings (loss) before accounting
change........................... $ 0.27 $ (0.10) $ 0.34 $ 0.19 $ 0.25 $ 0.01 $ 0.26 $ 0.42
Cumulative effect of accounting
change........................... -- -- -- -- -- -- (0.04) --
-------- ------- -------- ------- -------- ------- -------- -------
Earnings (loss) per share.......... $ 0.27 $ (0.10) $ 0.34 $ 0.19 $ 0.25 $ 0.01 $ 0.22 $ 0.42
======== ======= ======== ======= ======== ======= ======== =======
Weighted average shares
outstanding...................... 50,184 49,193 49,742 49,130 49,528 48,951 49,403 48,764
======== ======= ======== ======= ======== ======= ======== =======
Diluted earnings (loss) per share
data:
Earnings (loss) before accounting
change........................... $ 0.26 $ (0.10) $ 0.33 $ 0.18 $ 0.25 $ 0.01 $ 0.25 $ 0.42
Cumulative effect of accounting
change........................... -- -- -- -- -- -- (0.04) --
-------- ------- -------- ------- -------- ------- -------- -------
Earnings (loss) per share.......... $ 0.26 $ (0.10) $ 0.33 $ 0.18 $ 0.25 $ 0.01 $ 0.21 $ 0.42
======== ======= ======== ======= ======== ======= ======== =======
Weighted average shares
outstanding...................... 51,533 49,193 51,040 49,866 50,086 49,971 49,709 49,544
======== ======= ======== ======= ======== ======= ======== =======
During 1999, pre-tax provisions for reinsurance of $29.5 million and $14.0
million were recorded in the second quarter and fourth quarter, respectively.
Also, during the fourth quarter of 1999, the Company recorded a pre-tax
restructuring expense of $5.5 million. During the fourth quarter of 2000, the
Company recorded a $4.4 million pre-tax increase in reserves of discontinued
lines of business that were part of the 1999 Centris acquisition and a $1.5
million in pre-tax restructuring expense. The sum of the quarters earnings
(loss) per share may not equal the annual amounts due to rounding. The net
earnings shown in the above table for the first quarter of 2000 do not match the
amount reported in the Form 10-Q filed with the SEC due to the cumulative effect
of the change in accounting principle subsequently recorded due to the Company's
adoption of SAB 101.
F-31
79
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULES
To the Board of Directors and Shareholders
HCC Insurance Holdings, Inc.:
Our report on the consolidated financial statements of HCC Insurance
Holdings, Inc., which included an emphasis paragraph related to a change in the
Company's method of revenue recognition for certain contracts, is included on
page F-1 of this Form 10-K. In connection with our audits of such financial
statements, we have also audited the financial statements schedules listed in
Item 14(b) of this Form 10-K. These financial statement schedules are the
responsibility of the Company's management.
In our opinion, these financial statement schedules present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
March 21, 2001
S-1
80
SCHEDULE 1
HCC INSURANCE HOLDINGS, INC.
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2000
COLUMN A COLUMN B COLUMN C COLUMN D
- -------- ------------ ------------ ---------------
AMOUNT AT WHICH
SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- ------------------ ------------ ------------ ---------------
Fixed maturities:
Bonds -- United States government and government
agencies and authorities..................... $ 71,155,000 $ 72,612,000 $ 72,612,000
Bonds -- states, municipalities and political
subdivisions................................. 61,076,000 62,506,000 62,506,000
Bonds -- special revenue........................ 142,692,000 146,809,000 146,809,000
Bonds -- corporate.............................. 100,881,000 103,700,000 103,700,000
Mortgage backed securities...................... 39,722,000 40,792,000 40,792,000
Bonds -- foreign government..................... 7,295,000 7,425,000 7,425,000
------------ ------------ ------------
Total fixed maturities.................. 422,821,000 $433,844,000 433,844,000
------------ ============ ------------
Equity securities:
Common stocks -- banks, trusts and insurance
companies.................................... 2,551,000 $ 1,511,000 1,511,000
Common stocks -- industrial..................... 3,342,000 1,575,000 1,575,000
Non-redeemable preferred stocks................. 3,003,000 3,196,000 3,196,000
------------ ------------ ------------
Total equity securities................. 8,896,000 $ 6,282,000 6,282,000
------------ ============ ------------
Short-term investments............................ 262,982,000 262,982,000
Other investments................................. 7,182,000 7,182,000
------------ ------------
Total investments....................... $701,881,000 $710,290,000
============ ============
S-2
81
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
DECEMBER 31,
---------------------------
2000 1999
------------ ------------
ASSETS
Cash........................................................ $ 886,000 $ 23,000
Short-term investments...................................... 2,660,000 395,000
Investment in subsidiaries.................................. 614,536,000 626,802,000
Receivable from subsidiaries................................ 1,437,000 5,840,000
Intercompany loans to subsidiaries.......................... 126,325,000 76,260,000
Other assets................................................ 3,974,000 3,996,000
------------ ------------
Total assets...................................... $749,818,000 $713,316,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable............................................... $207,500,000 $235,000,000
Note payable to related party............................... 4,633,000 7,546,000
Deferred Federal income tax................................. 562,000 948,000
Accounts payable and accrued liabilities.................... 7,688,000 12,394,000
------------ ------------
Total liabilities................................. 220,383,000 255,888,000
Total shareholders' equity........................ 529,435,000 457,428,000
------------ ------------
Total liabilities and shareholders' equity........ $749,818,000 $713,316,000
============ ============
See Notes to Condensed Financial Information.
S-3
82
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
Equity in earnings of subsidiaries.................... $60,379,000 $30,948,000 $75,228,000
Interest income from subsidiaries..................... 9,160,000 4,165,000 2,052,000
Interest income....................................... 343,000 146,000 285,000
Net realized investment gain.......................... -- -- 840,000
Other income.......................................... 146,000 73,000 --
----------- ----------- -----------
Total revenue............................... 70,028,000 35,332,000 78,405,000
Interest expense...................................... 20,249,000 12,907,000 6,036,000
Other operating expense............................... 1,582,000 266,000 1,730,000
----------- ----------- -----------
Total expense............................... 21,831,000 13,173,000 7,766,000
----------- ----------- -----------
Earnings before income tax benefit.......... 48,197,000 22,159,000 70,639,000
Income tax benefit.................................... 5,234,000 2,964,000 1,639,000
----------- ----------- -----------
Net earnings................................ $53,431,000 $25,123,000 $72,278,000
=========== =========== ===========
See Notes to Condensed Financial Information.
S-4
83
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
2000 1999 1998
----------- ------------ -----------
Net earnings......................................... $53,431,000 $ 25,123,000 $72,278,000
Other comprehensive income net of tax:
Foreign currency translation adjustment............ (172,000) 167,000 (344,000)
Investment gains (losses):
Investment gains during the year, net of deferred
tax charge of $294,000 in 1998.................. -- -- 546,000
Consolidated subsidiaries' investment gains
(losses) during the year, net of deferred tax
charge (benefit) of, $2,386,000 in 2000;
$(8,042,000) in 1999; and $1,205,000 in 1998.... 4,118,000 (15,271,000) 2,454,000
Less reclassification adjustment for gains included
in net earnings, net of deferred tax charge of
$294,000 in 1998................................ -- -- (546,000)
Less consolidated subsidiaries' reclassification
adjustments for (gains) losses included in net
earnings, net of deferred tax (charge) benefit
of $1,862,000 in 2000; $1,457,000 in 1999, and
($218,000) in 1998.............................. 3,459,000 2,707,000 (405,000)
----------- ------------ -----------
Other comprehensive income (loss).................... 7,405,000 (12,397,000) 1,705,000
----------- ------------ -----------
Comprehensive income....................... $60,836,000 $ 12,726,000 $73,983,000
=========== ============ ===========
See Notes to Condensed Financial Information.
S-5
84
SCHEDULE 2
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
2000 1999 1998
------------ ------------- ------------
Cash flows from operating activities:
Net earnings.................................... $ 53,431,000 $ 25,123,000 $ 72,278,000
Adjustment to reconcile net earnings to net cash
provided (used) by operating activities:
Undistributed net income of subsidiaries........ (60,379,000) (30,948,000) (75,228,000)
Change in deferred Federal income tax, net of
tax effect of unrealized gain or loss........ (885,000) 687,000 3,934,000
Changes in other assets and other............... (245,000) 2,252,000 --
Depreciation.................................... 24,000 29,000 29,000
Increase in accrued interest receivable added to
intercompany loan balances................... (5,160,000) (4,035,000) (2,052,000)
Change in accounts payable and accrued
liabilities.................................. (5,286,000) (7,819,000) 124,000
Net realized investment gain.................... -- -- (840,000)
------------ ------------- ------------
Cash used by operating activities............ (18,500,000) (14,711,000) (1,755,000)
Cash flows from investing activities:
Sales of other operating investments............ 307,000 -- --
Sales of fixed income securities................ -- -- 16,680,000
Cash contributions to subsidiaries.............. (1,130,000) (36,030,000) (62,000)
Purchase of subsidiaries........................ (10,345,000) (201,947,000) (30,355,000)
Change in short-term investments................ (2,265,000) 4,144,000 (3,339,000)
Cost of investment acquired..................... -- (2,898,000) (2,525,000)
Change in receivable from subsidiaries.......... 4,403,000 10,084,000 (4,056,000)
Intercompany loans to subsidiaries.............. (16,509,000) (27,404,000) (34,530,000)
Payments on intercompany loans to
subsidiaries................................. 42,838,000 66,595,000 15,986,000
Cash dividends from subsidiaries................ 21,598,000 93,228,000 24,450,000
------------ ------------- ------------
Cash provided (used) by investing
activities................................. 38,897,000 (94,228,000) (17,751,000)
Cash flows from financing activities:
Proceeds from note payable...................... 26,700,000 547,000,000 74,200,000
Payments on notes payable....................... (57,042,000) (433,600,000) (49,950,000)
Sale of Common Stock............................ 21,158,000 4,783,000 2,203,000
Dividends paid.................................. (10,350,000) (9,221,000) (7,139,000)
------------ ------------- ------------
Cash provided (used) by financing
activities................................. (19,534,000) 108,962,000 19,314,000
------------ ------------- ------------
Net change in cash.............................. 863,000 23,000 (192,000)
Cash as of beginning of year.................... 23,000 -- 192,000
------------ ------------- ------------
Cash as of end of year.......................... $ 886,000 $ 23,000 $ --
============ ============= ============
See Notes to Condensed Financial Information.
S-6
85
HCC INSURANCE HOLDINGS, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL INFORMATION
(1) The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements and the related notes
thereto of HCC Insurance Holdings, Inc. and Subsidiaries. Investments in
subsidiaries are accounted for using the equity method.
(2) Intercompany loans to subsidiaries are demand notes issued primarily to fund
the cash portion of acquisitions. They bear interest at a rate set by
management, which approximates the interest rate charged to the Company for
similar debt. As of December 31, 2000, the interest rate on intercompany
loans was 8%.
S-7
86
SCHEDULE 3
HCC INSURANCE HOLDINGS, INC.
SUPPLEMENTARY INSURANCE INFORMATION
(DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C(1) COLUMN D(1) COLUMN F COLUMN G(2) COLUMN H
- ---------------------------- ----------------- ----------------- ----------- -------- -------------- -----------------
DECEMBER 31, FOR THE YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------- ---------------------------------------------
FUTURE POLICY BENEFITS, CLAIMS,
BENEFITS, LOSSES, LOSSES AND
DEFERRED POLICY CLAIMS AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT
SEGMENTS ACQUISITION COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES
- -------- ----------------- ----------------- ----------- -------- -------------- -----------------
2000
Insurance Company.......... $ 9,095 $1,030,877 $190,550 $267,647 $27,948 $198,470
Underwriting Agency........ 7,547
Intermediary............. 3,293
Other Operations........... 476
Corporate.............. 530
------- ---------- -------- -------- ------- --------
Total................ $ 9,095 $1,030,877 $190,550 $267,647 $39,794 $198,470
======= ========== ======== ======== ======= ========
1999
Insurance Company.......... $ 658 $ 966,864 $188,524 $141,362 $23,400 $109,650
Underwriting Agency........ 4,186
Intermediary............. 2,491
Other Operations........... 424
Corporate.............. 432
------- ---------- -------- -------- ------- --------
Total................ $ 658 $ 966,864 $188,524 $141,362 $30,933 $109,650
======= ========== ======== ======== ======= ========
1998
Insurance Company.......... $(3,615) $ 460,511 $201,050 $143,100 $22,995 $ 91,302
Underwriting Agency........ 3,949
Intermediary............. 362
Other Operations........... 536
Corporate.............. 1,493
------- ---------- -------- -------- ------- --------
Total................ $(3,615) $ 460,511 $201,050 $143,100 $29,335 $ 91,302
======= ========== ======== ======== ======= ========
COLUMN A COLUMN I COLUMN J(3) COLUMN K
- ---------------------------- ----------------- ----------- --------
FOR THE YEARS ENDED DECEMBER 31,
- ---------------------------- ------------------------------------------
AMORTIZATION OF OTHER
DEFERRED POLICY OPERATING PREMIUM
SEGMENTS ACQUISITION COSTS EXPENSES WRITTEN
- -------- ----------------- ----------- --------
2000
Insurance Company.......... $23,743 $ 19,849 $283,788
Underwriting Agency........ 69,092
Intermediary............. 25,679
Other Operations........... 15,755
Corporate.............. 586
------- -------- --------
Total................ $23,743 $130,961 $283,788
======= ======== ========
1999
Insurance Company.......... $ 8,177 $ 63,963 $139,924
Underwriting Agency........ 63,325
Intermediary............. 30,416
Other Operations........... 16,399
Corporate.............. (417)
------- -------- --------
Total................ $ 8,177 $173,686 $139,924
======= ======== ========
1998
Insurance Company.......... $10,978 $ 17,555 $121,883
Underwriting Agency........ 50,325
Intermediary............. 8,241
Other Operations........... 14,936
Corporate.............. 1,190
------- -------- --------
Total................ $10,978 $ 92,247 $121,883
======= ======== ========
- ---------------
(1) Columns C and D are shown ignoring the effects of reinsurance.
(2) Net investment income was allocated to the subsidiary, and therefore the
segment, on which the related investment asset was recorded.
(3) Other operating expenses is after all corporate expense allocations and
amortization of goodwill have been charged or credited to the individual
segments.
Note: Column E is omitted because the Company has no other policy claims and
benefits payable.
S-8
87
SCHEDULE 4
HCC INSURANCE HOLDINGS, INC.
REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- -------- ------------- -------------- ------------ ------------ ----------
(1) PERCENT OF
ASSUMED FROM AMOUNT
CEDED TO OTHER OTHER ASSUMED
DIRECT AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET
------------- -------------- ------------ ------------ ----------
For the year ended December
31, 2000:
Life insurance in force...... $633,988,000 $633,851,000 $ 0 $ 137,000 0%
============ ============ ============ ============ ===
Earned premium:
Property and liability
insurance.................. $290,928,000 $285,020,000 $ 92,253,000 $ 98,161,000 94%
Accident and health
insurance.................. 372,530,000 421,928,000 218,884,000 169,486,000 129%
------------ ------------ ------------ ------------
Total.............. $663,458,000 $706,948,000 $311,137,000 $267,647,000 116%
============ ============ ============ ============ ===
For the year ended December
31, 1999:
Life insurance in force...... $832,305,000 $799,573,000 $ 0 $ 32,732,000 0%
============ ============ ============ ============ ===
Earned premium:
Property and liability
insurance.................. $230,879,000 $277,089,000 $127,495,000 $ 81,285,000 157%
Accident and health
insurance.................. 63,251,000 169,782,000 166,608,000 60,077,000 277%
------------ ------------ ------------ ------------
Total.............. $294,130,000 $446,871,000 $294,103,000 $141,362,000 208%
============ ============ ============ ============ ===
For the year ended December
31, 1998:
Earned premium:
Property and liability
insurance.................. $190,030,000 $233,549,000 $140,354,000 $ 96,835,000 145%
Accident and health
insurance.................. 2,506,000 76,426,000 120,185,000 46,265,000 260%
------------ ------------ ------------ ------------
Total.............. $192,536,000 $309,975,000 $260,539,000 $143,100,000 182%
============ ============ ============ ============ ===
- ---------------
(1) Most of the reinsurance assumed by the Company's insurance company
subsidiaries was underwritten directly by one of the Company's underwriting
agency subsidiaries, but issued by other non-affiliated companies in order
to satisfy local licensing, contractual or other requirements.
S-9
88
SCHEDULE 5
HCC INSURANCE HOLDINGS, INC.
VALUATION AND QUALIFYING ACCOUNTS
2000 1999 1998
----------- ------------ ----------
Reserve for uncollectible reinsurance:
Balance as of beginning of year..................... $ 5,541,000 $ 2,499,000 $2,535,000
Total provision charged to expense.................. 465,000 43,650,000 60,000
Total amounts written off........................... (1,949,000) (40,608,000) (96,000)
----------- ------------ ----------
Balance as of end of year........................... $ 4,057,000 $ 5,541,000 $2,499,000
=========== ============ ==========
Allowance for doubtful accounts:
Balance as of beginning of year..................... $ 1,729,000 $ 284,000 $ 220,000
Acquisitions of subsidiaries........................ -- 629,000 --
Total provision charged to expense.................. 2,740,000 1,171,000 783,000
Total amounts written off........................... (1,219,000) (355,000) (719,000)
----------- ------------ ----------
Balance as of end of year........................... $ 3,250,000 $ 1,729,000 $ 284,000
=========== ============ ==========
S-10
89
INDEX TO EXHIBITS
(Items denoted by a letter are incorporated by reference to other documents
previously filed with the Securities and Exchange Commission as set forth at the
end of this index. Items not denoted by a letter are being filed herewith.)
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(B)3.1 -- Bylaws of HCC Insurance Holdings, Inc., as amended.
(A)3.2 -- Restated Certificate of Incorporation and Amendment of
Certificate of Incorporation of HCC Insurance Holdings,
Inc., filed with the Delaware Secretary of State on July
23, 1996 and May 21, 1998, respectively.
(B)4.1 -- Specimen of Common Stock Certificate, $1.00 par value, of
HCC Insurance Holdings, Inc.
(C)10.1 -- Stock Purchase Agreement dated effective October 1, 1998
by and among HCC Insurance Holdings, Inc., and Sun
Employer Services, Inc. and Howard V. Barton and
Elizabeth A. Barton.
(D)10.2 -- Share Purchase Agreement dated January 29, 1999, among
HCC Insurance Holdings, Inc. and Gerald Axel, Barry J.
Cook, Gary J. Lockett, Christopher F.B. Mays, Mark E.
Rattner, Marshall Rattner, Inc., John Smith and Keith W.
Steed.
10.3 -- Agreement and Plan of Merger dated as of January 19, 2001
by and among HCC Insurance Holdings, Inc., HCC Employee
Benefits, Inc. and James Scott Schanen, Lisa Rae Schanen,
Conor Schanen qsst, Austin Schanen qsst, Kevin Tolbert
and Schanen Consulting Corporation.
(E)10.4 -- Loan Agreement ($300,000,000 Revolving Loan Facility)
dated as of December 17, 1999 among HCC Insurance
Holdings, Inc. as Borrower, Wells Fargo Bank (Texas),
National Association, as Agent, lead arranger and lender,
Bank of America, N.A. as documentation agent and lender,
Bank of New York as senior managing agent and lender,
Bank One, N.A. as co-agent and lender, First Union
National Bank as syndications agent and lender and
Dresdner Bank AG, New York and Grand Cayman Branches, as
co-agent and a lender.
(F)10.5 -- HCC Insurance Holdings, Inc. 1994 Nonemployee Director
Stock Option Plan.
(G)10.6 -- HCC Insurance Holdings, Inc. 1992 Incentive Stock Option
Plan, as amended and restated.
(G)10.7 -- HCC Insurance Holdings, Inc. 1995 Flexible Incentive
Plan, as amended and restated.
(G)10.8 -- HCC Insurance Holdings, Inc. 1997 Flexible Incentive
Plan, as amended and restated.
(G)10.9 -- HCC Insurance Holdings, Inc. 1996 Nonemployee Director
Stock Option Plan, as amended and restated.
(D)10.10 -- Employment Agreement effective as of January 1, 1999,
between HCC Insurance Holdings, Inc. and Stephen L. Way.
(G)10.11 -- Employment Agreement effective as of January 5, 2000,
between HCC Insurance Holdings, Inc. and John N. Molbeck,
Jr.
10.12 -- Employment Agreement effective as of January 5, 2000,
between HCC Insurance Holdings, Inc. and Benjamin D.
Wilcox.
10.13 -- Employment Agreement effective as of January 5, 2000,
between HCC Insurance Holdings, Inc. and Frank J.
Bramanti.
(H)10.14 -- Employment Agreement effective as of January 5, 2000,
between HCC Insurance Holdings, Inc. and Edward H. Ellis,
Jr.
90
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(I)10.15 -- Agreement and Plan of Merger dated as of October 11, 1999
among HCC Insurance Holdings, Inc., Merger Sub of
Delaware, Inc. and The Centris Group, Inc.
12 -- Statement Regarding Computation of Ratios
21 -- Subsidiaries of HCC Insurance Holdings, Inc.
23 -- Consent of Independent
Accountants -- PricewaterhouseCoopers LLP dated March 30,
2001
24 -- Powers of Attorney
- ---------------
(A) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Registration Statement on Form S-8 (Registration No. 333-61687) filed
August 17, 1998.
(B) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Registration Statement on Form S-1 (Registration No. 33-48737) filed
October 27, 1992.
(C) Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-K for the fiscal year ended December 31, 1998.
(D) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-Q for the fiscal quarter ended March 31, 1999.
(E) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Form 8-K filed December 20, 1999.
(F) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Registration Statement on Form S-8 (Registration No. 33-94472) filed July
11, 1995.
(G) Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-K for the fiscal year ended December 31, 1999.
(H) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Form 10-Q for the fiscal quarter ended March 31, 2000.
(I) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s
Schedule 14D-1 Tender Offer Statement in respect to shares of The Centris
Group, Inc. filed October 18, 1999.