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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended March 31, 2004.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 from _______ to __________
Commission file number 001-13790
HCC Insurance Holdings, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 76-0336636
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
13403 Northwest Freeway, Houston, Texas 77040-6094
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(713) 690-7300
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
On April 30, 2004, there were approximately 64.5 million shares of common stock,
$1.00 par value issued and outstanding.
1
HCC INSURANCE HOLDINGS, INC.
INDEX
PAGE NO.
--------
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 31, 2004 and December 31, 2003 ..................................................... 3
Condensed Consolidated Statements of Earnings
For the three months ended March 31, 2004 and 2003 ....................................... 4
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the three months ended March 31, 2004 ................................................ 5
Condensed Consolidated Statements of Cash Flows
For the three months ended March 31, 2004 and 2003 ....................................... 6
Notes to Condensed Consolidated Financial Statements........................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................. 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 27
Item 4. Controls and Procedures........................................................................ 27
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 28
Item 6. Exhibits and Reports on Form 8-K............................................................... 28
Signatures....................................................................................................... 29
This report on Form 10-Q 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. We have based these forward-looking statements on
our current expectations and projections about future events. These
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 strategy,
competitive strengths, goals, growth of our business 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 these 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.
2
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(unaudited, in thousands, except per share data)
March 31, 2004 December 31, 2003
-------------- -----------------
ASSETS
Investments:
Fixed income securities, at market
(cost: 2004 - $1,236,538; 2003 - $1,134,128) $ 1,275,619 $ 1,164,166
Marketable equity securities, at market
(cost: 2004 - $16,369; 2003 - $12,007) 16,382 12,002
Short-term investments, at cost, which approximates market 620,180 518,482
Other investments, at cost, which approximates fair value 17,306 8,696
-------------- -----------------
Total investments 1,929,487 1,703,346
Cash 25,382 96,416
Restricted cash and cash investments 182,009 210,301
Premium, claims and other receivables 1,007,745 899,031
Reinsurance recoverables 967,483 916,190
Ceded unearned premium 302,916 291,591
Ceded life and annuity benefits 76,065 77,548
Deferred policy acquisition costs 122,471 106,943
Goodwill 400,483 386,507
Other assets 176,506 176,423
-------------- -----------------
TOTAL ASSETS $ 5,190,547 $ 4,864,296
============== =================
LIABILITIES
Loss and loss adjustment expense payable $ 1,644,644 $ 1,535,288
Life and annuity policy benefits 76,065 77,548
Reinsurance balances payable 298,786 296,916
Unearned premium 649,060 592,311
Deferred ceding commissions 86,880 88,129
Premium and claims payable 814,663 745,559
Notes payable 310,302 310,404
Accounts payable and accrued liabilities 206,926 171,221
-------------- -----------------
Total liabilities 4,087,326 3,817,376
SHAREHOLDERS' EQUITY
Common stock, $1.00 par value; 250.0 million shares authorized
(shares issued and outstanding: 2004 - 64,437; 2003 - 63,964) 64,437 63,964
Additional paid-in capital 458,753 447,671
Retained earnings 548,892 509,159
Accumulated other comprehensive income 31,139 26,126
-------------- -----------------
Total shareholders' equity 1,103,221 1,046,920
-------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,190,547 $ 4,864,296
============== =================
See Notes to Condensed Consolidated Financial Statements.
3
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(unaudited, in thousands, except per share data)
For the three months ended March 31,
2004 2003
------------------ ------------------
REVENUE
Net earned premium $ 217,063 $ 162,422
Fee and commission income 43,843 25,652
Net investment income 14,435 10,997
Net realized investment gain (loss) 518 (21)
Other operating income 2,159 894
------------------ ------------------
Total revenue 278,018 199,944
EXPENSE
Loss and loss adjustment expense, net 125,864 100,032
Operating expense:
Policy acquisition costs, net 43,219 31,963
Compensation expense 22,813 18,746
Other operating expense 15,379 13,099
------------------ ------------------
Total operating expense 81,411 63,808
Interest expense 2,212 1,682
------------------ ------------------
Total expense 209,487 165,522
------------------ ------------------
Earnings from continuing operations before income tax provision 68,531 34,422
Income tax provision from continuing operations 23,729 12,082
------------------ ------------------
Earnings from continuing operations 44,802 22,340
Earnings (loss) from discontinued operations, net of income
taxes (benefit) of $(146) in 2004 and $740 in 2003 (234) 1,427
------------------ ------------------
Net earnings $ 44,568 $ 23,767
================== ==================
BASIC EARNINGS PER SHARE DATA:
Earnings from continuing operations $ 0.70 $ 0.36
Earnings (loss) from discontinued operations (0.01) 0.02
------------------ ------------------
Net earnings $ 0.69 $ 0.38
================== ==================
Weighted average shares outstanding 64,249 62,637
================== ==================
DILUTED EARNINGS PER SHARE DATA:
Earnings from continuing operations $ 0.68 $ 0.36
Earnings from discontinued operations -- 0.02
------------------ ------------------
Net earnings $ 0.68 $ 0.38
================== ==================
Weighted average shares outstanding 65,416 63,335
================== ==================
Cash dividends declared, per share $ 0.075 $ 0.065
================== ==================
See Notes to Condensed Consolidated Financial Statements.
4
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the three months ended March 31, 2004
(unaudited, in thousands, except per share data)
Accumulated
Additional other Total
Common paid-in Retained comprehensive shareholders'
stock capital earnings income equity
------------- ------------- ------------- -------------- --------------
BALANCE AS OF DECEMBER 31, 2003 $ 63,964 $ 447,671 $ 509,159 $ 26,126 $ 1,046,920
Net earnings -- -- 44,568 -- 44,568
Other comprehensive income -- -- -- 5,013 5,013
--------------
Comprehensive income 49,581
473 shares of common stock issued upon
exercise of options, including tax benefit of
$1,631 473 11,082 -- -- 11,555
Cash dividends declared, $0.075 per share -- -- (4,835) -- (4,835)
------------- ------------- ------------- -------------- --------------
BALANCE AS OF MARCH 31, 2004 $ 64,437 $ 458,753 $ 548,892 $ 31,139 $ 1,103,221
============= ============= ============= ============== ==============
See Notes to Condensed Consolidated Financial Statements.
5
HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands, except per share data)
For the three months ended March 31,
2004 2003
--------- ---------
Cash flows from operating activities:
Net earnings $ 44,568 $ 23,767
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Change in premium, claims and other receivables (102,988) (62,217)
Change in reinsurance recoverables (43,618) (47,032)
Change in ceded unearned premium (8,366) (24,431)
Change in loss and loss adjustment expense payable 93,623 78,921
Change in reinsurance balances payable 37 28,835
Change in unearned premium 27,632 56,224
Change in premium and claims payable, net of restricted cash 97,445 39,880
Depreciation and amortization expense 3,390 2,976
Other, net (10,858) 4,948
--------- ---------
Cash provided by operating activities 100,865 101,871
Cash flows from investing activities:
Sales of fixed income securities 103,092 95,229
Maturity or call of fixed income securities 33,116 27,358
Sales of equity securities 300 983
Change in short-term investments (59,045) (148,199)
Cost of securities acquired (213,354) (164,237)
Payments for purchase of subsidiaries, net of cash received (43,307) --
Other, net 2,266 (1,523)
--------- ---------
Cash used by investing activities (176,932) (190,389)
Cash flows from financing activities:
Issuance of notes payable, net of costs -- 134,845
Sale of common stock 9,924 3,731
Payments on notes payable (91) (67,527)
Dividends paid (4,800) (4,061)
--------- ---------
Cash provided by financing activities 5,033 66,988
--------- ---------
Net change in cash (71,034) (21,530)
Cash at beginning of period 96,416 40,306
--------- ---------
CASH AT END OF PERIOD $ 25,382 $ 18,776
========= =========
See Notes to Condensed Consolidated Financial Statements.
6
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data)
(1) GENERAL INFORMATION
HCC Insurance Holdings, Inc. and its subsidiaries ("we," "us" and "our")
provide specialized property and casualty and accident and health
insurance coverages and related agency services to commercial customers.
Our lines of business include group life, accident and health; diversified
financial products (which includes directors' and officers' liability,
errors and omissions, employment practices liability and surety); our
London market account (which includes energy, marine, property and
accident and health); aviation; and other specialty lines of insurance. We
operate primarily in the United States, the United Kingdom, Spain and
Bermuda, although some of our operations have a broader international
scope. We market our products both directly to customers and through a
network of independent and affiliated agents and brokers.
Basis of Presentation
The unaudited condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in
the United States of America and include all adjustments which are, in our
opinion, necessary for a fair presentation of the results of the interim
periods. All adjustments made to the interim periods are of a normal
recurring nature. The condensed consolidated financial statements include
the accounts of HCC Insurance Holdings, Inc. and those of our wholly-owned
subsidiaries. All significant intercompany balances and transactions have
been eliminated. The condensed consolidated financial statements for
periods reported should be read in conjunction with the annual audited
consolidated financial statements and related notes. The condensed
consolidated balance sheet as of December 31, 2003 was derived from
audited financial statements, but does not include all disclosures
required by accounting principles generally accepted in the United States
of America. Included in 2003 net earnings is a charge of $3.9 million, or
$0.06 per share, due to the cumulative effect on years prior to 2003 of
our 2003 restatement to change our accounting for certain fee and
commission income.
During the third quarter of 2003, we completed one acquisition. The
results of operations of this entity are included in our consolidated
financial statements beginning on the effective date of the transaction.
Thus, our condensed consolidated statements of earnings and cash flows for
the three months ended March 31, 2003 do not contain any activity
generated by this entity.
Income Tax
For the three months ended March 31, 2004 and 2003, the income tax
provision has been calculated based on an estimated effective tax rate for
each of the fiscal years. The difference between our effective tax rate
and the United States federal statutory rate is primarily the result of
state income taxes and tax exempt municipal bond interest.
7
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(1) GENERAL INFORMATION, CONTINUED
Stock Options
We account for stock options granted to employees using the intrinsic
value method of APB Opinion No. 25 entitled "Accounting for Stock Issued
to Employees". All options have been granted at fixed exercise prices at
the market price of our common stock at the grant date. Because of that,
no stock-based employee compensation cost is reflected in our reported net
income. However, the Financial Accounting Standards Board has issued an
exposure draft of a pronouncement that, if adopted in its present form,
will require stock-based employee compensation to be deducted from net
income beginning in 2005. Options vest over a period of up to seven years
and expire four to ten years after grant date. The following table
illustrates the effects on net income and earnings per share if we had
used the fair value method of SFAS No. 123 entitled "Accounting for
Stock-Based Compensation".
For the three months ended March 31,
2004 2003
---------- ----------
Reported net earnings $ 44,568 $ 23,767
Stock-based compensation using the fair value
method, net of income tax (1,220) (1,939)
---------- ----------
Pro forma net earnings $ 43,348 $ 21,828
========== ==========
Reported basic earnings per share $ 0.69 $ 0.38
Fair value stock-based compensation (0.02) (0.03)
---------- ----------
Pro forma basic earnings per share $ 0.67 $ 0.35
========== ==========
Reported diluted earnings per share $ 0.68 $ 0.38
Fair value stock-based compensation (0.02) (0.04)
---------- ----------
Pro forma diluted earnings per share $ 0.66 $ 0.34
========== ==========
Discontinued Operations
In December 2003, we sold the business of our retail brokerage subsidiary
HCC Employee Benefits, Inc. In the fourth quarter of 2003, we began
reporting this business as discontinued operations and prior year
financial information has been reclassified to reflect this presentation.
Summarized financial data for discontinued operations for the three months
ended March 31, 2004 and 2003 is shown below. Earnings before income tax
provision exclude allocated general corporate overhead expenses of $0.4
million for 2003.
For the three months ended March 31,
2004 2003
--------------- ---------------
Revenue $ (197) $ 4,449
Earnings (loss) before income tax provision (380) 2,167
8
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(1) GENERAL INFORMATION, CONTINUED
Reclassifications
Certain amounts in our 2003 condensed consolidated financial statements
have been reclassified to conform to the 2004 presentation. Such
reclassifications had no effect on our net earnings, shareholders' equity
or cash flows.
(2) ACQUISITION
On January 31, 2004, we acquired all of the shares of Surety Associates
Holding Co., Inc., the parent company of American Contractors Indemnity
Company, a California surety company specializing in court, specialty
contract, license and permit bonds. American Contractors Indemnity Company
will further expand our diversified financial products segment. We paid
$46.9 million in cash. This business combination has been recorded using
the purchase method of accounting. The results of operations of American
Contractors Indemnity Company have been included in our consolidated
financial statements beginning on the effective date of the transaction.
We are still in the process of completing the purchase price allocation
for this acquisition, as we are still gathering some of the information,
including information related to litigation contingencies, needed to make
the required calculations. Goodwill resulting from this acquisition will
not be deductible for United States federal income tax purposes.
The following table summarizes the combined estimated fair values of
assets acquired and liabilities assumed at the acquisition date.
January 31, 2004
------------------
Total investments $ 87,719
Premium, claims and other receivables 5,726
Reinsurance recoverables 7,675
Other policy related assets 14,477
Goodwill and intangible assets 12,671
All other assets 6,033
------------------
Total assets acquired 134,301
Loss and loss adjustment expense payable 15,733
Unearned premium 29,117
Other policy related liabilities 1,833
All other liabilities 40,709
------------------
Total liabilities 87,392
------------------
Net assets acquired $ 46,909
==================
9
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(2) ACQUISITION, CONTINUED
The following unaudited pro forma summary presents information as if this
acquisition had occurred at the beginning of 2004 and 2003 after giving
effect to certain adjustments, including amortization of intangible
assets, presumed interest expense from debt issued to fund the acquisition
and income taxes. The pro forma summary is for information purposes only,
does not necessarily reflect the actual results that would have occurred,
nor is it necessarily indicative of future results of the combined
companies.
For the three months ended March 31,
Unaudited Pro forma Information 2004 2003
------------------------------- ------------- -------------
Revenue $282,352 $210,035
Net earnings 44,988 24,893
Basic earnings per share 0.70 0.40
Diluted earnings per share 0.69 0.39
(3) REINSURANCE
In the normal course of business our insurance companies cede a portion of
their premium to non-affiliated domestic and foreign reinsurers through
treaty and facultative reinsurance agreements. Although the ceding of
reinsurance does not discharge the primary insurer from liability to its
policyholder, our insurance companies participate in such agreements for
the purpose of limiting their loss exposure, protecting them against
catastrophic loss and diversifying their business. The following table
represents the effect of such reinsurance transactions on premium and loss
and loss adjustment expense:
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
--------------- --------------- -------------------
For the three months ended March 31, 2004:
Direct business $ 371,961 $ 358,079 $ 211,108
Reinsurance assumed 87,620 74,226 57,989
Reinsurance ceded (223,626) (215,242) (143,233)
--------------- --------------- ---------------
NET AMOUNTS $ 235,955 $ 217,063 $ 125,864
=============== =============== ===============
10
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(3) REINSURANCE, CONTINUED
Loss and Loss
Written Earned Adjustment
Premium Premium Expense
--------- --------- -------------
For the three months ended March 31, 2003:
Direct business $ 296,780 $ 255,871 $ 167,216
Reinsurance assumed 82,668 61,948 51,827
Reinsurance ceded (186,947) (155,397) (119,011)
--------- --------- -------------
NET AMOUNTS $ 192,501 $ 162,422 $ 100,032
========= ========= =============
The table below represents the composition of reinsurance recoverables in our
condensed consolidated balance sheets:
March 31, 2004 December 31, 2003
------------------- -------------------
Reinsurance recoverable on paid losses $ 100,619 $ 101,013
Reinsurance recoverable on outstanding losses 443,069 425,609
Reinsurance recoverable on incurred but not reported losses 439,300 404,479
Reserve for uncollectible reinsurance (15,505) (14,911)
------------------- -------------------
TOTAL REINSURANCE RECOVERABLES $ 967,483 $ 916,190
=================== ===================
Our insurance companies require their reinsurers not authorized by the
respective states of domicile of our insurance companies to collateralize the
reinsurance obligations due to us. The table below shows amounts held by us as
collateral plus other credits available for potential offset.
March 31, 2004 December 31, 2003
------------------ -----------------
Payables to reinsurers $ 433,872 $ 393,214
Letters of credit 208,350 195,329
Cash deposits 28,269 11,195
------------------ -----------------
TOTAL CREDITS $ 670,491 $ 599,738
================== =================
11
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(3) REINSURANCE, CONTINUED
The tables below present the calculation of net reserves, net unearned
premium and net deferred policy acquisition costs:
March 31, 2004 December 31, 2003
-------------------- -------------------
Loss and loss adjustment expense payable $ 1,644,644 $ 1,535,288
Reinsurance recoverable on outstanding losses (443,069) (425,609)
Reinsurance recoverable on incurred but not reported losses (439,300) (404,479)
------------------- -------------------
NET LOSS AND LOSS ADJUSTMENT EXPENSE PAYABLE $ 762,275 $ 705,200
=================== ===================
Unearned premium $ 649,060 $ 592,311
Ceded unearned premium (302,916) (291,591)
------------------- -------------------
NET UNEARNED PREMIUM $ 346,144 $ 300,720
=================== ===================
Deferred policy acquisition costs $ 122,471 $ 106,943
Deferred ceding commissions (86,880) (88,129)
------------------- -------------------
NET DEFERRED POLICY ACQUISITION COSTS $ 35,591 $ 18,814
=================== ===================
We have a reserve of $15.5 million as of March 31, 2004 for potential
collectibility issues and associated expenses related to reinsurance
recoverables. This includes the exposure we have with respect to disputed
amounts. While we believe that the reserve is adequate based on currently
available information, conditions may change or additional information
might be obtained which may result in a future change in the reserve. We
periodically review our financial exposure to the reinsurance market and
the level of our reserve and continue to take actions in an attempt to
mitigate our exposure to possible loss.
Certain reinsurers have delayed or suspended the payment of amounts
recoverable under reinsurance contracts to which we are a party. Such
delays have affected, although 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. We generally
expect to collect the full amounts recoverable and, if necessary, we may
seek collection through judicial or arbitration proceedings.
12
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION
The performance of each segment is evaluated based upon net earnings and
is calculated after tax and after all corporate expense and purchase price
allocations 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 our
offices and does not represent the location of insureds or reinsureds from
whom the business was generated. In December 2003, we sold our retail
brokerage subsidiary that was a significant portion of our intermediary
segment. As a result, operationally we have combined the underwriting
agency and intermediary segments (excluding the former retail brokerage
subsidiary, which is now shown as discontinued operations) to form the
agency segment, and we have reflected this change in our 2003
presentation.
13
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Other
Company Agency Operations Corporate Total
----------------------------------------------------------------------
For the three months ended March 31, 2004
Revenue:
Domestic $ 189,901 $ 18,987 $ 2,154 $ 398 $ 211,440
Foreign 53,796 12,782 -- -- 66,578
Inter-segment -- 21,696 -- -- 21,696
----------------------------------------------------------------------
TOTAL SEGMENT REVENUE $ 243,697 $ 53,465 $ 2,154 $ 398 $ 299,714
======================================================
Inter-segment revenue (21,696)
----------
CONSOLIDATED TOTAL REVENUE $ 278,018
==========
Net earnings:
Domestic $ 24,630 $ 6,896 $ 1,193 $ (731) $ 31,988
Foreign 8,890 5,191 -- -- 14,081
----------------------------------------------------------------------
TOTAL SEGMENT NET EARNINGS (LOSS) $ 33,520 $ 12,087 $ 1,193 $ (731) $ 46,069
======================================================
Inter-segment eliminations (1,267)
Loss from discontinued operations (234)
----------
CONSOLIDATED NET EARNINGS $ 44,568
==========
Other items:
Net investment income $ 13,353 $ 840 $ 89 $ 153 $ 14,435
Depreciation and amortization 811 2,435 126 18 3,390
Interest expense (benefit) 348 2,040 190 (366) 2,212
Capital expenditures 853 131 4 641 1,629
Income tax provision (benefit) 15,722 8,200 418 617 24,957
Inter-segment eliminations (1,228)
----------
CONSOLIDATED INCOME TAX PROVISION FROM CONTINUING OPERATIONS $ 23,729
==========
14
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
Insurance Other
Company Agency Operations Corporate Total
------------------------------------------------------------------------
For the three months ended March 31, 2003:
Revenue:
Domestic $ 137,236 $ 11,040 $ 447 $ 1 $ 148,724
Foreign 44,322 6,898 -- -- 51,220
Inter-segment -- 26,994 -- -- 26,994
------------------------------------------------------------------------
TOTAL SEGMENT REVENUE $ 181,558 $ 44,932 $ 447 $ 1 226,938
=========================================================
Inter-segment revenue (26,994)
---------
CONSOLIDATED TOTAL REVENUE $ 199,944
=========
Net earnings:
Domestic $ 15,973 $ 9,121 $ (590) $ (219) $ 24,285
Foreign 3,387 2,328 -- -- 5,715
------------------------------------------------------------------------
TOTAL SEGMENT NET EARNINGS (LOSS) $ 19,360 $ 11,449 $ (590) $ (219) 30,000
=========================================================
Inter-segment eliminations (7,660)
Earnings from discontinued operations 1,427
---------
CONSOLIDATED NET EARNINGS $ 23,767
=========
Other items:
Net investment income $ 10,030 $ 932 $ 4 $ 31 $ 10,997
Depreciation and amortization (1) 821 1,636 239 239 2,935
Interest expense (benefit) 9 2,450 193 (970) 1,682
Capital expenditures (1) 440 748 -- 265 1,453
Income tax provision (benefit) 8,761 7,274 (282) 758 16,511
Inter-segment eliminations (4,429)
---------
CONSOLIDATED INCOME TAX PROVISION FROM CONTINUING OPERATIONS $ 12,082
=========
(1) Excludes immaterial amounts related to discontinued operations.
15
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED
The following tables present selected revenue items by line of business
for the periods indicated:
For the three months ended March 31,
2004 2003
------------- -------------
Group life, accident and health $ 79,389 $ 71,983
Diversified financial products 56,399 18,306
London market account 26,114 29,376
Aviation 24,269 23,882
Other specialty lines of business 12,571 54
------------- -------------
198,742 143,601
Discontinued lines of business 18,321 18,821
------------- -------------
NET EARNED PREMIUM $ 217,063 $ 162,422
============= =============
Group life, accident and health $ 12,992 $ 15,479
Property and casualty 30,851 10,173
------------- -------------
FEE AND COMMISSION INCOME $ 43,843 $ 25,652
============= =============
16
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(5) EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period 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
period divided into net earnings. Outstanding common stock options, when
dilutive, are considered to be potential common shares for the purpose of
the diluted calculation. The treasury stock method is used to calculate
potential common shares 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.
The following table provides a reconciliation of the denominators used in
the earnings per share calculations:
For the three months ended March 31,
2004 2003
--------------- ---------------
Net earnings $ 44,568 $ 23,767
=============== ===============
Weighted average common shares outstanding 64,249 62,637
Additional dilutive effect of outstanding options
(as determined by the application of the treasury stock method) 1,167 698
--------------- ---------------
Weighted average common shares and potential
common shares outstanding 65,416 63,335
=============== ===============
Anti-dilutive shares not included in computation -- 2,218
=============== ===============
17
HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, in thousands, except per share data, continued)
(6) SUPPLEMENTAL INFORMATION
Supplemental information for the three months ended March 31, 2004 and
2003, is summarized below:
2004 2003
---------------- ----------------
Interest paid $ 3,270 $ 2,431
Income tax paid 31,558 5,931
Comprehensive income 49,581 22,944
Ceding commissions netted with policy acquisition costs 29,892 24,379
(7) COMMITMENTS AND CONTINGENCIES
We are party to lawsuits, arbitrations and other proceedings that arise in
the normal course of our business. Many of such lawsuits, arbitrations 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, arbitrations 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. A
subsidiary has been named along with several other defendants in legal
proceedings by certain of the insurance company members of a discontinued
workers' compensation reinsurance facility commonly known as the Unicover
Pool. During 1997 and 1998, our subsidiary was one of two
co-intermediaries for the facility. Other defendants in the current
proceedings include the other reinsurance intermediary, the former
managing underwriter for the facility and various individuals, none of
whom are affiliated with us. It is claimed in the proceedings that the
actions of the various defendants resulted in the recission of certain
reinsurance contracts in an arbitration to which we were not a party and
include allegations of breach of fiduciary duty, negligence, fraud and
other allegations. The claims in the proceedings are for unspecified or
substantial compensatory and punitive damages. We believe that we have
meritorious defenses to the allegations and intend to vigorously defend
against the claims made in the proceedings. In addition, we are presently
engaged in litigation initiated by the appointed liquidator of a former
reinsurer concerning payments made to us prior to the date of the
appointment of the liquidator. The disputed payments were made by the now
insolvent reinsurer in connection with a commutation agreement. Our
understanding is that such litigation is one of a number of similar
actions brought by the liquidator. We intend to vigorously contest the
action. Although the ultimate outcome of these matters may not be
determined at this time, based upon present information, the availability
of insurance coverage and legal advice received, we do not believe the
resolution of any of these matters, some of which include allegations of
damages in material amounts, will have a material adverse effect on our
financial condition, results of operations or cash flows.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We primarily receive our revenue from earned premium derived from our insurance
company operations, fee and commission income generated by our agency
operations, proceeds from ceded reinsurance (ceding commissions in excess of
acquisition costs) earned by our insurance company subsidiaries, investment
income from all of our operations and other operating income. Our core
underwriting activities involve providing group life, accident and health,
diversified financial products, London market account, aviation and other
specialty lines of business, each of which is marketed by our insurance
companies and our agencies either directly to customers or through a network of
agents, third party administrators and brokers.
The results of operations of Surety Associates Holding Co., Inc. and its
subsidiary American Contractors Indemnity Company, which were acquired in the
first quarter of 2004, and Covenant Underwriters Limited and Continental
Underwriters Limited, which were acquired in the third quarter of 2003, are
included in our condensed consolidated financial statements beginning on the
effective date of their acquisition. Thus, our condensed consolidated statements
of earnings and cash flows for the three months ended March 31, 2003 do not
include the operations of these companies. Amounts related to these acquired
subsidiaries included in our 2004 condensed consolidated statement of earnings
include revenue of $9.6 million and net earnings of $0.9 million.
Results of Operations
The following table sets forth the relationships of certain income statement
items as a percent of total revenue for the three months ended March 31, 2004
and 2003:
2004 2003
----- -----
Net earned premium 78.1% 81.2%
Fee and commission income 15.7 12.8
Net investment income 5.2 5.5
Net realized investment gain 0.2 --
Other operating income 0.8 0.5
----- -----
Total revenue 100.0 100.0
Loss and loss adjustment expense, net 45.3 50.0
Total operating expense 29.3 31.9
Interest expense 0.8 0.9
----- -----
Earnings from continuing operations
before income tax provision 24.6 17.2
Income tax provision 8.5 6.0
----- -----
Earnings from continuing operations 16.1% 11.2%
===== =====
Three months ended March 31, 2004 versus three months ended March 31, 2003
Total revenue increased 39% to $278.0 million for 2004 driven by significant
increases in net earned premium, fee and commission income and investment
income. Most of this growth was organic as only a relatively small amount, $9.6
million, came from subsidiaries acquired in the past year. We expect revenue
growth to continue in 2004 and into 2005.
19
Fee and commission income increased 71% to $43.8 million in 2004 due
principally to organic growth in our agency subsidiaries. Additionally, 2003 fee
and commission income included a charge of $6.5 million due to the cumulative
effect on years prior to 2003 of our 2003 restatement to change our accounting
for certain fee and commission income. The table below shows the composition of
fee and commission income for the three months ended March 31, 2004 and 2003
(amounts in thousands):
2004 2003
------------- --------------
Continuing subsidiaries, excluding 2003 charge $ 42,055 $ 32,180
Subsidiaries acquired during past year 1,788 --
2003 charge -- (6,528)
------------- --------------
Total fee and commission income $ 43,843 $ 25,652
============= ==============
Net investment income increased 31% to $14.4 million in 2004. This increase was
due to higher investment assets, which increased to $1.9 billion as of March 31,
2004 compared to $1.7 billion as of December 31, 2003 and $1.3 billion as of
March 31, 2003, resulting from significant cash flow from operations and the
acquisition of American Contractors Indemnity Company in January 2004. Net
investment income increased despite low yields on our fixed income and
short-term investments. We expect investment assets to continue to increase and
produce additional growth in investment income in 2004. If market interest rates
were to rise, the growth in investment income would be expected to accelerate as
our current portfolio has a relatively short duration and would become available
to be invested on a longer-term basis to take advantage of higher rates. Our
weighted average tax equivalent yield was 3.7% in 2004 and 3.9% in 2003. As of
March 31, 2004, the weighted average duration of our fixed income portfolio was
3.96 years and the weighted average maturity was 4.76 years.
Compensation expense increased as staffing levels have increased from the prior
year. However, the increase in compensation is not as great as the increase in
revenue resulting in higher margins and increased net earnings. Compensation
expense for the three months ended March 31, 2004 and 2003 (amounts in
thousands) and the number of employees as of March 31 of each year are shown
below:
2004 2003
----------- -----------
Continuing subsidiaries $ 20,970 $ 18,746
Subsidiaries acquired during past year 1,843 --
----------- -----------
Total compensation expense $ 22,813 $ 18,746
=========== ===========
2004 2003
----------- -----------
Continuing subsidiaries 1,119 1,052
Subsidiaries acquired during past year 176 --
Subsidiaries sold during past year -- 54
----------- -----------
Total number of employees 1,295 1,106
=========== ===========
Other operating expense increased during 2004 compared to 2003, principally as a
result of acquisitions made in 2004 and 2003.
Interest expense was $2.2 million in 2004 compared to $1.7 million in 2003. The
increase is due to interest on our 1.3% convertible notes, which were issued on
March 31, 2003.
Income tax expense from continuing operations was $23.7 million in 2004 compared
to $12.1 million in 2003. Our effective tax rate was 34.6% in 2004 compared to
35.1% in 2003. We expect an incremental decrease to our income tax rate in 2004
compared to 2003 as a higher percentage of our expected pre-tax income will not
be subject to U.S. state income taxes.
20
Net earnings increased 88% to $44.6 million, or $0.68 per diluted share, in 2004
from $23.8 million, or $0.38 per diluted share, in 2003. Growth in net earned
premium, fee and commission income and investment income and continuing
favorable underwriting results increased 2004 net earnings. Also included in
2003 net earnings is a charge of $3.9 million, or $0.06 per share, due to the
cumulative effect on years prior to 2003 of our 2003 restatement to change our
accounting for certain fee and commission income.
At March 31, 2004, total assets were $5.2 billion, shareholders' equity was $1.1
billion and book value per share was $17.12, up from $16.37 as of December 31,
2003.
21
SEGMENTS
Insurance Companies
The following table sets forth certain premium revenue information for the three
months ended March 31, 2004 and 2003 (amounts in thousands):
2004 2003
-------------- --------------
Direct $ 371,961 $ 296,780
Reinsurance assumed 87,620 82,668
-------------- --------------
Gross written premium 459,581 379,448
Reinsurance ceded (223,626) (186,947)
-------------- --------------
Net written premium 235,955 192,501
Change in unearned premium (18,892) (30,079)
-------------- --------------
Net earned premium $ 217,063 $ 162,422
============== ==============
The following tables provide information by line of business (amounts in
thousands):
Gross Percentage Net Percentage Net Percentage
written change from written change from earned change from
premium prior year premium prior year premium prior year
----------- ----------- ------------ ----------- ------------ -----------
For the three months ended March 31, 2004:
Group life, accident and health $ 146,654 5% $ 77,967 2% $ 79,389 10%
Diversified financial products 170,866 59 71,508 115 56,399 208
London market accounts 56,700 (7) 32,717 (12) 26,114 (11)
Aviation 43,133 (3) 20,950 1 24,269 2
Other specialty lines of business 31,020 nm 18,905 nm 12,571 nm
----------- ----------- ------------ ----------- ------------- -----------
448,373 27 222,047 33 198,742 38
Discontinued lines of business 11,208 nm 13,908 nm 18,321 nm
----------- ----------- ------------ ----------- ------------- -----------
TOTALS $ 459,581 21% $ 235,955 23% $ 217,063 34%
=========== =========== ============ =========== ============= ===========
For the three months ended March 31, 2003:
Group life, accident and health $ 139,320 $ 76,185 $ 71,983
Diversified financial products 107,320 33,307 18,306
London market accounts 60,718 37,232 29,376
Aviation 44,531 20,679 23,882
Other specialty lines of business 1,464 39 54
----------- ------------ -------------
353,353 167,442 143,601
Discontinued lines of business 26,095 25,059 18,821
----------- ------------ -------------
TOTALS $ 379,448 $ 192,501 $ 162,422
=========== ============ =============
nm - Not meaningful.
22
Gross written premium increased 21% to $459.6 million in the first quarter of
2004. Net written premium increased 23% to $236.0 million and net earned premium
increased 34% to $217.1 million, both due principally to the growth in gross
written premium and increased retentions in some areas. The increase in premium
is expected to continue throughout 2004 and into 2005. The growth in gross
written premium results principally from the following factors:
- The largest growth was in our diversified financial products line of
business. Within this line of business, directors' and officers'
liability and professional indemnity insurance written in the United
States and internationally continued to show accelerated growth due
to higher premium rates, increased new business and higher renewal
percentages. Surety business increased due to our acquisition of
American Contractors Indemnity Company on January 31, 2004.
- Our other specialty lines of business also increased significantly
due to new business activities commenced during the past year. These
activities include underwriting of marine insurance on the Gulf
Coast of the United States, our quota-share reinsurance
participation in a book of surplus lines insurance and our
participation in a Lloyds syndicate writing UK liability insurance.
- Our London market account experienced somewhat reduced premium
writings due to more selective underwriting of property business,
particularly risks located in the United States, as premium rates
softened.
- We recently determined to cease writing certain accident and health
reinsurance business previously included in our other specialty
lines of business. Amounts related to this business, which are now
included in our discontinued lines of business, are gross written
premium of $11.5 million in 2004 and $19.4 million in 2003; net
written premium of $12.0 million in 2004 and $17.4 million in 2003;
and net earned premium of $15.3 million in 2004 and $9.5 million in
2003. This business is expected to run off profitably.
The table below shows the composition of net incurred loss and loss adjustment
expense for the three months ended March 31, 2004 and 2003 (amounts in
thousands):
2004 2003
------------------------------ -------------------------
Amount Loss Ratio Amount Loss Ratio
------------- -------------- ------------- ----------
Deficiency $ 2,153 1.0% $ 1,295 0.8%
All other incurred loss and
loss adjustment expense 123,711 57.0 98,737 60.8
------------- -------------- ------------- ------
Net incurred loss and loss
adjustment expense $ 125,864 58.0% $ 100,032 61.6%
============= ============== ============= ======
Our net loss and loss expense deficiency was $2.2 million for 2004 compared to a
deficiency of $1.3 million in 2003. We continue to benefit from disciplined
underwriting in a hard insurance market. We have no material exposure to
environmental or asbestos losses and believe we have provided for all material
net incurred losses. Our gross loss ratio was 62.2% for 2004 compared to 68.9%
for 2003. During the first quarter of 2003, we increased gross losses by $15.0
million on certain accident and health business included in the discontinued
line of business. This had the effect of increasing our gross loss ratio by
4.7%. Since these contracts were substantially reinsured, the effect on our net
losses was not material.
23
The following table provides comparative net loss ratios by line of business
for the three months ended March 31, 2004 and 2003 (amounts in thousands):
2004 2003
--------------- -------------------
Net Net Net Net
earned loss earned loss
premium ratio premium ratio
-------- ----- -------- -----
Group life, accident and health $ 79,389 62.9% $ 71,983 63.6%
Diversified financial products 56,399 46.3 18,306 43.7
London market accounts 26,114 29.6 29,376 42.2
Aviation 24,269 62.5 23,882 65.5
Other specialty lines of business 12,571 61.2 54 44.4
-------- ----- -------- -----
198,742 53.6 143,601 57.0
Discontinued lines of business 18,321 105.2 18,821 96.8
-------- ----- --------- -----
TOTALS $217,063 58.0% $162,422 61.6%
======== ========
Expense ratio 25.3 27.2
----- -----
Combined ratio 83.3% 88.8%
===== =====
Comments on significant changes in the comparative net loss ratios by line of
business are attributed to the following:
- London market accounts -- Underwriting results generally improved in
this line of business. Both quarters have been affected by reserve
redundancies following our ongoing review of outstanding claims.
- Other specialty lines -- The current loss activity reflected is as
expected and is due to new business activities commenced during the
past year.
- Discontinued lines of business -- Both years have been affected by
reserve additions resulting from our ongoing review of outstanding
claims. Additionally, given the limited amount of earned premium on
this line of business, a minor adjustment to the reserves can
significantly impact the loss ratio.
Policy acquisition costs, which are net of the related portion of commissions on
reinsurance ceded, increased to $43.2 million during the first quarter of 2004,
from $32.0 million in the same period in 2003. This increase is due to and
proportional to the increase in net earned premium. Although operating expenses
increased as our revenues expanded, they increased in a smaller percentage than
revenues and thus our expense ratio declined from 27.2% in 2003 to 25.3% in
2004.
Net earnings of our insurance companies increased 73% to $33.5 million in 2004
due to increased premium volume, continuing profitable underwriting results, a
lower expense ratio and increased investment income. We expect this growth to
continue through 2005. Our increasingly profitable underwriting results are
reflected in a 2004 combined ratio of 83.3% compared to 88.8% in 2003.
Agency
Revenue from our agency segment increased 19% to $53.5 million in 2004. This
results primarily from higher premium rates, increased new business and higher
renewal percentages. Subsidiaries acquired during 2003 accounted for $2.5
million of the increased revenue. Net earnings of our agency segment increased
6% to $12.1 million in 2004 for the same reasons. Higher corporate cost
allocations in 2004 caused the increase in segment net earnings to be less than
the comparable increase in segment revenue. We expect continued improvement in
this segment during the remainder of 2004.
24
Other Operations
The increase in the revenue in this segment in 2004 is primarily due to income
from strategic investments and securities trading activities. Quarter to quarter
comparisons may vary substantially depending on other operating investments or
dispositions of such investments in any given period.
Liquidity and Capital Resources
We receive substantial cash from premiums, reinsurance recoverables, 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, purchases of investments, debt service, 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 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 $155.1 million, or 9%, during the first quarter
of 2004 and totaled $2.0 billion as of March 31, 2004, of which $645.6 million
was cash and short-term investments. The increase resulted primarily from
operating cash flows and the acquisition of American Contractors Indemnity
Company. During the first quarter of 2004, due primarily to changes in market
interest rates, the net after tax unrealized gain on our investments recorded in
other comprehensive income increased $7.9 million. However, during the month of
April we estimate that our net after tax unrealized gain decreased approximately
$14.8 million, again primarily due to changes in market interest rates.
We have filed registration statements with the United States Securities and
Exchange Commission, which provide shelf registrations for an aggregate of
$750.0 million of our securities, of which we have $625.0 million available to
be issued. These securities may be debt securities, equity securities or a
combination thereof.
Notes payable as of March 31, 2004 and December 31, 2003 are shown in the table
below (amounts in thousands):
2004 2003
--------------- ---------------
1.3% Convertible notes $ 125,000 $ 125,000
2% Convertible notes 172,451 172,451
Other debt 12,851 12,953
--------------- ---------------
Total notes payable $ 310,302 $ 310,404
=============== ===============
Debt to total capital 22.0% 22.9%
=============== ===============
Our $200.0 million Revolving Loan Facility, which had no outstanding borrowings
as of March 31, 2004, expires on December 17, 2004. We expect to replace the
facility with another facility.
25
Holders of our 2% Convertible Notes due in 2021 may require us to repurchase the
notes at par on September 1, 2004. Because the recent market price of these
notes ($114.25 as of March 31, 2004) is significantly in excess of the par
value, we do not expect that a significant portion of the notes will be tendered
for repurchase. In the event that any such notes are tendered for repurchase we
would expect to use funds from our revolving loan facility to repurchase the
notes for cash.
The following table shows the composition of our gross, ceded and net reserves
at the respective balance sheet dates (amounts in thousands):
Gross Ceded Net
-------------- -------------- -------------
As of March 31, 2004:
Reported losses $ 864,182 $ 443,069 $ 421,113
Incurred but not reported loss 780,462 439,300 341,162
-------------- -------------- -------------
Total loss and loss adjustment expense payable $ 1,644,644 $ 882,369 $ 762,275
============== ============== ==============
As of December 31, 2003:
Reported losses $ 791,322 $ 425,609 $ 365,713
Incurred but not reported loss 743,966 404,479 339,487
-------------- -------------- -------------
Total loss and loss adjustment expense payable $ 1,535,288 $ 830,088 $ 705,200
============== ============== ==============
Reserves and recoverables continue to grow primarily due to our large account
directors' and officers' liability business. These claims have a longer duration
and tend to be more highly reinsured than our other lines of business due to
their potential volatility.
We have a reserve of $15.5 million as of March 31, 2004 for potential
collectibility issues and associated expenses related to reinsurance
recoverables. This includes the exposure we have with respect to disputed
amounts. While we believe that the reserve is adequate based on currently
available information, conditions may change or additional information might be
obtained which may result in a future change in the reserve. We periodically
review our financial exposure to the reinsurance market and the level of our
reserve and continue to take actions in an attempt to mitigate our exposure to
possible loss.
Certain reinsurers have delayed or suspended the payment of amounts recoverable
under reinsurance contracts to which we are a party. Such delays have affected,
although 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. We generally expect to collect the full amounts
recoverable and, if necessary, we may seek collection through judicial or
arbitration proceedings.
We believe that our operating cash flows, short-term investments, bank facility
and shelf registrations on file with the United States Securities and Exchange
Commission will provide sufficient sources of liquidity to meet our operating
needs for the foreseeable future.
Critical Accounting Policies
We have made no changes in our methods of application of our critical accounting
policies from the information provided in our Annual Report on Form 10-K for the
year ended December 31, 2003.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risk from the information provided
in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" in our
Annual Report on Form 10-K for the year ended December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of disclosure controls and procedures.
The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, or the Exchange Act. This term
refers to the controls and procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified by the Securities and Exchange
Commission. Our management, including our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this quarterly report.
Based upon the evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this quarterly report.
b. Changes in internal controls.
There were no changes to our internal control over financial reporting during
our last fiscal quarter that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are party to lawsuits, arbitrations and other proceedings that
arise in the normal course of our business. Many of such lawsuits,
arbitrations 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,
arbitrations 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. A
subsidiary has been named along with several other defendants in
legal proceedings by certain of the insurance company members of a
discontinued workers' compensation reinsurance facility commonly
known as the Unicover Pool. During 1997 and 1998, our subsidiary was
one of two co-intermediaries for the facility. Other defendants in
the current proceedings include the other reinsurance intermediary,
the former managing underwriter for the facility and various
individuals, none of whom are affiliated with us. It is claimed in
the proceedings that the actions of the various defendants resulted
in the recission of certain reinsurance contracts in an arbitration
to which we were not a party and include allegations of breach of
fiduciary duty, negligence, fraud and other allegations. The claims
in the proceedings are for unspecified or substantial compensatory
and punitive damages. We believe that we have meritorious defenses
to the allegations and intend to vigorously defend against the
claims made in the proceedings. In addition, we are presently
engaged in litigation initiated by the appointed liquidator of a
former reinsurer concerning payments made to us prior to the date of
the appointment of the liquidator. The disputed payments were made
by the now insolvent reinsurer in connection with a commutation
agreement. Our understanding is that such litigation is one of a
number of similar actions brought by the liquidator. We intend to
vigorously contest the action. Although the ultimate outcome of
these matters may not be determined at this time, based upon present
information, the availability of insurance coverage and legal advice
received, we do not believe the resolution of any of these matters,
some of which include allegations of damages in material amounts,
will have a material adverse effect on our financial condition,
results of operations or cash flows.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification by Chief Executive Officer.
31.2 Certification by Chief Financial Officer.
32.1 Certification with respect to quarterly report.
(b) Reports on Form 8-K
On February 19, 2004, we furnished on Form 8-K our
announcement of financial results for the fourth quarter and
full year of 2003.
On February 23, 2004, we furnished on Form 8-K the text
material used for presentations at various investor
conferences.
On March 1, 2004, we furnished on Form 8-K the text materials
used for presentations at various investor conferences.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HCC Insurance Holdings, Inc.
--------------------------------------------------
(Registrant)
May 6, 2004 /s/ Stephen L. Way
- ------------------- --------------------------------------------------
(Date) Stephen L. Way, Chairman of the Board,
Chief Executive Officer and President
May 6, 2004 /s/ Edward H. Ellis, Jr.
- ------------------- --------------------------------------------------
(Date) Edward H. Ellis, Jr., Executive Vice President
and Chief Financial Officer
29
INDEX TO EXHIBITS
Exhibits
31.1 Certification by Chief Executive Officer.
31.2 Certification by Chief Financial Officer.
32.1 Certification with respect to quarterly report.